00:00:00
Welcome to personal finance for
00:00:02
long-term investors, where we believe
00:00:04
Benjamin Franklin's advice that an
00:00:06
investment in knowledge pays the best
00:00:08
interest both in finances and in your
00:00:10
life. Every episode teaches you personal
00:00:13
finance and long-term investing in
00:00:15
simple terms. Now, here's your host,
00:00:18
Jesse Kramer. Hello and welcome to
00:00:20
Personal Finance for Long-Term
00:00:21
Investors, episode 132. My name is Jesse
00:00:23
Kramer. By day, I work at a fiduciary
00:00:25
wealth management firm helping clients
00:00:27
nationwide. You can learn more at
00:00:28
bestinterest.blog. blog/work. [music]
00:00:31
The link is in the show notes. By night,
00:00:32
I write the best interest blog and I
00:00:34
host this podcast. I also put out a
00:00:35
weekly [music] email newsletter. And all
00:00:37
those projects help busy professionals
00:00:39
and retirees avoid mistakes and grow
00:00:41
wealth by simplifying their investing,
00:00:43
their taxes, and their retirement
00:00:44
planning. Today is our 14th Ask Me
00:00:47
Anything episode, and this is going to
00:00:48
be a fun one. As some of you know, I
00:00:50
keep a a running list of possible AMA
00:00:52
questions. The list is now long enough
00:00:54
that for the most part, I'm going to try
00:00:55
to weave some sort of underlying theme
00:00:57
into each AMA episode. And today, this
00:01:00
AMA episode is going to focus on
00:01:02
controversial and misunderstood topics
00:01:04
from the world of financial planning and
00:01:05
investing. Some questions came from blog
00:01:08
readers and podcast listeners just like
00:01:09
you, who submitted them to my email,
00:01:11
jesse at bestinterest.blog. Other
00:01:13
questions came from a LinkedIn post I
00:01:15
made where I kind of uh previewed that
00:01:17
I'd be recording this episode and a
00:01:18
bunch of people chimed in with their
00:01:20
ideas. But we'll cover topics today like
00:01:22
dividend investing, individual bonds
00:01:24
versus bond funds, tax planning versus
00:01:26
tax avoidance, kind of the gray area
00:01:29
there, buying the dip as it's called as
00:01:31
an investment strategy, and a few more.
00:01:33
But first, before we get into the fun
00:01:34
stuff, we'll do a quick review of the
00:01:36
week. This one is from Carowind 21, who
00:01:38
says, "A numbers-based approach, five
00:01:41
stars. I love how Jesse goes beyond the
00:01:43
basics and actually crunches the
00:01:44
numbers. A great listen for DIYers and
00:01:47
those who are data driven." Well,
00:01:48
Carowwin, thank you very much for the
00:01:50
five-star review and the kind words. You
00:01:51
can shoot me an email to
00:01:52
00:01:54
and I'll get you hooked up with a
00:01:55
supersoft podcast t-shirt. The first
00:01:57
question today comes from Goran. And
00:02:00
Goran says, Jesse, in episode 127, you
00:02:03
explained the 4% rule and how dividends
00:02:05
are part of it. But I got puzzled when
00:02:07
you said that dividends are not free.
00:02:09
What do you mean by that? I've heard
00:02:11
that when a company pays out a dividend
00:02:12
on that day, allegedly the stock price
00:02:14
drops by the dividend percentage. But
00:02:17
why? For example, if Apple makes uh $1
00:02:19
billion in a quarter, pays out $100
00:02:21
million in dividends, and stashes 900
00:02:24
million under a mattress, shouldn't that
00:02:26
trigger the price to go up as the
00:02:28
investors would reinvest dividends and
00:02:29
create a demand for a stock? Not that
00:02:31
any of it matters as much as what Tim
00:02:33
Cook will say during the investors
00:02:34
conference. Maybe you can provide some
00:02:36
insights on one of your future episodes.
00:02:38
Well, Goran, yeah, great question. And
00:02:40
here we go. First, I'm going to explain
00:02:41
kind of the myth around the way
00:02:43
dividends work and and dividend
00:02:45
investing as a practice and then I'll
00:02:47
explain the truth once I explain the
00:02:48
myth. So, let's say you own a share of
00:02:50
Apple. Very good. It's currently trading
00:02:52
at about $250 per share and it has a
00:02:54
dividend yield of about.42%.
00:02:57
And if you do some quick math,42% of
00:03:00
$250 is just about precisely $1. So,
00:03:04
every year you could expect that Apple
00:03:06
will pay you about a dollar for being an
00:03:08
owner. That's your dividend. and you
00:03:10
still own the stock on top of receiving
00:03:12
that $1 dividend. And next year you'll
00:03:14
get another dollar, maybe even a little
00:03:15
more. And the year after that, another
00:03:17
dollar, maybe even a little more. So you
00:03:19
still own the stock and you're getting
00:03:20
this income stream in the form of
00:03:22
dividends. And that dividend income
00:03:24
stream is one of the main ways that
00:03:26
stock owners receive their return on
00:03:28
investment. Dividends are a wonderful
00:03:30
thing. But here's the question at the
00:03:32
heart of this myth. If instead of giving
00:03:34
you that dollar in the form of a
00:03:36
dividend, if Apple decided to hang on to
00:03:38
that dollar instead, what would happen
00:03:40
to Apple's stock price? Now, it might be
00:03:42
a challenging question to conceptualize
00:03:44
because Apple is such a huge company and
00:03:46
it's so complex. So, let's do what every
00:03:48
finance and economics lesson does
00:03:50
starting in elementary school. Let's
00:03:52
examine a lemonade stand. You know, you
00:03:54
help your daughter open a lemonade stand
00:03:55
and you're trying to understand how much
00:03:57
her business is worth. She's got a
00:03:59
table. She's got a picture of lemonade.
00:04:01
She's got some signs. She's built this
00:04:03
positive reputation in the neighborhood
00:04:05
and that's worth something too. She's
00:04:07
making sales every day and all those
00:04:09
future sales are worth something too to
00:04:11
the business. But then let's imagine she
00:04:13
tells you, "Hey dad, I also have $10,000
00:04:16
sitting in cash here in my cash register
00:04:18
from all the sales I've made." Well,
00:04:20
that money is certainly going to go onto
00:04:22
her business balance sheet, and it's
00:04:24
definitely worth something. And I hope
00:04:25
you all agree with me that we must
00:04:27
somehow account for the $10,000 sitting
00:04:29
in her cash register if we're taking an
00:04:31
accurate snapshot of the business value.
00:04:34
In fact, that's probably the easiest
00:04:35
part of her business to value,
00:04:37
right?$10,000 in cash is worth $10,000
00:04:40
to the business. But what if she said,
00:04:42
you know, hey, Dad, rather than keeping
00:04:44
this $10,000 in the cash register, I'm
00:04:46
going to distribute these profits out to
00:04:47
the owners. And that's you, my dad, and
00:04:50
that's me, your daughter. So, so me and
00:04:52
you, dad and daughter, are now going to
00:04:54
receive the $10,000 into our personal
00:04:57
accounts, and the the business cash
00:04:59
register no longer has the $10,000
00:05:01
inside of it anymore. Well, listeners,
00:05:04
that is essentially a dividend
00:05:05
distribution. The owners of the business
00:05:07
just received profits in the form of
00:05:09
money in their pocket. But is the
00:05:11
business worth as much after the
00:05:13
distribution as it was before? Well, the
00:05:16
the booth is the same, the table is the
00:05:18
same, the pitcher and the signs and the
00:05:20
reputation and the future sales, they
00:05:22
are all the same for this lemonade
00:05:24
stand, but the cash register that once
00:05:26
held $10,000 now holds nothing. So,
00:05:29
pretty clearly the business is identical
00:05:32
minus $10,000 in value. That dividend
00:05:34
payment that your daughter made was not
00:05:36
free for the business. This is such a a
00:05:39
simple idea really. The owners received
00:05:41
$10,000 because the business lost
00:05:44
$10,000. It wasn't free. It wasn't magic
00:05:46
money. It wasn't something for nothing.
00:05:49
And there are some investors out there
00:05:51
who don't quite grasp that. Now, now
00:05:53
why? I would say because in their mind,
00:05:55
they they do still own the booth. They
00:05:57
own the picture. They own the signs.
00:05:58
They own the reputation, all the future
00:06:00
sales. They still own those things
00:06:02
exactly like they owned them before.
00:06:03
That's absolutely true. But the company
00:06:06
valuation, including the stock price
00:06:08
itself, absolutely incorporated the
00:06:10
company's cash on hand. In corporate
00:06:13
finance lingo, they might call it CCE,
00:06:15
cash and cash equivalents. That is
00:06:18
usually its own line item on a on a
00:06:20
corporate balance sheet. And if you look
00:06:21
at the CCE before and after a dividend
00:06:25
payment is made, you will see the CCE
00:06:27
drop by exactly the amount of that
00:06:29
dividend payment. It's simple
00:06:31
subtraction. There's nothing magical
00:06:33
going on here. And if you are rationally
00:06:35
evaluating that business, you will take
00:06:37
that reduction in in cash and cash
00:06:39
equivalents into account. But back to
00:06:42
Goran's example, he said, "If Apple
00:06:44
makes a billion dollars, puts $900
00:06:46
million under a mattress into its cash
00:06:48
and cash equivalents, then pays out
00:06:50
hund00 million in dividends." Goran was
00:06:52
asking, "Shouldn't the stock price go up
00:06:55
because, well, in Goran's mind, and he's
00:06:57
and he's right to some extent, right?
00:06:58
They now have more in CCE than before.
00:07:00
They have more in cash than before
00:07:02
because they took $900 million and and
00:07:04
stuck it under the mattress. But we need
00:07:06
to ask, where did the billion dollars in
00:07:09
revenue come from?" And I would argue
00:07:11
that the $1 billion arrived because uh
00:07:13
future revenue or what was previously
00:07:16
called future revenue was realized and
00:07:18
became current revenue. And from an
00:07:20
analysis perspective, that money didn't
00:07:22
appear out of nowhere. Investors already
00:07:25
had that future revenue incorporated
00:07:27
into the stock price. Like Warren
00:07:29
Buffett would say, he he would say, you
00:07:30
need to discount all future revenue that
00:07:32
a company might make. So that $1
00:07:34
billion, Goran, it was already
00:07:36
incorporated into the stock price. And
00:07:37
all that happened was the the $1 billion
00:07:40
moved from it'll be here next quarter.
00:07:42
So maybe it's worth a tiny bit less
00:07:43
than1 billion because we need to
00:07:45
discount it. So it moves from that state
00:07:47
into a column that now says okay the $1
00:07:50
billion is literally in our hands and
00:07:52
now it's worth a full $1 billion. And
00:07:54
that's simply how it works. So I hope
00:07:57
that to some extent explains why
00:07:59
dividends aren't free, right? It's it's
00:08:02
money moving from the cash register of
00:08:03
the business into the pockets of the
00:08:05
owners. But therefore, it's value that's
00:08:08
disappearing from the balance sheet of
00:08:09
the business. And therefore, the value
00:08:11
of the business has to drop when a
00:08:12
dividend payment is paid out. And then
00:08:15
even if a company puts more money into
00:08:17
cash after a good quarter, the question
00:08:20
really is, well, was that good quarter
00:08:22
already part of the of the stock
00:08:24
valuation, right? Did the company
00:08:26
predict it was going to have that good
00:08:27
quarter? all the investors took that
00:08:29
into account and then that's what ended
00:08:30
up happening. That's what drives a stock
00:08:33
price. Now, if the good quarter happened
00:08:35
and nobody was expecting it, that's the
00:08:37
kind of thing that could cause a stock
00:08:39
price to actually go up. It's when those
00:08:41
future expectations of a company are
00:08:43
actually incorrect. And if they're
00:08:45
incorrect to the upside, you're probably
00:08:46
going to see a stock price that goes up.
00:08:48
But anyway, excellent question, Goran. I
00:08:50
hope I answered it sufficiently. Okay,
00:08:52
the next question is going to be about
00:08:54
individual bonds versus bond funds.
00:08:56
Recently, a reader, John, wrote in and
00:08:58
said, "Jesse, I'm not sure why people
00:08:59
would buy traditional bonds if you can
00:09:01
get a similar yield in an ETF, which is
00:09:04
more liquid." But then again, lots of
00:09:06
readers, lots of listeners will write in
00:09:07
and say something like, "Well, Jesse, my
00:09:09
bond funds, they took a beating in 2022,
00:09:12
and some of them are still lower in
00:09:14
value now than they were 3 or 4 years
00:09:16
ago. Yet, individual government bonds,
00:09:19
they will always return to par. I'm
00:09:21
always going to get my full money back
00:09:22
out of a government bond." So, why would
00:09:25
you ever want to own a bond fund that
00:09:27
can lose value and stay down when
00:09:29
instead you can own a government bond
00:09:30
that's always going to get back to its
00:09:32
par value? So, it's an excellent
00:09:34
question. I will link an article if
00:09:35
you'd prefer to read through this and
00:09:36
take your time, an article I just wrote.
00:09:38
But anyway, this is a nuance topic, but
00:09:40
since most retirees either own bonds
00:09:42
right now or future retirees will own
00:09:45
some bonds during their retirement, it's
00:09:46
definitely a topic worth delving into.
00:09:48
And when we peel back the onion over the
00:09:50
next few minutes, I hope you realize
00:09:51
that this question is equivalent to, or
00:09:53
at least I would say it's equivalent to,
00:09:55
would you rather buy your eggs one at a
00:09:56
time or would you rather buy them by the
00:09:58
dozen? It doesn't change the egg. It
00:10:00
doesn't change the meals you could make
00:10:02
with the egg. It doesn't change the
00:10:04
space in your fridge. They are the same
00:10:06
eggs. And so really, that's the question
00:10:08
that we want to ask today. Think of it
00:10:10
that way. And now we'll dive into the
00:10:12
details about whether retirees should
00:10:13
own individual bonds instead of bond
00:10:15
funds or vice versa. The root of the
00:10:17
issue is that individual bonds mature,
00:10:19
eventually an individual bond will
00:10:21
return its face value back to its owners
00:10:23
plus interest along the way. And if
00:10:26
interest rates go up and bond prices
00:10:28
fall, the owners of those individual
00:10:30
bonds, they tend to think, well, that's
00:10:32
okay. My my bond price maybe it fell
00:10:34
according to Bloomberg, but I'm just
00:10:36
going to hold my bond to maturity and
00:10:38
get the full value back. So the bond
00:10:41
owners, they feel like they can ignore
00:10:43
the current price. And I would argue
00:10:45
that's borderline imaginary. They are
00:10:47
choosing to ignore the current price
00:10:49
because they know someday way out in the
00:10:51
future, maybe in a few months, most
00:10:52
likely in a few years, they can get
00:10:54
their full value back. But bond funds,
00:10:56
bond funds don't mature. They only
00:10:59
return interest. To get your capital
00:11:01
back out of a bond fund, you would need
00:11:02
to sell shares of that fund, possibly at
00:11:05
a loss. The same interest rate hike that
00:11:07
the individual bond owners ignored. It
00:11:10
feels much harder to ignore when it's a
00:11:12
bond fund. Okay. Okay, well let's pause.
00:11:14
What is a bond fund? What does a bond
00:11:16
fund hold? Isn't it nothing more than
00:11:19
the sum of many individual bonds? And if
00:11:22
people have convinced themselves to
00:11:23
ignore the price changes in individual
00:11:25
bonds, why can't we do the same thing
00:11:28
with a bond fund? Well, I think there's
00:11:30
one vital difference between individual
00:11:32
bonds and bond funds. And as far as I'm
00:11:34
concerned, this is the only difference
00:11:36
that actually matters in this
00:11:37
conversation, right? This is the only
00:11:39
difference that holds any water in this
00:11:41
conversation. And the difference is that
00:11:43
bond funds and those who run them, they
00:11:46
tend to reset the funds duration
00:11:49
regularly. Most individual investors on
00:11:51
the other hand will only do so
00:11:53
sporadically. Okay, now that is a very
00:11:56
jargony statement I just made. But what
00:11:59
exactly does it mean? Let's take for
00:12:01
example BSV, the Vanguard short-term
00:12:04
bond ETF. It holds a bunch of 1 to5year
00:12:08
US Treasury bonds and currently it has
00:12:10
an average duration of 2.6 years.
00:12:13
Duration, as a reminder, is a measure of
00:12:15
interest rate sensitivity. The higher
00:12:17
the duration, the more sensitive an
00:12:20
asset like a bond is to an interest rate
00:12:23
change. Every day the the individual
00:12:25
bonds inside of BSV because again BSV is
00:12:28
a fund has a bunch of individual bonds
00:12:30
in it. So every day the individual bonds
00:12:32
get one day closer to maturity. Every
00:12:35
day the overall duration of BSD ticks
00:12:37
downward. Everything's getting one day
00:12:39
closer to maturity. And if the managers
00:12:41
over at Vanguard, right, if those fund
00:12:43
managers stood by and did nothing, the
00:12:45
fund would eventually completely mature
00:12:47
and return all of its capital to its
00:12:49
owners. But BSV has a job. And that job
00:12:52
is not to reach maturity. Its job is to
00:12:55
maintain a duration in that mid 2.x
00:12:58
range. That's the purpose of this
00:13:00
specific tool. And there are a bunch of
00:13:02
investors out there who depend on it.
00:13:04
who depend on BSV to maintain that
00:13:06
predefined purpose. The reason why they
00:13:08
hold BSV in their portfolio is because
00:13:11
they want something with that duration
00:13:12
of 2.x years. So to accomplish this, the
00:13:15
fund managers over at Vanguard, they are
00:13:18
going to regularly trim a little here,
00:13:19
trim a little there, reinvest some of
00:13:21
the fund income into probably longer
00:13:23
duration bonds to offset the remaining
00:13:26
bonds as they shimmy their way toward
00:13:28
maturity. That's how bond funds like BSV
00:13:31
work. They are on a very regular basis
00:13:34
resetting their durations. But now let's
00:13:36
compare that to Joe Retiree. You know
00:13:39
the DIYer out there maybe like some of
00:13:41
you Mr. DIY bond ladder. Joe might have
00:13:44
$50,000 in each of one and two and three
00:13:47
and four and 5year Treasury bonds.
00:13:49
That's his bond ladder. And every day
00:13:52
Joe's bond ladder gets one day closer to
00:13:54
maturity. Every day the overall duration
00:13:56
of Joe's bond exposure ticks downward.
00:13:59
But unlike the fund managers at BSV, Joe
00:14:02
really doesn't care about that. In fact,
00:14:04
it's actually probably what Joe had in
00:14:05
mind in the first place. To him, it is a
00:14:07
feature. It's certainly not a bug. Joe
00:14:10
wants his one-year treasury to mature
00:14:12
soon. He wants that capital to fund his
00:14:14
retirement. Then, he's going to
00:14:15
rebalance his portfolio to free up
00:14:17
50,000 new dollars, and he's going to
00:14:19
buy a new shiny 5-year bond with that.
00:14:21
And that's the lading that he has in
00:14:23
mind. That's how a bond ladder works.
00:14:25
But now let's pause because did you kind
00:14:27
of catch what just happened there? Joe
00:14:30
retiree is doing exactly what the BSV
00:14:33
fund manager is doing. He's resetting
00:14:35
his duration, but Joe is only doing it
00:14:37
once a year. He's taking the new $50,000
00:14:42
essentially that just matured from his
00:14:43
one-year bond and he's circling back
00:14:46
around and buying a 5-year bond with it,
00:14:48
getting his ladder to exactly where it
00:14:51
was before. Um, duration wise, the BSV
00:14:54
manager is probably doing it like once a
00:14:55
week, but Joe, Mr. DIY ladder, he's
00:14:58
doing it once a year. That's the only
00:15:00
difference is how frequently they're
00:15:02
resetting their duration. Other than
00:15:04
that, bond funds and individual bond
00:15:06
ladders are essentially the same. Okay,
00:15:09
real quick aside, and then we'll get
00:15:10
back to the main show here. Would you
00:15:12
rather purchase a 10-year bond that
00:15:14
costs $1,000 and is yielding 2%. Or a
00:15:18
10-year bond that costs $900 and is
00:15:21
yielding 3%. I know it would probably
00:15:23
help if you could write this down and do
00:15:24
the math, but it is a trick question.
00:15:26
They lead to the same result because 10
00:15:28
years from now, in both cases, you would
00:15:30
have $1,200 in hand from either bond.
00:15:33
And yes, that the specific cash flows
00:15:35
might be different. And if we apply a
00:15:36
discount rate, the end result might be
00:15:38
slightly different. But please, you
00:15:40
know, accept this example for what it
00:15:41
is. My point here is that price and
00:15:44
interest rate are these counterveiling
00:15:46
forces. The the price of your bonds
00:15:48
might be down, but that's because the
00:15:50
yield has increased in an equal but
00:15:52
opposite way. And if the price of your
00:15:54
bonds rises, that's because the the
00:15:56
yield of those bonds has decreased. And
00:15:58
that's just cold mechanical math. Bond
00:16:00
math is very cold mechanical math. And
00:16:03
the reason why I'm saying all this is
00:16:05
because I know some of you might be
00:16:06
saying, Jesse, everything you've said
00:16:08
makes sense to me, but my bond funds,
00:16:11
their prices are still down from 2022.
00:16:13
And that's totally true. If you look at
00:16:15
a chart for Agg, A is a kind of this mid
00:16:18
duration bond fund. It's the duration
00:16:21
for what it's worth is about 6 years. A
00:16:23
is still down 15% from 2022. It still
00:16:27
hasn't recovered. Although I will say
00:16:28
its owners have been receiving a nice
00:16:30
income stream along the way. But a is a
00:16:33
fund and the managers of that fund are
00:16:36
consistently resetting its duration. If
00:16:38
Joe Retiree had built something like a
00:16:40
12-year bond ladder in 2022, its
00:16:43
duration would also be about 6 years,
00:16:45
the equivalent to agg. And if Joe
00:16:47
Retiree had done that, where exactly
00:16:49
would his bond ladder be right now? I
00:16:51
can tell you his longer duration
00:16:53
individual bonds would have taken a
00:16:54
beating in 2022 and they would still be
00:16:57
underwater. And Joe could make himself
00:16:59
feel better by saying, "Well, they don't
00:17:00
feel underwater to me because I'll just
00:17:02
wait 6 7 8 more years until they
00:17:04
mature." And that's fine if it makes Joe
00:17:06
feel better. But mathematically, Joe's
00:17:09
revolving bond ladder has matched a in
00:17:12
this case step for step along the way.
00:17:14
Joe rebalances his ladder once a year,
00:17:16
whereas the A rebalances much more
00:17:18
frequently. That's the only difference.
00:17:21
Other than that, the cash flows are the
00:17:22
same. The portfolio values are the same.
00:17:25
The yields are the same. Everything is
00:17:27
the same. Bond funds are collections of
00:17:30
individual bonds. A retirees bond ladder
00:17:32
is exactly the same. Aside from any
00:17:35
tracking error due to rebalancing
00:17:36
frequency or aside from any, you know,
00:17:39
discrepancies due to maybe the fund just
00:17:40
holding different types of bonds. You
00:17:42
know, maybe it has some corporates
00:17:43
instead of all treasuries or something
00:17:45
like that. But other than those things,
00:17:47
we shouldn't expect any significant
00:17:48
differences between individual bond
00:17:50
ladders and bond funds. So, excellent
00:17:53
question, John. Thank you for writing
00:17:54
in. I hope that answered your question.
00:17:57
Here's a quick ad and then we'll get
00:17:58
back to the show. I love getting your
00:18:00
questions and some of you ask me
00:18:01
questions about the wealth management
00:18:03
firm I work for in Rochester, New York.
00:18:05
Others ask about the best interest blog
00:18:06
and this podcast, Personal Finance for
00:18:08
Long-Term Investors, which operate
00:18:09
without advertising, without pushy
00:18:11
sales, and with no payw walls. How can
00:18:13
the blog and podcast stay afloat without
00:18:14
me dumping my own money into it? Well,
00:18:17
to answer both those questions, I want
00:18:18
to point you to episode 78 of Personal
00:18:20
Finance for Long-Term Investors. I
00:18:22
intentionally recorded episode 78 to
00:18:24
shine light on those topics and inform
00:18:26
you how you are actually helping and can
00:18:28
continue helping these projects carry
00:18:29
forward. So, if you've ever been curious
00:18:31
about the business of my blog and
00:18:33
podcast, or if you're curious about my
00:18:35
day job in wealth management, please
00:18:36
check out episode 78 and let me know
00:18:38
what you think. On to the next question
00:18:40
here. Jennifer wrote in and said,
00:18:41
"Jesse, my husband and I have saved and
00:18:43
invested about $3 million over the past
00:18:45
35 years. Or more accurately, we've
00:18:48
saved about 1 million of that and the
00:18:50
rest is due to market growth.
00:18:51
Compounding is an amazing thing. But
00:18:53
here's our struggle. Is tax planning
00:18:56
just a way for well-off people to not
00:18:58
pay their fair share?" Jennifer, very
00:19:00
good question, and here's the way I see
00:19:02
it deep down. Everybody pays taxes for
00:19:04
the most part. I think if you're not
00:19:05
paying taxes, you're either very low
00:19:07
income or you're probably doing
00:19:10
something illegal. I know there are
00:19:11
stories out there and you maybe you can
00:19:13
hear the hesitation in my voice. I know
00:19:15
there are stories out there about kind
00:19:17
of ridiculously rich people not paying
00:19:19
any taxes due to interesting corporate
00:19:23
accounting. And that very well might
00:19:24
take place. In my personal experience,
00:19:27
I'm not working with anybody who's the
00:19:29
CEO of of a Fortune 500 company or or
00:19:32
anyone who's making, you know,
00:19:33
tripledigit millions a year, but somehow
00:19:35
it's all not technically income and
00:19:38
therefore they don't pay any tax. I
00:19:39
mean, that stuff might be going on, but
00:19:40
for the most part, everybody pays taxes.
00:19:43
99% plus of people work hard for decades
00:19:46
of their lives and working people pay
00:19:48
income taxes. Now, most of us pay other
00:19:50
kinds of taxes, too. And while everybody
00:19:52
I don't think anybody likes to see their
00:19:55
tax dollars used on things that they
00:19:57
perceive as bad or stupid or just
00:19:59
inefficient, I would also argue that
00:20:01
many of us are happy with paved roads
00:20:03
and firefighters and after school
00:20:06
programs for atrisisk youth. But you're
00:20:08
right in one way, Jennifer. You have
00:20:10
presumably built up this nice little
00:20:12
account out there of pre-tax retirement
00:20:14
dollars. I'm making an assumption. I'm
00:20:16
assuming that some of your $3 million
00:20:17
are pre-tax. And you're hearing a lot of
00:20:20
people like me offer up ways that you
00:20:22
could pay 0% or 10% or 12% taxes on
00:20:26
those dollars instead of 24 or 32 or 35%
00:20:30
taxes on those dollars. And now part of
00:20:32
the question might be, is it fair that
00:20:34
you might be paying less tax when
00:20:36
working people are paying more tax? Now
00:20:39
I'm going to lean toward no because you
00:20:42
already went through the period of your
00:20:44
life where you were paying more tax
00:20:45
during your working years. like you
00:20:47
already went through that phase. So from
00:20:49
that point of view, I don't see
00:20:50
necessarily any sort of, you know, moral
00:20:53
or ethical quandry as far as maybe you
00:20:55
are paying less tax than the people who
00:20:57
are actively working. But then you could
00:20:59
say, well, what about the poor sap who
00:21:01
who never listens to this podcast? He
00:21:03
might be stuck paying more than you
00:21:05
simply because he didn't know any
00:21:06
better. And I mean, on that front, I'd
00:21:09
say I'd love to educate that poor sap.
00:21:10
But until he finds that education, until
00:21:13
he educates himself on these topics,
00:21:15
he's going to be paying somewhat of an
00:21:17
ignorance tax. And that idea of an
00:21:19
ignorance tax, it exists everywhere, not
00:21:22
just in the world of retirement
00:21:23
planning. In fact, we're probably all
00:21:25
paying various forms of ignorance taxes
00:21:27
every day. It's just that we don't know
00:21:29
any better. Part of the problem with
00:21:30
being ignorant is you're not even aware
00:21:32
you're ignorant in the first place. You
00:21:34
know, in your question, Jennifer, you
00:21:35
mentioned the idea of compounding. And
00:21:37
you know, is it fair? In the same way,
00:21:38
we could ask, "Is it fair that you and
00:21:40
your husband discovered and seized upon
00:21:42
the magic of compounding 35 years ago
00:21:44
while other people never realize it in
00:21:45
the first place?" I would argue that
00:21:47
you're receiving the reward of having
00:21:49
discovered something very valuable long
00:21:51
ago and maybe other people are paying
00:21:53
some form of ignorance tax for not
00:21:55
realizing that in the first place. So,
00:21:57
is it a moral issue? Is an ethical
00:21:59
issue? I don't think so. It's probably
00:22:01
just an education issue. I think it's
00:22:03
one of the reasons why I think to myself
00:22:04
that an investment in knowledge pays the
00:22:06
best interest is that by kind of
00:22:08
learning these things and applying them
00:22:09
in our own lives and maybe doing a
00:22:11
little part here or there to make sure
00:22:12
that other people know them too, we can
00:22:14
all benefit from some form of of better
00:22:16
financial education. And the important
00:22:19
thing here too when it comes to taxes,
00:22:21
tax planning versus tax avoidance, there
00:22:24
are certain things you can do in the tax
00:22:26
world that are either very gray. Like
00:22:29
maybe uh someone at the IRS could find
00:22:31
them illegal or just are straight up
00:22:33
black and white. That is an illegal
00:22:35
thing. And nothing we talk about here on
00:22:37
this podcast at least is even close to
00:22:39
the gray part. We are always on the good
00:22:42
side of the fence and by a long shot.
00:22:44
So, I'm sure there are certain tax quote
00:22:47
unquote tax planning ideas out there
00:22:49
that flirt with some form of gray
00:22:52
illegality. I wouldn't recommend doing
00:22:54
that. I would get uh good tax planning
00:22:56
ideas from a CFP and then I'd run them
00:22:59
by your CPA. As long as it's legal and
00:23:02
as long as it's kind of, you know, on
00:23:03
the legal side by a good margin, I think
00:23:05
you have absolutely nothing to worry
00:23:07
about. That's my two cents. Thank you
00:23:08
for that question, Jennifer. And now
00:23:10
we're going to go to a question from
00:23:11
Kyle. Kyle says, "Jesse, I see market
00:23:13
crashes as opportunities. I contribute
00:23:15
to my 401k on a regular basis and that
00:23:18
gets invested, but then I take about
00:23:19
$500 a month and that $500 it sounds
00:23:22
like has gone up over time. So maybe at
00:23:23
one point it was a couple hundred a
00:23:25
month. Now it's $500 a month." Kyle
00:23:27
takes $500 a month and it goes into his
00:23:30
opportunity fund, which sounds to me
00:23:32
like a like a bank account. Then
00:23:34
whenever the market takes a sharp drop,
00:23:36
I dip into that opportunity fund to
00:23:38
invest. I guess I'm smart enough to
00:23:40
realize that people like you think I'm
00:23:42
wrong for doing this, but I'm not smart
00:23:44
enough to understand why. That's okay.
00:23:47
Kyle says he's smart enough to realize
00:23:48
that some people think he's wrong, but
00:23:50
he doesn't understand why he's wrong.
00:23:52
So, he's asking, "Could you please
00:23:53
explain it in a way I'd understand?"
00:23:55
Kyle, thank you for the question, and
00:23:56
that's a great question. It comes up
00:23:58
pretty often, and I think the
00:23:59
explanation here is pretty
00:24:00
straightforward. So, you take $500 a
00:24:03
month, you put it into your opportunity
00:24:04
fund, and presumably that opportunity
00:24:07
fund is something like a high yield
00:24:08
savings account earning 3% per year
00:24:10
right now. Excellent. And then what is
00:24:13
the rest of the market doing in the
00:24:14
meantime? Is it growing at 3% like your
00:24:17
bank account? Is it growing at more than
00:24:18
3% or is it growing at less than 3%. And
00:24:21
I hope you would agree with me that on
00:24:23
average the market and your portfolio
00:24:26
will grow at a rate faster than the 3%
00:24:29
in your opportunity fund. So at least up
00:24:31
front your opportunity fund seems to be
00:24:33
kind of losing ground to the market. But
00:24:36
wait, you say, you know, because you are
00:24:38
waiting for a period of time when the
00:24:40
market drops sharply, 10%, 20%, 30% or
00:24:43
more. And we know that during that
00:24:45
specific period, you'll be very happy
00:24:47
that your opportunity fund was earning
00:24:49
3% while the rest of the market dropped
00:24:52
20%. So you're losing on the front end
00:24:55
because we know the market will tend to
00:24:57
outperform your opportunity fund over
00:24:59
time. But then you've got to be winning
00:25:01
on the back end because when the market
00:25:03
drops, you're really glad you've had
00:25:05
money sitting there in the bank account.
00:25:07
And so really the question comes down to
00:25:09
does the winning portion that we just
00:25:11
described more than make up for the
00:25:13
losing portion that we just described?
00:25:15
And it's actually pretty easy to find
00:25:17
that out because if we were to back test
00:25:19
that strategy over historical markets,
00:25:22
if we were to look at, you know, S&P 500
00:25:24
price history or NASDAQ price history or
00:25:27
the Russell 3000 price history and just
00:25:29
try to back test one of these
00:25:30
strategies, we could find out if you
00:25:33
were losing more than you were winning
00:25:35
or vice versa. Now, what would you find
00:25:37
out? Well, you would see pretty clearly
00:25:39
that this strategy that the losing would
00:25:41
be not only more frequent, but would be
00:25:43
more consequential than the winning. Or
00:25:45
in other words, that those short periods
00:25:47
of winning, the times where buying the
00:25:49
dip actually seems to work out, they
00:25:52
wouldn't be consequential enough to make
00:25:54
up for all the losing you would be doing
00:25:56
on the front end. Now whether your
00:25:58
opportunity fund is some tiny fraction
00:26:00
of your investing dollars or a huge
00:26:02
fraction of your investing dollars,
00:26:04
those dollars will over history have
00:26:06
been losing dollars instead of winning
00:26:08
dollars. And and we don't really want
00:26:09
that. Now, could you create some sort of
00:26:12
specific niche rules to improve your
00:26:15
odds or some some rules to maybe win
00:26:18
during a historical back test? I'm sure
00:26:19
you could. I've heard some things before
00:26:21
where, you know, maybe you would change
00:26:22
the opportunity fund depending on the PE
00:26:25
ratio of the market. The theory there
00:26:27
being if the market is overpriced or
00:26:28
underpriced, maybe uh your your
00:26:30
opportunity fund strategy would be more
00:26:32
or less effective. Maybe you could make
00:26:34
your decisions based on the Buffet
00:26:36
indicator, which is a fraction of the
00:26:37
total stock market value against the
00:26:40
gross domestic product of the US. You
00:26:42
could whatever. You could look at rates
00:26:43
of inflation. You know, you could put
00:26:44
more money in during the odd months or
00:26:46
the even months, something quacky like
00:26:47
that. You could look at the astrology
00:26:49
signs on and on and on and on. And I'm
00:26:51
sure some of those rules might improve
00:26:54
your odds. Some of those rules might
00:26:56
even prove to be effective when examined
00:26:58
in hindsight. And if you want to pursue
00:27:00
those rules, more power to you. I
00:27:02
personally don't uh in my portfolio or
00:27:05
in my practice use any rules like that.
00:27:07
And I think buying the dip on net is
00:27:09
just a losing game. So I don't uh I
00:27:11
don't partake in it. But thank you for
00:27:12
the excellent question, Kyle, because I
00:27:14
think it's always good to review that
00:27:15
question and use it as a uh as a
00:27:17
learning opportunity. And the next
00:27:19
question is from Derek. Derek says, "Is
00:27:21
tax loss harvesting just a thing that
00:27:23
advisers say when they're trying to get
00:27:25
somebody to sell out of a bad stock
00:27:27
position and make it sound like a
00:27:28
strategy?" Derek goes on to say, "Here's
00:27:31
my logic. If I have a target asset
00:27:33
allocation, presumably over the long
00:27:34
term, all of the components will be
00:27:36
profitable. But in the intermediate
00:27:38
term, if one fund, say bonds, is showing
00:27:40
a loss, the act of rebalancing would
00:27:43
have me sell some of my stock fund and
00:27:46
invest the proceeds into the bond fund
00:27:48
to reestablish my desired asset
00:27:50
allocation. That sounds like the
00:27:51
opposite of tax loss harvesting to me.
00:27:54
Of course, when the time comes to enjoy
00:27:55
the fruits of my investments, I see
00:27:57
there's definitely an advantage to
00:27:58
considering the tax basis of whatever
00:28:00
funds I'm selling. It just sounds to me
00:28:02
like there's a lot more discussion than
00:28:03
necessary on the loss harvesting topic.
00:28:05
Yeah, Derek, you make a really good
00:28:07
point and if I can summarize what you're
00:28:08
saying, you're basically saying that
00:28:09
smart rebalancing is often the opposite
00:28:12
of tax loss harvesting. Rather than
00:28:14
selling your losing positions at a loss,
00:28:16
you buy more of your losing positions. I
00:28:19
mean, that's what rebalancing is. And
00:28:20
you are absolutely correct on that
00:28:22
front. However, I will say I don't think
00:28:24
that's necessarily how most financial
00:28:26
planners position tax loss harvesting.
00:28:28
Instead, they say this. If Dererick
00:28:30
invests $1,000 a month into his taxable
00:28:32
brokerage account and he is dollar cost
00:28:34
averaged into say VTI into that ETF for
00:28:37
years and years and years and then one
00:28:39
year the markets drop pretty
00:28:41
significantly. While many of Dererick's
00:28:43
individual past purchases are still
00:28:45
definitely going to be at a profit
00:28:46
because he's been investing for years
00:28:47
and years and years, some of his most
00:28:49
recent purchases of VTI, they will be
00:28:52
sitting at a loss. The monthly purchase
00:28:54
he made 3 months ago, well that's going
00:28:55
to be at a loss now because the market
00:28:57
just dropped. So the idea is can we
00:28:59
harvest those losses and then
00:29:01
immediately reinvest those dollars into
00:29:03
something similar like a VO. That is how
00:29:06
I think tax loss harvesting is usually
00:29:08
positioned Derek. So it's not
00:29:10
rebalancing. It's just that we're we're
00:29:12
selling some assets that are at a losing
00:29:14
position in order to use those losses
00:29:16
somewhere in the portfolio. But the
00:29:18
question is how are we going to use
00:29:19
those losses? Now that to me is the the
00:29:22
allimportant question and I would wager
00:29:25
that that many advisers, many content
00:29:27
creators in this financial planning,
00:29:29
retirement planning space, they don't
00:29:31
realize just the minimal impact, the
00:29:34
very very small impact that these losses
00:29:36
have except in a few corner cases. And
00:29:39
what are those corner cases? Well, the
00:29:41
main one, the big one is a corner case
00:29:43
where you would be or should be tweaking
00:29:46
your allocation anyway. So here are some
00:29:48
examples. You inherited a lake home from
00:29:50
your uncle. Nice. Good for you. We're
00:29:53
sorry your uncle passed away. And since
00:29:54
you've inherited it, it's appreciated in
00:29:57
value and but it's a nuisance. You've
00:29:58
had it for a few summers. You don't use
00:30:00
it. It's kind of just a nuisance and
00:30:02
you're looking to sell the lake home.
00:30:04
And you sell it, but it's appreciated in
00:30:05
value. So, it's going to trigger some
00:30:07
capital gains for you. Well, if you have
00:30:09
losses sitting in your portfolio, you
00:30:11
can tax loss harvest in your brokerage
00:30:13
account and use those losses to offset
00:30:16
the gains from the lakehouse. So again,
00:30:18
going back to the corner case that I
00:30:19
described, it happens in a place where
00:30:21
you would be or should be tweaking your
00:30:24
allocation anyway. And in this
00:30:25
particular scenario, we're saying, well,
00:30:27
you want to sell the lakehouse anyway.
00:30:29
So, if you're going to sell it anyway,
00:30:31
you might as well see if there's an
00:30:32
opportunity to do some tax loss
00:30:34
harvesting somewhere else and use those
00:30:36
losses to offset the gains. Or here's
00:30:38
another one. You work for Google and
00:30:39
you've been wanting to sell some of your
00:30:41
concentrated Google position for the
00:30:43
good of your portfolio. you know, you
00:30:45
own too much Google, so you would be and
00:30:47
you should be tweaking your asset
00:30:49
allocation anyway, you need to
00:30:51
deconentrate from Google. So great, if
00:30:54
you can tax loss harvest and use some of
00:30:56
those losses to offset the gains, that's
00:30:58
a wonderful thing. So in other words, if
00:31:00
your financial plan suggests that you
00:31:02
ought to be making a change anyway, then
00:31:04
you can look into tax loss harvesting
00:31:06
and it'll likely be a terrific net
00:31:08
positive for you. But if your financial
00:31:11
plan or your portfolio suggests that you
00:31:13
ought to be staying the course and you
00:31:15
decide to tax loss harvest, all you're
00:31:17
going to be doing is reassigning your
00:31:19
cost basis from one good asset to
00:31:21
another good asset and postponing your
00:31:24
capital gains tax bill to a later date.
00:31:26
Now, technically speaking, postponing
00:31:28
your capital gains bill to a later date
00:31:30
is worth something positive, but it's
00:31:32
not worth very much and it's usually not
00:31:34
worth the hassle. The juice in this case
00:31:36
is not worth the squeeze. So again, tax
00:31:38
loss harvesting can be good. I I do
00:31:41
think it's probably oversold in your
00:31:42
defense, Derek. The real, if we want to
00:31:44
call it like a metric of merit or the
00:31:46
real question we ought to be asking
00:31:47
ourselves is, would I be making some big
00:31:50
change in my financial plan or in my
00:31:52
portfolio anyway? And if the answer is
00:31:54
yes, then you can say, oh well, do I
00:31:56
have an opportunity to also tax loss
00:31:58
harvest and use those losses to offset
00:32:01
some gains? Thank you, Derek, for that
00:32:03
excellent question. And now the next
00:32:05
question is a kind of a two-parter from
00:32:06
Cody Garrett and Derek Tharp. Both of
00:32:08
whom are very much uh respected voices
00:32:10
in the world of financial planning. And
00:32:12
this came from my LinkedIn post that
00:32:14
they responded to. So Cody Garrett, he
00:32:16
basically says that peace of mind is a
00:32:18
bad reason for someone to pay down a
00:32:20
lowinterest mortgage. His argument
00:32:22
basically is that the math is so clear
00:32:24
that you should not pay down a
00:32:26
lowinterest mortgage. It's kind of a
00:32:28
copout to say that peace of mind is the
00:32:30
reason why you're doing it. But then
00:32:31
Derek Tharp kind of had a bit of a
00:32:32
rebuttal and he said, you know, hey,
00:32:34
should we be telling clients or other
00:32:36
people, should we be telling people what
00:32:38
their goals ought to be? So, in other
00:32:40
words, you know, right, Cody is saying
00:32:42
if you're a long-term investor and you
00:32:44
have a 3% mortgage, while it might feel
00:32:45
good to pay down that mortgage, that's
00:32:47
still not a good enough reason to do so
00:32:49
because more times than not, long-term
00:32:51
investing is going to be financially
00:32:53
better. The spreadsheet will clearly say
00:32:54
that that's a better thing. But then
00:32:55
Derek is saying, well, if a family has a
00:32:58
goal of say being debtree or owning
00:33:01
their house in full or or something
00:33:03
similar to that, should we be sitting
00:33:05
here as outsiders or as their financial
00:33:07
planner and saying like, "No, no, no.
00:33:09
Trust me, you don't want that to be your
00:33:11
goal?" And to me, this begs an even
00:33:13
bigger question that I'll I'll sometimes
00:33:15
laugh about with clients. And that
00:33:17
bigger question is just that it's not my
00:33:19
job. I don't think it's any financial
00:33:21
planner's job to tell you whether owning
00:33:23
a boat is good or bad. To tell you
00:33:25
whether taking a trip to Thailand is
00:33:27
good or bad or whether spending $100,000
00:33:30
to to redo your kitchen is good or bad.
00:33:33
That's not my job. It's it's certainly
00:33:35
not my job to layer my personal value
00:33:38
judgments onto your spending, onto your
00:33:41
decisions, or onto your goal setting.
00:33:43
It's just not my job to do that. My job
00:33:45
though is to educate you on the
00:33:47
trade-offs, to explain to you the
00:33:49
various opportunity costs of the options
00:33:51
in front of you, and quite often to
00:33:53
explain to you that one choice might be
00:33:55
mathematically better than the other.
00:33:56
And if I'm really good at my job, I will
00:33:58
even instill in you how much better one
00:34:01
choice is than the other. Some choices
00:34:03
are, you know, kind of like a 5149 split
00:34:06
where there's really not that big of a
00:34:08
difference. Sure, maybe one is
00:34:09
technically slightly better on paper,
00:34:11
but let's be honest, 51.49 is pretty
00:34:13
darn close to 50/50, but other choices
00:34:15
are it's going to be like someone who
00:34:17
wants to max out their credit card so
00:34:18
that they can go gamble at the casino.
00:34:20
It's just a very obvious bad choice or a
00:34:22
very, very obvious good choice. So, I
00:34:24
think that's where I fall on this
00:34:26
conversation where, you know what, I do
00:34:27
think that it's right for me to explain
00:34:30
if someone does want to pay down their
00:34:31
low interest mortgage, I'll explain to
00:34:33
them the pros and cons of doing so. And
00:34:36
I might explain to them that all us
00:34:37
being equal, a spreadsheet might not
00:34:39
agree with that choice. But I also want
00:34:41
to understand where they're coming from.
00:34:42
And if they're the kind of person who
00:34:44
says, you know what, my entire life I've
00:34:46
hated the idea of having debt. I never
00:34:48
want to have any debt on my balance
00:34:49
sheet. No amount of spreadsheets are
00:34:51
going to tell me that having debt is a
00:34:52
good thing. Well, for that person, I
00:34:54
think paying down a low interest
00:34:55
mortgage is the right thing to do. So
00:34:57
anyway, thank you Cody and Derek for
00:34:58
that one. The next one is from Phil.
00:35:00
Phil is a fellow uh financial adviser
00:35:02
and Phil said that his controversial
00:35:04
take is uh don't hire an adviser just
00:35:06
S&P and chill. And anyway, I like that
00:35:09
one, Phil. But listeners, I've already
00:35:11
talked about that one pretty in-depth.
00:35:12
So, if you want to go back to episode
00:35:14
81, uh you can hear some specifics about
00:35:16
the 100% S&P 500 portfolio. And then you
00:35:20
can go back to episode 124 for my kind
00:35:22
of deep dive answer on whether DIY
00:35:24
finance afficados should consider hiring
00:35:27
any sort of outside advisory help.
00:35:29
Here's a quick ad and then we'll get
00:35:31
back to the show. I send a free weekly
00:35:33
email to thousands of readers that
00:35:34
shares two simple things, just two. The
00:35:36
first are my new articles and podcasts
00:35:38
so you'll never miss when I publish new
00:35:40
content. And the second is my favorite
00:35:42
financial content from other corners of
00:35:44
the internet so you can see what's been
00:35:45
helping me the most. But Jesse, I don't
00:35:48
want another email.
00:35:49
>> I hear you. I make this newsletter
00:35:51
short, sweet, and full of essential
00:35:52
information. And readers enjoy that.
00:35:54
About 85% of newsletter subscribers are
00:35:57
engaging with the newsletter more than
00:35:58
once a month. They're enjoying it and
00:36:00
you will too. You can subscribe for free
00:36:02
on the homepage at bestinterest.blog and
00:36:04
you'll get a free PDF of my white paper
00:36:06
titled the step-by-step guide to
00:36:08
building your retirement paycheck.
00:36:10
That's right, a free weekly email that
00:36:12
thousands of people like you are already
00:36:13
reading, a free white paper to help you
00:36:15
plan for retirement. And you can sign up
00:36:17
for free at bestinterest.blog.
00:36:20
This next one we actually will get into
00:36:21
some detail here on the next one. John
00:36:23
wrote in and he said that his
00:36:24
controversial take is that Roth
00:36:26
conversions are oversold, that asset
00:36:29
location is oversold, and that tax
00:36:31
planning in general is oversold. I
00:36:34
really like this one, and in fact, I
00:36:35
think I've discussed it, you know, in
00:36:37
before to some detail. I've had some
00:36:39
pretty serious conversations with
00:36:40
serious people about the Roth conversion
00:36:43
that they think they want to make and
00:36:45
I've told them, hey, I think this is a
00:36:47
bad idea. You know, where did this idea
00:36:49
get into your head in the first place?
00:36:50
And the answer they give me is usually,
00:36:52
well, aren't Roth conversions just like
00:36:54
universally a good thing? Anyway, back
00:36:56
on episode 127, I shared a story of a
00:36:58
woman who sold the idea of buying a
00:37:00
fixed indexed annuity under the guys
00:37:02
that doing so would open up doors for
00:37:04
her to then execute Roth conversions. In
00:37:07
other words, Roth conversions were the
00:37:09
sizzle that this particular insurance
00:37:11
company was using to sell their stake,
00:37:13
the fixed index annuities, to this
00:37:15
woman. Roth conversions are a great
00:37:18
tool. Plenty of people at some time in
00:37:21
their long-term investing journey would
00:37:23
benefit from using Roth conversions, but
00:37:25
Roth conversions are one of many things
00:37:27
in financial planning that have a
00:37:28
distinct Goldilock zone. And this is
00:37:31
actually a good idea that I think I'll
00:37:32
turn into an article or a future podcast
00:37:34
topic at some point in more detail. The
00:37:36
Goldilock zone, you know, not too hot,
00:37:38
not too cold, just right. And one key
00:37:39
aspect of Roth conversions is not
00:37:42
overdoing it because overdoing it can
00:37:44
absolutely end up being worse than not
00:37:46
doing any Roth conversions at all. The
00:37:48
idea of a Roth conversion is to
00:37:49
intentionally move income from some
00:37:52
future highinccome year into a very low
00:37:55
income year. But if you overdo it, if
00:37:57
you overdo your Roth conversions, you
00:37:59
will accidentally turn your, you know,
00:38:02
very low income year into a high income
00:38:04
year because you've pulled in too much
00:38:06
income. So that is not what we want to
00:38:07
do. Anyway, so yes, Roth conversions
00:38:09
certainly can be overdone. I might agree
00:38:11
with John in terms of the fact that I
00:38:13
think sometimes they are used as a
00:38:14
selling point to take action and it's
00:38:17
not always the right thing. Like Roth
00:38:18
conversions are not universally good in
00:38:20
all in all scenarios. And John also
00:38:22
mentioned um asset location. This one is
00:38:25
definitely oversold, at least in my
00:38:26
opinion. I'm not sure I've ever seen
00:38:28
someone seriously try to sell asset
00:38:30
location strategies while also providing
00:38:32
a real number to describe the benefit of
00:38:35
doing so. So some quick definitions,
00:38:36
right? Asset location refers to
00:38:39
strategically placing your assets,
00:38:41
stocks, bonds, whatever into the quote
00:38:43
unquote right account, the right
00:38:45
location to achieve smart tax benefits.
00:38:48
The simplified logic is that bonds for
00:38:50
example, which create lots of taxable
00:38:52
income. Well, those should go into a
00:38:53
qualified account where that taxable
00:38:55
income isn't actually counted against
00:38:57
you. Isn't actually taxable, right? It's
00:38:59
a qualified tax-free account. Whereas a
00:39:02
lower income producing asset like a
00:39:04
growth stock, well, that should go into
00:39:07
your taxable account because even though
00:39:09
the the income is counted against you
00:39:10
there, we already defined this growth
00:39:12
stock as being a lowinccome asset. It's
00:39:15
kind of matching up that the the
00:39:16
lowinccome assets should go into taxable
00:39:18
accounts. The highinccome assets should
00:39:20
go into qualified accounts. And I'll
00:39:22
just pause there, I guess, before I tell
00:39:23
you the problem because on its face,
00:39:26
don't get me wrong, that is a good idea.
00:39:27
It's a good thing to do. And and sure,
00:39:29
you know, all else being equal, if you
00:39:31
got everything else done, all your ducks
00:39:33
in a row, you might as well get asset
00:39:35
location done, too. The problem is that
00:39:37
asset location just has a relatively low
00:39:39
or small benefit. It's on the order of
00:39:42
like.1% to 2% per year. In other words,
00:39:46
if you think of someone who initially
00:39:48
has a equal waiting across all their
00:39:50
different accounts, you know, taxable,
00:39:52
traditional, and Roth, and then you
00:39:54
compare that to someone where the only
00:39:55
thing they are trying to do is optimize
00:39:57
their tax location, and you compare
00:39:59
their long-term investing results over
00:40:01
time, you would find that the tax
00:40:02
location optimizer has a better after
00:40:05
tax return of something like.1% to 2%
00:40:09
per year. And that's not nothing. It's
00:40:11
certainly worth examining, but this is
00:40:13
not something that's going to alter your
00:40:15
life. And and there are lots of things
00:40:16
in financial planning that can move the
00:40:18
needle that much, if not much more. And
00:40:20
the problem or the the important note is
00:40:22
that asset location has a lot of
00:40:24
externalities attached to it. It can
00:40:27
introduce liquidity and accessibility
00:40:29
and timeline issues into your financial
00:40:30
plan because you're you're intentionally
00:40:33
kind of moving around assets into these
00:40:34
very specific accounts. And for example,
00:40:37
one thing I'm a major proponent of is
00:40:40
that your kind of shortest duration
00:40:41
assets should be readily available for
00:40:43
you to spend. Usually meaning some sort
00:40:45
of, you know, short-term bond. But here
00:40:47
we are with asset location and we're
00:40:49
putting all of our short-term bonds into
00:40:51
our qualified accounts, into our
00:40:53
traditional accounts and Roth accounts.
00:40:54
I will say usually for most people it
00:40:56
would be into their traditional account.
00:40:58
But at the same time, an optimal
00:41:00
withdrawal strategy does not have you
00:41:02
pulling on your traditional account
00:41:04
first. has you pulling on your taxable
00:41:05
account first. So that right there,
00:41:07
there's this kind of timeline mismatch
00:41:09
with the rest of your financial plan.
00:41:11
Asset location can also introduce
00:41:12
rebalancing problems for for some of the
00:41:14
same reasons. How are you supposed to
00:41:16
rebalance across accounts if you only
00:41:17
are supposed to hold bonds in your
00:41:20
traditional account and you're only
00:41:21
supposed to hold stocks in your taxable
00:41:23
account? It causes friction as I already
00:41:25
mentioned with optimal withdrawal
00:41:26
strategies. Similar friction can be
00:41:28
caused in estate planning due to the
00:41:30
different rules governing how taxable
00:41:31
accounts and qualified accounts get
00:41:33
passed down to heirs. So anyway, asset
00:41:35
location is a place where the juice
00:41:37
might not be worth the squeeze. And I do
00:41:39
think when I see people really pushing
00:41:41
hard on asset location, I question
00:41:43
whether they've thought through kind of
00:41:45
the full, you know, long-term
00:41:47
multi-deade ramifications of of
00:41:49
optimizing your portfolio in that way.
00:41:51
So John, thank you for your question on
00:41:52
that one, and I'd be interested to know
00:41:53
what what you think about my answer. The
00:41:56
next one's from Wilson. Wilson says,
00:41:57
"Once you have enough assets, why would
00:41:59
you still hire an AUM adviser, an assets
00:42:01
under management adviser? Why wouldn't
00:42:03
you just hire a flat fee adviser?" Quick
00:42:06
uh definitions for those who aren't
00:42:07
familiar. Assets under management, AUM,
00:42:10
that's a type of adviser who might say,
00:42:11
"I charge you 1% of your assets or 75%
00:42:15
of your assets." So, every year, their
00:42:16
annual fee is based on a percentage of
00:42:18
the assets that the adviser is managing.
00:42:20
Flat fee, as the name might imply,
00:42:23
usually just means a a price is quoted
00:42:25
to you. I charge you $8,000 a year. I
00:42:27
charge you $12,000 a year, regardless of
00:42:30
the assets I'm managing. That is my flat
00:42:32
fee. Both of those fee arrangements can
00:42:35
still be fee only. It can be the only
00:42:37
way that an adviser charges their fee.
00:42:39
And I see that definition messed up
00:42:41
actually a lot online. Again, that that
00:42:44
fee only word says uh an adviser, it's
00:42:46
the only way they charge fees. And
00:42:47
usually and and still in in today's kind
00:42:50
of financial services industry and
00:42:52
landscape, most feeonly advisers fall
00:42:55
under the AUM model. It's the only way
00:42:56
they charge fees. They are fee only. It
00:42:58
is an AUM fee. But yes, there is a
00:43:00
growing tide of what might be called
00:43:03
adviceonly advisers who either charge
00:43:06
hourly. They don't actually manage
00:43:08
assets. They're advice only. And they
00:43:09
charge hourly or they charge flat fees.
00:43:12
There's kind of a bit of a mix and a
00:43:13
match. And I totally understand. Let me
00:43:14
say this too. totally understand from
00:43:16
the consumer point of view why it's so
00:43:18
confusing because I even see other
00:43:20
professionals messing up the verbiage
00:43:22
and I can see some people right now the
00:43:24
way I just described it to you I could
00:43:26
see some people coming back to me and
00:43:27
saying Jesse I actually think you got
00:43:28
that one wrong I'm pretty sure I got it
00:43:30
right but if you think I got something
00:43:31
wrong let me know so again Wilson is
00:43:33
saying once you have enough assets why
00:43:35
would you still hire an AUM adviser why
00:43:37
wouldn't you just hire a flat fee
00:43:39
adviser and I think what Wilson's saying
00:43:40
here is I think it was Jennifer who
00:43:42
asked us a question a few minutes ago
00:43:43
and Jennifer's question had to do with
00:43:45
the difference between tax planning and
00:43:46
tax avoidance. And her story was that
00:43:48
she and her husband have saved up $3
00:43:50
million over their careers. They're
00:43:51
retiring with $3 million. So, I think
00:43:53
what Wilson is saying is, well, listen,
00:43:55
if a adviser is going to come in and
00:43:57
charge Jennifer 1%, that's $30,000 a
00:44:00
year and Jennifer could probably go find
00:44:02
a flat fee adviser for again 8 or 10 or
00:44:05
12 or maybe $15,000 a year. There's I
00:44:08
think Wilson's saying that she could
00:44:09
probably save some money. So, great
00:44:11
question. Fees are an incredibly
00:44:12
important topic. I have lots of thoughts
00:44:14
on fees as you've probably already heard
00:44:16
and you know as long as they're not too
00:44:18
too biased. I really enjoy hearing
00:44:20
people share their thoughts on the
00:44:21
various fee structures in this industry
00:44:23
whether it's an adviser and how they
00:44:24
charge fees or whether it's a a client
00:44:26
and how they perceive or you know how
00:44:28
they pay fees or how they perceive the
00:44:30
different fee structures that are out
00:44:31
there. And I do think when it comes to
00:44:33
this whole fee debate because it is a
00:44:35
debate and it's been to some extent
00:44:37
beaten to death but I think of one of
00:44:39
Warren Buffett's famous apherisms. He
00:44:41
said that price is what you pay and
00:44:43
value is what you get. And of course, he
00:44:45
was talking about stocks. You know,
00:44:46
price is what you pay, value is what you
00:44:48
get with a stock. But I think that
00:44:49
applies here. And I I sit here and I
00:44:51
think to myself, if I charged people
00:44:54
1.5%, 1% or.5%.
00:44:57
If I charged them a flat fee of 20K a
00:45:00
year or 10K a year or less or more, or
00:45:03
if I charged them, I don't know, $1,000
00:45:05
a month or $500 an hour. All those
00:45:08
different ways of pricing, right? Those
00:45:09
are all different prices. But I think to
00:45:11
myself, in all those different price
00:45:12
scenarios, would the value I deliver be
00:45:15
any different? You know, would my
00:45:17
knowledge be different? Would I care
00:45:18
about people more or less? And the
00:45:20
answer to those questions is I don't I
00:45:22
don't think so. I think the value I
00:45:24
deliver would be the same. I could see
00:45:25
in some situations maybe the time I have
00:45:28
to deliver advice might be different. If
00:45:30
if I'm charging more, I get to work with
00:45:32
fewer clients and I get to devote more
00:45:34
time and energy to them. If I'm charging
00:45:37
less, I might have to work with more
00:45:38
clients to kind of make the business
00:45:40
model work and I might have less time.
00:45:42
So, I think that's an important
00:45:43
difference. But as far as, you know, my
00:45:45
my knowledge, my desire to help, my
00:45:48
care, I think a lot of the value is the
00:45:50
same for me personally, regardless of
00:45:53
the price that I'm charging. So, then I
00:45:55
put myself in your shoes, Wilson, or the
00:45:56
shoes of someone who's looking to work
00:45:58
with a financial adviser. And I think
00:46:00
you need to really care about both the
00:46:02
value and the price. Obviously, you
00:46:03
know, all else being equal, we all need
00:46:05
to be very fee conscious. There's no
00:46:07
doubt about it. One of my friendly
00:46:09
acquaintances, Wilson, he's this upper
00:46:10
level executive at a publicly traded
00:46:12
company that you absolutely would have
00:46:14
heard of. And I'd reckon this guy is
00:46:16
probably making, you know, a million
00:46:18
dollars a year or more, a smart guy,
00:46:20
nice guy, all the things. And he
00:46:23
occasionally likes to pepper me with
00:46:24
financial planning questions. And I've
00:46:26
asked him, well, hey, do you work with a
00:46:28
financial planner? and he told me he
00:46:30
works with the same, you know,
00:46:31
70-year-old Northwest Mutual Insurance
00:46:34
guy that his uncle introduced him to 30
00:46:36
years ago when he got out of college.
00:46:38
And to me, I hear that story and it's a
00:46:40
little bit blasphemous. You know, I'm
00:46:42
not a huge fan of of Northwest Mutual
00:46:45
and the whole life insurance products
00:46:47
and the annuity products. And at the
00:46:49
same time though, going back to this
00:46:51
high net worth executive who's kind of
00:46:52
the character in my story here, this
00:46:54
this person I know, he told me in no
00:46:56
uncertain terms, Jesse, I would trust
00:46:58
this guy with my life. So my point is
00:47:00
there is some value there in the
00:47:03
relationship itself. I think it's hard
00:47:05
to express that value on a spreadsheet.
00:47:07
It's certainly not tangible. It's
00:47:08
intangible. Now, just because it's
00:47:10
intangible doesn't mean we should be
00:47:12
okay with a 2% AUM fee or a 10%
00:47:15
commission on an insurance product or a,
00:47:17
you know, I would say I would argue a
00:47:19
whole life insurance product in the
00:47:20
first place or all the other
00:47:22
questionable ways that financial advice
00:47:23
can be charged for. I don't think that
00:47:25
we have to make excuses for that. But I
00:47:28
will say that I think there is a lot of
00:47:29
value in the relationship and the trust
00:47:31
itself. And I guess just wrapping things
00:47:33
up and and gathering my thoughts here,
00:47:34
Wilson, it's to go back to what I said a
00:47:36
minute ago. I think it's really
00:47:37
important for you to definitely think
00:47:39
about both the price and the value. You
00:47:41
you have to think about both. And again,
00:47:44
as investors, we all need to be
00:47:45
conscious of fees. Absolutely. And we
00:47:47
all need to make sure that whatever fees
00:47:49
we are paying, we're getting requisite
00:47:51
value out of paying those fees. So
00:47:53
that's probably the hard part for you. I
00:47:55
think I think understanding the price is
00:47:56
the easy part when you're determining if
00:47:59
you want to go out and seek professional
00:48:01
financial advice, or at least it should
00:48:03
be the easy part, right? If fees are
00:48:04
ever confusing to you in some way, it
00:48:06
probably says more about the fees that
00:48:08
are being charged and the people who are
00:48:11
charging them than it says about your
00:48:12
math skills. Like fees should be very
00:48:14
easy to understand conceptually. The
00:48:17
value is probably the harder part
00:48:19
because I think there is a pretty wide
00:48:20
spectrum of advice and advisors out
00:48:24
there. That's your challenge is to make
00:48:25
sure that you're getting enough value
00:48:26
for the price that you're paying. So,
00:48:28
thank you for that question, Wilson. And
00:48:30
now we're going to pivot to Alex. Alex
00:48:31
had a great question. This is again a
00:48:33
question or a controversial take. You
00:48:35
could say a controversial question and
00:48:37
it is when you read balance, aren't you
00:48:39
by definition selling what's good and
00:48:41
buying what's bad? And of course you
00:48:44
kind of are and who in their right mind
00:48:45
would want to sell something that's good
00:48:47
and buy something that's bad? You can
00:48:49
kind of hear me laughing to myself cuz
00:48:51
there's this Homer Simpson quote where
00:48:52
Homer's son Bart says, "This is the
00:48:55
worst day of my life." And then Homer
00:48:57
says, "Oh, this is the worst day of your
00:48:59
life so far." And I think something
00:49:01
similar applies here to your portfolio
00:49:03
because the funny Simpsons joke is that
00:49:05
life can always get worse. But I think
00:49:06
the important takeaway for us is that
00:49:08
your portfolio has done X and Y and Z so
00:49:11
far. And when you rebalance, you're
00:49:14
selling what's been good so far and
00:49:16
you're buying what's been bad so far.
00:49:18
Because if you do it right, and I think
00:49:20
this we actually talked about this with
00:49:21
one of the questions earlier today. If
00:49:23
you do it right, hopefully you're
00:49:24
filling your portfolio with assets that
00:49:26
you believe in over the long run. and
00:49:28
you understand that some of these assets
00:49:30
will both over and underperform over
00:49:33
different shorter periods of time. You
00:49:35
believe in the assets in the long run,
00:49:36
but you know over the short run there's
00:49:38
going to be over and underperformance.
00:49:40
And you understand that reversion to the
00:49:42
mean is this strong undercurrent in
00:49:44
investing. You also understand that
00:49:45
trees don't grow to the sky. As they
00:49:47
say, nothing goes up forever. Everything
00:49:49
has an upper limit. And when you
00:49:50
rebalance, you're taking all of those
00:49:52
ideas into account. You're saying, I
00:49:54
like everything I own. Some things have
00:49:57
done much better than others over this
00:49:58
recent short period of time and my
00:50:00
belief is that such outperformance
00:50:02
doesn't continue forever. I don't know
00:50:04
exactly when the outperformance will
00:50:06
stop but eventually it will. And in
00:50:08
order to account for that fact while
00:50:10
also accounting for my own ignorance
00:50:12
about the specific timing. The smartest
00:50:14
thing I can do right now is create
00:50:16
rules. Right? Rules about how to
00:50:18
rebalance, how and when I'm going to
00:50:19
rebalance and then follow those rules
00:50:21
really strictly in, you know, in 60
00:50:24
seconds. That is the theory behind
00:50:25
rebalancing. Technically speaking,
00:50:27
you're selling what's good and you're
00:50:29
buying what's bad. But you're only
00:50:31
selling what's been recently good and
00:50:33
you're buying what's recently been bad
00:50:35
because deep down inside, if you've done
00:50:37
it right, you you think that everything
00:50:39
you own is going to be good over a long
00:50:40
enough period of time. You just don't
00:50:42
know exactly what those periods of time
00:50:44
are going to look like. You're ignorant
00:50:45
to that fact. And so, you have to set up
00:50:47
rules and then follow them. Thank you,
00:50:49
Alex, for the excellent question. And
00:50:50
now, I think this is the final question
00:50:52
today. It is. We're going to go to
00:50:54
Crystal. And Crystal said, "Jesse,
00:50:57
market commentary. This is literally
00:50:59
just one person's comments on the
00:51:00
market." And I think Crystal is right.
00:51:02
It's kind of funny. You know, in a
00:51:04
market full of millions of investors and
00:51:06
trillions of dollars, we're going to put
00:51:07
a microphone in front of one person and
00:51:09
allow them to share their opinions. Yes,
00:51:12
my own workplace has CNBC on in the
00:51:14
break room. And well, I think it's much
00:51:16
better than having on ESPN or The Price
00:51:19
is Right or the Golden Girls reruns.
00:51:21
CNBC makes sense. But sometimes I'm
00:51:23
walking in to get my morning coffee and
00:51:25
I watch the TV for a minute and I think
00:51:27
this is just entertainment, right? This
00:51:29
is not education. Going back a couple
00:51:31
months ago, one of the podcast reviews
00:51:33
that a listener like you wrote for me,
00:51:34
they included a line where they said,
00:51:36
"This is not an exciting podcast, but it
00:51:39
is very educational." And I thought,
00:51:41
"Good. I don't want this to be like
00:51:43
paint drying, you know? I don't want it
00:51:44
to be that boring, but I also don't want
00:51:46
this podcast to be your dopamine fix."
00:51:49
Because I mean, here's a little tell or
00:51:51
a little story. You know, next time you
00:51:52
have CNBC on, watch it all the way
00:51:54
through the commercial break, right?
00:51:56
Don't turn the channel at the commercial
00:51:57
break. And you'll see some
00:51:58
advertisements for Vanguard and Schwab
00:52:00
and stuff like that. And that's all
00:52:02
good, but you're going to see a lot of
00:52:04
ads that are selling gold to senior
00:52:06
citizens that are selling option
00:52:08
strategies to young gambler types.
00:52:10
You'll see some lady named Diane who's
00:52:12
selling her husband Roger's stock
00:52:13
picking service. I'm dead serious.
00:52:15
because Roger is too busy in the back
00:52:17
picking winning stocks to appear in the
00:52:19
commercial himself. So, he has his wife
00:52:21
Diane come sell the service for him. I
00:52:23
mean, come on, right? Market commentary,
00:52:26
in my view, is kind of part of this
00:52:28
whole galaxy. And, you know, that the
00:52:30
CNBC, the investing galaxy. And I say
00:52:33
galaxy intentionally because it's, you
00:52:35
know, a collection of many, many
00:52:36
different things that all technically
00:52:38
orbit around the same black hole. That's
00:52:40
what a galaxy is. And what's that black
00:52:42
hole exactly? I guess I'm not sure in
00:52:44
this metaphor. It's probably some
00:52:45
combination of the economy and the stock
00:52:47
market or just money in general. You
00:52:50
know, that's the black hole. That's the
00:52:51
big pull. That's the thing that's
00:52:52
sucking us all in. And when I see CNBC,
00:52:56
when I hear the market commentary that
00:52:58
Crystal's calling out here, they are
00:53:00
closeish to the center of the galaxy.
00:53:03
And there's a lot of gravitational pull
00:53:05
on them. The pull of whatever is in that
00:53:07
black hole is warping what CNBC and
00:53:10
those market commentators decide to say.
00:53:12
And I'll certainly admit I am within
00:53:14
that galaxy, too. And I think so are you
00:53:17
because you're here listening. But I
00:53:19
very much want to be way on the
00:53:20
outskirts of the galaxy. I want to be
00:53:22
really far away from the black hole. I
00:53:24
want the effects of that gravity to be
00:53:26
pretty minimally felt and not too
00:53:29
warping of what I have to say. And so
00:53:31
you won't hear my market commentary
00:53:33
about, you know, the prognostications
00:53:35
about the 2026 market returns because I
00:53:38
think that the only rational answer ends
00:53:40
with I don't know. So, thank you for the
00:53:43
excellent question, Crystal. And again,
00:53:44
all of you, thank you for the amazing
00:53:46
AMA ask me anything questions. Please
00:53:47
keep them coming. You can submit
00:53:49
questions by sending me an email. The
00:53:51
email address is
00:53:52
00:53:54
And while you're there on the blog, make
00:53:55
sure you sign up for the free weekly
00:53:57
email newsletter. I think we're a little
00:53:59
bit north of 41 or 4,200 subscribers
00:54:01
right now. And as always, thank you for
00:54:04
listening to Personal Finance for
00:54:05
Long-Term Investors.
00:54:07
>> Thanks for tuning in to this episode of
00:54:08
Personal Finance for Long-Term
00:54:10
Investors. If you have a question for
00:54:12
Jesse to answer on a future episode,
00:54:14
send him an email over at his blog, The
00:54:17
Bestin Interest. His email address is
00:54:19
00:54:21
Again, that's jessevestinterest.blog.
00:54:25
Did you enjoy the show? Subscribe, rate,
00:54:27
and review the podcast wherever you
00:54:29
listen. This helps others find the show
00:54:31
and invest in knowledge themselves. And
00:54:34
we really appreciate it. We'll catch you
00:54:36
on the next episode of Personal Finance
00:54:38
for Long-Term Investors. Personal
00:54:40
Finance for Long-Term Investors is a
00:54:42
personal podcast meant for education and
00:54:45
entertainment. It should not be taken as
00:54:47
financial advice and it's not
00:54:48
prescriptive of your financial
00:54:50
situation.