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Joe Anderson
ABOUT Joseph

As President of Pure Financial Advisors, Joe Anderson has led the company to achieve over $2 billion in assets under management and has grown their client base to over 2,160 in just ten years of the firm opening. When Joe began working with Pure Financial in 2008, they had almost no clients, negative revenue and no [...]

Alan Clopine
ABOUT Alan

Alan Clopine is the CEO & CFO of Pure Financial Advisors. He currently leads Pure Financial Advisors along with Michael Fenison and Joe Anderson. Alan joined the firm about one year after it was established. At that time the company had less than 100 clients and approximately $50 million of assets under management. As of [...]

Published On
August 6, 2019

Private equity, venture capital, hedge funds, real estate investment trusts (REITs) and angel investing: Joe breaks down what these alternative investments are and whether they belong in your portfolio. Plus, the fellas talk about risk parity investing, net unrealized appreciation, what to do with a large settlement and the break-even point for Social Security benefits.

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Show Notes

  • (00:48) Alternative Investments: Private Equity, Venture Capital, Hedge Funds, Real Estate Investment Trusts, and Angel Investing
  • (18:56) What About Risk Parity Investing for Better Returns?
  • (28:09) How Much Should I NUA? Should I Take the Monthly Pension or Lump Sum?
  • (33:01) What Should I Do With a $250K Settlement?
  • (36:23) When is the Social Security Break-Even Point?

Free Download Newly Updated for 2019: Pursuing a Better Investment Experience

Transcription

We’ve had a number of people over the past few months ask about alternative investments, so today on Your Money, Your Wealth® Joe gives his take on Private Equity, Venture Capital, Hedge Funds, Real Estate Investment Trusts, and Angel Investing. The fellas discuss risk parity investing, net unrealized appreciation, what to do with a large settlement and the break-even point for Social Security. I’m producer Andi Last, and you still have a couple of weeks to help us make this your favorite podcast ever! Fill out my YMYW podcast survey in the show notes for this episode at YourMoneyYourWealth.com for a chance to win a $100 Amazon gift card. Now, let’s talk about those alternative investments! Here are Joe Anderson, CFP® and coming up later, Big Al Clopine, CPA.

00:48 – Alternative Investments: Private Equity, Venture Capital, Hedge Funds, Real Estate Investment Trusts, and Angel Investing

Joe: We got Steve from San Diego. “Hi, Andi.”

Andi: He actually emailed us a while ago. You guys answered his question about how to diversify his portfolio for the best returns or tax efficiency. When I sent him the response that you guys gave him, this is how he responded to me.

Joe: Got it. “Thank you so much for writing and your nice letter.” What do you send him, love letters, or what?

Andi: I sent him the link to the podcast and the video and he’s all set.

Joe: Sure.  I got it. “And the great material you provided. I can’t tell you enough how thrilled I was to listen to the answer on your show. I have to tell you the fellows knocked it out of the park with their answer. Joe gave us a seminar a minor portfolio theory and gave us another seminar on the tax implications of the different accounts and they each contributed to the other’s topic. It was truly riveting radio.”

Andi: I swear I did not write this about you guys.

Joe: Steve. Steve. Loving it.  “During the show, you asked them about alternative investments, which was actually a topic I was very interested in. So I was hanging on my seat waiting to hear about that. Of course, there wasn’t enough time which is very understandable. They already had packed in a lot of information maybe this week we can address that. What alternative investments have you seen people use in effect a balanced portfolio from the ridiculous to the sublime with an emphasis of things they found to work. If that’s too much, no worries.” All right Steve, let’s talk alternatives, I guess.

Andi: Everybody hears, “this is the greatest investment ever, you gotta get into this because it’s going to make you a ton of money.”

Joe: All right. Well, let’s start with there’s a few that people should probably understand. Like private equity. So there are more private companies than there are public companies. And most of them are small right. If you take a look at the grand scheme of all the companies in the United States, I would say 80% or more, 90%. I don’t know the exact figure. Big Al would know that. Are smaller companies and then a majority of them are very private. And so private equity is getting a lot more popular. I think in the last probably 10 years. More and more companies don’t want to go public because they just don’t want to deal with the B.S. of being a public company.

Andi: The bureaucracy involved.

Joe: To be honest with you, you’ve got to answer to people a lot more than just your employees and your clients. Because before that was the only way for companies to raise capital. So why people go public to begin with is that all right, well here, I started this business and then the business gets a little bit bigger and it gets a little bit bigger and a little bit bigger and a little bit bigger. And then either that you want to continue to grow or the owner wants to diversify a little bit because every ounce of his life in his net worth is in that company. So it’s like OK well what do I do? I can’t really cash out of anything in the company without capital. Right?  So then that’s where IPOs came in, initial public offering, so then they would go to investment bankers and say hey we need cash and then they said OK well let’s do this let’s take your company public and so people can buy shares of your stock. And so when people went public. Right? People bought these shares and then that gave owner liquidity. So now it’s kind of the same concept if you will but it’s just private. So you got private equity managers. So what they’re doing is they’re going to institutions, they’re going to individuals and they build these funds. And so let’s say they’ve got $100,000,000, $200,000,000, $500,000,000, you know it’s a pretty big fund.  So they’re going around looking for really good opportunities. So they’re going to look at growing companies that want liquidity or that have a really good story that they could make a fairly good profit off of in maybe a 3, 5, 7-year timeframe. If I’m an investor in a private equity fund, my funds are locked up. It’s very illiquid. So you have to wait five years and hopefully, the fund manager knows what they’re doing or finds these little diamonds in the rough. So as an investor…

Andi: It’s companies that are going to do well instead of tank.

Joe: Correct. But most small companies fail. So these private equity firms are going around looking to say this is a really good growth story. Maybe we pump some capital into this firm and we can help them grow. But we’re flipping out we’re getting out. So as an investor in a private equity fund it’s like you’re stuck with that money in five years. On the other side of the coin is that let’s say I’m a small business owner and I’m working with private equity. They’re just going to pump and dump me. They’re going to come in for five years. They’re going to try to make it grow. They’re going to put all this money into it and then hopefully they can get their multiple plus X out of it within five years. So they’re looking at firms in certain growth stages. Right? So is that a good investment? Sure. I mean a lot of these companies that private equity firms look at are growing companies or they probably wouldn’t necessarily waste their time with them.

Andi: But the risk.

Joe: There is a ton of risk because a lot of these small companies fail. And then you know it’s like OK well what are they going to do. The private equity firm needs to get their bottom line so they could shred that company, try to do something and flip it again. So there’s a lot of things that happen within the private world that you can’t necessarily do in the public world which is good and bad. There are pros and cons to each. So when you hear private equity I know there’s a lot more to this but I guess we’re just talking really elementary here. So if you could get into private equity funds a lot of times you have to be an accredited investor which means you have to have a certain level of net worth and a certain level of income. I don’t know who comes up with that B.S. either because I know a lot of people that have a lot of large income and fairly large net worth but are incompetent to save their you know what. And I know that some individuals that are still growing are the smartest people that you probably meet that should be able to invest in some of this stuff. So yeah that’s private equity. I guess we could talk about venture capital, we could talk about real estate we could talk about. I don’t really want to talk about crypto.

Andi: So real quick. So if somebody is going to put money into alternative investments have you got like a— should it be 5% of their portfolio? Or does it depend on each person?

Joe: Yeah I would say it depends on how much money that they have. If you’re just trying to build I would say keep it simple. But if you’ve got money that’s discretionary, that if you lose it all tomorrow then not a problem, then that’s when you would probably look at it. Yeah. So most of our listeners it’s probably 0%.

Andi: Okay.

Joe: So Steve was curious about alternative investments. If you’re just joining us, I talked a little bit about private equity. Let me just do a caveat here. I’m a total novice when it comes to alternative investments. We could get someone on that would bore the hell out of us and talk oh all about it. I’m just giving you a very high level of what I know. It could be wrong. That’s just that’s my CYA. Venture capital is another kind of hot topic that you know other kids are talking about when they’re drinking their pints of… you know…

Andi: Not Coors Light.

Joe: Not Coors Light, whatever that microbrew shepherd’s pie malt liquor whatever?

Andi: Man, you are really showing yourself as not being a craft beer drinker!

Joe: Well, what the hell’s a craft beer?

Andi: I don’t know. I don’t drink it either. Mine’s Modelo Especial. That’s my beer of choice.

Joe: Oh nice little accent there with the Especial. You gotta throw that in there?

Andi: Of course, it’s San Diego.

Joe: We were talking about venture capital.  OK well, that’s kind of very similar to private equity in a sense where it’s really a startup.

Andi: So, it’s like we’re talking even riskier than the private equity.

Joe: Yes. Yes. Yes. Well I mean it’s all pretty risky to tell you the truth. But this is like Facebook, Netflix, and you know companies like that in the very beginning, they’re not making a profit. There are still all these companies still don’t make profits. Where PE firms come in they’re going to take a look at all right. Well what’s the EBITDA I hear, what are you guys doing?

Andi:  Wait, wait, wait. EBITDA? Explain that.

Joe: I’m not gonna get into that.

Andi: What does it stand for?

Joe: Is there a profit? So with venture capital, they’re going gonna be like you’re not even in the black. What the hell’s going on. Because these firms are kind of just pumping everything back into their overall company. Itself. There’s no profit. But the idea’s cool. The technology might be there and so they’re just going to start pumping money so that those are VC firms at the very beginning of the cycle potentially. So they’re just going to pump money in and pump money in and pump money in and then just try to flip it out either with an IPO. I don’t think Facebook made a dime. Well, they might have but you know didn’t it make a lot until the IPO. So a lot of these like tech firms you look in it’s like well here they’re not really making a lot of money or Tesla you know firms like that, it’s like how the hell are these getting these valuations. You know the firm is worth X but the profits not there. Just because it’s so forward-looking. Hedge funds?  Wanna talk about hedge funds?

Andi: Tell me about hedge funds, Joe. By the way, EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortization.  Crikey.

Joe: That’s why I didn’t want to go through that whole… yeah.

Andi: Hedge funds.

Joe: All right. With a hedge fund, most of them will invest in a public company.

Andi: See to me hedge fund automatically sounds like a bad thing because you always hear bad news about things happening with hedge funds. Or people getting in trouble with them.

Joe: Because they could be unregulated. So could be family money. It could be friends and family, so they might not be registered through the S.E.C. potentially. But those are the smaller ones. But a hedge fund would be they’re doing their investing in public companies. So the liquidity feature on those is a lot different than venture capital private equity because private equity might be OK, well we’re going to lock this thing up. We’re going to flip this fund in five years and then from there, the capital will get released and then the investors will get their money back. Maybe we start another fund and kind of do it all over again. Or maybe they might have two or three, four funds going at the same time. And then one gets liquidated. Then another one kind of gets built up.  With hedge funds they’re investing in public companies so the redemptions are a little bit quicker but they might do like long-short funds. What that means is that they’re shorting the market in some areas. What that means is that they think some area of the market is going to go down. So if you short it your profit when stocks go down and then they’re long on other parts of the market. So it’s kind of like a long-short fund so they’re hedging.

Andi: They’re hedging their bets.

Joe: Yes. And so hence the term hedge fund. So they’re like all right well I’m going go long on U.S. stocks. I’m going to go short International. That’s really broad and simple but that sort of shows their anticipation or their bet or their gamble is to say international stocks are going to go down so let’s bet that they’re going to go down. The U.S. is going to continue to perform so let’s go along there. So if someone owns that fund they can have the best of both worlds. If U.S. companies do well in international stocks do not do well. So there’s other like arbitrage. They could have a lot of leverage on it. So they’re just doing things just to potentially hedge. So in really boom markets, hedge funds don’t necessarily perform and as you can see over the last 10 years hedge funds have not performed as well as maybe just the U.S. broad stock market index fund because they’re hedging the risk. And so they suck until they don’t. You know what I mean. And I think there’s a lot of bad press when it comes to hedge funds just because they’ve underperformed a little bit. Plus the hedge fund managers they’re going to charge you know 2% and 20% of the profit. So they’re expensive. So a normal registered investment advisor like ours would charge let’s say 1% of the assets that we manage. They’re charging 2% of the assets that are managed and then 20% of any profit. So it can get a little pricey.

Andi: So yeah they have to make a whole bunch of money for you to actually make a decent return.

Joe: Right. In some hedge funds you know they have killed it. Yeah absolutely killed it. But it’s private money. I mean you can’t even come close to as laymen people like us to get in there right now because they’ve got their little circles. And the bigger the fund it’s a lot more challenging for people to make money. The more stocks you buy you’re going to manipulate the price of that stock. If you manage billions where if I’m managing maybe $100 million. OK. Well now I can kind of get in and out of the market and I can produce higher returns. Hypothetically is kind of what they say. But every squirrel finds a nut.

Andi: Can I ask you about one more?

Joe: Sure. I don’t care. I don’t know if I know the answer.

Andi: REITs  Real Estate Investment Trusts. This is something that everybody says if you want to get invested in real estate, but you don’t want to be a landlord you should go with REITs because it spreads out your risk across a bunch of different properties. So what’s your take on real estate investment trusts?

Joe: Well there are two different types of REITs you can purchase. There’s public – traded – and non-traded. So non-traded REITs. That kind of gets a little bit dicey because there’s a lack of transparency. If I’m in a non-traded REIT, there’s one price and it doesn’t get repriced for a while and how they’re sold, it could be a little dicey too of what they’re representing what the true rate of return is of the real estate investment trust is – but it’s basically a diversified portfolio of real estate. So you could buy apartment buildings, you could buy health care facilities, you could buy nursing homes, hospitals, hotels.

Andi: The whole Monopoly board.

Joe: Right. And so then it’s like okay I can be diversified in my portfolio strategy by buying real estate I can package it up and buy a bunch of properties at a low cost in. So I mean in theory it’s a really good investment if you want real estate exposure and not necessarily be a landlord. Right. But the downside of non- traded REITS is that lack of transparency. So they might say it’s paying 7%. But that 7% is could be the return of your capital which a lot of times you don’t really know you’re getting a dividend check of 7% and they’re not changing the price. You put $100,000 in, you’re getting $7,000 a year.

Andi: You look at your statement back from your $100,000.

Joe: Yeah, yes but on the statement, it still says $100,000 until they reprice the REIT. nd then they’re hoping that potentially that the real estate is going to go up and appreciate in value and then so they can cover their assets right that way. But if the market goes down like we saw in 2008 I mean that’s what blew a lot of people up. And then also they start repricing these non-traded REITs and it’s like what man I thought it was worth $100,000 it now gets repriced at $35,000. You know like what the hell just happened. So I don’t like the lack of transparency but in a bull market, you can hide anything. Warren Buffett said that you know but then “when the tide comes in you can see who’s naked” or whatever. Traded REITs: you can buy like an exchange-traded fund, a mutual fund. So there’s a lot more transparency there. So I mean you’ve got a net NAV. The pricing will fluctuate depending on the value of the overall securities within the fund. I like that a little bit better. If you want to get out of it, trade it, buy more, buy less. It’s daily liquidity. And then you still get the same exposure of the real estate. So there’s pros and cons to each but I’m a bigger fan of the traded one because they’re a lot less expensive. They’re liquid and they’re transparent.

Andi: Okay. So overall for Steve and other people who are trying to consider you know what they should do about alternative investments, how should they look at these things and what should inform their decision about whether to make that an alternative investment?

Joe: Well, I don’t know if I’m equipped to give that advice because if you look at let’s say Yale’s endowment, which is one of the best investments. About 33% of their overall portfolio is in alts – and they’re in hedge funds. But they have access to different managers than a lot of people that listen to this show. So it really depends on their goals, what they’re trying to accomplish, what their risk tolerance is, how much capital that they have, do they even qualify to get in any of this crap anyway. I would say for the average investor I would probably not necessarily venture into it. But like I said before if you’ve got a couple of extra bucks that you’re willing to lose 100% of it then you know buying some bitcoin you know trying to get into you know a little private equity. But you know most of the time you need a lot more money than that or you know being an angel investor. You’ve gotta be a multimillionaire to do some of this stuff. So you hear the alternative investment kind of slogan because some of this stuff is super sexy, super cool. You watch Shark Tank. You know those are angel investors and hey let’s get in the mix you can see all these new — there’s a story behind it. Here’s this company that’s doing X Y and Z and then you get excited and it’s like Oh my God I’m gonna be a millionaire overnight.

Andi: Then you start to relate to them. Then you feel you know and care about them.

Joe: But that’s not necessarily investing, that speculating. That’s like OK, well here let me put a little bit down just to try to make a billion dollars versus your investment strategy should be watching grass grow should be extremely boring. It should be predictable in a sense where you know what’s going to happen if markets are volatile

Andi: So don’t let that greed get ahold of you.

Joe: That’s right.

10 key decisions can help you target long-term wealth. Learn what strategies will improve your odds of long-term investing success in our free white paper, Pursuing a Better Investment Experience, newly updated for 2019. Seriously, fresh off the press today! You can download it from the podcast show notes at YourMoneyYourWealth.com – click the show notes link in your podcast app to take you there. Now let’s get to some more of your money questions and comments. Go to YourMoneyYourWealth.com, scroll down and click “Ask Joe and Al On Air”. You can send in your comments, thoughts, compliments, complaints, and questions as an email or as a voice recording…

18:56 – What About Risk Parity Investing for Better Returns?

Joe: Just like Jason did from Seattle.

Jason: “Hey guys. Appreciate the show. It’s good fun. Wondering what your thoughts are on risk parity investing specifically mixing equities with long term treasuries, with maybe a small slice of gold to achieve higher risk-adjusted returns? Historically it’s worked pretty well but interest rates have been falling for 30 years now. So I wondered what your thoughts are on the strategy going forward? All right, thanks a lot.”

Joe: OK. Jason was in like a wind tunnel.

Andi: He told me he actually recorded that on his iPhone.

Joe: I like it.

Al: Yeah he may have just gone for a jog. He’s out of breath.

Joe: Well no, you know what? It’s our stupid computer little button there.

Andi: He did say that he had to hit the button seven times.

Joe: He was out of breath because the thing sucks.

Al: That’s probably true. Risk parity. That’s a good word.

Joe: Yeah, risk parity. So risk parity investing is… how do I explain this real simply? A lot of hedge funds do this type of investing, and you’re right Jason, you’ve done a little bit of homework. Historically, risk parity investing has performed higher expected returns. You know then maybe like a normal 60/40 split. Here’s how it works. How most people invest, or I guess most professionals invest is that we’ll take a look at a certain target rate of return that a client needs to achieve. And we try to mitigate that risk as much as possible. And so that is based on the roots of modern portfolio theory.  And so it’s any level of risk that you’re willing to take, you should anticipate a certain expected rate of return and then that pops out a portfolio of maybe 60% stocks, 40% bonds. And then you look at the bond component of that portfolio and the stock component of that portfolio, stocks are a lot more risky than bonds are. So a lot of the risk if you really get into the technical stuff of like Sharpe Ratios and all of that is that most of the risk that’s performed in that portfolio is done by stocks. Would you agree with that?

Al: Yeah.

Joe: Because bonds are fairly safe depending on what type of bonds you own. So what risk parity investing does it says let’s look at the risk side of it and they use leverage. So they’ll say OK I want a certain target risk of let’s say variance of standard deviation of 11%. But I want to have that target 11% risk equally weighted by stocks and bonds. So if that were the case let’s say you have a 60/40 split but so much of your risk is by your stocks, I want the same risk parity if you will, but my portfolio might be 80% bonds and 20% stocks. But if I look at the expected rate of return of an 80% stock 20% equity portfolio, a 60/40 split is going to be a lot higher expected return.

Andi: Wait, wait, wait. Say that again, because you said 80% equity 20% stock.

Joe: I’m sorry. Mine would be 80% bonds…

Andi: 20% equities.

Joe: If that risk parity was equal. But if I have 80% of my portfolio in bonds, my expected rate of return is going to be a lot lower.

Al: Yeah, than 60/40, correct.

Joe: Than 60% stocks. Because I only have 20% of my portfolio is subject to risk. So what do I do? I lever. I add leverage to the overall portfolio. So, in that case, I would two times lever that thing up. So now I’m going to have a higher expected return just due to the fact I’m adding more risk to the equity side of the portfolio. But there’s less equity component of the portfolio because I’m adding leverage. And Alan, explain leverage.

Andi: That was gonna be my next question.

Al: I guess simply put if you want to buy $100 worth of stock, it costs you $100. But if you want to buy $200 worth of stock, one way to do it is to invest $100 and borrow $100. So now you’ve still invested $100 but you’ve borrowed another $100. So you have $200 invested in the market and leverage is great when the market goes up because in that example you double your return. But it also kills you terribly on the downside because it doubles your loss.

Joe: So you’re putting more money in safer asset classes. Less money in riskier asset classes and you’re adding leverage to the riskier asset classes to get your higher expected return up. But that all works out perfectly in a mathematical equation.  But then there’s a cost to all of this. There’s a cost of margin, there’s the cost of the leverage.  So how much are you actually paying? If I’m an individual investor, it’s going to cost me a lot more than if I’m an institution. So that’s why hedge funds probably do this a lot better than you know maybe Jason from Seattle can. So parity investing I guess in a nutshell is how it works. So he’s looking at you know, I really simplified this. You can use several different asset classes I just use stocks and bonds.

Andi: And he’s talking about equities long term treasuries and maybe a slice of gold.

Joe: He’s still talking stocks and bonds. So because you have to have an expected risk-adjusted expected return your bonds need to be higher than your stocks. That’s why he’s using longer-term treasuries. Treasuries are a very, very safe investment. If I go a little bit longer on the yield curve, you’re going to get a higher expected return on that. So that’s why he’s using that. And then you throw a little bit of commodity in there you know mash it out with some derivatives. We got a whole little piece of pie there. So I don’t know. Try it, bud. I’m a fan of it but it’s really hard to execute. It’s pretty expensive depending on where you go. I mean there’s ETFs right now that are doing this type of investing. It’s been around since the ’70s. AQR is one of the better alternative firms. They’re like the DFA of alternatives. And so they have a parity fund, you could get into that. I’m not sure what their minimums are. I’m not recommending anything, but Jason’s a good listener and I thought I’d not leave him hanging.

Andi: And so what do you think about the idea of using leverage for this, too risky?

Joe: No. I mean it depends on your goals, your timeframes and what you’re trying to accomplish. I mean everyone uses leverage every day. If you have a mortgage, you’re using leverage. If you use credit cards, you’re using leverage. If you have any type of loan, you’re using leverage. It’s just how are you going to manage the leverage that you’re currently using. People get greedy because they see the returns of leverage of what it can do and then 2008 happened and then what happened. Everyone blew themselves up.

Andi: All their leverage killed them.

Joe: Right. Because it’s a double-edged sword. So if I’m looking at it and saying hey I want to take a small sliver of my portfolio and add leverage to it. Sure, but is it worth it. That’s the problem. Because you can do the math, mathematically saying yes, it would probably be worth it to use parity investing just in a bubble. But life doesn’t work in a bubble.

Andi: We’ve had that conversation before.

Joe: Right. You’ve got to look at costs. You’ve got to look at trading costs. You’ve got to look at the cost of all of that combined. And then you have to look at behavioral. Because some of this stuff will take, you need like a pit in your stomach to make it through. It’s patient investing. Because you see the market tank and that leverage is going to go on the other side. And all of a sudden you see that sh*t blow up. You’re like oh my God this sucks. You’re going to get out. You know what I mean. So it all depends. But we’re talking fractional percentages. It seems like a lot of work for that.

Al: So here’s my two cents. For the average person, don’t do it. I’ll just put it that way.

Andi: Jason listens to this show. He is not average.

Al: No, but I mean for the rest of our listeners. I would say this is a much riskier way to invest I think.

Joe: Right. Because you get a higher expected return from it.  And it’s not a lot too, Al, it’s like maybe 50 basis points, 30 basis points. For the average person. Is that really going to make or break? Maybe over 30 years, if you’ve got millions of millions of dollars. But if I’m managing a hedge fund that has a billion dollars, 30 basis points is a lot.

Al: Oh sure. Yeah, that’s different.

Joe: You know your $100,000. Don’t worry about it. Who cares?

Al: Oh, you think I have a hundred now. I’ll always be working on it anyway. So yeah. That’s my two cents is, it’s an interesting discussion but it’s not for most people.

Joe: All right. Yes and we never give advice on this show.

Andi: These are suggestions.

Joe: That was a chat with my buddy from Seattle. Have a little coffee right there at Starbucks. That was so stupid. How many times, if you’re from Seattle I mean how many times you hear that from some jackass in San Diego.

Al: Yeah, well that’s what you say when you hear Seattle.

Andi: I don’t think I’ve ever heard you talk about anything other than beer. I’m kind of shocked

Joe: I know that coming from Minnesota. It’s like, “hey, how’s that greenbelt?”

28:09 – How Much Should I NUA? Should I Take the Monthly Pension or Lump Sum?

Joe: All right. Dan, he’s 58, lives in Florida. “I’m ready to retire.” So he’s been with this company for 30 years. “I have over $1.4 million dollars in this 401(k) plan which is 40% company stock with the cost basis of $46,000. I have a pension that will pay a lump sum of $248,000 or monthly payout where my wife would receive the same amount if I die of about $1200 bucks. If we take Social Security when I’m 62 we will jointly get $3,000 a month. That plus a monthly pension will give us $4,200 which will pay all of our expenses if need be.  My wife and I are about the same age and currently both in good health. I think I will most likely be able to stay in the 12% tax bracket in retirement. I would also like to convert as much as possible from the 401(k) rollover IRA to my Roth each year while staying in the 12% tax bracket. Here are my questions. How much should I NUA? Number two, should I take the lump sum or monthly pension? As you can probably tell, I’m leaning towards a monthly payout. I believe it works out to be about 5.8%. Love your show and podcast, And this is my second time submitting questions.” Oh wow. Wow. Damn. So only one question per lifetime. “Thanks so much for all the great information. You guys rock.” All right. So how much should I NUA? Well, first of all, let’s explain what NUA is. NUA is net unrealized appreciation.

Andi: (simultaneously) Net unrealized appreciation.

Joe: Wow, look at you, Andi.  Okay. So what he’s saying here is, of course, I don’t know my calculator with me today. Let’s call it $700,000. It’s close enough. 47% of his $1.4million is in company stock. So $700,000 is in company stock. $46,000 is his basis. So he bought shares for $46,000. It has grown to $700,000.

Andi: That’s pretty incredible. And it’s all company stock.

Joe: Yes. So he’s asking how much should I NUA? NUA a pretty cool – or not pretty cool, it’s a really cool tax strategy. If you do have company stock inside your 401(k) plan. So I work for XYZ company I have XYZ company stock in my 401(k) plan. The IRS allows me to take the stock out of my 401(k) plan and only pay tax on whatever the basis is. So, as ordinary income, if he keeps the stock in the 401(k) plan, that $700,000. He sells the stock and throws it out. It would all be taxed as ordinary income. Or he could do net unrealized appreciation. So he could move the full $700,000 out the 401(k) plan and only pay ordinary income tax on $46,000. So he’s asking how much should I do? All of it. Who cares? $46,000, he gets $700,000 out. Then yes, all of it. Absolutely, without question. That’s a no brainer. Unless he forgot a zero in saying it’s $460,000 and if that’s the case, well then Dan will be probably sending us a third question. But if it’s $46,000, absolutely do it all, pay the tax. Ordinary income tax. I don’t care what tax bracket that you’re in. $46,000. Move that over. Now you got $700,000 sitting in a brokerage account you can slowly. And then you could sell those at capital gains rates. Then you just want to be careful of selling that stock at a capital gains rate. Just look for net investment income tax which is AGR modified adjusted gross income of $250,000. They add another 3.8% on top of the capital gain. If you go in the highest bracket so if you sell that all you sell the full thing of $700,000 that might put some of that capital gain at 20% so then you would just want to have a capital gains strategy from there.

Andi: And then the question is should he take a pension as a monthly or a lump sum?

Joe: I think he’s already made up his mind there, 5.8% is pretty good. He did the math. I would have to double-check it with my calculator, which I don’t have. But 5.8% is his internal rate of return is what he calculated. So I’m right on board with Dan. He’s on track. Good for you, buddy. Thanks for the question.

33:01 – What Should I Do With a $250K Settlement?

Joe: Maurice. “I want to know your suggestion for a person about to receive a settlement of over $250,000.” All right Maurice. I don’t know, what’s the money for?

Andi: How old are you?

Joe: How old are you? What are you trying to do here? What’re your other assets? What’s your income? What tax bracket are you in?

Andi: Married, single?

Joe: Yeah. Well, a couple more details here for us the answer that appropriately. But in general terms, I would probably, if it was for long term retirement?

Andi: It’s a settlement, so I’m assuming that this is a legal settlement for some case. Is that taxable?

Joe: I don’t know. I have no idea. It could be.

Andi: Okay. So, it’s a lot of information that we need for you to be able to answer this question.

Joe: I have no idea. It could be a structured settlement. It could be or maybe just settled something with someone it was to. I don’t know. Let’s say it’s net $250,000.  But even if it was taxable, then he would have to do some other set of tax planning if it’s ordinary income. But let’s assume Maurice gets $250,000. We get this question all the time, what would you do with it? I mean they only give us this. I would go in a globally diversified portfolio, low-cost, and tax manage it. I don’t know. I mean that’s a stupid answer to a question that doesn’t give me a lot to work with. So Maurice, go to YourMoneyYourWealth.com, go to our Resources Center and I believe there is an investment guide there, isn’t there? Don’t we have something there?

Andi: Talking about Pursuing a Better Investment Experience?

Joe: Yeah, Pursuing a Better Investment Experience.

Andi: That is in our White Paper section in the Free Financial Resources section at YourMoneyYourWealth.com.

Joe: So that can kind of give you an idea of what to think about when you are investing. And then if you want more, then there’s calculators that you can go to, to kind of give you an idea of what that portfolio should be made up of given your risk tolerance, you know age and all that.

Andi: And maybe if you have debt, pay that off before you start investing.

Joe: Yeah. You want to make sure that you have a cash reserve. I mean if it’s for a home, you put it in cash right?

Andi: Right.

As I mentioned earlier, I’ve also put that Pursuing a Better Investment Experience white paper in the podcast show notes. In your podcast app, just tap the link in the description of this episode to get there.

This week on the Your Money, Your Wealth® TV show, Joe and Big Al are talking about how to create a steady stream of retirement income – and you can watch that in the podcast show notes too, and download the companion guide on creating retirement income. All free. There are a ton of free financial resources at YourMoneyYourWealth.com! Now, who do you know that’s thinking about retirement, or should be? How much would they appreciate it if you were to share all these resources with them? If you send them the link to subscribe to the YMYW podcast, you’ll be a retirement hero! What are you waiting for? Oh, that’s right, at the top of the episode I promised a discussion of Social Security break-even. All right we’ll do that, then you’ll share, right? Okay, it’s a deal.

36:23 – When is the Social Security Break-Even Point?

Joe: We got Dan writing in from Fallbrook. He commented on our television show Social Security Secrets. I don’t know if there are too many secrets when it comes to Social Security.

Al: I think that was the title of our show.

Joe: I understand.

Al: It just catches your attention.

Joe: Oh I wonder.

Al: I wonder what they are, right?

Joe: So Dan writes in “While I enjoy your financial insight, I do wish you would have quickly gone into numbers a bit. For example, if a retiree takes Social Security benefits at the earliest possible age at what age would he or she break even? Is it true that most retirees who take benefits at the earliest possible time will receive about the same benefits overall as the person that waits an additional eight years?” All right, Dan apparently hasn’t listened to any podcasts, he’s just watched one, he watched our Social Security Secrets TV show. That was probably one of our worst shows.

Al: We probably didn’t talk about the break-even point.

Joe: Let’s get into the break-even point.  Dan, you’re right. If you look at Social Security as an investment some people look at it as a break-even. So you could use thousands of assumptions here.

Al: And I’ve got a table here which is from FI guide powered by NAPFA, National Association of Personal Financial Planners.

Joe: So I’m guessing. I mean I’ve seen break evens at 78, I’ve seen break evens at 74.

Al: So here’s what they say. And it depends on which age you’re comparing.  So let’s start with the most obvious. The earliest you can take it at age 62 and the latest is age 70. So if you wait instead of taking it at age 62 you take it at age 70. The break-even point is 80 which is kind of — we’ve seen 78, 79, 80, 81, 82. Depends on what assumptions you use. Now if you take a straight line.

Joe: For example, let’s say Dan’s Social Security benefit at full retirement age is $1,000. If he claims his Social Security benefit at age 62 which is the earliest that Dan can claim it’s going to be $750. If he waits until age 70 it’s going to be about $1,300.  So that’s the difference. So Dan’s saying, “hey man, if I take my benefit at 62, even though I’m going to receive a lower benefit and if I live until normal life expectancy, I’m going to have X amount of dollars in the kitty. If I wait until age 70 I’m waiting but I’m going to get a higher benefit but I’m still dying. I’m going to receive the same amount of money from the Social Security benefit,” and that is absolutely true if we had life expectancies in the 1980s. Because the Social Security Administration did not care. But what happened is that what OBRA, the Omnibus Budget Reconciliation Act, then they change a lot of stuff with Social Security but they did not change kind of the life expectancy within it. Because before everyone claimed their benefit at age 65 was their full retirement age and then they pushed it out to age 70 depending on what date of birth you were born. Then they taxed an additional 35% on the benefit. And this is back in the 80s with Reagan. And then Bill Clinton kind of signed it again in the 90s but with all of this stuff and this is coming from Kitces.  Remember when he talked about that?  It’s like what they didn’t do is they didn’t kind of change things for life expectancy so if you took it back in the 80s it didn’t matter. Social Security didn’t care. So that’s why there’s so much more information and noise in articles and questions about Social Security than ever before in the 20 some odd years I’ve been in business. Is that because people are living a lot longer and because of that there are more claiming strategies that people should be educated upon. So it depends on when you die, Dan. If you know when you’re going to die, we’ll tell you exactly when to take it.  But we don’t really know that answer.

Al: So I’m going to add a couple of comments here. First of all, I wanted from this chart, full retirement age is currently age 66. And if you don’t take it, if you took it to 66 versus age 70, the break-even point is 82 at that point, the delta between those four years. But I’m also going to say this isn’t a very relevant question, even though it’s the one everyone asks because the way I look at it is Social Security is kind of like longevity insurance. And now if you need Social Security like there’s a lot of folks where Social Security is 90% of their income – that’s about half of us. That’s about 90% of the income. So if you need the income you’re going to delay it as long as you possibly can work and then as soon as you stop working and you’ve got to claim it the next day because you don’t have any other choice. And so be it. But for the rest of us that have savings and don’t necessarily need it, it’s good longevity insurance for long life and a lot of times the folks that have saved money can afford better medical care and they’re living longer. So I would kind of think of it more that way than trying to calculate the break-even point and even the break-even point so they just told you don’t make any sense if you save it and invest it because then now it’s completely different numbers.

Joe: Because then you look at because God I don’t know maybe that this was 10, 12 years ago, we interviewed Lloyd Watnik and he’s like, “well when should we claim it?”

Al:  Long pause.  We’re on the edge of our seats.  Long pause.

Joe: But he was like, well you take at 62 and invested in municipal bonds that are producing a 5% rate of return tax-free blah blah blah blah blah. That’s the best way to go. But if you need to spend it, I mean that’s a totally different question. So what are you using the money for? Are you taking it and saving it? Are you consuming it? If you’re consuming it, well then if you can push it out, that’s probably a better answer because we’re living longer and a lot higher benefit is probably better off for all of us if you have a little bit more cash flow.

Al: I think another better way to look at this is, is work as long as you can or you’re able to as long as you enjoy your work so you can delay Social Security even if you retire and don’t need it. Push it out because it’s going to be a lot greater benefit. If you’re married, the person with the highest benefits should push it out as long as possible so that whichever one survives the other one will get that higher benefit.

Joe: But then you’ve got to look at it, do you think it’s going to be there?  If you don’t, take it now.  If you’ve got large pensions, do you think means-testing is coming down the road? Take it now.  Or maybe they’ll tax more of it, take it now. I mean there are so many different answers with this. You’ve got the political side of people thinking, “OK well I’m gonna get screwed here so I better take it.” Some people are thinking, I think maybe Dan might be, you know sitting with spreadsheets, figuring out what is the most optimal way here to maximize this. It’s more of a personal question than just about any other question that we get. It’s almost like paying off your mortgage. Let’s say you have a mortgage. Couple hundred thousand dollar mortgage you get a 3% interest rate. And you’re going into retirement. The mathematical financial answer to that is probably to keep the mortgage. Because 3.5% your cost of capital might be 2% depending on your tax bracket. Sounds like okay but I hate debt. I want to pay this thing up. I mean then that’s emotional. It doesn’t make any financial sense but emotional sense if it makes you have that financial peace of mind. That’s going to make more sense because that’s going to put you to bed at night. That’s going to help you sleep.

Al: Or if you keep your mortgage and you spend the difference you’re actually worse off, which is what most people do. So that whole computation is kind of meaningless, really. It depends upon the behavior of the person.

Joe: It’s so just about every answer we give. It depends. We do say that a lot because we don’t know. Yeah. B.S. answers is all we give here.

Al: Well and we don’t know all the facts on all these questions although we do our best.

Joe: Thank you, Andi, for filling in today, it was a lot of fun.

Andi: Thank you, Joe.

Joe: I’m Joe Anderson, we’ll be back again next week. This is called Your Money, Your Wealth.

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You may be retiring in a few months or a few years – either way, claiming Social Security is one of the most important decisions you’ll make for retirement. The Social Security Handbook walks you through everything you need to know: who is eligible, how benefits are calculated, the difference between collecting early and late, working while taking Social Security, the rules around spousal, survivor and divorced benefits, and the all-important taxation of your Social Security benefits –  and that Social Security Handbook is free to download from the podcast show notes at YourMoneyYourwealth.com, along with the links to share this podcast and subscribe. While you’re there in the show notes, don’t forget to fill out my 2019 podcast survey before August 18th for your chance to win a $100 Amazon gift card.

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Pure Financial Advisors is a registered investment advisor. This show does not intend to provide personalized investment advice through this broadcast and does not represent that the securities or services discussed are suitable for any investor. Investors are advised not to rely on any information contained in the broadcast in the process of making a full and informed investment decision.