Why you probably need an estate plan. How financial advisors provide value. And why young Americans would rather talk about their sexually transmitted diseases than their debts. This is Your Money, Your Wealth. Today on Your Money Your Wealth, Joe and Big Al explain the difference between a will and a trust, and why your family will love you for putting sticky notes on that collection of commemorative plates. They’ll also talk to Don Bennyhoff from Vanguard about target date funds and something called “Advisor’s Alpha”. And the fellas bust open the email bag to answer questions on Roth conversions, taxation on day-trading stocks, tax write-offs on retirement contributions and why some great companies have low stock prices. And yes, they’ll also discuss the recent SoFi survey where millennials said they’d rather disclose a preexisting STD to a potential partner than to reveal their debt. Prepare yourselves, here are Certified Financial Planner Joe Anderson, and Big Al Clopine, CPA.
1:00 – Young Americans Would Rather Disclose Their STDs Than Their Debt
JA: Exciting show lined up we’re going to get into estate planning today.
AC: We sure are, Joseph.
JA: Because I think, just simple things that people should know, and there’s also for you folks that live in Southern California, or California in general, there’s that new TOD for primary residence.
AC: Owning real estate, TOD means transfer on death. And that actually avoids probate.
JA: It sure does.
AC: And that’s that’s an alternative to getting a living trust.
JA: So we’re going to talk about death. (laughs)
AC: What else ya got? You talking about diseases?
JA: Diseases? Well speaking of… see, I wasn’t going to go here, Alan.
AC: But I set you up.
JA: You did! You set me up because, all right so our crack research team always comes up with good articles and these people that write these articles, they catch our eye.
AC: Yeah, with the snappy titles.
JA: Yes. This is Financial Advisor Magazine, and, young Americans would rather disclose their STDs than their debts.
JA: Yes. And we talked about student loan debt.
AC: I thought you were going to say that we talked about STDs, I don’t recall that.
JA: No, no that was off the air.
AC: Oh yes.
JA: So this company called SoFi, have you heard of SoFi?
AC: No I have not.
JA: SoFi is a good, it’s a student loan company. And we’re not affiliated with SoFi, it seems like we always have to give this disclaimer.
AC: We sure do, because there’s compliance, always.
JA: Sure. They look at, like, let’s say, if I want to refinance my student loan debt, and I am a physician and I have a couple hundred thousand dollars in student loan debt, but I don’t have a paycheck yet. And my FICO score might not be great because I got a lot of debt, and I now am going to make X amount of dollars. So they have a different way of how they categorize who’s approved and who’s not approved. And so, SoFi came up with this and said, you know, since it’s Valentine’s Day coming up…
Student loan company SoFi has thrown it’s hat into the ring with the old standby of Valentine’s Day. But their marketing called V-Day. And they shorten it up, and it’s VD.
AC: Yes of course.
JA: So here was the pitch, OK. It seems 39% of millennials would rather disclose a preexisting sexually transmitted disease to a potential partner than reveal their debt. According to a survey of 2000 millennials SoFi conducted using Survey Monkey. In addition this survey found that serious debt was the second biggest romantic deal breaker after workaholism.
JA: Yes. I didn’t know that.
AC: And where’s the STD?
JA: I don’t know. I guess it’s OK. I don’t know. “Do you work a lot? Do you have debt? You’re out of the picture.”
AC: STD, not as bad.
JA: But, all right. So they interviewed a couple of people. This individual, she remembers how she was $81,000 in debt after getting her bachelor’s degree in theater at Cal State University of Long Beach and a master’s in performance studies at New York University. So she couldn’t find a job in her field. Well I don’t know, theater and performance?
AC: You’d think you’d get right in.
JA: I don’t know what job she was looking for. So then, after graduation, she was forced on food stamps and working for a 10 hour job in Portland. So she remembers how heightened, she felt embarrassed by going to high priced schools, and she thought she was doing the right thing. Working part time and everything else in between there. And this is going to be a big deal. Right? I think this is just at the cusp of student loan debt. It’s now more than consumer debt. You know we’ll see some tumbling effects when it comes to this. But I guess, what’s your advice? Having two children… and I don’t want you to go on your rant.
AC: You know my feelings. My feeling is that students and their parents should look at this more like a business. And so they should look at, alright, what degree am I getting? How much is it going to cost and how am I going to be able to pay that off? All right. And so if it’s performing arts, you know, wonderful. I love it, but have a plan to pay it off. And if you don’t have the money, I wouldn’t recommend going to the more expensive universities because you could hit it big, but the likelihood is you won’t.
JA: Right, if I want to be a Hollywood actor, it’s going to be, I mean what’s the percentage? It’s just like a professional athlete.
AC: It’s not high. So I mean if you’re going to get trained in theater, then pick a state school. Masters, do it while you’re working.
JA: I think there’s a lot of value though to performance because, I think with any job that you have, especially if you deal with people, right? There’s a level of showmanship.
AC: There’s no question about that. In fact you know as well as I know, that the the folks that have great people skills are the ones that advance in any company, in any endeavor.
JA: Right, if I’m a CEO of a company, I have to relate to the employees of that firm to motivate them to get them inspired. If you don’t necessarily have that type of performance skill, I mean if you’re dry as a bone and very analytical in everything that you discuss, I mean, you can be the smartest guy in the room, you probably have the best ideas, but are those ideas going to be heard? So I think it’s just looking at, all right, well maybe that’s my passion to be an actor or an actress. But understand there’s a fallback plan. If I’m not going to make it in Hollywood, what’s Plan B look like? Really make sure that you have that plan B in play.
AC: I think that’s a good point Joe. So I mean I guess my advice would be, your major would be something more practical. But then you minor in theatrical arts and I know some of you will say, well if you’re going to make it, you have to go for it all in. And I understand that too and for some people they want to go all in. I’m just saying you gotta consider the finances here, and I think in a lot of cases the students and parents have not. And that’s why student debt is ballooning and it’s becoming a big problem.
JA: Because, well, there’s a lot of issues I think, with the student loan debt, is that it’s a lot easier to get that money. And then of course the universities are increasing their price, and everything else because they can get the money.
AC: It’s a circular thing, right?
JA: You got it. I mean the same thing happened in 2008 in the housing crisis right? Well here it’s really easy to get a loan. You know let me get a $600,000 mortgage. I don’t necessarily have the finances to cover the payment, maybe I do an interest only loan for, whatever. And then next thing you know all that resets. Now I have my payment went from $1200 to four grand. Oops. I can’t afford this right. Right? And so it’s just being, I guess, practical on what you’re trying to accomplish too. And when it comes to schooling, and I’m a recent grad, right? Twenty years ago? (laughs)
AC: That’s loosely said! (laughs) I’m thinking’ where are you going with this?? Last year, something I didn’t know about?
JA: Yeah I’m just fresh outta college.
AC: You’ve been faking it for a while.
JA: Yes. But it’s it’s important too, I think, to network early, to get contacts early, because, Al and I interview a lot of individuals with our firm, and you know who gets in for the interviews first are people that might have referred in that we might know. Either through a client saying “hey, you know what I have this niece that, she is really interested in finances, can she come in and mirror, you know, one of your financial planners for a day.” Or it could be someone that another colleague that we work with maybe an attorney or a CPA firm: “Hey, there’s this individual that I vouch for.” You know what, we might not have room today, but we’ll interview that person, versus just getting that cold resume you know through your e-mail box. It’s pretty challenging, because most of the time it’s like, delete. I don’t necessarily have time, and, you know, half the resumes that we see…
AC: Yeah, and you know when you get those resumes via e-mail you know they’ve probably sent out five hundred just kind of a shock kind of approach and hopefully someone will respond and I’m not saying you shouldn’t do that, but you’re absolutely right Joe, and that’s true of anything. I mean whether you want a contractor to fix something in your home, you want a referral from a neighbor. Our fence blew down in the in the last major storm of 2017 (laughs). So what do we do. We went to our neighbor two houses down. Because their fence blew down about six months earlier. I guess they’re all going down right now (laughs). 28 years old. That’s I guess how long they last. And so they have a person, I went and he was actually doing another fence in the neighborhood where he got another referral. I looked at his work. He gave us a great price. I said great. So yeah, course I’m going to hire him I don’t even need another quote.
JA: Or you can kiss ass too. Philip, our intern, right? He’s getting his degree at San Diego State University in San Diego. He sends me an e-mail, says, “Joe. I’m a huge fan of your TV show. I get up at 6:30 in the morning and I watch your TV show, you and Big Al are great. I listen to the podcast. I’ve learned so much from that.” He goes “I’m really interested. I’m getting my CFP certificate. I’m going through this program at San Diego State. Do you think I could just spent five minutes of your time.” Of course! Philip, come on in buddy! Right? And that guy is a stud. He interned with us, and I’ve just offered the guy a full time position with the firm.
AC: There you go, there’s a little secret for you people that are trying to get in business, that’s a great way to do it.
JA: Right. And I understand student loan debt. I had student loan debt, I paid for my own schooling. And it’s just a necessary evil, but you have to be a little smart about it. And I know we don’t have a lot of younger individuals that listen to this. We had Listen Money Matters, Andrew on last week and his podcast is really up for the younger generation, saying “hey, get your stuff together. You know, we can sit around have a beer, but be responsible – your money matters.” Because, I think there’s a lot of insecurity when it comes to money. This article, even though, you know, it catches your eye, STD, I don’t know why it caught my eye, but whatever. (laughs) But it’s like, OK, well most people would rather say “yes, I have a really gross disease,” versus telling you, “you know what, I’ve got about $50,000, $100,000 student loan debt. I feel more comfortable talking about that.” That proves that there’s an issue, there’s a problem in all ages when it comes to money. It’s this weird thing that we have because it’s so important for us to deal with our everyday life. But we also need to approach our fears, I think, and identify what do I need to do to be successful. So if you’re 65-70, looking to retire, do you got your ducks in a row or if you’re just getting out of college and you’re buried in student loan debt, what are the strategies that you need to do? So, I think it always boils down to a plan, a strategy on how to tackle all this.
12:11 – The Importance Of An Estate Plan
JA: Want to get into Alan’s favorite part of the show, it’s called “Big Al’s Crazy List.” What do you think about that title? It’s a work in progress.
AC: Yeah I like it. We need some more marketing help. It doesn’t sound very cool. And here’s kind of a startling statistic: nearly 60% of Americans don’t have wills. 60%. Only 40% have a will or a trust. And then when you break it down even further, baby boomers are OK. 58% have a will or trust. 81% of those 72 and above, that’s better. But Gen-Xers, Joe, your generation, only 36% and millennials only 20%. So we’ve got some work to do when it comes to estate planning and I think most estate planning attorneys recommend that, boy, I mean, once you’re, certainly by the time you’re going to college, you need at least a basic will. And if you die without a will what happens is your assets are distributed in accordance with state law, which may or may not be what you want. And also, if you have kids they’re going to go however the state thinks they should go. Not necessarily what your wishes are.
JA: Well I know you got a list there, but, question for you. What do you think? What advice would you give? I mean, when would someone want to consider looking for a full blown estate plan, a trust and all the bells and whistles.
AC: Yeah, I think, Joe, in California, which is where we’re at, I think once you have children and/or once you own real estate, I think a living trust is appropriate. And the reason I say that is because you basically have two choices: you can have a will-based estate, or a trust-based estate.
JA: And we’re not estate planning attorneys. Full disclosure.
AC: No we’re not. We’re not. Yeah. Very good. Thank you. Basically that means don’t listen to a thing he says because… (laughs) anyway, but a will-based estate just simply means that your assets get distributed in accordance with your will. It’s a legal document, but you have to go through court to get it to be official. That’s called probate, and probate, Joe, can be 4% of your estate, 5%, 6% of your estate, just depends upon the dollar amount.
JA: So I think that’s why younger people don’t necessarily- “I don’t have any assets.” But yeah I think as soon as you get married, have a child, you know, have some children, or if you buy a primary residence, because if I have IRAs and 401(k)s or things like that, well that has a direct beneficiary designation that can go to, you know, whoever that you name right on that form. But then, if I have assets outside of those retirement accounts, that’s where things get a little bit tricky. So what do you do?
Big Al’s List: Estate Planners 11 Tips for the New Year
AC: I got my Estate Planner’s 11 Tips for the New Year, which I don’t think we’ll do all of these, but we’ll hit a few of them. The first one is write a letter. In other words write a letter of instructions. Even though you’ve got the full blown estate plan, you got the trust, you got the wills you got the financial power of attorneys, you get the health care directives. You should have a letter of instructions for things that are not necessarily in there, like where you stored sensitive documents, maybe what those passwords are, what you want to do with certain, you know, I don’t know, photos, pictures and mementos in your home, that sort of thing, that’s not necessarily part of that estate.
JA: So, my grandmother recently passed, she was in her 90s, and she named my father and my uncle, the successor trustee, my grandpa – well, when my grandfather passed away, then she named my dad and my uncle co-successor trustees. The first mistake. Because what would happen when my father and his brother would get together, family get togethers, you know, the barbecue, thrown down a couple of beers, they would start already planning Grandma’s death. “Well, this is what we’re going to do.” “No, you don’t know what the hell you’re talking about.” Right, so they would argue and fight. And then lo and behold, my father dies. And then a couple of months after that my uncle dies. And so my grandmother, who does she go to.
AC: She goes to you.
JA: Yeah, yours truly. You know what I told her? I said “No way. The last two people that had that job are dead! It’s dangerous!” So anyway, I took the job right? But she was a quilter. She quilted a lot of stuff, she had a lot of arts and crafts. You know all these different mementos. So, when she passed away, we’re at the house. And so my aunts are there, and they were like “well, where’s the letter?” And I was like “oh I don’t know. You tell me.” “She said that she was going to like put little sticky notes on all these different quilts and who they were going to go to.” Yeah, never happened. So then they’re like, “well, no I want that!” So, what, it would take you half an hour to maybe to bust that thing out? So from personal experience, it’s very, very important. It just stops all that unnecessary drama after someone passes. You should be mourning and celebrating the life, versus bickering about who’s going to get a stupid quilt.
AC: You know, that’s so true. I’ve got a story too. My grandmother passed away several years ago and she liked to collect plates.
JA: Sure, yeah, or spoons and knives…
AC: Whatever may be, right. So I guess there’s a whole community of people out there where you get these designer plates and they’re superimposed on them is like a painting or something. And she had, I don’t know how many plates she had. It was in the thousands.
AC: I think so. However, not all of them were valuable, but the ones that were valuable, I remember when we went up to her apartment after she passed, and it was my dad, and my uncle, and several family members from both sides, and every single plate that had value had a sticker on the back with a name on it.
JA: So she was tight on it.
AC: She was tight. Yeah. And so I still have my plates.
JA: Oh there you go. Very cool.
AC: Yeah. They’re in the garage. (laughs)
JA: Yeah at Thanksgiving they come out.
AC: Yeah, if I could find them. But anyway that was very sweet of her and I know where they are. And I could always look at them if I want to. (laughs) However, when it comes to estate planning which is a nicer way of saying death, by the way.
JA: But estate planning is not always about death. It could be about disability.
AC: Boy that’s true. In fact, Joe, when you get a living trust, it’s not just for your passing, a living trust has a lot of living documents, including…
JA: This is not legal advice.
AC: Yes. Thank you. (laughs) Clearly a financial power of attorney, here’s why this is important. Like let’s say you get injured, and you’re incapacitated, and all of yours and your spouse’s money is in your IRA? Well, unless there’s a financial power return attorney your spouse doesn’t have access to your IRA, so they got to get a court approval on that.
JA: Right. Conservatorship.
AC: Yeah conservatorship and so a financial power of attorney takes care of that and then health care directives. That’s really important too because if something happens to your spouse the doctors may or may not want to even talk to you without those directives
JA: HIPAA. (Health Insurance Portability and Accountability Act of 1996). It’s not the animal, right (laughs)
AC: Hippo, HIPAA. (laughs)
JA: Yeah that’s very important too, when it comes to medical records. They won’t even share it with spouses so there’s a lot of different documents that you have.
AC: So here’s some things you got to consider with regards to estate planning. One is to review and potentially revise your beneficiary designations. And Joe, that is so important because sometimes people name, let’s say their parents, years ago and they’re now passed away, or they named a spouse, and they’ve gotten divorced, and they think that they got all this estate planning then they got the trust that says everything goes to their current spouse and kids, whatever. But no, not when it comes to IRAs, 401(k)s, Roth IRAs. It’s the beneficiary designation that supersedes the trust.
JA: Right. 401(k)s under ERISA law. So your current spouse will be the beneficiary of that account, but not IRAs and not 403(b)s. So be careful there.
AC: Ok, So I stand corrected.
JA: So let’s say if you have an IRA, individual retirement account, you had an old 401(k), or you’re retired, most people, like once they get later in age, they’ll have IRAs versus 401(k)s because most people will want to consolidate. You don’t have to by any stretch, but I think that’s what most people do. But that IRA, you can name a different beneficiary than your spouse. So if you have an ex spouse, and especially if you have like a Brady Bunch type family? Right? So what that means is that I remarried, I have kids from a previous spouse, maybe my new spouse has kids from their ex-spouse. And then when you look at retirement accounts, it’s like well I want to make sure that my current spouse is taken care of, but then hey, if she were to pass, I don’t necessarily want that money to go to her kids, or his kids. I wanted to go to my kids. So it gets complex, so you absolutely want to make sure that you understand, A, what is the law when it comes to beneficiary designations. And I think that’s one of the most important estate planning documents that we have. Most people overlook it, or they don’t necessarily truly understand the power of it, because what Al said is that that supersedes your living trust. It supersedes a divorce decree. I mean that is it. That is the document.
AC: Right. And we have seen cases like that where the money went to some other place than was certainly intended. Joe another one is is sharing your passwords, and this would be akin to maybe adding that to your letter of instructions that we just talked about. Now don’t share your passwords with everybody, but you have a special document that shows your critical passwords. It’s in a place where the important people in your life know where it is and they can go to it and access it if they need to. And you talk about nowadays it seems like everything is online and digital and without passwords, going back to, you know, you’re incapacitated. How is your spouse going to even pay the bills? Don’t even know how to get into online banking.
JA: Yeah – checkbook? Never heard of that. What’s the most common password?
AC: Password. That’s the word, password.
JA: Right. Yeah. Who’s on first? (laughs) Or 123456. You’ve got to get a little bit more creative.
AC: Yeah at least do 54321. (laughs)
JA: Or something. It’s crazy. It’s like I have this sheet of paper in my office. It’s actually in a safe. (laughs)
AC: It’s in his top drawer. (laughs)
JA: It’s basically on a sticky note.
AC: Right next to your computer monitor.
JA: It’s on my computer monitor. Yes that’s exactly. Confidential. (laughs)
AC: Do not read.
JA: I mean how many passwords do you have. It’s so annoying. And you know, what most people do, we shouldn’t do is just kind of get the password that we like.
AC: Yeah and just keep using it over and over again.
JA: Oh, my Apple password? I had to restart my Apple phone like five times because it’s like, “well what the hell is it again?” Oh man I really want to get this app! Declined, declined. Wait a minute! I know where my passwords are, they’re in this app. Well what’s the password to get into this app! Dammit!!
AC: Well it’s so funny. Talk about our iTunes and Apple password with Anne, I would say that some of this stuff, I mean, she’s a people person, not a technical person and this whole password stuff, and her her Apple account, we have changed the password so many many many times because… and then you forget it. And so then you have to reset it, and then you do something different, and they say we can’t use the same one as last time, oh I didn’t know that was the one. So then you redo it. And then now she still tries to get on and she’s putting in her Google password for Apple. No that’s Google. Well I think this is confusing! According to this article, there are apps out there where you can track your passwords, like, they recommend an app called Keeper Security. I haven’t used that. I actually got one of those apps and it was too complicated. (laughs) Couldn’t figure it out. So what I did is I have all my passwords on my phone in notes, but I have learned how to password protect my notes. So, with my finger. So I suppose if I’m lying there on the ground you can put my finger on the phone. (laughs)
JA: Which finger is it, Clopine?
AC: I’m not saying, you have to try all ten! (laughs) So here’s another one. This is important. Buy burial plots.
JA: How about if I want to get cremated?
AC: Well then buy a cremation service.
JA: It’s a big business.
AC: I guess. Yeah. But how about this, reviewing life insurance. I think that’s certainly important for a lot of people especially, you think about why you have life insurance, if you are the main provider, you know, for for the finances, for the company, for your family I should say, from your salary? And if something happens to you, your family would be in trouble, that’s why you have life insurance.
JA: I mean, most of you right now listening to this are way under insured. And I know life insurance, it’s like, “do I really want to get it” and this and that. But you know, just get maybe 10-20-30 year term policy. You don’t have to do all this funny business with whole life, variable life, and everything else like that. You know it’s very cheap, inexpensive. But what I found doing this for many years is that there’s this sense of relief. You know, it’s like OK, I travel a lot for work, I do this, I like to do that. You know, I do different activities and I have a family and I’m the breadwinner. And once you get it, it’s all of a sudden, ok. Now I kind of feel that, well I’m the provider of the household, or both of spouses are providers. Just make sure that you get it, get something cheap. Be careful with group insurance when it comes to life insurance. Don’t ignore it. If your company offers it but in most cases, unless you get hit by a truck, you’re going to get sick first. You’re going to leave your job because you’re sick, because you’re on your deathbed, and then you pass. So it’s not going to cover you. So you want a stand alone policy. Like I said get a term policy, go with an independent agent, shop it around. But once you do get it, trust me you will feel better.
26:47 – Joe and Big Al are always willing to answer your financial questions! Email firstname.lastname@example.org
JA: This is from George. “I have a question regarding Roth conversions. I’m in my 40s and have $170,000 in a rollover IRA and $50,000 in Roth. Should I withdraw the money from the Roth IRA to pay the conversion taxes today and convert the rollover IRA so future growth and withdrawals are tax free? Is the goal to do this as quickly as possible? Or does it matter if it takes 15 years? Let me know your thoughts.” Well first let’s explain the conversion.
AC: OK. All right that sounds good. So a Roth conversion is when you have money in the IRA, which you have $170,000 in a rollover IRA. You’re allowed to convert all or part of that at any given time to a Roth IRA. You will pay tax on what you convert but once it sits in the Roth IRA all future growth income and even principal is tax free, for you, your spouse, and your kids. So whoever gets this Roth, with you or someone else eventually, it’s tax free to them. The downside is you’ve got to pay the tax. So a couple of things, number one is, you want to be cognizant of your your tax bracket. So if you’re let’s say you’re in the 25% bracket, and you’ve determined you’ll always be in that bracket, or maybe even higher later, well convert up to the top of the 25% bracket. Maybe that’s $10,000, maybe it’s $30,000. You wouldn’t want to do all 170, because that would put you in too high of a tax bracket. The second thing is, it’s highly recommended that you pay the tax with non-retirement funds. OK, so what that means is you would have money in your savings account, in your trust account, your brokerage account, outside of retirement. That’s the best funds to actually pay the tax with. Right? Because then you’ve got as much money in the Roth as possible. Now there are cases where you don’t have money in your savings account or the trust account to do that. It’s a little bit trickier. You may actually have to use a little bit of your Roth money or your rollover money, but then you’re sort of defeating the purpose. So if that’s the case, it’s just going to just take a little bit more analysis.
JA: Yeah but I would say, George this is what I would do. All right, so you’re in your 40s, let’s just say you’re 40. You’ve got $170,000. Well, let’s say you do $10,000 a year. First of all look at your tax return. What tax bracket are you in? And that’s line 43 on the tax return. It’s second page of your 1040 halfway down. Take a look at that, and then look at the tax tables to see how much room that you have in that current bracket. Then convert to the top of it. Or maybe you just want to do a smaller amount, maybe you don’t necessarily have to max out the brackets, because you’re young. All right? So you’ve got plenty of time. Let’s say if you want to retire at 60. Well you got 20 years to get $170,000 into that overall account. So you could do, I don’t know, $7-8-10,000 a year, pay a little bit of tax, a couple of thousand bucks in tax to do that. You just change your withholdings.
AC: Just cash flow your salary.
JA: You got it. Cash flow. Because then you just think of it like this is that, each conversion that I make of that $10,000, and then I mean a few thousand dollars in tax, well, I change my withholdings a little bit. I’m not going to have a huge tax bill at the end of the year. It might work out pretty good that way. Now you have a large chunk of money because that each dollar that you put in there is going to grow 100% tax free for you. You already have $50,000. I would hate to see you take the money out of the Roth to pay the tax because you have so much time.
AC: Yeah, you sort of go backwards.
JA: But here’s here’s a rule too. So people are thinking “well he’s in his 40s, he can’t take the money out of the Roth.” Not necessarily, because Roth IRAs have FIFO tax treatment, first in first out. So any dollar that you put into the Roth IRA you can always pull out tax free no matter what your age is. That has nothing to do with 59 and a half. That’s your money. But the growth of that money needs to season in the Roth IRA until you’re 59 and a half to pull that out tax free, or five years, whichever’s longer.
AC: And we should say That’s relating to contributions, not conversions. Conversions have a different rule. But if you do a Roth contribution you can always pull that money out well before 59 and a half.
JA: Right. So if you do a conversion let’s say at 40. All right if I did a conversion at age 40 I still have access to that conversion money before 59 and a half. But I just have to wait five years. So I have to wait until I was 45 to take that conversion dollar out. If you’re going to wait if you’re giving me the money in five years don’t do the conversion to begin with. So yeah there’s two different five year clocks when it comes to conversion dollars. Another thing if you’re under 59 and a half, and if I’m doing a Roth IRA conversion some people will withhold taxes, because any time you might say, all right, well here, I’m going to convert. I talked to my custodian, or maybe your advisor that’s not necessarily familiar with tax law and say I would like to convert $20,000. All right well how much would you like to withhold because you’re going to have to pay taxes on that. Well let’s withhold 20%. All right well now you just blew yourself up because that withholding, they’re going to withhold that for taxes. That’s that’s not qualified as a qualified distribution. Right. Because when you get a 10% penalty on that withholding.
AC: That’s that’s absolutely right. Couple more thoughts for George. Sometimes people get bonuses at year end, or first quarter, or whatever it may be, instead of spending your bonus, use your bonus money to help pay the Roth tax. That’s one thing. Also sometimes people get tax refunds because they have too much withheld – use that tax refund to pay the tax. You don’t want to use your Roth IRA to pay the tax.
JA: Right, just find any other means possible and if you don’t have… I mean, we gave you some pretty good ideas and if the last resort is to pull from the Roth, I wouldn’t do it at all.
AC: Yeah I agree with that.
32:41 – Interview: Vanguard Senior Investment Strategist Don Bennyhoff
JA: It’s that time again we got Don Bennyhoff, he’s on the line. He’s from Vanguard. Vanguard is the largest mutual fund company. He works as a senior investment strategist for the investment strategy group over there. He’s a CFA, chartered financial analyst. He’s written many articles, and so, this article that I’m very interested in, it’s called “Advisor Alpha.” And so instead of Al and I talking about it, I thought let’s just go to the horse’s mouth. Let’s get Vanguard on the phone and see you, where did the genesis of this whole article come about. So that’s why Don Bennyhoff is with us. So Don welcome to the show my friend.
DB: Well thanks very much for having me.
JA: Just give our listeners just a little bit about your background and then we can kind of dive into this article about Advisor Alpha.
DB: Sure. The last 19 years I’ve spent at Vanguard, primarily in the role I’m currently in, as a strategist. Prior to that I was a financial advisor myself for about seven years. So we try and wear both hats from both the advisor perspective as well as maybe the industry perspective too.
JA: You know, Vanguard is the largest mutual fund company, I think you brought in like $47 trillion last month. Give or take a couple of bucks (laughs) and a lot of people use Vanguard more as a self-directed type vehicle. But I thought it was very interesting in a very well thought out article talking about, maybe on the advisor side of things. And I know that Vanguard now is developing more of more advice driven type programs. But let’s dive into Advisor Alpha. What actually is it?
DB: Quite simply it’s just trying to help advisors explain their value proposition. We’ve been providing, as a former advisor, we certainly always believe that advisors can add some value. Vanguard itself hasn’t always been quite enthusiastic about supporting advice because most of the time it was done in a transaction-based relationship, and more and more it’s in a fee-based relationship. For many advisors we were hearing that they were struggling with their value proposition because in a fee-based world, clients wanted to know what they were going to get for that advice, and sometimes the best strategy, or the best move for the portfolio, is to not move anything around in response to the market, right? So a lot of advisors were looking for some help in that regard and we thought we could help them. So the Advisor’s Alpha we see as the framework for how an advisor can add value to the relationship. And in many cases we just believe that it’s not about so much investment strategies per se but the advisor themselves, them being part of the picture to help guide investors through those overly good or overly bad times that can really make a difference in where the advisor can add a lot of value in the relationship.
JA: You know you look at the Behavior Gap, you know, Dalbar does their study, and you take a look at the average investment return versus the average investor return. And it’s funny, every year that that thing comes out it’s shocking to me that we still tend to buy and sell at the wrong time. And I think you’re right. One of the main focuses of a good fee only financial advisor is really to understand the client’s needs, wants, risk tolerance, cash flow needs, taxes and everything else in between, but then coach them through those bad times. And it’s still funny that the differential of the investment return versus the investor is staggering. It’s it’s not even in the same ballpark.
DB: Yeah it’s a real challenge and we do see that as really a people problem. So, quite frankly, it’s one of the things we talk to advisors about just as much as we do to individuals from the standpoint that that people have a tendency to believe a lot of the press they hear, or maybe they react overly conservatively by taking in some of the headlines whether it’s Brexit, or the U.S. elections, or you know, the events of Fukushima. They see those things as very significant and they react to them. But really, those are the headlines in the marketplace, but really don’t have anything to do with their portfolio, which was built by advisors typically, based on what the clients said were their most important goals, how they felt about risk, and so forth. So we do a lot to try to help people see that as a behavioral challenge, and help advisors and investors understand that they should react to the headlines in their lives when they’re approaching retirement, or they have a child, or they’re planning for college, rather than reacting to the headlines in the news.
AC: Yeah, Don, about a year ago you did write that investors should pay attention to the headlines of their lives not the headlines in the news, and I think that’s so true. But still, we’re emotional. We want to we want to react to the headlines in the news. So how do we combat that?
DB: It’s a great question, and it’s a great challenge. We do see information as something that needs to be taken in. We’re sort of surrounded by it. We live in sort of that instant news culture whether it’s coming across the television, or our smartphones. Now a lot of investors have the ability to do transactions right on their smartphone after they get a text or an e-mail about whatever just happened. They have easy access to executing on it, or doing something about it. So it is a challenge. We like to think that investors, like most people, can probably can probably benefit from having a coach involved, having an advisor involved. It takes a really unique person to have the discipline to set a set all that aside and not need some help along the way.
JA: So keeping people in their seats I guess is a component of Advisor Alpha. What other components did you guys look at?
DB: Well there are some things regarding investment strategies. Helping people to find the asset allocation that’s right for them. Many people get tempted to try for the highest returns and sometimes they they really don’t need them. We like to look at it from the standpoint of investors should be focused, or setting their benchmark for success, around the required return which is based on those goals and objectives from the financial plan, and the things that investors said they were really most interested in being successful in trying to achieve. So there’s the asset allocation, there’s investing cost effectively, not only just from the expenses of products like mutual funds and ETFs but also considering taxes and what you might do to lessen the tax bill that ends up getting sent to Uncle Sam. So there’s there’s a number of different means for adding value just beyond the behavioral coaching.
JA: And we’re going to have that article on our Web site, “Advisor’s Alpha,” it’s by Vanguard. I got another quick question for you, because I know that you’ve done a lot of work with target date funds, and we get a lot of questions on target date funds. And can you help our listeners to see who would be a good candidate for a target date fund, or is everyone a good target for a target date fund, and maybe what are some of the pros and cons of those?
DB: To start at the beginning, I think anyone can be a good candidate for target date funds. Most of them are constructed more similarly than differently. So paying attention to the cost certainly is one factor you might consider. But most of them follow some sort of glide path where, you know, earlier as a younger investor, they have a higher equity allocation, and gradually that declines to something more balanced as you approach or enter retirement. So I think anyone can benefit from a structure like that. But that being said, it’s not the only choice. There are other choices out there. There is the target date fund or target retirement offering. There are also things like target risk funds. They may be your more traditional asset allocation type of funds, where it’s a blend of different stocks and bonds, and maybe cash, things like that. The main difference between those is that the target date fund really only requires you to know your expected retirement date and let the rest of it work for you, you just pick the plan or the fund that works for that date. On the other hand, when you start to move into an asset-allocation-like product, or target risk product, now you have to do a bit more self-assessment to understand your risk and reward dynamics, and figure out what asset allocation is right for you too. So target date products can be a useful tool for most anyone, but they’re certainly not the only option out there for investors.
JA: You know when I find, I think it’s a great solution, but I think still most consumers, I don’t think they know how to use them. Because typically, we’ll see someone that will use five different target date funds. And it’s like, well, what target date are you shooting for? Maybe you can help me clarify, but my understanding is if you’re going to use a target date fund or target retirement fund, all the money should go in that fund, because with the program itself, it’s basically allocating your entire portfolio appropriately towards your target date of retirement. But if I have a target date fund of 2025, 2030 and 2040, I mean, isn’t that defeating the purpose a little bit?
DB: We tend to say yes. We tend to structure our target date funds with sort of that five years, as you said – you know, 2025, 2030, 2035. Not everyone does though. So it is sort of subject to the funds that you have available to you. So you’re retiring in 2025, but you only have a 2020 and 2030 option, you could sort of understand that. I don’t think people need to over think that aspect of the plan too much. I think, really, the heavy lifting for retirement planning and so much of investing isn’t the choice to save at all. I think the asset allocation and things like that tend to be the beginning, but I think actually that aspect of saving and investing to begin with, and saving to your retirement accounts, tend to get overlooked in terms of their significance.
JA: I think that’s well said Don. I think the bigger problem is people not necessarily saving enough, versus, you know, how cute I can get with my asset allocation, or should I pick a target date fund versus my own allocation. You know when you’re only dealing with, you know, $14000 and I’m 65 looking at retirement, it really doesn’t matter.
DB: Yeah it’s definitely one of those things where I wish people would spend more time figuring out how to eke out an extra percentage or two to their retirement contributions, rather than worrying as much about the right asset allocation. In the end it’s really the savings and contribution that do most of the heavy lifting for investment portfolios.
JA: Hey Don, I appreciate your time. Any last words of wisdom for our listeners?
DB: I appreciate the opportunity. I think we certainly like to encourage people to contact us, or their advisors, for questions. I think people have resources available to them and they have good questions, but sometimes they’re reluctant to actually act on them, and therefore they do the best that they feel like they can with what information or familiarity they have, but maybe they could lean on the experts a little bit more, if only to just help direct them towards more education to help them along.
JA: Great stuff, that’s Don Bennyhoff, he’s from Vanguard. He’s a CFA. Smartest guy in the room right now, Big Al.
AC: You usually say that about me! Not this time. (laughs)
JA: No, we got a lot smarter guy than you. (laughs)
AC: He brings up a lot of good points and we know this from being advisors, that the tendency for advisors is to get very emotional when there’s negative headlines, and when there’s negative headlines, we tend to pull out of the market. And then we tend to get back in it when things seem really good. And so what you’re doing in that situation you tend to end up buying high, because things are good, and you end up selling low, when things are down.
JA: So I mean what would you think of the interview?
AC: I’m just… well, I’m getting there.
JA: Was it good? Was it bad? (laughs)
AC: It was fantastic.
JA: Vanguard is a pretty big company so he can’t really say much. You know what I mean? It’s like, “what do you think of target date funds?” “Well, I think they’re appropriate for everyone. Or maybe they’re not appropriate. But I get it, I mean I think there’s a lot of different things. I thought he was great. I liked Don.
AC: Yeah me too. So you didn’t let me finish.
JA: I’m sorry.
AC: He was great. End of story.
JA: And now it’s time of the show folks. For the e-mail bag. I love this part of the show.
AC: I know, it’s great. So you got some good ones?
JA: You know why I love this part of the show so much? Because there’s zero preparation. (laughs)
AC: And people think we’ve heard and prepared for these questions. You haven’t read them, I haven’t heard them. So this is off the cuff.
JA: I just printed it, off the printer right before we went on.
AC: We think it’s more honest that way. It’s not a rehearsed answer. If you came into our office and asked this question, this is what we’d say.
JA: This is what you’d get. (laughs)
All right. So here you go Big Al, this is a good one for you. And these are from advisor insights Investopedia. These are not from our clients. I disclose when they come from our listeners, our clients, because those questions are usually more well thought out. (laughs)
AC: Of course.
JA: Because our listeners and our clients are very sharp. Because they listen to Your Money Your Wealth.
AC: The ones that ask questions at Investopedia… kinda hit or miss.
48:00 – JA: Yes, hit or miss, like this one. “How will my profits and loss from day trading be taxed at the end of the year?” So, “how is my profit and loss from day trading tax at the end of the year, I also have a job and I’m always in the 15% tax bracket. If I make a profit from trading while I work, and my earnings from trading and working stay within that 15% tax bracket, will I be taxed the same?” Big Al, whaddya got?
AC: Interesting, yes. Well, day trading gains and losses, those are short terms.
JA: You probably have more losses than gains.
AC: Yeah, probably. I’m going to go out on a limb and say you’re one of the out of ten that has gains…
JA: One out of 1000….
AC: (laughs)…and so I’ll address both. So, if you have gains, it’s short term capital gain which is taxed at ordinary income rates, and so if you’re in the 15% bracket, it’s taxed at 15%. 25% bracket is taxed at 25%. So that’s how that works. There is something called the trader designation in the IRS, and I won’t get into all of that right now, but if you do a lot of trading, you might qualify for that which can allow you to take some ordinary losses on these types of things – if you have losses. Because otherwise, if you’re just a day trader kind of dabbling in it, the losses are considered capital losses. You can only offset capital losses with capital gains. So it’s not like you can deduct them against your salary. The IRS says you can deduct gains against losses, and if you still have excess losses, we’ll let you take $3000 per year, but that’s that’s it.
JA: But that loss could offset that gain, dollar for dollar.
AC: If you had if you had a gain, that’s right.
JA: But here’s the problem. It’s something that’s called anchoring. Heard of that?
JA: So let’s say that this individual bought the stock for $50 per share. And it goes down to $30 per share. He’s a day trader. Right? So he’s, like, grinding this thing out. He wants to make some money. So that thing goes down to $30 per share. Do you think he sells that stock?
AC: No because he doesn’t want a loss.
JA: Right. And he’s going to wait until when, until he sells it?
AC: When it’s $51.
JA: Yes! It’s like the stupidest thing ever! That’s what we do, it’s like, “well no, I bought it at 50, it’s down to 30, I’m not going to take the loss, but I’d rather take the gain on this and pay ordinary income tax versus taking the loss on the other one and netting dollar for dollar. And then you can buy back the stock 31 days later, whatever.
AC: You know, interestingly enough if you just do this how we would suggest which is long term hold…
AC: Yes but it works. If your gain is for a year or longer, then the capital gain rate is actually zero when you’re in the normally 15% bracket.
JA: Right, the guys in the 15% tax bracket, just hold on to it for a year, make that profit there if you’re such a good stock picker. Pick the right ones, wait a year, sell in the 15% tax bracket, zero tax.
JA: E-mail question number two.
AC: OK let’s go for it.
50:46 – JA: “Can I still deduct a maximum amount of taxes on a traditional IRA if I contribute to a 401(k) plan” is the header of the title of the email. OK. “I want to contribute to a traditional IRA for the tax write off but I contribute to my employer’s 401(k) plan. Can I still get the maximum write off on the traditional IRA?” Big Al, what say you?
AC: The answer is a qualified yes because you’re allowed to do an IRA and a 401(k) at the same time. In other words if you’re under 50, your maximum into the 401(k) is $18,000, and you can still do an IRA which is $5500, but your actual ability to take that as a tax deduction depends upon your income level. So if you’re single, it starts phasing out at about $62,000 of adjusted gross income. And by the time you hit $72,000 of income, then you can no longer deduct the IRA. You can still make the IRA you just can’t deduct it.
JA: So let me put that in real terms. So I’m single, I’m working, and let’s say I make $70,000 but I max out the plan of $18,000. Or let’s say I make $68,000, max out the plan at $18,000.
AC: OK, I like that. So $68,000 right? But then the 401(k) $18,000, that’s deducted off what your taxable pay. So your W-2 says you made $50,000 taxable, that’s below the $62,000. So you can fully deduct the IRA and this is actually a great strategy for those that are right on the bubble. Which is if they go ahead and do a full 401(k), or more 401(k), they can actually deduct more of the IRA if they want to.
JA: Right. And I think it only makes sense if I want to double dip the deduction and say, max out the 401(k) first. I’ve seen this, it’s like well, here, I’m putting money into my 401(k) to the match, and then I also want to deduct an IRA. Well I get it. Maybe because you want a different investment option in the IRA than in your 401(k), that may make sense. But I think just do it out of the 401(k) plan, set it up to max that thing out then start looking at other alternatives.
AC: I agree with that Joe but let me just do it circle around. So if you’re if you’re married, these numbers are $99,000 to $119,000 to where you can deduct the IRA. But I completely agree with what you just said, which is if you’ve already maxed out your 401(k), maybe you ought to be looking at a Roth IRA instead. And get some tax free growth. But there’s limits on that too. So if you are single, the ability to do a Roth contribution phases out at $118,000, it goes to $133,000. And if you’re married it’s $186,000-$196,000. In other words if you’re below those numbers you can do at least partial or full Roth contribution, and that might be a better bet because now you’ve got money in the 401(k). That’s growing tax deferred. You’ve got a tax deduction. We also have some tax free money.
JA: Yeah, I think that’s a major part of confusion is that, “well no, I cannot do an IRA or a Roth IRA because I’m contributing to my 401(k).” You could double up. You can put money into your 401(k) and into a Roth IRA. Now, how about this Al. How about if I’m maxing out my 401(k) plan and I have a little side hustle. Can I also contribute to let’s say a SEP plan, or like a self-employment plan?
AC: Yeah, so you’ve got a side business, you’re making money? You’re not allowed to do another 401(k) because that’s on a personal, person-by-person basis.
JA: Unless I didn’t max out the 401(k). So let’s say if I did $10,000 in my employer 401(k) and I have a side hustle so I can set up another 401(k) and put $8000 in it. Up to the maximum allowable limit.
AC: That’s correct. If you so desired, but let’s say you’ve maxed out your 401(k), yeah you can do a SEP, a simplified employer pension plan, or SEP for short, as a self-employed business person you don’t have to be incorporated. You can be, but you don’t have to be, you can be a sole proprietorship. And by the way the amount that you can put in is 20% of your bottom line profit. So that’s the formula you make $100,000 you can put another $20,000 into a SEP IRA and that’s over and above your 401(k). It’s also over and above your regular IRA, so you can potentially do all three of them.
55:51 – JA: Here’s another question for you. “I am currently 69 years old. My wife is 66. We are both retired. My wife begins receiving Social Security benefits this month, and I plan to begin receiving Social Security benefits when I reach age 70. At that time our income will consist primarily of monthly pension payments, as well as both of our Social Security payments. We expect to live comfortably on this income alone. We both have a significant amount of assets in various qualified plans, 401(k)s, 403(b)s, etc. and will be required to begin taking RMDs at age 70 and a half. What is the best way to leave the maximum amount of these qualified plans to our two adult children and minimize the tax implications of the RMD for my wife and myself?”
AC: Well this is like the all star question of the month.
JA: Gold Star!
AC: First of all, you’re doing a lot of things right. I’ll give you one suggestion before we get into the Roth or the 401(k), 403(b), is depending upon the numbers, you might want to have your spouse take the spousal. Of course, you’d have to wait till you’re receiving your benefit. Unless you did some things last April.
JA: Well he’s 69 right. So probably the numbers might jive for him to take his benefit, and the spouse take the spousal benefit, and then switch to her own then at age 70.
AC: That’s what I’m thinking. I mean they’re three years apart not four. But I think this still works out pretty well. And the reason you would do that is because the spousal benefit means you can take half of your spouse’s, and then your benefit continues to grow and when you take your benefit at age 70 it’s a lot higher amount than if you had taken it at age 66. Something else that happens as a result of that is probably the Social Security payments maybe a little bit less, which means your taxable income will be lower, which might allow you to do more Roth conversions before you hit your required minimum distributions at age 70 and a half, and so the main part of this question is what’s the best way to transfer these these retirement accounts to the kids. Well, the best way bar none is to get it into a Roth IRA, because when they get it it’s tax free to them. Of course, the problem is, what you always know, you’re allowed to do a Roth conversion but you have to pay tax on the amount that you convert. So if you can keep your income lower for these next few years, then you can actually do more in Roth conversions and stay in the same tax bracket.
JA: We find this problem a lot, is that now they ask us, at 69. They see the problem coming next year, when they should have been asking this 10 years ago.
AC: Yeah. So if we take this next step, let’s just say they retired five years ago, then that would have been the best time to do this. Because all they had was their pensions at that point. They didn’t have Social Security, they didn’t have required minimum distributions.
JA: So I guess to get in the weeds is a little bit more on this question, is that Al’s suggesting to go into a Roth IRA and that money will grow 100% tax free for your life and then when the kids inherit it, it’s tax free for their life. So that’s a pretty cool thing. However there’s a couple of more details that you want to make sure that you cover. What tax bracket are you in? How big is your pensions and Social Security? And then what tax bracket is your kids in? So if your kids are very successful and they’re in large tax brackets, well, maybe it might not make sense, because you might be paying more tax on your tax return, or they will be paying more tax, or whatever, right? You just kind of take a look at the whole picture here. If they’re in large tax brackets and you’re in a low tax bracket, conversions make all the sense in the world. But if they’re in very low tax brackets, so they’re not doing that great, it’s not expected to change. And maybe that’s the case because they’re concerned or not. I don’t know. So that’s diving in a little bit more. You have to look at what tax bracket that you’re in. How much room do you have in your tax bracket to determine, does it make sense to do the conversion? I would say 90% of the time in this fact pattern, it’s absolutely the right decision to do the conversion.
AC: Yes and something happens later on in life, sometimes when you need more medical care, or you got to go into assisted living or long term care. All those things, in terms of long term care, that’s completely 100% deductible as a medical deduction. It puts, oftentimes, the parents in a very low bracket and that’s a great time to do Roth conversions as well.
JA: And then what happens when, let’s say, one spouse dies? It sounds like they have plenty of fixed income. So it depends on the pensions, do they have 100% survivor benefit on those? You’ll lose one of the Social Security benefits. But what we find, too, is that all right, well, both of my spouses… both of my spouses! Whoa, hey now! (laughs)
AC: This is Utah!? (laughs)
JA: Yeah! Welcome to the show! (laughs) Let’s say both spouses have large retirement accounts. Well, when the spouse dies, they still have this large retirement account. The required distribution now is based on, still, this large amount. Now they’re at a single tax bracket. So, all of a sudden those RMDs are going to push them even to a higher tax bracket and more of those dollars potentially could be lost to unnecessary taxes.
JA: Okay, last e-mail question of the day.
1:00:43 – JA: Well this is an interesting question, so I’m going to ask a CPA this, even though has nothing to do with taxes. (laughs) “Why do some great and well-known companies that sell a lot of products and services, have a lower stock price than other less profitable companies? For instance, Berkshire Hathaway, with a stock price of 200,000, for example. Apple, the most valuable company in the world, has a stock price of around 120. Well Berkshire’s is 200. Why is that?
AC: That’s that’s a great question, and I think there’s a lot of mystery when it comes to stocks and investments. The reason, it all has to do with the value of the company in relationship to the number of shares that are outstanding. And so, if you have just a few shares and your company value is growing, then your stock price is going to be more. Here’s what most companies do, is they do stock splits. Right. So all of a sudden there’s 100,000 shares, and they say you know what, let’s make it 300,000 shares, so that’s like like a two to one or three to one split, I guess is what you call that. So now you got three times as many shares as what you had before. What does that do to the stock price? It cuts it by three. So the company value is always the same, it’s the value of the company.
JA: Right, if the stock price was $100 a share, now it’s 33 bucks.
AC: Yeah, if you if you did that three to one split, right. That’s how it works. And Berkshire Hathaway has not wanted to do stock splits.
JA: Well they have two share prices. I mean they have two classes of shares. You’ve got class A, class B. Class A, he doesn’t want to split. That’s Warren for you, right? “No, I’m not going to split it. All right. One share’s 200 grand! But you can buy Berkshire for less than 200,000, it’s just the B share class that has split. So yeah, you have to look at market cap, right? Outstanding shares times…
AC: Market cap means the value of the company. The capitalization of the company.
JA: So you look at that. That’s what’s going to determine, but not necessarily the share price. You multiply the share price by the outstanding shares, that gets you your market capitalization . So if you have a ton of outstanding shares versus some, like Berkshire Class A, does not have a lot of outstanding shares.
AC: And interestingly enough, when you look at new companies that do an initial public offering, an IPO, in general they try to price the stock somewhere around $10 a share because it seems affordable.
JA: And that’s why companies do stock splits.
AC: So how do they do that, well they take, what’s the value of the company, let’s let’s divide it into how many shares it is going to come out to 10 bucks a share, or 20 bucks a share, or whatever number they want to hit, so that it’s affordable.
JA: Right. And then so you say it’s $10 a share. Well, you know what, let’s make it $5 a share. So if I own one share of that stock at $10 a share, when they do the stock split, guess what. Now I get two shares at $5 apiece. I still have the same value. So my brokerage account is not going to change, it’s going to have the same market value, but now I have that many more shares. And if the stock price continues to go up. All right, that’s good, because I have more shares that are going to go up in value. So yeah, that’s a great question.
AC: It’s a good question and I think it’s a complete mystery to probably a lot of people.
JA: Yeah, it’s like “well this is a lot better company because the share price is that much higher.” Well that’s not necessarily the case. You’ve got to take a look at the market cap. But then, what has higher expected returns in the overall market, if we will really want to get deep here, are they lower price stocks or higher priced stocks? Well if you look at history, lower price stocks have a higher expected return based on market cap. So the market cap could be the same. And what I mean by that, let’s say you have company A and company B, the market capitalization could be the same. Or all of a sudden one is falling in value right because of maybe under-performance. You know in a given year or maybe in a certain area of the overall markets, that area, like oil for instance, a sector of the market has not performed. So that stock price goes down. So then you look at which is going to give me a higher expected return, a lower price stock, or higher priced stock? Well over the long term lower price stocks will outperform higher price stocks because they’re more volatile they’re more risky and you are compensated for that risk.
AC: Wow, you did get in the weeds there!
JA: I had to do that is my job.
AC: Good for you. It’s also known as value stocks and that’s what Warren Buffett invests in, companies when they’re on sale. When they’re cheaper. A value stock, and value stocks do have a higher expected return over the long term. But on a year by year basis, they may not outperform. But over the long term they tend to.
JA: Yes. And what value is it. So you have to look at the book value of the company. All companies have a book value, so you take a look at your equity, your assets, your liabilities, and everything else and then, you know, an accounting firm says, “well, here’s your book value.” But then the market, it has a different opinion of that book value. So you look at a book to price ratios and if they say, you know what, the price is actually higher than what’s on the books, well then that’s more of a growth company. If they’re saying, you know what, it’s a little bit lower than that. Well then that would be a value company. Value companies, as Al said, have a higher expected return, long term over the markets. It’s called a risk premium. So you want to make sure how you invest is you take advantage of the risk premiums in the overall market. It’s a cheaper way to invest. You can potentially get a lot higher rate of return, you can mitigate your volatility, and so on and so forth. So that’s it for us. We ran out of time, hopefully enjoyed the show. We’ll be back again next week with another great guest, your e-mail questions and big Al’s list! Can’t wait!
So, to recap today’s show: Basic estate planning can save you and your family a lot of headaches later. A financial advisor can help you figure out your needs and wants, your risk tolerance, your cash flow needs, your tax situation, and they might be able to talk you off the ledge during the bad times. And for Generation Y, workaholism and serious debt are more of a relationship deal breaker than STDs.
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