Risk management investing strategies: is selling rental property and buying a variable annuity to reduce sequence of return risk and interest rate risk a good idea? Do small-cap or emerging markets have better risk-adjusted returns against market volatility? Should eREITs (non-traded real estate investment trusts) be in your retirement investments? Is RPAR Risk Parity ETF a good inflation hedge? Should you be tax gain harvesting in declining financial markets?
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- (01:18) Should I Sell Rental Property and Buy a Variable Annuity, Since Bonds Will Lose Value as Interest Rates Increase? (Tom, Lynwood, WA)
- (15:10) What Do You Think of eREITs? (Jim, Santa Cruz, CA)
- (18:00) Inflation: Should I Invest in RPAR Risk Parity ETF? (Mo, Orange County)
- (24:39) Emerging Markets vs Small-Cap: Which Has Better Risk-Adjusted Return? Should I Get Rid of My Variable Annuity? (Rikki, NJ)
- (35:10) Is Tax Gain Harvesting in a Down Market a Good Idea? (Sid, KS)
READ | Pure Blog: Types of Risk Management
READ | Pure Blog: 7 Ways to Protect Yourself Against Inflation
WATCH | Pure’s Investing Philosophy and Q1 2021 Market Update Webinar
Listen to today’s podcast episode on YouTube:
What’s your level of risk tolerance? Today on Your Money, Your Wealth® podcast #321, Joe and Big All are looking at investing strategies to manage risk. Should Tom sell his rental real estate property and buy a variable annuity to reduce sequence of return risk, since bonds will lose value with increasing interest rates? Rikki wants to know whether small-cap or emerging markets have a better risk-adjusted returns against market volatility, and whether or not to ditch a variable annuity. Jim has a limerick for us and wants to know what Joe and Big Al think of eREITs, non-traded real estate investment trusts. Given the possibility of inflation, should Mo invest in the Risk Parity ETF to generate a return? And Sid asks whether tax gain harvesting is a good strategy in declining financial markets? And just a reminder right up front here before we start talking about all these products, Pure Financial Advisors is a registered investment advisor. Your Money, Your Wealth® 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. And investors are of course advised not to rely on anything discussed in this broadcast in the process of making a full and informed investment decision. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.
Should I Sell Rental Property and Buy a Variable Annuity, Since Bonds Will Lose Value as Interest Rates Increase?
Joe: Tom from Lynwood, Washington, he writes in. “Hello, Your Money, Your Wealth® team, thoroughly enjoy your show. It provides helpful information and very entertaining. Keep up the good work. I’m interested in hearing your thoughts on buying an annuity as suggested by a financial advisor. I’m 58, my wife, 63, and we intend to retire one or two years. We have a globally diversified portfolio consisting of pre-tax brokerage and Roth accounts allocated at 65% stocks/35% bonds. Also have a rental house that we intend to sell in about 8 years. I’ve been managing our finances during the accumulation phase, but as we move closer to the decumulation phase, I want to have my calculations and assumptions checked by CERTIFIED FINANCIAL PLANNER™ to reduce sequence of return risk and build an income floor.”
Joe. This guy just got a lot of buzzwords that all-
Al: I think Tom went to Investopedia and got a couple words.
Joe: It hurts to laugh. This is good stuff. All right. “The CFP® suggested we sell the rental property in early retirement and purchase a variable annuity. For a $300,000 contract, the annuity worst case return will be 5% per year, which equates to about $18,000 a year of income starting at age 68. Payout for historic market returns will be $27,500 per year. The CFP®’s strategy is to reduce the percent of bonds and increase the percentage of stocks after the annuity is established. The combined annual annuity fee is 3.1%. The CFP® says he does not gain financially from the purchase of the annuity. The current market value of the rental property $650,000; cost basis of $270,000; mortgage $165,000. The property generates about $5000 to $6000 per year after property tax, maintenance, etc.; vacancy rate’s about 3%- less than 3%. Property values in the area are estimated to increase by 11% per year. The proposed annuity strategy does not make sense to me, as real estate values are relatively stable and we are gaining equity on the leveraged debt. Additionally, the annuity does not begin paying until I’m 68, which misses most of the sequence of return risk period. The response from the CFP® was that I am conditioned for optimizing returns. And I’m not considering the risk of bonds losing value as interest rates increase.” Can you imagine- ?
Al: Can you follow that?
Joe: Yes. You are a conditioned, Tom. You have a problem, you have a real problem here. You’re conditioned. Your condition is that you are looking for optimizing returns. You should not be optimizing returns. You should be thinking about income preservation and you don’t know anything about bonds losing money because you will lose your ass with interest rates increase. That’s what this CFP® was saying.
Al: So what are his questions?
Joe: He’s like, “do you think selling the rental property makes sense and buying the annuity? Should I change my stock/bond ratio? Am I missing a key reason to buy an annuity in our situation? What situation would you suggest an annuity? Thanks for answering my questions.” All right. So I get the gist here. So Tom’s looking to retire in a couple of years, he’s got a nice portfolio. He wants to have an income floor, Al.
Al: He does. Yeah. To mitigate the risk of-
Joe: – sequence of returns-
Al: – sequence of returns, thank you.
Joe: So sequence of return risk. It’s a big one.
Al: Yeah, that is a good one.
Joe: So when you start taking money from the portfolio and the market goes down, and you’re still selling shares, that’s how-
Al: You never recover.
Joe: Yeah, that’s reverse dollar cost averaging.
Al: That’s right.
Joe: You should have put that in there, too. So here’s the strategy for some advisors, is that they’re looking at let’s have a floor of income. So your Social Security and some annuities, so a guaranteed income floor to cover the basic necessities of your life. And so when the market crashes, you don’t have to sell any stocks when they’re down because you have a basic floor of income that you can count on. I like the premise of that, but it’s really geared- and I think how this advisor was- it was almost like a pitch, it sounds like. Right?
Joe: You need to purchase this annuity to get you this income floor. Well, let’s talk about the annuity for a second and let me do the math for you, Tom. Because don’t worry about all the other BS that he’s throwing out there.
You gave me the right numbers. You’re putting $300,000 in. At age 68, 10 years, you’re going to receive $18,000 per year as a guaranteed income and that $18,000 will never run out. That’s at that 5% guaranteed roll-up that the annuity contract is giving you. So if I do the math Al, if he makes it to age 68 and he pulls $18,000 per year out of the contract, OK, and if I take $18,000 and I divide it into $300,000, what’s that about 16, 17?
Al: Yeah, something less than 20.
Joe: So let’s call it 17 years. So if he’s 68-
Al: When he starts.
Joe: – when he starts taking the money-
Al: 78, 88- So about 85-
Joe: So 85 life expectancy-
Al: – is when he gets his money back.
Joe: – when he gets his $300,000 back. He’s not going to make a dime on this money until he reaches the basis return to him. So if he makes it past 85, one day he’ll make a certain percentage but he has to live a very long time for this contract to make sense. So does a paying 3.1% to the insurance company and then the advisor saying that he’s not getting compensated for it?
Al: What do you make of that?
Joe: What is he doing? Did he refer it to an insurance agent and say, hey, here’s my buddy, he’s going to sell you this annuity contract? I’m not going to get paid on it. I’m not going to help manage it for you. I highly doubt that. It’s a variable annuity. He’s definitely getting the commission.
Al: And a commission on that would be-
Joe: – probably 7%, 8%. Maybe 6%. Who knows? It depends on what schedule. He could even do probably 1% per year. So his fees could be 4.1%. It’s just like a standard money managed account. That’s a little you know, I don’t know, I wasn’t there, I don’t want to throw the CFP® under the bus, maybe he was just a hey hourly guy, right? And says here, I’m just going to give you the advice, you implement it on your own. Why don’t you talk to Joe Schmo over here? He’ll sell you the annuity. Why don’t you talk to this person over here and they can manage your money or whatever? So we need a little bit more information there.
Al: So but- so the concept is it’s going to take you- first of all, you wait until age 68 and then you basically gotta live til 85 or so to get your money back.
Joe: To get your basis back. You invested $300,000.
Al: If you- let’s say Tom lives to 82 and passes. So he didn’t even get the money back. And so is all the rest of the money lost?
Joe: No, it would depend on what the contract value is. So there’s-
Al: So there’s some recovery there.
Joe: Sure. Well there’s a good question. Because there’s two different pools of money that you’re looking at in regards to a guaranteed income variable annuity contract. You have your cash surrender value and then you have this roll-up that is a fictional number that will tell you what your guaranteed income is.
Al: And that’s like what the income is based upon is that number. But your real number is the cash surrender value.
Joe: Yes. You only buy this if you understand that you want a guaranteed $18,000 per year. You don’t care. If I get my money back, I get my money back and I don’t make a return, I don’t care. All I know is I have a guaranteed income for the rest of my life. If I live to 105, who cares what the return is? This is not looking at returns. This is looking at a guaranteed income. But the math doesn’t make sense to me in this particular contract because he’s really not getting his money back. He’s putting $300,000 in. He’s going to get- he can’t take it- well he can- but the guaranteed income doesn’t start until he’s 68. And then it’s $18,000 per year. And so he makes it to 85, $300,000 comes back. OK. Not a great investment. So but if he doesn’t care about the percentage of growth there-
Al: Just to have security.
Joe: Just to have security. It’s insurance, you’re buying insurance. It’s not an investment. So if he’s understanding this- if all you guys that are getting pitched annuities, just understand it is insurance. If you are wanting to buy insurance, then purchase the annuity. If you are buying an investment, do not purchase annuities. The second question here is real estate. That’s a pretty terrible cap rate on- 1%.
Al: It is. But I assume it’s in Washington State where Tom lives and people are moving to Washington. A lot of Californians are, among others. It’s a tax-free state in terms of income taxes. So in the past, real estate has done pretty well there. There’s no reason to think it wouldn’t continue. I don’t think personally, I don’t think there’s much reason to sell real estate that you think is going to go up in value unless you need a better cash flow. And right now, they don’t need a better cash flow.
Joe: Right. He needs tha- he wants to bridge the gap. He’s going to retire at 59 or 60 and he wants to bridge the gap to Social Security. That’s what he’s worried about. That’s why he’s throwing out these terms of income floor and sequence of return risk and all this other BS. Because he’s like, I’m not going to claim my Social Security until probably 67 or later. I’m going to have to pull money from my overall portfolio. And if the market tanks as I’m pulling more dollars from that portfolio before my other fixed income comes in, it could blow me up. So he’s looking at other options.
Al: Yeah. Basically to answer that question, we’d have to understand what your other assets are to see if- like if this is really is your only source of income potentially, then maybe it does make sense. But you’re going to have to pay a fair amount of taxes to create that liquidity. So does that make the most sense? We don’t really have enough information to know that. But to sell a piece of real estate and pay tax to buy an annuity, that strikes me as not a great idea.
Joe: I guess how do you look at real estate, Al? So he’s got a market value of $650,000. He’s got a note of $150,000. So it’s $500,000 equity that’s getting $5000 of income.
Al: Yeah it’s- as you say, 1% cap rate.
Joe: So that’s not that great.
Joe: But if he thinks it’s going to grow at 11%, then that’s a 12% return.
Al: Yeah exactly. Yeah. That 11% plus the 1% cash flows is exactly right. So I think the answer there is if you retire in the next year or two, you might consider it then. But if you think it’s going to go up as much as it is and real estate’s doing rather well right now, who knows how long it’s going to continue, right? And you never actually hit the top. So I guess- but it depends, Joe, to me, if Tom has a lot of other assets and doesn’t need to sell the real estate, I wouldn’t necessarily do it yet. But if this is like the only asset and you’ve got to create a cash flow from this, then maybe it’s a little different story.
Joe: Well, he says he’s going to sell it in 8 years anyway. If you’re going to sell it, now’s a really good time to sell, to be honest with you. We don’t know what the hell is going to happen with real estate. He’s probably- he’s made a really good profit on it.
Al: He has. But I guess my point is it depends- I don’t know enough about his other assets to know what’s the best way to generate the cash flow that he needs to get the Social Security full retirement age.
Joe: Right. So if he was going to hold on to this, would you tell him- and if he had plenty of other assets, would you want more leverage on it? Or would you like the amount of leverage that he has?
Al: No, I think me personally, going into retirement, I don’t really like to leverage stuff up too much. It’s too much risk. But there is some leverage and that does help the growth if you think it’s going to continue to grow. Again, I personally like the idea of if you’re in an area that’s appreciating, which I think Washington State as a general rule is, if you’re in an area that’s appreciating, I’d rather not sell my real estate until I needed to. And again, that’s why I want to understand his other assets, to know how he could bridge the gap for cash flow.
Joe: How far away is Lynwood from Bend?
Al: Well, Bend’s in Oregon.
Joe: Well, that’s one thing. So probably pretty far.
Al: A different state. Besides that, it’s Pacific Northwest, though. You’re in the right region.
Joe: All right. I gotta go.
The risk of losing money is scary, regardless of region or age or any other factor – and today we’re only talking about a few of those risks, we’re not even getting into longevity risk, liquidity risk, opportunity risk, tax risk… I’ve compiled some free resources on risk management and inflation in the podcast show notes at YourMoneyYourWealth.com so you can learn more about all of these different types of risk, how to manage them, and why its important. Click the description of today’s episode in your podcast app to get access. Then click the “Get an Assessment” button to schedule a free financial assessment with a CERTIFIED FINANCIAL PLANNER™ professional on Joe and Big Al’s team at Pure Financial Advisors. They’ll take a look at your financial situation, what risks you’re exposed to, and your tolerance for them, and they’ll help you come up with a plan to manage those risks and put you on the path to a more successful retirement. Click the Get an assessment button to schedule yours.
What Do You Think of eREITs?
Joe: We got Jim calling from Santa Cruz once again. “Joe remarked- ?
Joe: “- on show 314 that I call all the time, but this is only my 5th email since I began listening to your podcast last Summer.”
Al: That seems like a lot of times.
Joe: It’s like 4 more than most. “A financial advisor named Joe, refuses to prep for his show. He hates IUL, and relies on Big Al, to explain the Roth garage doe- ”
Al: – doa, rhymes with showa-
Joe: I like it.
Al: Yeah, it’s yet another limerick.
Joe: Look at Jim.
Al: I like it.
Joe: I wonder if-
Al: I guess we will come out and say it publicly, we like limericks.
Joe: I don’t know if I ever knew what a limerick was until this show.
Al: Now you do.
Joe: “So now for the important question of the day, what, if any, guidelines, warnings, suggestions do you have clients about investing in REITs? Since I’m not an accredited investor, I’m excluded from most of these investments, but Fundrise and DiversiFund offer every-man type opportunities. The biggest caveat would seem to be liquidity, a risk I understand and accept. About 5% of my portfolio is invested with Fundrise and I’m considering an investment in DiversiFund. Any thoughts can offer would be greatly appreciated. Your show rocks.” These are just looks like non-traded REITs.
Al: Yeah, he uses the word eREIT, which I think is a trademark term for Fundrise.
Joe: Because it’s probably easy to buy the REIT via app.
Al: Hard to sell it though.
Joe: It’s very hard to sell it. Yeah. You know, I think Al and I are both big real estate proponents. We have a lot of our clients in REITs. But we like traded REITs better than non-traded REITs. A lot more liquidity, a lot less expense. But, as long as you understand what the underlying assets are that the company’s purchasing, then we’ve seen some good non-traded REITs as well.
Al: You know would you say, though, that a non-traded REIT, the money comes in, it gets invested, and you don’t have to have flows in and out as people add money and take money out. So maybe in some ways you have more of your funds invested in a non-traded. But that may- I think in yours and my opinion, that may not outweigh the non-liquidity issue.
Joe: Yeah. So Jim’s fine with the non-liquidities. He’s comfortable with the risk and it looks like he’s online doing some research with DiversiFund and eREIT. There you go. All right, Jim, we’ll get email number 8 here shortly.
Inflation: Should I Invest in RPAR Risk Parity ETF?
Joe: We got Mo. He writes in. Where’s he from? No idea. “Hello, Andi, Joe, Al. I enjoy your podcast on morning walks around my neighborhood in South Orange County-” There he is.
Al: There you go.
Joe: “- north of San Diego.” Really? Mo.
Al: Well, you don’t get out of San Diego much, so you might not know that.
Joe: South Orange County is north of San Diego.
Al: I know for a fact you’ve been to Orange County.
Joe: You know what- ?
Al: In fact, I played golf with you at Pelican- what’s it called?
Joe: Pelican Hill.
Al: Pelican Hill. I was thinking Bay, but that didn’t sound right.
Joe: “I drive a Tesla and love the car, but I have not invested in the stock. I’m not asking you a question about a backdoor Roth IRA so maybe you will answer this on the air. I’m sure many others would be interested in alternatives to savings or money market accounts in this environment.” All right, interesting. Let’s see what Mo’s going to ask. “With interest rates in savings, money market accounts at all time lows, I’m trying to find something that is low risk but will generate a return. I’m wondering what you think of an actively managed ETF called RPAR, risk parity ETF. It is modeled after the Bridgewater’s All Weather Fund. It’s actively managed by Alex and- oh, we don’t need to do this.
Al: A couple guys.
Joe: A couple guys. It’s target investment is 25% each in Treasuries, commodities, equities and TIPS.” We talked about the All Weather Fund and the strategy on how they rebalance that- I forget that was maybe a couple of years ago?
Al: Yeah, it was a while ago.
Joe: The expense ratio is 53 bips. So. All right. So we got some commodities, we got Treasuries, we got Treasury inflated protected securities, and then we have some equities.
Al: So it’s about 50% bonds I guess, 25% equities, 25% commodities-
Joe: 50% cash, almost like Treasuries and TIPS.
Al: And yeah, in between those two.
Joe: Very close. Very safe. And then he got some commodities that was on the other side of the spectrum of risk.
Al: Yeah. That goes all over the place.
Joe: Right. And then, equities, of course we know it’s risky. “What do you think about using this fund as a liquid alternative to savings money market account, especially with the risk of inflation? Or instead of a typical asset allocation of 60% equities and 40% bonds for my age? Maybe add this in the ETF, say 50% equities, 20% the RPAR, 30% bonds, especially with the risk of the higher interest rate? Any other suggestions you can provide? Thank you in advance.” So he’s looking for a free lunch Mo. Risk and expected return are related.
Al: We have said that before.
Joe: You cannot have expected returns without taking on a little bit of risk.
Al: And in this particular fund, 25% is equities, which we know are volatile, and 25% commodities, which go up and down too.
Joe: Yeah. Little pork bellies.
Al: So if you like this allocation, why not just invest in ETFs, 25% across the board? The same thing.
Joe: I don’t mind the fund. I like the fund. But it’s not for cash and money market.
Al: No. But it’s .5%, which is a little bit on the high side of costs for funds.
Joe: Well, yeah, but you take a look at an average commodity fund, well Treasuries and TIPS you’re going to get dirt cheap.
Al: Yeah, it’s like free almost.
Joe: Almost. Almost give them away.
Al: Especially now.
Joe: So, yeah, I guess if you’re looking at the expense ratio, but maybe they rebalance and they keep that target allocation, because it’s actively managed for an actively managed fund at 25- for 50 bips, that’s pretty cheap.
Al: For an active fund, I agree.
Joe: And it’s actively managed.
Al: Half of its cash, so how tough can it be?
Joe: I get it but I- OK well, Alan doesn’t like the expense ratio. I like the fund, personally. I do not like the fund for your savings account, though. It’s not a savings money market alternative.
Al: So I agree with you on that.
Joe: If you want to put-
Al: Yeah, you got much equities and commodities in there. It’s not stuffed with cash.
Joe: The Treasuries, yeah that would be your cash reserve. But you don’t like the return there. So you want to hear something like, oh yeah, they’ll give you a good return. Very little risk. I’m not going to say it, because it’s not true. But I like his second part, 50% equities, 2% in this fund, 30% bonds. I don’t know how much money Mo has. I do know that he lives north of San Diego.
Al: Yeah, he did say that, just for your own edification.
Joe: And he’s not asking me about a backdoor Roth, which is great. So no, people are getting a little goofy, you know what I mean?
Al: Well, they want to get some return out of their fixed income. And it’s hard to do right now. So what you can do is you can go lower quality, i.e. junk bonds. You can go on longer duration, which means there’s more risk as interest rates eventually go up. It seems like someday they will. But people thought that for a decade or two. So who knows? So you take more risk in your fixed income but historically the risk that you take with fixed income doesn’t necessarily compensate you for the extra return you get. So I don’t even like that idea. I think I would stay safe in your bond portfolio. And if you want to be a little bit more aggressive in the stocks, make sure you got some small companies, some value companies, some international, some emerging markets, and then just whatever percentage you want, 50% equities, 60%, 70%, 20% equities. I don’t care. But just stay safe in your bonds, if there’s not really a good alternative, I don’t think.
Joe: No, I agree. OK Mo, thanks for the question, bud.
There are 10 key investing decisions that can help you to more effectively target long-term wealth in capital markets. To learn the strategies that can improve your odds of investing success, download the free white paper, Pursuing a Better Investment Experience from the podcast show notes at YourMoneyYourWealth.com. You’ll learn how to let markets work for you, why chasing past performance is a mistake, and what drives expected returns. Pursuing a Better Investment Experience – download it free by clicking the link in the description of today’s episode in your favorite podcast app, you’ll see it right there before the podcast transcript.
Emerging Markets vs Small-Cap: Which Has Better Risk-Adjusted Return? Should I Get Rid of My Variable Annuity?
Joe: All right. We got Rikki from New Jersey. “Dear Andi, Al, Joe. Don’t worry, Joe. I saved the best name for last.” All right.
Al: That’s true. I’ll give you that, Joe.
Joe: Rikki. “Actually, I think Andi’s the best. So I gave her top billing.”
Andi: Thank you, Rikki.
Joe: “I drive a 2016 Honda Accord, bought used 3 years ago. And my wife drives- ” So I thought Rikki would be a girl how Rikki spells Rikki. R I K K I?
Andi: Could still be.
Al: Could be. It still could be wife and wife.
Joe: Oh, OK. I’m very sorry. ” – bought used 3 years ago and my wife drives a 2017 Toyota Highlander, also bought used 2 years ago. I’m obsessed with the podcast and binge listened all the way back from 2014. You guys are phenomenal.”
Al: Wow. Can you imagine doing that? Our shows? Listening?
Joe: Absolutely not. I can listen to 30 seconds. “The banter is hilarious and the advice, I mean information, is top notch. Thank you for offering the free assessment and took advantage and had a deep-dive financially profound conversation with Bob McCulloch.” Bob is one of our advisors here. “The dude’s awesome.” Is this a testimonial?
Al: You’re getting close. Joe.
Joe: “Joe, as president, give the guy a raise.” OK. “As part of the assessment, he made the honest opinion that my written financial plan was completely sound and we could not add to it. He did not try to sell me anything as per of the fiduciary mission of your firm. Much of our discussion involved questions with no real right answer, but would love your thoughts as well. A little background: I’m a neurologist, age 39 and unfortunately live in New Jersey, similar insane taxes like Cali. But instead of sunshine, just pollution and The Sopranos.”
Al: Well, they got something.
Joe: They do. “I’m married to an anesthesiologist, 40 years old, and was planning on being financially independent in 10 years.” A couple of docs there.
Al: Yeah, that’s raking it in, New Jersey.
Joe: “I plan to work until 65. We max out both of our 401(k)s and do backdoor Roths yearly. Also put money in a taxable account. In total, put 20% of gross income for retirement; plan to take Social Security at age 70; do some Roth conversions from 66 to age 70. I don’t care to leave a legacy to the kids. My current asset allocation is 65% total US; 25% total international; and 10% small cap value. I slept like a baby during the Coronabear.” What the hell is a Coronabear?
Al: That’s the bear market during the Coronavirus. That two month swoon?
Joe: I understand, Alan. I understand. “Actually, I was upset that the market didn’t crash harder and longer- ”
Al: ” – so I could buy some more cheap stocks.”
Joe: Yes, yeah. Coronabear. This terminology. These little sayings that the kids nowadays are coming up.
Al: Yeah, well and compared to you, she’s a kid.
Joe: Or he.
Al: Or he.
Al: Rikki. He or she.
Al: I should just say-
Joe: Rikki’s real fast. Rikki’s real fast. Rikki, congratulations on stealing 3000 bases. Yeah. Rikki. Rikki runs real fast.
Al: I gotcha now. Took me a minute. Ricky Henderson.
Joe: You got it. Thank you, sir. “Does emerging markets have a higher risk adjusted return compared to small cap value? I was debating adding EM to boost a return to my portfolio in the long run, given my super high risk tolerance and capacity. I know EM-” he’s talking emerging markets- ”
Al: Yes. I can imagine.
Joe: “- also can help dampen volatility, given it is a lower correlated asset to my overall portfolio as well. However, can I just increase my small cap value? I plan on adding some bonds gradually before retirement, so already has going to add that non-correlated asset. What extra risks are involved in emerging markets compared to small cap value? And do we expect a higher premium? Or EM just different form of small in value premium as EM companies are smaller with lower valuation compared to US companies?”
Al: OK, that was one question. I guess.
Joe: OK. Yes, I would go- go with the emerging markets for sure.
Al: You know, it’s interesting, emerging markets, if you look at all the different asset classes, tends to be the most volatile. But also, if you look back 20 years, it very often is at or near the top of the return list. So it does have highest expected return, but it’s a crazy ride. So we think it’s important to have some, just not too much, unless you just love the roller coaster ride.
Joe: Rikki’s not going to retire until 65 and Rikki is, 39?
Joe: 39. So that’s a long time for emerging markets to do their thing. Why don’t you go small cap value emerging markets, Rikki. Then that’s really high octane.
Al: Well, and plus emerging markets can be large companies or small companies. There’s actually small and value emerging market funds if you really want to go all out.
Joe: Correct. You look at the US market, you can go small in value, large in growth. You can go international, same, and emerging markets, the same. So if you want to go small value emerging markets, Rikki, why don’t you do that?
Al: That just means it’s in a emerging country like India or China or-
Joe: There ya go.
Al: I was trying to think of the- it wasn’t coming quickly.
Joe: “Was the Coronabear a true test of risk tolerance? Also, I just started investing two years ago and lost $30,000 during the Coronabear, which I tax loss harvested. Is that too low of a sum of money to test my risk tolerance? Was the Coronabear also just too quick?” If I have to say Coronabear one more time, I’m going to lose my-
Al: So that’s another- garage and garage backdoor Roth. We’re not talking-
Al: Coronabear. That’s off the list now.
Joe: Oh God.
Al: Anyway, Rikki, that was not a long enough time. Try to get through the Great Recession or the dotcom bust and then tell me how you do on this.
Joe: Yeah, I think it was a blip. There was a lot of fear, I think-
Al: We had a blip in December, 2018. I mean-
Joe: This was a little bit different, though, I think, because it was like this weird virus.
Al: More unknown. Kind of more scary.
Joe: It’s like, oh, what the hell is going to really happen here? But then they’re like, we’re going to be OK. It wasn’t like the financial crisis when there was a whole siege in the credit markets.
Al: Do you remember even Warren Buffett was saying, you know what, I really think if we don’t do this stimulus we could be in real trouble. It’s like, OK, that caught our attention.
Joe: So it’s shot back quickly because people knew we’re going to get shot down. We didn’t know how long, how bad it was going to be, but I think people kind of stuck with their investments. And the people got laid off and furloughed. And what’d they do? They started investing.
Al: Because the market was cheap.
Joe: They were like, yeah, I got nothing better to do. I’m sitting at home. I’m ‘working’ quote.’ “Number three, I was previously hoodwinked, bamboozled, led astray, run amok by Northwestern Mutual Financial Advisor, high school buddy of mine that sold me, my wife and I, some life insurance. 7 years and $25,000 underwater on each policy, I 1035 exchanged the cash value to a low cost variable annuity at Fidelity to preserve my cost basis. My wife grew to cost basis-” I don’t know what grew to- the original cost basis, I guess?
Al: I guess.
Joe: “- and now that money is invested in a taxable. But mine is $1000 away from cost basis. Any utility in keeping this low cost VA?” No, if you can get your basis out- you could actually take a loss.
Al: Yeah, you can. Although it’s-
Joe: Is that an-
Al: That used to be a miscellaneous itemized deduction, which you can’t take. So you may not get to write that off.
Joe: So just take it out now. I don’t know why he’s wasting his time and he’s waiting- So let’s say it’s $25,000 was the cost basis. It’s worth $24,000. He’s waiting for it to grow to $25,000 to take the money out?
Joe: Well take it out at $24,000. What’s the difference?
Al: Psychologically, you don’t want a loss.
Joe: I got it. But he’s got the Coronabear.
Al: Yeah, but get over it.
Joe: The Coronabear.
Al: So Rikki, I’m not going to say he or she again, Rikki wants to- he wants to be able to say that he never incurred a loss.
Joe: I’m not going to say he or she again, but he wants-
Al: I did. Didn’t I? Oh my God.
Andi: Old habits die hard.
Al: Let me say re-say that. Rikki wants to say that-
Joe: – Rikki-
Al: – that Rikki doesn’t want to incur a loss.
Joe: Got it.
Al: Thank you.
Joe: OK, just get the heck out of there. “Perhaps a buffer asset between my retirement and claiming Social Security now invest in bonds within the VA?” No, just get out of the VA. It’s a non-qualified VA that you can get out. Go to a brokerage account, invest it and have capital gains treatment, a lot cheaper. No big deal. “By the way. You’ll love this too. The same advisor rolled my residency training 401(k) into an IRA and purchased the VA within the IRA.” All right. Well, looks like he had some really good advice there from his high school buddy. All right. Thanks, Rikki. Appreciate it.
Andi: He says, “Thanks, guys. And keep up the dominating work. You guys are dominating.”
Joe” Rikki said that?
Al: He? Or she?
Andi: Yeah, right. See? Old habits do die hard. Rikki said “Keep up the dominating work.”
Al: Even you did it. We don’t even know we’re saying he or she, do we?
Al: It just comes out.
Joe: I say, Rikki, because Rikki runs real fast.
Al: That was almost the end of me. Who is the other guy? Was it Bo Jackson? He was the third person.
Joe: Yeah. Bo knows- Yeah.
Is Tax Gain Harvesting in a Down Market a Good Idea?
Joe: We got Sid from Kansas, Alan. He goes “Hey Joe, Al, and Andi. You have the best financial podcast I’ve found. Great entertainment and great information. I don’t hear much about tax gain harvesting. Could you talk about that? Specifically, is it best to do in a down market or if that is a non-issue? Thanks.” Tax gain harvesting.
Al: OK, well, that’s when you have a position and it’s gone up in value and you purposely sell it because let’s say you’re in the lowest two brackets, the 10% bracket and the 12% bracket. For single, that would be around $40,000 of taxable income, married about $80,000. Let’s say you’re married and you got $60,000 of taxable income. You can sell a security at a $20,000 gain to get to that $80,000 taxable income and you would pay no federal tax, you would pay state tax potentially, but no federal tax. Then you could turn right around and buy that same stock at a higher tax base. So now when you sell it again later, you’ll have a smaller gain. That’s a great strategy if you’re in the 10% or 12% bracket. Or potentially if you’re in a higher bracket but you’re in a lower bracket than you will be forever and ever in the future, it could be. But generally, we see it most often when you’re in the lowest two brackets, that’s when you would do it. In a down market, I don’t know, because the stocks are down. But potentially, I guess if you’re in a down market so the gain is less that you can sell more and then buy more back, why not? But it’s basically all you’re trying to do is fill up that 12% tax bracket.
Joe: Right. You can increase the basis, too. If you really like the security, you can sell them and buy- There’s no wash sale rule.
Al: That’s right. No 30 days. Not a gain.
Joe: So if you like your stock, you could sell it, increase your basis, and all good. All right, that’s it. Is that it, right?
Andi: That’s it.
Joe: Okay. Thanks a lot for listening, we’ll see you guys again next week, Andi, wonderful job, Big Al, great stuff. The show is called Your Money, Your Wealth®.
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