Afford Anything - Ask Paula: Are Index Funds Unsafe?

Episode Date: August 12, 2019

#209: Anonymous wants to retire early and often. They’re going overseas, where they’ll make their annual salary within six months. Where should they put their extra income? Anonymous also wants to know: how can they find a financial advisor they can actually trust? Another anonymous listener wants to know - is it possible to spend more while minimizing taxes in early retirement? JuanCarlos asks: is $20,000 too little to invest with a financial advisor? Angela is wondering how to create a Roth IRA account for a teenager. Rose is thinking about switching from mutual funds to index funds because it means encountering less fees, but her and her husband are in their 60s. Does this make sense? Ari has $700,000 to invest in a taxable brokerage account. He wants to know if a 90 percent total stock market index and 10 percent bonds is a good asset allocation. Dave and his wife want to use their defined benefit plans as their primary income stream in retirement, and supplement with Roth and 457 incomes. Where else should they be saving? Myself and former financial planner Joe Saul-Sehy answer these questions on today’s episode. Enjoy! For more information, visit the show notes at https://affordanything.com/episode209 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make is a trade-off against something else, and that doesn't just apply to your money. It applies to your time, your focus, your energy, your attention, anything in your life that's a scarce or limited resource. And that leads to two questions. Number one, what matters most to you? Not what does society say ought to matter most, but what actually is high priority in your own life. Number two, how do you align your daily decisions in accordance? Answering these two questions is a lifetime practice, and that is what this podcast is.

is here to explore and facilitate. My name is Paula Pan. I am the host of the Afford Anything podcast. Every other week, I answer questions that come from you, the community. And today, former financial planner Joe Saul Seahy is with me to help answer these questions. What's up, Joe? What's happening? Oh, man, I am fired up and ready to go. I just got back from a regional theme park called Cedar Point with my 10-year-old nephew. And I got to say, like they told us when we were getting ready to ride Steel Vengeance, the number one roller coaster in the country, buckle up because we're about to have some fun. You know, Joe, I don't think I've ever told you this, but when I was in high school,

I worked for Cedar Point's rival. I lived in Cincinnati, Ohio, and I worked for the, the rival, Kings Island. Kings Island, the rival amusement park to Cedar Point. Yes. And it was a precursor to my podcasting days because my job, I was a carney, my job was to get on the microphone and be like, step right up. There's a winner every time. Just $3 to play. Step right up. I did that on a microphone all day, every day for two summers while I was in high school. That's really all you're doing here is going step right up, ask the question. You bring them up. We knock them down.

Step right up. It's time to answer a question. Now, here's a question, not to get too far off base for people don't know these things. But number one, so you got to ride the beast whatever you wanted. Yes. Oh, the beast is the world's long. longest wooden roller coaster? I rode so many roller coasters all of the time. It's just what I did at work all day. Now, you know, they're all, because of consolidation, they're all owned by the same company. Cedar Fair owns Kings Island, Kings Dominion, Carol Wins, Cedar Point, Knottes Berry Farm out in L.A. and a few others. And of course, their ticker symbol is F-U-N. Oh, I thought you were going to say their ticker simple as FU. That would be great. That would be good.

That's not it. It's FU.N. We should start a financial independence index fund. They might put the FU in FUN. All right. Well, speaking of FUN, our first question comes from Rose. Hi, Paula. This is Rose.

here I am again looking for your help in the Joe's. My husband and I are in our early 60s and retired. We have a financial consultant that we pay 1% annual fee in a portfolio of about 1 million. And of course, we have a few mutual funds in this account. At this point, is it worth to build a portfolio with index funds? A financial consultant says it's riskier. then with mutual funds, because with index funds, you own the whole market. And if the market goes down, your whole portfolio goes down as well.

Following your week 23 advice, I have checked the fees of these funds and found out that out of 11, only 3 has an expensive ratio of 0.50% or less. In my small Roth IRA, all three funds have expense ratio of about 1%. I just found out that Vanguard charged 0.30% as management fee. I am thinking if it is worth transferring my account to Vanguard to save on fees and simplify my portfolio. Yours and Joe's input is greatly appreciated. Rose! Fire your financial advisor. We'll talk about why in just a second, but a couple of things I want to say right off the bat.

Number one, it is true that when you own an index fund, you own everything that that index represents. So for example, if you own a total U.S. stock market index fund, then you own every stock within the total U.S. market. If you own an S&P 500 index fund, then you own a share of every stock within the S&P 500. And what that means is that your portfolio does as well or as poorly as the underlying index or combination of underlying indices that it tracks. No better, no worse. Now, compare that with owning a mutual fund in which you have a fund manager who is picking and choosing what stocks are inside of that fund. The hope is that that fund manager will be so good at his or her job that they will pick funds that outperform the market.

That's the theoretical hope. But statistically speaking, most funds underperform the market, particularly after taxes, trading costs and fees are subtracted from the overall return. You are more likely to do better in an index fund than you are having someone pick and choose the stocks that should belong in an actively managed mutual fund. Now, that being said, there are a couple of issues kind of going on here. Number one is, I don't know what your asset allocation is with the mutual funds that you hold. If we're talking about changing up your asset allocation, then we're actually talking about two different issues here, right? There's the issue of switching from actively managed funds to passively managed funds, and then there's potentially the issue of changing up your asset allocation. So if your financial advisor is warning you about changing up your asset allocation, okay, cool.

that's perfectly fine. You want to make sure that the asset allocation that you have is appropriate for your timeline, your age, your risk tolerance. So the mix of equities and bonds that you hold and the types of equities that you hold, large cap, small cap, international versus U.S., absolutely, you want to make sure that that is nailed down and you don't want to make any drastic changes that are outside of the scope of what would be appropriate for you. I'm totally on board with that. But to state in a more broad way, The index funds are somehow inherently riskier than actively managed funds. That is just flat out not the case. In fact, statistically speaking, the case is the opposite. One last thing I want to say is that it sounds as though you might not have a financial advisor. It sounds as though you might have an investment manager. So with that, I'm going to kick this over to Joe because Joe, I can see on your face. You've got some words.

I love Rose. I want to help Rose. Rose, we're swooping in. Here's the thing. I think you're making one assumption, though, Paula. We don't know what Rose has. And Rose didn't say that the advisor said that it was riskier because of active versus passive. He did say passive is riskier than what she has.

We don't know what she has. And that exactly is why she should fire advisor. Right, right. Exactly. My first thought when I heard her question is there's two issues at play. One is active versus passive. The other is asset allocation. And you're right, Joe, we don't know what she has.

No, we have no idea. In fact, it's funny. There is a fund as an example that I just pulled up. I just pulled up this fund that is a fairly well-known active fund. Somebody wrote me recently about this fund, which is why I wanted to bring it to the table. I'm going to leave the name out of it, all right, because it's irrelevant. But what I will say is it's a mid-cap global fund, meaning it doesn't buy huge companies globally, doesn't buy small companies, buys in the middle.

So in some ways, it's a little bit of a niche fund. But the person was upset because they have a 1.1% expense ratio in this actively managed fund. The first thing I did, call me crazy, was I went to Morning Star and said, what do we have? And even if you don't know to go to Morning Star, that was a little flippant there, if you don't know to to Morningstar, you at the very least want to know what you own. What do I own? And Morning Star is a great third-party reference. So I pull it up and I find out that this is a four-star fun on a scale of one to five. Person writing me says, I want to get rid of this thing. They don't even know that. But that kind of perks my interest a little bit. Okay. All right. Well, let's see why

it's four stars. I see this 1.1 percent expense ratio. Morning Star, who takes all of the funds that are out there and looks at them, but then segregates the market into types for this type of fun, which we could even talk about, does this person need this fund or not? We won't even get that far. But fee level below average, 1.1% is already a lower fee than the average fund in that area.

So where this person who wrote me said, I'm paying an arm and a leg, no, you're not. You're paying less than most people are for this type of fund. Then I go down to the portfolio. Listen to this. 2018, the funded negative 18, which was 4% worse than a category and also 4% worse the index.

The year before that, it did 52%, which was 27% better than the category and 28% better than the index. Two years before, by the way, it beat the category by 15%, the indexed by 15%. Two years before that, it did 40, beat the category by 9.7%. percent the index by 14. It is up and down in terms of whether it's ahead or behind of its index and the category competes against. But if you even those things out and you look at the three year, five year, 10 year, 15 year track record, you know what we have? We have a fun that is beaten the pants off of both its category and its index on a fairly consistent basis when you're

looking at those time frames. So then I pull back to the analyst at Morningstar. Once again, not affiliated with a fund. Guy says, a successful but risky fund. Yes. Now we know what the person has. They have a fund that takes more risk than other funds in its category. What I like, by the way, Morning Star has this cool graph that shows growth of a $10,000. If you had purchased in 2009, the index, you would have dropped your fee through the floor. You, you would have grown that $10,000 to $31,996. With this fund, you would have grown it to $47,443. Okay, Joe.

Now, hold on. All right. Hold on. You can see my face. You can quit the fun. You can quit the fun. That's fine. Had you done that historically, you would have had a cheaper, much more mediocre position

than what you actually had here. you would have paid less money. It would have been a quick win because you paid less money, and you would have been $16,000 further away from your goal than you are today. Know what you own. You've got to know what you own. It doesn't mean to get rid of it or not. But at the very least, if you know what this fund does,

you know what it has, then you can have a much better idea about whether to sell it or not. All right. Here's where the boxing gloves come on because, Joe, here's where you and I disagree, which is, you know, why have you on the show? Because it's good to hear a variety of opinions. What you have just described as a fund that has historically in the last 15 years outperform the market. What we know is when you look at the broad aggregate universe of funds, the majority of funds do not consistently outperform the market and those that do revert to the mean. And so here's where I'm going to say, don't conflate results with statistical likelihood. Just because one particular fund has outperformed, don't succumb to the temptation to engage in resulting and think that because that particular fund has outperformed, A, it always will, it will continue to outperform.

And B, that means that we have the ability to hand-select, actively managed funds. What we know is that statistically speaking, the majority of funds... We so know, statistically speaking, that fund managers historically who have had a history of beating the market are the ones who usually continue to do so. And the ones who drag it down are the ones who continue to drag it down. The one thing that changes that, by the way, is asset flows. What's funny is this particular fund would have done even better. You know why it didn't? If you look at asset flows, guess when most money flowed into the fund at the beginning of 2018 after the fund had done 52%. This is why I hate actively managed funds, by the way, is because people will

call them not people who are fans of Paula or Joe go, oh, that did phenomenal last year. I need to buy me some. And they go and they buy it. And you and I have talked about this before, a great report by a guy named Brett Arendt's recently showed that the reason why a lot of active fund managers don't perform is because these people are morons. It's because people hand them money at the wrong time and then they take money out at the wrong time and the managers forced to do things that they wouldn't have done. And historically, by the way, if you take away those things that make an active manager do the wrong thing, active management's way better than what we have seen in the, that what we've

seen. But historically, you're, you're looking at the huge universe of managers. And there is a sucker born every minute who will buy a horrible fund. I'm not saying to go out and even buy this fund, Paula. I'm saying if you own this fund right now and you know this is what you have and you know how this particular manager performs because it's like a heartbeat. When the heartbeat doesn't keep beating like the heartbeat, what do you do? Well, then you move on. But do you move from this fund right now if you own it? I would, yes. I absolutely would. Because I totally wouldn't. I absolutely would. I would I would move from that fund because I know a strategy and a manager who's working, why do I fire them? Because I know that the expected value of any fund, any actively managed fund is lower than the

expected value of an index fund over time. You're taking the big huge universe and saying it's all created equal. It ain't created equal. It's not created equal. That's like saying that if we took an index like the All Japan Index Fund, that should be compared to the S&P 500. No, no, no, no. We're talking about actively managed funds versus passively managed funds that represent the same underlying industry. You can't lump them all together. You can't. If we have an active fund that purchases mid-cap growth, and then we have an index fund that

represents mid-cap stocks, the index fund. The index fund is likely to do better over time. An outperforming actively managed fund is likely to revert to the mean. Well, you're right, but this hasn't happened in 10 years with this fund. Yes, but just because it hasn't happened in the last 10 years doesn't mean... Tomorrow. No, you're right. Maybe it doesn't change the expectation for year 11.

If you flip a coin 10 times and that coin, it's a fair coin toss, it's a heads tales, fair, unweighted coin. But it's not a coin toss. you have a system at work here. This is not like voodoo. For some managers, maybe it's voodoo. If you find a manager who is working successfully, listen, if I go into a classroom of people, we can take a classroom of people

and we can call those active fund managers. I've got person A who sits in the front row and gets A's all the time. I can put my money with that person thinking they're going to get an A or I can put my money with a person, who sits in the back, sleeps all day, and constantly gets Ds and Fs. I have my choice. Hold on. I have my choice or I can get, but what you're saying is they're

all going to revert to the mean. Not true. The group as a group will revert to the mean. The individual fund doesn't have to revert to the mean. And these are systems at work. So if you're going to be an active fund manager, you have to understand the system that you're working. You have to, which by the way, people are going to hear this and they're going to think that I'm advocating active management and I'm not. I'm not. I think you should go passive. I just think that calling all active managers bad, baloney. I'm not calling them bad. I'm just saying that you cannot consistently have a quarterback who wins every single Super Bowl. No, but I'm putting my money on Peyton Manning. I'm putting my money on Tom Brady because those guys successfully continue to do it.

who's who's more likely to win the Super Bowl next year? I don't know who's playing. Or anybody else. Well, that's a good point. But if you're going to make an analogy, your analogy is exactly what I'm saying. You're taking a way, way, big thing and you're using it on this individual thing. I don't know what Rose has, and I don't vote to sell any of it until I know what the system is. And then, by the way, you know what else I asked myself, this whole discussion you and I have had,

I then ask myself, if I'm Rose, do I care about any of that? Do I really care what I have? Because frankly, if you don't care what you have, I would not go with active management again. Because everything I just said means we have to know who this manager is. We have to know if they retire or not. Because the second that somebody retires, the system changes. We have to follow the fund to see if the heartbeat works the way that it has in the past, because systems do not continue indefinitely.

So I do have to track my stuff. But why would I sell something just for a cheaper fee? I get that a cheaper fee is an easy win. But this idea of conflating, cheaper equals better is still wrong. It is still wrong. Cheaper is cheaper. It's not better. You would have been better off paying a crap load more money with these people.

even though your methodology would not have gone there. And I'm not saying that you should go do it tomorrow. I'm just saying you lost. But there is no way to predict that. And statistically speaking, if you were to choose 10 actively managed funds, you are likely to do worse. Joe, this is where you and I disagree, right? Because I do think that cheaper is better because you're paying,

why would you pay a price premium for something that statistically speaking is likely to do worse? why would you pay a premium for the thing that is worse? Because it's not worse. There are worse. That dude in the back in the F is who you're lumping in with the person in the front of the room. But that dude in the back getting in the F is going to be fired and replaced. Like there's fund manager churn. So why do we pick that fund?

Why would you pick that fund? And yet you insist in including them in your statistic, right? I insist that the F people that get churned, I'm going to put them in the statistic. I'm telling you, if you take out those people, you come up with a whole different playing field of statistics. But even when you look at funds that have outperformed, those funds revert to the mean. This one hasn't. I'm looking at one right now. What about this one?

This one has not reverted to the mean yet, but it is likely to do so. And you cannot cherry pick outliers and make pronouncements about strategy based on outliers. I don't think that hiring people that have gotten A's in the past is an outlier that they're going to get A's in the future. I do not think so. I do not think that hiring a quarterback who has won over and over and over to quarterback your team versus somebody who's been the middle of the pack forever is an outlier. I don't think those are outliers. What we have seen historically is that they do revert to the mean. We see that consistently over and over and over. the managers who outperform, then become the managers who underperform.

Ray Dalio never ever reverted to the mean. Again, you are cherry picking the outlier. I'm not cherry picking the outlier. You are cherry picking the outlier. You are using hindsight bias. There's always going to be an outlier, but that is not how you make rules about how to manage a system. If I'm making rules today, I'm going to pick passive funds. I'm just telling you that half the stuff people say about active management is crap.

It is complete and utter crap. And Rose doesn't know what she owns. She has no idea if she owns something. And I think that changes the game. This gentleman that wrote me recently about this particular fund, he said before he knew what he was doing. He put money in this fund. Now he knows what he's doing.

And now he's going to sell it. But if he knew what he was doing, he'd look at the fun first. I disagree. I say get rid of all your active funds because they are likely to do worse. And even if they are outperforming, that is unlikely to continue. What do I say to that? Who is playing in the Super Bowl next year, Joe?

Have they determined that yet? They have not determined that yet. But statistically speaking, it will be somebody with a great quarterback. All right. forward to the Cleveland Browns versus the Cincinnati Bengals. That will not happen. All right. Well, thank you, Rose, for asking that question. I hope we've answered it. We'll come back to this episode after this word from our sponsors.

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Our next question comes from Dave. Hey, Paula. Thanks for everything you do as we all adventure through personal finance. My name is Dave and my wife and I live in the Central Valley of California, earning about $95,000 net annually. We have no debt other than the house and have a savings account of $32,000. We are both 38 years old. I work for a county government with a 3% at 60 defined benefit plan. My wife works for the state of California with a defined benefit plan as well. We started our jobs at 22 and both want to state our jobs until retirement. We have Roth IRAs with a combined total of 43,000. We contribute 11,000 per year to the Roth. I also have a 457B plan

with $52,000 in the account and contribute $7,200 a year. We envision using our defined benefit plans as our primary income stream in retirement and supplement with Roth and 457B. incomes. So our question is, where should we go next in retirement planning and what else should we be saving slash investing in? As a side note, we are not overly interested in real estate investment. Thanks for the help, Paula. Thanks for the question, Dave. There is an actively managed midcap global fund. Oh my God, I'm going to kill you. It's really well managed. But actually, seriously, before I get into answering the full question, Dave, and I know Paula has a lot here too. Just because you're not interested in real estate investing doesn't mean that you can't

have real estate in your portfolio and also doesn't mean that you shouldn't. If you're broadening your diversification, there are plenty of ways to invest in real estate that don't require the type of hands-on stuff that I think you're talking about when you say you're not interested in real estate. I look at real estate and stocks as two asset classes that historically over long periods of time, the North American Real Estate Index, the Neary Index, and the S&P 500, really similar results over long periods. And yet, over most timeframes, they act differently on any given day. So what's cool is you put both of them together. You can actually lower the volatility of your portfolio by having it.

So even though you're not interested in real estate, I may still look at having some traded reits in your portfolio. Vanguard has a fine reet fund. that might be a part of your mix. I know when I was a financial planner, we would often put 10% of a portfolio for someone like you into a re. And I don't know how much to put there because my bigger answer is this.

I like beginning, like Stephen Covey says, with the end in mind. So start off with when do I need this dollar and then invest that way. So I think you're doing a great job with the Roth. I like the 457. the pensions, the high five that you have a pension, that's fantastic. And I love your strategy to live off of that.

My one thought process is this. And Paul and I are going to get to this with a future caller later in the episode. You want to watch out having all of your money in tax shelters because of the fact that at some point you need to take the money out. So I would make sure that you have some tax flexibility. You already have that with Roth and 457. You know, you might even want to have some of your money just in a brokerage account. You're going to pay more tax along the way that creates a little bit of friction, which means it slows down the results of your net worth growing a little bit.

But I like then having the ability to have some money that I can take out whenever I want it, if you want that money before 59 and a half or before retirement. So I don't know exactly where to invest because I don't know the goal. Once I know the goal, I then look at the amount of time. until that goal. And then I take this huge, wide bouquet of investments that are available to me, which really gives people deer in the headlights, right? They don't know what to do because there's so many choices. That helps you narrow the field. And instead of having to be an expert in everything, you can now just focus on the few investments that fit that time frame. It'll make your job a lot

easier to begin with the goal. Yeah, I agree with that. So whenever we talk about investing, the question is always for what? So are you investing for retirement? Are you investing for some major purchase that you might want to make 10 to 15 years from now, in which you'll want to be able to access this money within 10 to 15 years? But you want to have it invested prior to then. You know, there are going to be different buckets with different goals. And each of those would have asset allocation that would be appropriate for that timeline. So that's where I'll what I would start with is what exactly are you investing for? And if the answer is primarily retirement, then depending on your timeline to retirement, I mean, that will influence your mix of, say,

equities and bonds. But then beyond that, inside of equities, the split that you want to take between U.S., international, and as Joe was saying, reeds or other types of commodities, I mean, that's a lot of that is going to be self-knowledge. A lot of that is going to be how complex do you want your portfolio to be. There are some people who would, would trade off a bit of return for the sake of simplicity. There are some people actually who would argue that you might not even be trading off return for the sake of simplicity, if that motivates you to manage your portfolio better because you can often better manage what is simpler. So that's kind of one component of it, the simplicity versus complexity of the asset allocation within your portfolio. You know, how many different types of low correlation assets do you want in there?

When I say low correlation assets, that means things that do not. move in lockstep with one another, which reduces the volatility inside of your portfolio. There isn't to right or wrong answer to it. A lot of it really boils down to a question of simplicity versus complexity. How many types of asset classes do you want to hold? The simplest thing to do is the fewest number of asset classes, and they're both pros and cons to that approach. I think there is one, there is actually a wrong answer, which is picking an investment that makes you comfortable, but doesn't fit the time frame. And when I saw people messing up with their money more than any other time, it was generally for that reason. I feel very comfortable

with a CD. Well, a CD right now may earn around 2, 2.5% if you're lucky. And inflation historically, 3%, 4%, depending on the year. So you are very safely, Paula, going backward. Right, absolutely. And if that money is a laddered CD for an emergency fund, then that's fine. In fact, that's great. But if it's for a long-term goal, then that's absolutely the wrong vehicle for the timeline. The other wrong answer is to go into actively managed funds. I agree with that. I totally agree with that. I know you're just poking me. I totally am. But if he's just starting out, I wouldn't do it that way. I get it. And hoping that a fund manager continues to do that thing.

But if I'm already there, Paula, if I'm already in there, not going to use your flawed logic. Then you're just going to sunk cost fallacy, your way into sticking with it. I'd love you to go into a classroom and just go to that A student and go. You're not going to keep getting A. It's not going to continue. I'm just waiting for you. Just the fact that you've got them in the past, that was the past. There is no statistic about a students reverting to the classroom mean.

There is a statistic about fund managers and funds reverting to the mean. Based on, based on a selection of 100% of the market. Yes. Even when you look at funds that outperform, those funds revert to the mean. there is no statistic that the best students in a class revert to the classroom mean, but there is a statistic that outperforming funds tend to not outperform for the long term. So the analogy does not hold water. Well, great.

Which is why I'm telling Dave, Dave, you don't have that fund, so you don't have to worry about it. So go for it. But if I already own the fund. We should probably move on to our next question, eh, Joe? Already? Thank you, Dave, for asking that question. And please, don't go actively managed. Our next question comes from Ari. Hi, Paula. My name's Ari, and I'm 43 years old with no children. I plan on achieving fire next year.

I'm getting ready to sell a house that I co-own with my brother. I will have about $700,000, which will be tax-free due to a step-up basis and a $250,000 gain exclusion. I already have $80,000 in a Roth IRA invested 100% in a total stock market index. I will continue to work part-time on my side business that I love, brings me in around $20,000 a year. I plan on putting the $700,000 from the sale of the house in a taxable brokerage account and draw down on 3.5% annually. Do you think an asset allocation of 90% total, total stock market index and 10% bonds is a good asset allocation for what I plan to do. I also plan on being a renter versus buying a house going forward after the sale. Thank you. And thanks for answering my question.

Ari, first of all, congratulations on being so close to financial independence. That is fantastic. to answer your question, which is about a 90-10 split. So here is what I hear when I listen to your question. You have $700,000. You're going to draw down at a 3.5% rate, which means that you will be drawing down $24,500 per year from that $700,000 portfolio. In addition to that, you have a side hustle that brings in another $20,000 a year.

So between the drawdown, the 3.5% of $700,000, plus the $20,000 a year that you can. make from your side hustle, you will, between those two things, have approximately $44,500 per year prior to taxes that you will live on. What that says to me is that you absolutely need this drawdown on the $700,000 in order to cover your cost of living. Because when we're talking about a total of about $44,500 pre-tax that you'll be living on, then if the market declines, if the market goes bad, you can't just skip taking that 3.5% drawdown in a given year. You need this money.

And so to me, that signals one of two things, either investing it more conservatively because of the fact that your timeline to retirement is now, or if you are going to invest, it more aggressively, having some cash reserves that you can tap in the event of a recession so that you don't have to convert as many paper losses into real losses if the market were to decline. Yeah, I think just having some guardrails, if you're going to do that, is really important. And the whole, you know, financial planners use some industry jargon that's called sequence of return risk, which is what you get into when you run a 90% stock portfolio that you were drawing money from. If the market continues to go up, that's fantastic. However, if you're drawing money out

at the same time, the market is quickly deteriorating, you can turn normal volatility into devastating results for your portfolio. And that's what you're trying to avoid. For a very good discussion on sequence of return risk, check out the Afford Anything podcast episode in which we interview Dr. Wade Fow. His last name is. spelled P-F-A-U. We have an excellent conversation about sequence of returns risk, and that is episode 119, episode 119, of the Afford Anything podcast. In a nutshell, one recommendation that he makes is to, at the beginning of your retirement,

reallocate your portfolio in such a way that you significantly decrease the amount of risk that you're taking on. which means that you would want to have a much bigger percentage of your portfolio in bonds at the start of your retirement. And then once you get past those initial first few years of retirement, which means that you've survived the worst of the sequence of returns window, you then can actually increase the risk exposure in your portfolio. So that is a potential strategy that you could take. you could next year when you begin retirement, reallocate your portfolio so that you have a large percentage in bonds or cash equivalents, ride that out for the next five years and then start

upping your equities after that. I like that approach a lot better. Yeah, I do too. A lot of financial planners call that a bucket strategy where you'll keep a short-term bucket, a middle-term bucket, and a long-term bucket. And you continually move money from long-term to medium-term, medium-term to, uh, short term so that you're not taking on as much risk of taking money out of the market at the wrong time.

Exactly. Yeah. And that's my hesitation with a 90-10 split on a $700,000 portfolio in which you absolutely have to draw down that 3.5% every year regardless of what's happening in the overall market. You know, it would be one thing if you had enough money coming in through your side hustle that if the market were to go bad, you could just, you could lower your drawdown to maybe 1% or 2%, but given the fact that it doesn't look like the numbers would work with a strategy

like that, given the fact that it looks as though you have to take that 3.5% out each year, you know, we want to be a little bit more conservative with the bulk of that $700,000 lump sum. So thank you, Ari, for asking that question. We'll return to the show in just a moment. I'm always looking to discover those key pieces of clothing that are versatile, comfortable, and stylish, and on top of that, I've been trying to find clothes that don't have a huge impact on the environment. But shopping for myself can be a pain because I'm looking for clothing that's sustainable and environmentally responsible, and I would prefer the convenience of having it delivered to my door.

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completely risk-free. That's Frank and Oak.com slash Paula for $25 off your first subscription box. Frank and oak.com slash Paula. You know those thumb-stopping videos that you have to watch when you're on social media? Like when I'm scrolling Instagram and I come across this gorgeous travel video, I'm like, yep, watching it. So have you ever wanted to make some of your own? I have. And my new sponsor, Lumen 5 makes it so easy and fun to do. Lumen 5's AI makes it really easy to create videos for any.

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My name is Juan Carlos, and I am 24 years old. And I wanted to start off by saying that I love your podcast, which I found earlier this year, and I wish I would have found sooner. So I recently paid off the less of my consumer debt, which is around 5,000 and total. And within the last year, I've started saving pretty aggressively, putting 50% of my take-home pay into my savings and investment accounts. Currently, I have $11,000 in an emergency fund in the savings account that returns 2.2%. I have $15,000 in 401k with Fidelity, $10,000 in a Roth IRA with Vanguard. I also co-own a multi-unit home with my brother, or we run out one of the units and he stays in the other.

On top of this, I co-owned two small businesses formed as partnerships, and I have two two. 20,000 in cash on hand for future investments, which is a reason for my call. I feel that my financial life is getting a bit complex, and I've been reaching out to some CPAs and financial advisors for help, but I can't help feel that they are uninterested to dive deep into my finances once I let them know that I only have 20,000 to invest. Am I being too eager to look for a financial advisor? What's the exact title of profession that I should be looking for help, and how do I know that I found the right CPA or financial advisor.

Thanks for taking my call, and thanks for the quality and focus of the information you put out. That's very true, Juan Carlos. You have a ton going on. By the way, congratulations on that, and I have a few thoughts on it. I know Paula does as well. First, this is an issue, Paula, in financial planning, is that there is no name. There are too many people using too many of the same names, so you have to be able to ask clarifying questions. And by the way, in some cases, this might not even be a professional

advisor because of the fact that you have so many moving pieces, finding a mentor who does similar, has similar businesses and things that you have that you can glean knowledge off of might be a great person to have in your corner as well. The fact that you own specific types of businesses. If there's someone who will meet with you, who, you know, if you bought them lunch, a lot of times older people want to share that knowledge. And that might be helpful. Now, when it comes to CPAs, CPAs shouldn't care at all about how much money you have invested. CPAs get paid to file your tax return. So what you're looking for is a CPA who also is not dabbling in asset management. And the other thing that you're not looking for when it comes to financial

advisor, you should ask them if they prefer to work in asset management. Is their fee based on a percentage of assets or are they paid to manage assets? You're not really interested in that. You don't want that. So what you're looking for is a fee only financial planner where the fee is a set fee, not based on assets, but based on the amount of time they spend working with you. And you need to clarify because of those businesses. It needs to be somebody who has a business planning background. You need someone who works with business owners, not someone who works with people who have a W-2 paycheck

and just bring in money and they're helping them with the budget, the estate plan, make sure their insurances are in order, you know, the standard things for the standard family. That is not you. You need somebody who works with businesses. I would also say this, even though I'm not your advisor, one of the biggest mistakes I've seen business owners make

is that instead of owning a business, they end up owning jobs, meaning they work for the business, the business doesn't work for them. I like a book called The E-Mith to turn that around and begin building a business that's built to sell. And then a podcast, by the way, that's fantastic in that area,

is by John Worrello, and it's called Built to Sell Podcast. And it talks to entrepreneurs like you where they've restructured their businesses so that they could sell it. And it even tells you that podcast even talks about how they sold their businesses. Even if you have no plans in selling your business, building it to sell from the beginning is going to save you a lot of legwork later. And you're also going to find the business runs without you better. When it comes to your business, I think I would definitely listen to John Warillo. read the E-Mith as a starter there. And then, yeah, CPA should be pretty easy as long as they're not an

asset manager and fee-only hourly financial planner. Joe, I think you nailed it. The only thing that I would say is I want to echo this idea that your CPA and a financial planner who is paid on an hourly basis, those two people should not care about the amount of assets that you have. If you have a financial planner who gets paid fee only on an hourly basis and therefore does not get paid as a percentage of assets under management, then it doesn't matter to him or her how many assets you have. They're making the same 300, 350, 400 an hour regardless of how many assets you have. So you pay them at an hourly rate, and that's that. End of story, regardless of whether you have 24,000 or 240,000 or 2.4 million or 24 million.

And the same goes with the CPA. A CPA who's going to charge you at an hourly rate is a CPA who's going to charge you at an hourly rate. End of story. Yeah. And finding the CPA, Paula, should be way easier than finding that fee-only financial advisor who just charges a set amount based on time. That seems to be more of a struggle. That is, yes, because there are a lot of financial advisors who want to charge the asset under management model. One good place to start searching is the X, Y, planning network. They have a list of fee-only financial advisors whenever you go talk to one. The first question that you should ask is, do you have a fiduciary duty to me at all times? And the answer to that question should be yes. If it is not, walk away. I have another one to throw in there. I would also go to a place called Guidevine. What I like about Guidevine is they have all different types of financial advisors. But, Paula, you can look at how they work.

and watch videos made by them so you can get a feel for them and whether you even respond to them then. It's almost like you get to speed date without the person on the other end knowing that you're even considering them. So a lot of people find that a nice place to get started to guidevine.com. And we will have links to all of this in our show notes. Our show notes will be available at afford anything.com slash episode 209. It's afford anything.com slash episode 209. Thank you, Juan Carlos, for asking that question. Our next question comes from Anonymous.

Hi, Paula. Love your podcast and have been listening for over a year. My question is, how can I spend more while minimizing taxes in early retirement? I was fortunate enough to retire at 46 with a net worth of $3 million. Six years later, my net worth has risen to $4 million in my balanced well-diversified portfolio. I'm single and have no errors. While I live comfortably on now, my Marconi's, simulation suggests that I could easily spend another $6,000 a month based on life expectancy.

The downside is that doing so would require withdrawals from tax-advantaged accounts. I'm currently 52 and have no desire to be the richest man in the graveyard. I've considered 72T withdrawals and a rough conversion lighter, but these options would push my income higher and eliminate my ACA subsidy. I like my home. It's paid for and I don't want to sell. therefore I don't see a good option to tap the equity. I currently live on approximately $20,000 of long-term capital gains and dividends and withdraw an additional $35,000 a year from Roth IRA contributions.

Therefore, I'm in a minimal tax bracket and qualify for the full of Obamacare subsidy. I have additional Roth contributions and enough money in a taxable account to maintain my current spend rate to 59.5, but not enough to increase my spend up to what the Marconi simulations suggest that I can safely withdraw. How do I most tax-efficiently get an additional $6,000 a month? Anonymous, that is a great question. Now, first of all, the two options that you considered, the SEPP 72T and the Roth conversion ladder, are what I would suggest for the majority of people. But in your case, you're absolutely correct. It's not going to work because of what you said, which is that you're currently in a low tax bracket and getting at more money would push you out of the ACA subsidy.

And so unfortunately, you're going to have to choose between getting the ACA subsidy or taking out more money from your retirement accounts and increasing your income. But you can't increase your income while continuing to qualify for the ACA subsidy. Unfortunately, you do have to choose. The one thing that you can do, as I've thought about your question, the best way that I can think of to increase the amount of money that's available to you while still qualifying for that subsidy is that you could take out a HELOC or a home equity line of credit. And then you can live on that loan and then pay yourself back. And obviously, and Paul, you already know these downsides. There's going to be a new monthly payment. If you do that, there are also, you're going to pay a little bit of money to the bank.

in terms of interest. Luckily, interest rates are still pretty, pretty low. So I like all of those things. The issue with a home equity line of credit is it's usually at a variable rate. And we look at the fact that rates are low now. Obviously, the Fed just lowered rates again. The Fed just lowered rates, which is interesting. I don't know what to make of that, but I do know that at some point, interest rates will go up. And if interest rates do that, the interest rate on a home equity line of credit would continue to go up as well. The issue here, and it's interesting, Paul, it doesn't, it doesn't help him, but I think it can help a lot of the people listening that this is why we talk about putting money into different tax pockets so that you can draw from other places and not

run into this problem. And I know that's frustrating for him to hear that we're using this as a cautionary tale. By the way, I love the idea. I love the idea of not being the richest person in the graveyard. I mean, I'd high five myself. I'm like, that's the way you want to live life. Unfortunately, no matter how you take this out, it's going to be ugly. But I can't think of any way to do it other than either a home equity line of credit or a mortgage, a straight out mortgage. The good news about a mortgage is you'll get a fixed interest rate at the low rate versus one that floats. But if it's for a Shortish period of time, the home equity line of credit is going to involve fewer fees than a bitchwood.

I mean, yeah, or the only other option is to just no longer, just accept that you're no longer getting the ACA subsidy. Yeah. You know, and then decide if that is worth it to you. Those are tough decisions. And by the way, as long as we're discussing this, you know, we've had questions in the past, Paula, about people maximizing the HSA. And I love that.

But you look at a bill going through Congress right now. that a lot of us hope won't pass. And frankly, there are always bills going through Congress, so we don't pay a lot of attention to them. But get this one. This bill going through Congress wants to close a loophole. On one end, it will allow people who are seniors to still invest in an HSA, to have an HSA, which is pretty cool, because right now that's not a possibility. But on the other end, it closes one reason why a lot of us love the HSA, and that is, you will no longer be able to pay for Medicare for any of your Medicare expenses using HSA money.

And that gets rid of a huge, huge part of planning that a lot of people have banked on when it comes to the HSA, being able to use this for health care long into retirement. So this is another reason why I like tax. flexibility because rules are going to change. We don't know how they're going to change. I don't think this one's going to go through, just talking to people in Washington that are on top of it far more than I am. However, things will go through Congress. Rules will change. And when they change, we want to have the flexibility that our plan isn't based on this one rule, that we have the ability to kind of roll with the punches. So Anonymous, thank you for asking that question. And I'm

I'm sorry that I can't give you an answer that solves it. That solves it. Yeah, exactly. Exactly. Because unfortunately, you're going to have to choose between a higher income or the ACA subsidy. Or debt. Or debt. Or debt.

Or taking out a mortgage. Honestly, of those three, I like the option of taking out a mortgage the best. I like the option of taking out a he-lock or home equity line of credit, using that to give yourself some extra money. and then paying that off when you can increase your income. And that shows what a tough question. Right, exactly. We advocate debt. Exactly.

Exactly, Ramsey. So thank you so much Anonymous for asking that question. And our next question also comes from Anonymous. Hey, Paula, I have a two-part question for you today. The first one is how do I find a financial advisor? trust. And I'm hoping to get you and Joe's input on my next more specific question, but I definitely want to sit down and speak with a financial advisor, but don't really know where to start to find one. And so the next one is I'd like a suggestion on what I should do with all this extra income I'm

getting. I had an opportunity at work to go overseas, and I'll be making basically my annual salary within a short six months. Here's some numbers. I'm 25. I make roughly $70,000 a year. I have about $40,000 in debt, and I have $20,000 in my retirement as a TSP. My goals would be to retire early and often. Any of my investments, I'd like them to be as hands off as possible. So please let me know. Thanks. I love the goal of retiring early and often. Now, for the sake of anyone who's listening who has not heard me use that phrase before, this is one of my favorite phrases. To retire early and often means that you take mini retirements as you are on your way to an early retirement. A lot of people view fire, financial independence, retire early, they view fire as this binary yes, no, flipping a light switch. You're either early retired or you're not. I don't like that model. I love the model of retirement. early and often in which you perceive freedom as a spectrum and a variety of degrees. You know, you reach debt freedom. You reach the freedom that comes from having a strong emergency fund.

You reach all of these different levels of freedom as you are on the path towards financial independence. And while you're doing so, you also give yourself mini retirements and small breaks so that you can enjoy life during the 10 years, 15 years, 20 years that it's going to take you to reach financial independence. So love retiring early and off and love taking many retirements. Love that you're on board with the strategy. I do too. I also love that. I want to jump into what I do. I love this. Being able to help people make decisions with their money instead of my money. It's like the holidays. Ooh, I get to help you spend your money. Send it to your favorite podcaster.

I love the idea because of the retire early and off and goal. I love the idea of retiring this debt, ASAP. She has $40,000 in debt. I don't know what the interest rate is. Frankly, at 25 years old, while I can make a huge case for ignoring low interest debt and building assets at a higher rate of return, like the mathematician in me, the engineer in me wants to go that way. The person who wants the flexibility to retire early and often says get rid of baggage, get rid of payments. If I have fewer payments I can pick up and go whenever I want to. And the second I heard that goal, I don't know that that's a long-term goal. That's a short-term goal. Get rid of the debt that eliminates overhead. And now your ability to retire early and often happens that much quicker.

So I like that. Yeah, absolutely. And I agree. And it kind of goes back to what I said earlier about different degrees of freedom, right? So oftentimes it's tempting to think of financial freedom as the point at which your passive income, typically through investments, is enough such that it covers your basic bills, right? That's how a lot of people view financial freedom. But if you think at a level of the steps towards freedom or the degrees of freedom, debt freedom is a pretty significant degree of freedom. If you think of financial independence as a dial rather than as an on-off switch, debt freedom is a notch on that dial. Yeah. Think about how big. big that one is. You're 25 years old. Your overhead is eliminated. Do what you want to do. I think it's a great use of what sounds like it's extra money that might not be replicated.

You get to hit the reset button on whatever created that debt and you get a new new lease to start over. So love that. On the financial advisor question, I think that's easy. Same answer we gave before. I would look at the XY planning network. Fantastic. The cool thing if you're 25, younger advisors working with younger people. There are some older advisor working older people, but XY planning network, I look at the roster of advisors in that network. Lots of people working with Gen Z. Guidevine the same way. You've got a wide range of people there. The cool thing, I just looked at the Guidevine site. You can also toggle there. So back to Juan Carlos, you can toggle fee-only advisors. So toggle whatever type of thing you're looking for. Look at that. So those are two great resources.

Absolutely. So thank you, Anonymous, for asking that question. Our final question today comes from Angela. Hi, my name's Angela. I just had a question about starting some type of IRA for a teenager who's starting to work. Like Summer, just wanted to hear your feedback on specific companies or Roth kind of accounts to open up for the child to benefit from that time. for retirement. Angela, first of all, I think that is fantastic that you are helping a teenager open a retirement account. Starting to invest for retirement in your teens is one of the best financial moves that a person can make. So the fact that you are helping a teenager begin investing for retirement right now is absolutely commendable. I'm a huge fan of that. If this teenager has earned income, then they can invest that money into a wrong.

Roth IRA. That's going to be a fantastic option for any teen because they then get all of the growth tax exempt for the rest of their lives. So we're talking about money that you put in in your teen years that you withdraw 50 years down the road that has enjoyed 50 years of tax exempt growth. That's incredible. My favorite brokerage is Vanguard. I have no affiliation with them other than being just a normal run-of-the-mill ordinary customer. The reason that I like Vanguard is twofold. Number one, Vanguard is organized as a co-op, meaning that it is member-owned. Every account holder at Vanguard is a part owner.

So if you are familiar with the outdoor gear clothing store REI, Vanguard is the REI of brokerages. And so that structure means that there is no conflict of interest between the owners and the clients, because the owners are the clients and the clients are the owners. So that's one of the reasons that I like Vanguard. The other reason is that Vanguard, along with Charles Schwab and Fidelity, those three brokerages, they're the big three discount brokerages, which means that they are always in a race to the bottom in terms of fees. So any expense ratios that you pay, any fees that you pay,

are going to be rock bottom of the market. So I would recommend helping this teenager open a Roth IRA at Vanguard. Thank you so much for asking that question. Joe, we did it. I can't believe it. And only one, well, slight disagreement. Yeah, we opened this show with the boxing gloves on. Yes, yes, we did.

So a little behind the scenes here, Joe and I had a long conversation about that question before we started recording. It spilled over. Yeah, we both knew what was coming. totally spilled over. But lots of fun. Too bad you're wrong. But hey, you can't be right on everything. Uh-huh. You keep telling yourself that, Joe. I will. It'll help you sleep better at night, I'm sure. Right. Joe, where can people find you if they'd like to hear more from you? The circus that is the Stacky Benjamin show is every Monday, Wednesday, Friday. Paul is on Friday shows. A couple coming up. Actually, a couple that just happened. Speaking of circuses, we talked to the

biographer of P.T. Barnum, and there are many lessons we can learn from P.T. Barnum, one of which has to do with the phrase, there's a sucker born every minute. And another recent show is with our friend Brittany Burgett from Haven Life Insurance. She and I, she's a good friend, and we go through some popular characters in movies, movies, and TV series. And we ask the question, what would an insurance company think about the godfather? Or what insurance company. Think about Pam Beasley from the office. And it's cool because you learn all these things about life insurance that you would have never known. And of course, we have your and my mutual friend coming up soon, Len Penzo, with his annual sandwich study, which if you don't know about

Len's sandwich survey, every year he takes all of the ingredients that go into sandwiches that kids use in their school lunch. And he looks at the price. And it, Paula, as you know, Len, is one of the funnest ways to look at inflation. Like inflation is so boring, but learning whether peanut butter and jelly or baloney is the least expensive school sandwich. And how did that change from last year? I don't know. The geek in me, it loves that. So that's stuff coming up on stacking Benjamin's. Nice. Yes. And I've been on the stacking Benjamin's podcast. When did I start coming on the show? Like 2012? 2012? 2013? I don't know, but I was about to say this. You have been on before. four Stacking Bejimans.

When we were two guys in your money, that show went 69 episodes. You, I think, came on partway through the worst of the free financial advisor, which was before that. Stacking Bejamas is about to celebrate 800 episodes. Oh, wow. Congratulations.

Yeah. Oh, afford anything. Just as of the other days is celebrating 7 million downloads. Holy moly. Yeah. And I have to say, 6.2 million of those are for me. Oh, thanks, Joe.

I can't stop downloading it. I listen to it over and over and over and over. Wow, you must have a lot of time on your hands. I really do. You listen to the same episode thousands of times? It's amazing that I do, and everybody at Game Night finds it annoying, but I love it. So I guess that means that we have two listeners out there, real listeners. So thanks to both of you for tuning in.

And getting us to 7 million downloads. Me and the other one. We reached that by the time we got to like episode 206. So we hit 7 million downloads within about 200 episodes. Yeah, that's great. Congratulations. Thank you. Coming up on future episodes of the Afford Anything podcast,

we have an interview with Mark Manson. Mark Manson is the New York Times bestselling author of The Subtle Art of Not Giving a F***. And he is coming on the show. next week to talk about hope and why we should have it, despite lots of evidence to the contrary. Make sure that you hit subscribe or follow in your favorite podcast player so that you don't miss that episode of Afford Anything. Also, if you enjoy today's episode, please do two other things for us. Please share this episode with a friend or a family member and leave us a rating or a review on whatever app you're using to listen to Podcast.

You can go to afford anything.com slash iTunes to leave us a review there on Apple Podcasts. These reviews are super helpful in allowing us to book amazing guests like Mark Manson. As a quick reminder, I will be taking a September sabbatical. So in terms of my travel schedule, you can follow along on Instagram. But in the past three weeks, I went to Mexico City and then San Diego, and then L.A., and then Vancouver, Canada. I went to all of those places in the last three weeks. am now home in Las Vegas for 10 days. And after this, I am going to go spend a week in Croatia, a week in Slovenia, a week in Washington, D.C., and then two weeks in Japan. So that's what's

coming up for me within the next five weeks. What that means for this show is that for the month of September, I'm not going to be releasing any new episodes. Instead, during the month of September, we're going to release a combination of some of my favorite episodes, some my favorite archive episodes, as well as we will also be releasing interviews that I have done on other shows. So that is coming up on Afford Anything in the month of September. It'll be the September sabbatical. Meanwhile, if you want to follow along with my travels, you can do so on Instagram. I am there at Paula P-A-U-L-A, P-A-N-T. Thank you again for tuning in. This is the Afford Anything podcast. I'll catch you next week. By the way, my lawyer says that I need a disclaimer,

so here we go. This is purely for entertainment purposes. Basically, imagine that this is the least funny comedy show that you've ever listened to. We are not professionals. We barely can brush our teeth in the morning. And so we don't hold ourselves out to be experts or really for that matter even adults. Give us the same amount of respect that you would give, say, a goldfish. And always, always consult with a real grown-up before you make any decisions. That means consult with a tax advisor, consult with a lawyer.

consult with a financial planner, consult with people who actually have credentials and who know what they're talking about because that is definitely not us. All right, you've been warned.