Afford Anything - Ask Paula: Could the Stock Market Be Too Much of a Gamble?

Episode Date: November 2, 2020

#283: Andrea’s parents have a seemingly salesly financial advisor. He tried to get them to purchase a second life insurance policy, among other potentially pushy moves. Are her parents better off without his advice? Teresa can’t shake the feeling that the stock market is more of a gamble than an investment. Is there any advantage to holding funds for the long-run if the market drops and you lose your gains? June is curious about the best college planning strategies for families who are working toward, or close to, financial independence. How can you help your children while securing your financial future? Big Sister’s little sister rents a mobile home in an area she loves. The owner wants to sell, but her little sister might not obtain financing. Should Big Sister buy the property and sell it to her via seller financing? Managing for Mom in Massachusetts has an investment strategy that he wants to run by us. Does it make sense to shift a 50/50 stocks and bonds portfolio to 100 percent stocks, and shift back to a 50/50 split after the market returns to pre-pandemic numbers? My friend and former financial planner Joe Saul-Sehy joins me to answer these questions. Enjoy! For more information, visit the show notes at https://affordanything.com/283 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every choice that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to any limited resource in your life, like your time, your energy, your attention, your focus. Saying yes to something implicitly means. Saying no to other opportunities. And that opens up two questions.

First, what matters most to you? And second, how do you make decisions that reflect that? Answering these two questions is a lifetime practice, and that's what this podcast is here to explore. My name is Paula Pant. I am the host of the Afford Anything podcast. Every other week, we answer questions that come from you, the community. And today, my buddy Joe Sal Cahy, former financial planner and recent COVID-19 survivor is with me to answer these questions.

What's up, Joe? Oh, you know, just not sleeping because I slept for like six or seven days. I don't remember, but it was a long time. And yes, I'm alive. Thank you, by the way, everybody who wrote. to me and with the well wishes. And Paula, thanks for letting everybody know that I was alive and that I was doing fine. But I got really lucky. I did not have COVID, as you know, like you had it. I only had a fever for two days. It went to 102.5. And once it got there, I just used Tylenol. That's the only

thing I took was Tylenol. And the fever came down. The next day, it came back again to 102.5. Went down again. And luckily, it never came back. Yeah. I never had the sore throat that people have. I never had that horrible cough that you had and other people have had. I kept my sense of smell, my sense of taste. So, man, I got lucky. And even for me, though, I'll still tell people I haven't had it. You still don't want it. Sleeping for six days is horrible.

You kept telling me, no, it's wonderful. You get to sleep forever, Joe. And I told you, I'm like, I don't want to sleep. But I couldn't help. It was, yes. Things no joke. Well, I'm glad you're feeling better. Very glad you're feeling better.

And I'm glad you're feeling better. And I'm glad I'm glad your fever only lasted for two days. Yeah, me too. Me too. I feel very lucky because I have a friend who's very healthy who's in her 30s and in shape like you are and got it really bad. And, you know, I mean, people have said that I'm in shape and that helps. But, man, don't, if you're somebody who's in shape listening to this, don't think that that's a free pass. I think I just got a strain, luckily, that wasn't that bad.

Apparently, Paula, licking everything does not build antibodies like I thought it did. Your plan of licking doorknobs and all that science that I did, I have confirmed that that's not the way to antibodies, apparently. Well, I'm glad that you're healthy. I'm glad that you're back. We were worried about you, but you pulled through. So now there are two COVID survivors. You and me both. We got that.

And you know what's going to happen? This is going to end up being a podcast like CrossFit, where we're going to bring up the fact that we had COVID like every four minutes. You know, you'd be like, oh, well, when I had COVID, I thought about retirement planning. I did think about estate planning. Yeah, no joke there. So when we talk about life insurance, there was that time I had COVID. Did have I mentioned that before? Well, speaking of life insurance, our first question comes from Andrea.

Hi, Paula and Joe. My name's Andrea and I'm a huge fan. from southwestern Ontario near the border with Michigan. My question is for my parents. They have a financial advisor, which I'm currently using air quotes on financial advisor, because in my opinion, he's more of a salesperson. He has managed their investments for a long time, and they're very friendly with him. Through my brief encounters with him as a young single person,

he tried to sell me life insurance, and he had my money and actively managed mutual funds until I found you, Paula. And when he refused to put my money in index funds, I took it upon myself, and I haven't worked with him since. My parents are financially set. Their home's paid off. My mom is retired, and my dad is still running his construction company because he chooses to. A year ago, my parents started another business, which has been very successful. And this financial guy had him almost sold on an insurance policy for my mom's life as an investment for their excess cash. She was really unsure and she didn't understand how a second life insurance policy was an investment and he just went ahead and set her up with the health check anyways, which she didn't do.

I finally convinced my parents not to purchase the second life insurance policy and to instead invest their cash with a home renovation because they've wanted to do that for so long. The next time the financial advisor wanted to meet them, he advised them to borrow against their home in order to do a renovation and give him their excess cash so that he could invest it for them and he promised to beat the current mortgage rates. Can you and Joe please comment on the financial advice that he's been giving them? Because I think they need to hear from someone other than me and someone who has some financial expertise other than their current financial advisor. Thanks.

Andrea, first of all, thank you for asking that question and thank you for being such a good daughter to your parents. Thank you for looking out for them, for having their best interests in mind, for wanting to make sure that they are not getting ripped off. So let's talk about what's going on. First of all, I want you to find out if this financial planner, and I suspect I already know the answer, but let's get some confirmation, is this financial planner a fiduciary? So does he have a fiduciary duty to your parents at all times? That's the operative question to ask. I suspect, but I don't know, but based on your question, I suspect that the answer is probably no. He probably does not have a fiduciary duty, which means that he is able, legally,

to give advice that meets the suitability standard, meaning it needs to be suitable, but it doesn't necessarily have to be in your parents' best interest. You don't want a financial advisor who merely meets a suitability standard. You want a financial advisor who has a fiduciary duty. Now, the other thing is a person needs to have a fiduciary duty at all times because it is possible legally for a person to be a fiduciary within a meeting and then slip into a role in which they're not a fiduciary and then slip back into the fiduciary role. They can transition in and out of having a fiduciary duty within the same meeting without having to disclose the transition. It's a weird legal loophole, but it is possible. And so you'll want to ask, are you a fiduciary at all times? And then the follow-up question to that is, are you duly registered? Now, just because they're duly registered doesn't necessarily mean they're a bad person, but it is context to know when evaluating the information that you're getting from this person.

because if it is the case that this person is getting a commission from the insurance that he's selling, that's certainly something that your parents should know, given the fact that there are financial advisors out there who are fee only. And so that's another question to ask is, what's your compensation structure? Are you fee only? Or do you collect commissions from the products that you recommend? Because, again, that's going to inform the incentive structure that a financial advisor has. So establishing that baseline of what type of financial advisor are we talking about, what are his roles, responsibilities, duties, obligations, establishing that will hopefully for your parents

provide some context as to where he's coming from and how that differs from some of the other financial advisors out there who maybe have a different set of rules, regulations that there they're playing from a different book. As to specifically what you ask, the very last thing that you've said that he promises to beat the mortgage interest rate. Oh, man. Right? I mean, that in and of itself is not a justification for a given investment. An investment is entered into based on the risk and rewards of that particular asset class, based on what we know about it, based on its historic performance, what is the risk reward profile of that asset class? And is that a good fit for the person who's holding that asset based on that person's goals, timeline,

risk tolerance? Like, that's how assets are chosen. And so the question is not, can I arbitrage money, meaning, you know, can I borrow it at a given mortgage interest rate and invest it in a way in which it will produce a higher return. Like that's not a question that any financial advisor worth his salt would be leading with. Because ultimately the question is not can I arbitrage money. Ultimately, the question is what is the best comprehensive plan to put together for you, mom and dad, based on the other assets that you hold, based on the goals that you have,

based on the type of income that's coming in and the volatility of that income, like based on this entire comprehensive framework of where you are and where you want to be going, let's create a plan that fits with all of that. That's a very different question than can I arbitrage an interest rate. And I think, Paula, here is where presentation is everything and gives you a clue as to what type of advisor this is. a good financial advisor separates themselves from the investment. The advisor isn't going to be anything if they're a great advisor. The advisor is going to say, hey, Paula, here is the investment type that historically has been your best bet for this time frame. Now, here's the upside and here's

the downside. And my job then is to tell you this is why I would do it. This is what could potentially go wrong so that you know ahead of time. I mean, the one thing that always bothered me was if my client felt like they were surprised. If my client, if something bad happened, bad things happened all the time. But if my client was surprised by the bad thing that happened and thought that the investment was never going to go down and that we were going to magically just beat this interest rate, I wanted to explain how it was going to happen, not magically deliver this result. You know, you're not a magician. So the first of all, I think the, advisor separates themselves from the investment and talks about the strategy, not the investment.

And then I think a good advisor talks about the probability because there is. I mean, let's call us what it is. If the person is going to be investing for 20 years, the probability is a stock-based mutual fund will beat the interest rate on that mortgage. But you present it that way. Here's what would have happened historically. Here's the time frame when it was closest. Here is the downside risk that we have by doing this. Here's the upside of doing this. Here's why I like it.

Here's what might go wrong. It was all in the presentation. And if the advisor presented the way Andrea says that I guarantee we're going to beat that interest rate, that mortgage rate, are you kidding me? Or I can beat the rate. I can beat the rate. Yeah, that's a very different. it's selling snake oil to present in such a way that a person implies that they have some special

knowledge or power that gives them the ability to make incredible investments. It also feels salesy instead of, I mean, you're selling the investment instead of explaining the strategy. I want an advisor who's going to make me more educated. So if I'm hit by a bus tomorrow, the time I spent with this person understanding why this fund would beat that mortgage rate is what I really want to know. That's really what I want to know. Is this better than paying money down on my mortgage? Well, yes, it is. And here's the reason why. And here's exactly how you make that happen. And then you walk away. If you can explain it back to the

advisor, then, hey, you just had this big win because you left that meeting smarter about money than you were beforehand. But the advisor taking it and saying, I can beat it. Just hand it over to me, Paula, and I'll beat it. Are you, no, no. That said, you want to transition to the next thing? Or actually, the idea about index funds, I can explain that from the advisor point of view. And this is more in Andrea's, you know, the feeling she has that this is not a fiduciary advisor. Advisors don't get paid on index funds.

Index funds are so cheap, there's no room in the management cost structure to pay the advisor to have that inside of it. So unless it's what's called a rap account, which means that there's a fee attached to just managing the money in general, they can't get paid to do that. And in some advisory platforms, by the way, it used to be that we'd actually have to pay more money because Vanguard in particular doesn't play nicely with a lot of advisory platforms. It was more expensive for advisors to purchase a Vanguard fund than it was for you to go buy it on your own. A good advisor will still go tell you to go buy it on your own if it's the right thing. A bad advisor will say, well, we really don't need to use index funds. We need to use active funds. Well, I can talk positively about active funds all day, as you know, Paula.

However, in this case, I'm not smelling an active versus passive argument going here. I'm smelling a I don't get paid that way thing. So if they're refusing to put you in index funds, it's generally because they can't get paid to do that, which goes back to not only being a fiduciary, but being a fee. advisor, you know, know what you're paying for advice. When you buy a book and the book is full of advisory tips, you know what you're paying for that. When you listen to a podcast and you hear advertising on the show, the advertising on the show is the cost of the podcast, right? You have to know what you're paying for that advice. So that's what I think about the index fund thing. Do you agree? Yeah, absolutely. Absolutely. It sounds as though, like you said, Joe, he,

probably gets paid based on assets under management. Or a commission that's somehow baked into the fund. Right. Exactly. And he's seeing his paycheck shrink if those funds are transitioned into index funds. Some people that do get paid assets under management, by the way, can still use index funds. You're going to end up paying an extra 1% fee on that index fund because it'll be, and it'll be a fee that you see, but they still may be paid on an index fund. The fact that he doesn't have that in his holster leads me to believe that he is just sell

a mutual funds. Now, that gets the life insurance piece. The fact that Andrea led with, he recommended she as a single person get life insurance kind of makes me go, oh, boy, no, no, I don't get it. There are some reasons why she might need it, but she didn't present any of those. So I'm guessing that he didn't present any reason to her that she would need it outside of the generic, well, you know, it's life insurance. You should have it. Not necessarily.

You want to start off with a risk management strategy, not a life insurance strategy. Life insurance people want you to think about life insurance. You want to widen that argument and think, if something happens, if X thing happens, how would I cover that? If I get in a car accident, how would I cover it? If my house burns down, how would I cover it? If I die, what needs to happen, you know, to pay off my bills? what things need to happen. And if you do that, all of a sudden,

you have a lot of other avenues to look at besides insurance. Insurance is one option to cover it, but there's many others. So start off with risk management and life insurance. That said, the one place I will caution, Andrea, is the life insurance recommendation for mom and dad or for mom, I'm not sure that it's horrible. I'm kind of sure, based on the context of everything else,

this guy said, I think is horrible. But this particular one, if dad owns a successful company, this couple is in a high tax situation and they have huge amounts of cash flow that they don't need over the short term, you want to look for tax shelters. And I will tell you that if you, and this is a really long conversation, but for very wealthy or very high cash flow individuals, stuffing a ton of. money into a life insurance policy can be a very effective investment. And I'm going to say something that's going to be a little nerdy, but I know I've got some of the nerds listening here going,

no, it isn't. Well, let me tell you what we're looking at nerds. What we're looking at is, can the cost of insurance be less than the tax that you would pay on any tax that the investment throws off? And I'll tell you, for some people, the answer is yes. Now, how many people is that? I worked with a lot of families when I was a financial planner. I would present this type of a strategy, Paula, maybe once every other year. And I worked with some people that had some pretty good cash flow. It didn't work that much. But, ma'am, when it did, it hummed.

And there's some great people who will back me up on this, a guy named Ed Slot. A lot of people are familiar with, and he's a pretty trusted name in finance. David McKnight is another big name in finance who talks about it. David kind of likes life insurance more than I do, but David is another great name. There are lots of good, solid financial planners that will tell you that the planner might be right on that one, depending on how successful dad's company is. She presented dad's company is pretty successful. That tech shelter might work, but you've got to stuff it full of money so that you're

paying less money for life insurance, and then it becomes a great tax shelter. Zooming out big picture, what I'm hearing is the credibility of this advisor is in question, but that doesn't necessarily mean that everything that he has said is necessarily wrong. Yeah. Yeah, I don't know that it's right, and my gut says that it may be wrong because the rest of it, I kind of disagree with, and it feels salesy to me. Right. I mean, life insurance on a single person with ostensibly not a big need for life insurance.

Andrea seems to feel like she doesn't need life insurance. And I don't know anything about her personal situation, but I'll bet that she's right there. That bothers me. The no index fund thing bothers me. You know what it is that bothers me more than anything, though, Paula? What's that? I don't feel like there's an overall plan. A really good advisor isn't out talking product all the time, isn't talking about life insurance for Andrea.

isn't talking about which mutual fund active versus passive to use isn't trying to shoehorn somebody into another life insurance policy. What they're talking about is big picture how you reach goals. And the fact that Andrea is not talking about what goals the advisor's working on and instead has inundated us with products that the dude's trying to sell. It gives me a really bad taste in my mouth. Right. For a deep dive into insurance, Joe, you did a one hour deep dive on Scott and Mind podcast? I did. Yeah, I'm Bigger Pockets Money. Love Scott Mindy. I know you like Scott Mindy too. They're so fun. They had me on to do a whole, and it takes an hour to understand how life insurance works. But I also feel like, Paula, if you understand just a few basics and you invest an

hour of your time into learning how those basics work, which are a few things. You have to understand why some insurances are expensive and why those are generally, by the way, the types of issues you want to think about. And the cheap insurances are generally the ones you don't want to think about it all. And people usually think about that the other way. Like, well, you know, when I was a financial planner, people would show me insurance that they have. And I'd ask why they have it.

And they said, well, you know, it was a work thing and it was pretty cheap. If it's pretty cheap, there's usually it's a type of insurance you don't need. Now, give you an example. Accidental death and dismemberment is a type of insurance that most people don't need. If you stick your arms and machinery for a living, yes. But axel, dental death, and dismemberment only pays if you are dismembered or if you pass away or are maimed in an accident. Well, if you're somebody that has a desk job or you sit and talking a microphone like you and I do, Paula, this microphone stand isn't going to fall on my foot and dismember me. Famous last words.

That's right what it happens. But even if it does, let's talk about that. it does, if I have the right life insurance and the right disability policy, why do I need accidental death and dismemberment? Why do I care that I get paid more if it happens, if I get hit by a truck? If I have accidental death and dismemberment, here's what I want to have happen. I want to, if I feel heart attack coming on and that accidental death policy is not going to pay, I got to run out the front door down in the middle of street and hope I get hit by a truck so that Cheryl is cashing in because otherwise she doesn't.

You know, that's a very cheap type of insurance that we don't care about. But anyway, back to Scott and Mindy. I did a whole hour with them on this recently. I think it's a good use of people's time if you want to understand life insurance to go listen. In-depth, nuance discussion on life insurance. We will link to that episode in the show notes. By the way, you can subscribe to the show notes, get them delivered fresh to your inbox by going to afford anything.com slash show notes.

It's a great way to search our archives. Like if you just archive every single one of those emails and then one day you're like, hey, didn't they discuss such and such on a previous episode? I wonder when they talked about that. You just search for those keywords. And then in our show notes, we have timestamps for all of the questions. So you can quickly pull up exactly what we talked about, what episode, and then you'll have the timestamp for it as well. So again, all of that can be yours for free. just subscribe to the show notes at Afford Anything.com slash show notes.

So thank you, Andrea, for asking that question. We'll come back to this episode after this word from our sponsors. Fifth Third Bank's commercial payments are fast and efficient, but they're not just fast and efficient. They're also powered by the latest in payments technology built to evolve with your business. Fifth Third Bank has the big bank muscle to handle payments for businesses of any size.

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That's W-A-Y-F-F-A-R.com. Sale ends December 7th. Our next question comes from Managing for Mom in Massachusetts. Hi, my name is Managing for Mom in Massachusetts, and I am anonymous. I'm throwing this question out here for Paula and Joe. Paula, I love your podcast, but I also love the dynamic of you and Joe working off of each other. I don't know if I've ever heard anyone really compliment your specific ying and yang approach between the two of you and your debates. And I just want to say I really appreciate how the two of you tackle questions.

So I stumbled upon the strategy to use with index funds. And I'm wondering why I've never heard of this before. And I want to get some feedback on it. So I don't know if I'm a total genius or a total fool here. Also, a little bit of a leap for me to call in because if I did mess up here, it's with my mom's money. So don't tell her. And this is why I'm anonymous.

Okay, a bit of context. My dad passed away a couple years ago. So I ended up helping my mom with managing her stock investment portfolio as this was something my dad built and managed, and she doesn't really care or have any idea what to do with it. So, you know, he kind of taught me a bunch of stuff, and so I'm just kind of stepping and helping here. So coming to the pandemic, her portfolio was 50-50 stocks and bonds, evenly split between Vanguard total bond market and total stock market index funds. So good job, dad. And this is within a traditional IRA and my mom's almost 80 associated mandatory distributions.

So when the market crashed because of COVID-in-March, I realized it was sitting on a lot of money in the bond market, which had gone down a little bit, but nothing like what DTSAX went down. So I simply started selling bond market index shares in cost and chugs to cost average it and buying shares in stock market index funds, which were low. And my plan is to hold this new 100% stock portfolio, much of which I bought at the lowest points until the Dow gets back to its pre-pandemic numbers, around 29,500, I think, was the size of the index before it crashed and then I'm just going to sell off half of the stock index funds and buy back the bond ones and just wait until the next crash and repeat. You know, I know an issue here is that people

could say like, well, in a crash, you might not freak out and actually do this, but I'd live through the 2008 crash. It's actually when I started investing, so I'm not worried about that. Does this strategy make sense? What am I missing? Is there like huge tax things by selling and buying? I don't know if it helps for context. Mom doesn't need this money. She has a teaching pension, but I know we're going to need this money for long-term care at some point. So I really feel responsible to help make these returns as high as possible. And I feel like this buy-low so high strategy using just stock index funds and bonded X funds and kind of going between the two makes sense to me in my head.

But what am I missing? I'd love to get your thoughts. Thank you so much. Thank you for that question. And first of all, thank you so much for the compliments for the ying and yang of Joe and I. I mean, Joe, we've been podcasting together since what since. Stacking Benjamin started. Yeah.

I mean, even before that, was I ever on the free financial advisor, your podcast before stacking Benjamins? Yeah. Well, in the middle, there were 69 episodes of two guys in your money. So, yeah, you were on all those, too. Wow. So how long have we been recording together then since? Nine years. Jeez.

I know. Wow. Isn't that crazy? That's nuts. And I just saw Len Penzo recently, who introduced us, our good friend, Len Penzo. He and I were just talking about just how it doesn't seem like that long, does it? No, not even remotely. It does not seem like that long.

But it has been a long, strange trip, my friend. So I'm glad that we're entertaining you managing for mom. But really, I think Paul and I are just entertaining ourselves. But what do you think about this question? Let's get to it. The red flag that comes up for me right away is that fundamentally this is a market timing question. And as a principle, market timing is not something that I would want to encourage. The notion of this is going to be my strategy until the Dow returns to its pre-pandemic numbers. This is going to be my strategy until the next crash. This is going, you know,

that's, that is fundamentally the notion of dancing in and out of different asset classes based on trying to game the boom and bust cycle. The reason that that is not a sound strategy, in my view, is twofold. First, it is not customized for the way that exposure to those asset classes needs to shift based on the purpose of the money. So every bucket of money has a given purpose, meaning it has a given timeline. And the ideal asset allocation of that money needs to shift according to the goal of that money. Choosing your asset allocation based on how the market is performing rather than based on the goal of the money is by definition in conflict with the goal. That's the first reason that I don't advocate for market timing.

The second reason is that it's easy to point to the last few decades and say, hey, look, recessions are cyclical, here's how that market has performed over the past. We'll even expand to the past 100 years. Here's what's been going on. Sure, that's true. But it's all also true that Australia has had a 28-year bull run. It's also true that Japan has had three decades of stagnation. We simply don't know if the market in the future will behave as cyclically as it has in the past. I mean, there will be some cyclical nature there, I think we can say, but what is the period in between cycles? Is it going to be what it was in the past? Or will there be greater duration in between booms and busts. This past bull run was the longest bull run since the Civil War,

this 11-year bull run that we just came out of. Are we going to see more and more bull runs that have longer durations? I don't know. Maybe. Maybe not. Are we going to be Australia and have a 28-year bow run? Hope so. Or are we going to be Japan? Or are we going to be Zimbabwe and have runaway inflation? I mean, anything can happen. While it is important to look at from history, it is, I believe, a mistake to over extrapolate from history and assume that that is a roadmap of what will happen in the future. There's a great quote, I forget who said it, that the lesson that we should learn from history is that the quote says something to the effect of, the lesson that we should learn is that the world is surprising. History is the study of surprises.

it's the study of changes. It's the study of the unexpected happening and everyone dealing with it. And so that is what we should be learning from market history as well. We can't take a map of what's happened in the past hundred years and superimpose it onto the next hundred years and believe that the two will mirror one another. The frustration that I have with this strategy, number one, is it's not his money, it's mom's money. The big reason that frustrates me is because I like starting with the timeline and timelining your goal and looking back. And then you pick the investment based on the time frame. So different investments have different growing periods historically. And it makes it so much easier to choose investments when you start off with the

time frame and work backward. Mom has this uncertain time frame with someday I might need long-term care help for her. So I don't know what time frame that might be. However, what I do know is if the long-term care problem pops up at the same time that he's 100% stock market invested and the stock market is down in that period, he has to go after depreciated assets to achieve mom's goal. So I don't like that. The second thing that I don't like, to your market timing point, it's funny how many people do this. I want to just take this a piece at a time. the reason why people say they use index funds and he's using VTSAX is why because the manager's not worth it. This idea that we can buy and sell our way in and out of stocks isn't worth it.

And yet we then, and by the way, and I'm not picking just on you managing for mom. I'm picking on a lot of people because I see so many people do this. I don't trust a manager. By the way, a manager who has tons of data has computer systems that you would never believe has systems and processes for actively managing stuff and we won't give them our money. And yet we will take VTSAX and we will play our own little game with it. Are you kidding me? When we have no data, we don't have any of that data that these active managers have.

So we become the active manager. Yeah. Why would I do something that I wouldn't hire somebody else to do? If I fundamentally believe that passive is the way to go, which is why I buy VTSAX in the first place, I should not be trading in and out of my passive strategy. Do not do it or become a pro and do it based on a lot more data than this is when the market goes down. This is when the market goes up because I'll tell you what kills us. And the reason why I can defend active managers far more than I can defend this strategy is because the thing that kills us is not, fees, it's behavior. And what's going to happen is you're going to come to a point where the market

drops really, really fast and you're going to go, oh, crap, this month, I'm not going to follow this thing because it looks too dangerous. And then now you are no longer following this set strategy, you're no longer on rails, and now you're off the rails. And this thing that started off as an investment strategy that was point by point by point becomes emotional. And the second it becomes emotional, you throw it away. And if it's your money, that's one thing. But the fact that it's mom's money with an uncertain goal and you're using an active strategy and a passive investment, I just don't like it, Paula. Joe, we're in agreement there. What's up with that? I know, right?

After he complimented us and we're both like, nope. I know. This is not the podcast of telling you what you want to hear. But it always, it always sounds good. And doesn't this sound good? I mean, it totally sounds everything about this sounds like it makes sense well i'll just buy low and sell high what's uh what sounds bad about that there is nothing wrong with that right and it seems to make sense and if he told me by the way that he had a 25 year time frame until he knew he needed that money i may go probably not and still go through this why would i do something that i have no respect for when it comes to season pros doing this and by the way i'm not talking about me

I'm talking about anybody who uses just plain index funds. Right. Why would you be the active manager if you don't believe in active management? Right. Yeah. Then I might go, yeah, I wouldn't do it, but... Certainly, I can understand if a person is tempted to take a small portion of their portfolio, 10% of your portfolio, and that's like the fun portion. You know, some people do that with individual stocks as well.

Like, you understand that for the bulk of your money, for 90% of your portfolio, you're going to adhere to this passive approach. But for 10% or 5%, that's just your fun risk-taking percent. But the phrase I'm taking mom's retirement money and doing it doesn't slow your vote? Exactly. Yeah. Yeah, exactly. It's one thing to be 30 and put 10% of your portfolio that you don't intend to touch for the next 40 years. It's one thing to do that as a 30-year-old.

It's another thing to do that with money that mom might need for long-term care. Yeah. But I'm glad that you asked. Thank you for calling in. Thank you for asking. Like, that's what the show is all about. It's about asking those questions. It's about double-checking your assumptions.

It's about having that spirit of curiosity and learning and growing. So thank you for calling in. Thank you for asking. And thank you for shepherding your mom's money, making sure that she's going to be taken care of. That's two for two, by the way. between him and Andrea, taking care of parents. That's the theme today. Yeah. Yeah, it absolutely is. Cameron Huddleston, who is a former guest on this podcast, she is a caregiver for a parent, and she has a lot of great, great information for anybody out there who is a caregiver or who might be a caregiver,

anybody out there who's concerned about how to take care of mom, dad, grandma, grandpa, any member of your family, I definitely recommend checking out Cameron Huddleston. She's got a great body of work, and she is the authority that I turn to whenever I want to learn more about how to take care of the older generation. So thank you, managing for mom in Massachusetts, for asking that question. Our next question comes from Teresa. Hi, Paula. I love your podcast, and I love your philosophy of pursuing what's important to you. I've learned so much. and I've made really well-informed choices that have positively affected my life. So thank you. My question is about the stock market. Say I buy $10,000 of index funds. In five years, they're worth $15,000. Great. But in 10 years, the market drops and they're worth $10,000 again. So am I back to where I started? If a friend buys $10,000 at that time, do we now have the same worth in index funds? Do I have any advantage for having a held them for 10 years? If no, it seems that the market is more of a gamble than an investment.

And I've heard that what's important is your contributions, but contributions are still subject to a down market. So really, are you just gambling with more money? No one has really been able to explain this to me. So I hope that you can. Thanks so much, Paula. Teresa, thank you so much. I really appreciate it. Thank you for asking that question. To answer, let's talk about the two ways that assets, any assets, including index funds, make money. One is capital appreciation, and the other is the dividend or income stream that that asset pays. So, let's say that you buy $10,000 worth of index funds. In year one, that $10,000, let's just say for the sake example, has gone up to $11,000, a 10% return. Of that $11,000, a portion of it will have come from

appreciation and a different portion of it will have come from a dividend payout or an interest income payout, which is yours. That's not growth on the value of the stock. That is money that you've been paid as a result of owning this piece of a company. So let's say that you buy $10,000 worth of index funds, and one year later, it's worth $11,000. Of that $1,000 that you made, let's just say hypothetically that $200 of it came in the form of dividend or interest income, and the other $800 came in the form of appreciation. And then let's just say that that repeats every year for the next five years. So each year for the next five years, your investments grow by a,

a flat $1,000, of which $800 is appreciation and $200 is dividend or interest income. Five years down the road, those index funds are worth $15,000, a thousand of which came from dividend income, and the other $4,000 of which came from appreciation. Now, let's say the market falls, and the market falls back to the value of those index funds at the time in which you bought it. you would still have the dividend and interest income that you earned plus any additional gains that those dividends and interest earned over time. Because remember, as those dividends and interests accrue in your portfolio, they themselves start earning more dividends and interest.

So even if in five years the value of the investments fall back down. to the same price that you paid, you still have all of the dividend income, all the interest income. Sure, you've lost the gains, you've lost the appreciation, but you've kept the income that you've made because it is, it's income. It's yours. So that's the advantage in starting early, even if appreciation gets wiped out, and sometimes, depending on what year you start investing, sometimes you are unlucky. There's a whole period in the 2000s that's known as the lost decade, because if you look at a graph of this time frame in the 2000s, if you were unlucky enough to start at a given point in time, 10 years later, based on appreciation,

you'd be right there in the same place. But people who invested through the last decade still enjoyed the benefit of compounding dividends. And while that might be a disappointing consolation prize in an era when appreciation was nil, it is still certainly better than staying out of the market. That's one thing. The second thing is thinking probabilistically. The value that you get from starting to invest earlier is not just value that you receive if you get the result that's desired.

The value that you get from beginning earlier is giving your... a better probability of growth than a person who waits until later. And so in the example that you cited, person A invests $10,000, it grows to $15,000, the market declines, it's back to 10, person B invests at the time of the decline. The value that person A got in that example, again, putting dividends aside, is not the result, but rather the exposure to a higher probability of success. If you remember from the interview that we aired with Annie Duke, decisions should be judged not based on the result, but rather based on the soundness of probabilistic thinking.

And so if you make the choice that gives you the greater probability of success, then even if that success doesn't pan out, you still have the value of having made the more probabilistically sound choice. Yeah, I think that that's the key is, Paula, that this is not. voodoo. Certainly over a 10-year period of time to Teresa's question, yes, you could be no better off. If you invest in something that doesn't pay a dividend and you bought it 10 years earlier, your money could go up and go down and go sideways, go all over the place, and end up at the same spot. It's important to know, though, that that's the exception. It isn't the rule. And the reason,

Paula, that you can talk about the lost decade is because it was such a wild exception. that everybody talked about it. There's actually a reason, though, if we get just a little bit philosophical here for a second, there's a reason why it's the exception. The stock market over long periods of time is a reflection of a healthy or unhealthy economy. And so we have to back away from stocks as gambling investments where we just pick a number, we buy it, and then the number goes up. Hopefully the number keeps going up.

and I don't know why it's going up, but baby keep on going. And then it goes down at some point. I'm not sure why it went down. A bunch of people sold it. It can feel like magic or like betting. And really, over long periods of time, that's not at all what it is. If you look at company ownership, which is what a stock represents, you invest in a company because you believe that company is going to turn a profit.

It's going to be more profitable next year than it is this year. And if companies do that and people believe that, the stock, stock price then goes up. And when we look at indexes, which are large collections of these companies, if lots of companies are making profits, those stocks then go up. So if we believe that companies are going to turn profits over long periods of time, the stock market will rise. So over long periods of time, if the owner's going to get paid, the only way they're going to invest in a company, Paula, is if that company's going to turn profit. And if that company turns a profit, that's a reflection of a healthy economy. The reason why you just pointed to Japan,

Japan, Japanese stocks have been in big trouble. There have been a lot of headlines out of Japan about things that their version of the Fed has had to do to try to stimulate this economy that just doesn't seem to move. That's an economy that's in trouble. Our economy could be the same over a 10-year period. It's true. Historically, the reason that doesn't happen is because a healthy economy moves forward and creates profits. Thank you, Teresa, for asking that question. We'll come back to the show in just a second, but first, our next question comes from Big Sister.

Hi, Paula, this is Big Sister. My little sister is renting a mobile home in an area that she loves and plans to stay in, close to work and other family. The owner plans to sell next year and has offered my sister right of first refusal to buy. She would like to purchase the home, but would have difficult security securing competitive financing due to her modest income and a credit score that suffered from a past student loan issue that has since been resolved. I would like to purchase the $80,000 property, remove the mobile home, and build a modular home at an estimated cost of $120,000

for the foundation and structure. It would have an apartment over the garage or on the second floor that she could rent out to generate additional income. I would do all of this with cash on hand. My plan is to then sell her the property with seller financing. The estimated payments, not counting any income from rental are consistent with what she's currently paying in rent. The rental income would more than offset new expenses, such as property taxes. This would provide an affordable path to homeownership for her. My financial situation is solid. I own a home and my children's college expenses and my own retirement are covered. I'm not looking at this as an investment, but rather as a way to help a family member. What are your suggestions on how best to handle seller financing? If I charged a 0% interest, would that have any tax consequences such as triggering the gift tax? I would appreciate your thoughts and advice. Love the show. Thank you. Big sister, thank you for asking that question and thank you for looking out for your little sister. I think it's so awesome what you're doing to look out for your family. That's kind of the theme of today's episode.

Family, yeah, people looking out for their families, people looking out for their families, people looking out for their parents or their siblings, trying to make sure that the people that they love are in a good place financially. Big Sister, I love your plan. I would check with the covenants and restrictions of the mobile home park area to make sure that she is allowed to use that place as a rental unit and make sure that there aren't any rules associated with the mobile home park that might prevent her from being able to use this as a rental to generate additional income. That's just a piece of information that you would want beforehand. It's not a deal breaker necessarily.

It doesn't sound like it is, but certainly something that would be good to know going into it. Overall, I absolutely love the plan, and I commend you for thinking of it and for wanting to do this for her. In terms of your question, your question is, how do you handle seller financing? go to an attorney and have an attorney draw up documents, make sure that everything is well documented, make sure that you have all of the legal paperwork in place that governs the terms and expectations of the seller financing. So go to a real estate attorney, talk to a real estate attorney about what you're doing, and have that attorney draw up papers for both you and your sister to sign.

You also want to decide if you're going to collect. any collateral. You'll want to decide if the loan is assignable in the future. Can she transfer or assign the loan to somebody else? You'll want to make agreements based on what are called the four D's, death, disability, divorce, and drugs. So if any of those were to become an issue in the future, that might be a conversation that you and your sister would want to have. And if you can just search for the four Ds. Actually, we have a previous podcast episode in which we talk about it. So we'll link to that in the show notes as well. The four Ds are a conversation that you and your sister are going to want to have.

With the real estate attorney, you're just going to want to talk about the terms of the agreement itself. Payment schedule, consequences for late payment, collateral collected, if any, whether or not the loan is assignable or transferable. As to your question about gift tax, I would run that by a CPA. But the good news is, given that you're talking about what will be a relative. small amount of money. I mean, the total cost of this entire project is $120,000, and that's going to be turned into a mortgage that will be amortized over X number of years, 10 years, 20 years, 30 years. So even if a portion of this were to be considered a gift, and I'm not saying that it is, but even if that was the case, it would fall under the amount that would be considered a gift annually would fall under the amount that would be considered a gift annually would fall under the, the annual gift tax exemption. Because, again, because we're talking about such a small amount of money, and in the year 2020, you can give up to $15,000 in cash or assets to any one person without needing to file a gift tax return. But again, talk to a CPA specifically in order to discover the unknown unknowns.

Yeah, I had nothing to add there, I think, talking with a CPA about very specific questions around seller financing is a fantastic idea that will pay for itself. I had just one really random thought about this, which has to do with the rental attached to the property to generate extra income, Paula. And she doesn't mention where that idea comes from. I like that idea, but I also know,

and so do you, that there is a readiness level that some people have that other people don't have. And while it sounds like Big Sister and Little Sister on the same page about this, and it probably talked about that, one frustration I know that we money nerds have is that we get people this great advice and these great opportunities and they don't do anything with them. And so there's a little piece of me that wonders if Little Sister has the skills to rent out this rental property.

It's a great opportunity. Sounds like a layup. But I've seen that go badly so many times where you'll put something right in front of a friend or a loved one and then they don't pick it up. And then you spend a lot of time frustrated wondering why I just gave you this beautiful key. But people have different readiness levels for that. So that is maybe idle wondering on my part if little sister's ready for that or not. But I hope so.

And if not, I think sharing tools with her to make sure that she can. can be a successful landlord would be very helpful as well. That's a good point, Joe, because being a landlord is certainly work. You know, it is a job. And so to be successful at any job, you first and foremost need to want to do it. You need to be interested in it. Yeah. You know, you got to know where to turn for how do you collect the rent?

What if the toilet breaks? You know, where do I go? What do I do? As you know, there are systems, processes, and apps. I mean, there's tons of cool stuff that can help you. But if Little Sister doesn't know where to turn for that stuff, it could be an exercise and frustration for everybody. But that said, I mean, since you've asked the question, we focused on all of the things

that could go wrong just to sort of flag any obstacles, any challenges that may be in the way. Overall, I absolutely love the thinking. Yeah, I think it's a really cool thing that you're doing. If you want to do that for me as well, I accept. that would be fantastic. I do like it. And I like that her head's in the right place that she's helping a family member.

Because you know also, and so does Big Sister here based on the fact that she said this. She knows how that that can go poorly as well. But helping a family member, that is the intention versus a profitable investment. Very noble and super cool. So thank you, Big Sister, for asking that question. Our final question comes from June. Hi Paula, it's June in Detroit, Michigan. Thank you so much for answering my questions. I have what I think is a whole in your programming that would really help my family, and I would think would help other families who are either at or close to financial independence, which is college planning. Most of us know the basics, but I don't know if you've ever really even covered those on your show. And many of us could use a deep dive because otherwise up to 47 percent of our assets. can be taken away, which obviously threatens our retirement. I recently checked your questions on your

show, and you had told someone to buy a rental property and plan to have it paid off to sell when your kids go to college. But I've been told the opposite by several experts in the field because the depreciation can actually bring down your income for the year. Anyway, it seems to be a rabbit hole that there must be an expert on. Thank you so much. I love your show. Bye. Hey June, thanks for that question. You know what's interesting. I can't answer this for the Ford Anything podcast, but I can for stacking Benjamin's for our show. And what I'm going to answer is the hole in the programming, just as another podcaster like Paula is, you're right on. Good college planning can save people a bunch of money. By the same token, however, it only is applicable to a piece of

our audience. So at least for my show, and Paula, you mean, you can speak to this. too, but we don't do a whole show on college planning because three quarters of our audience doesn't get anything from that. They're not planning on going to school. They don't have kids going to school. I prefer to have episodes that help people think and help them think critically. And then they can use those critical thinking skills to apply to their own situation. So where something affects the majority of my audience, much more likely to talk about that. So if it were my, and Paul, I don't want to speak for you,

but if for my show, I do the same thing. I don't talk about college planning a ton. We do from time to time, like in an environment like this, where we're taking questions, but not a whole show. And sometimes it's frustrating, right? I also want to do like benefits for military for a whole show. That would be a fantastic thing. But we have so many people that aren't in the military that I can't devote a whole show.

But we'll certainly do a segment to help out our friends in the military. Very similar, similar thing. We've taken that same approach with PSA Thursdays. So on PSA Thursday, we'll do something that's very specific. Like, for example, we had one that was entirely devoted to student loan payoff and how student loan payoff strategy can shift in the context of 2020. And we had Travis Hornsby on as our guest in that PSA Thursday episode. But a PSA Thursday episode, by its very nature, is shorter and more targeted.

And many of those episodes are targeted only at a specific subset of the audience, the listenership. And Joe, I agree with you that when we're making our editorial decisions, we are thinking about what will have the greatest impact on the largest number of people. A lot of times that comes down to these universal themes, these life skills that people can carry anywhere, such as critical thinking, filtering, filtering noise from what's actually valuable in a world that's too clouded with information. How do you filter to understand what you need to know and what you don't? Asking questions, asking better questions, improving that skill set of how to be able to know what to ask. Those are universal skills that can be applied. in any context. If you know how to filter information, if you know how to ask better questions, you can apply that to learning how to explore your options when it comes to paying for college. Now, since I know some people are wondering, sure, there are plenty of people who are listening to this who are wondering what the 47% is in reference to. June mentioned 47% within her question.

It is a reference to expected family contribution. And the way that the EFC guidelines determine the amount of a parent's assets that should be spent towards their child's college education. That's the reference that she was making. Now, June, in response to your question, you had asked about whether or not a person should purchase a rental property and use it as a mechanism for paying for college. Your question stemmed from a previous episode in which Joe and I answered a question from a guy who had four kids, I believe, and he was wondering how to send them to college. His youngest was about three. One of the suggestions that we made was that he could purchase a home on a 15-year mortgage and rent it out, and when the youngest child turns 18, then he will

have a rental home that's paid for free and clear. And at that point, he can decide, does he want to use the free cash flow from that home to pay for his child's monthly college expenses? Or, Or does he want to sell that home? He'll have to pay capital gains on the sale since he's not 10-3-1ing it, but does he want to sell that home and then have a big lump sum? He can make that decision 15 years down the road at that time, at the time at which his youngest goes to college. Joe actually had a different idea, which, for the sake of time, we won't go into. But Joe's idea was to hang on to that home and have the child be the property manager for it. Anyway, you can find all of that.

For anybody who's listening, you can find all of that in the archives. We will put a link to that episode in the show notes as well. It's brilliant. Well worth going back to. But June, to your question about various experts talking to you about depreciation, the depreciation on a home can offset the taxes that you pay on the rental income that you collect from the home. But that shouldn't influence college planning strategy. So first of all, passive losses can only offset passive gains. So when we talk about rental income, which according to the IRS is classified as passive income, the fact that some passive losses are offsetting passive gains doesn't apply towards the tax treatment of actively earned income such as W2 income. Furthermore, in the context of college planning, I don't see why we're talking about housing depreciation on a rental property because, again, the goal is college planning.

the goal is not tax optimization with the highest level of income. If your question was, how do I get as much income as possible and pay the lowest possible tax bill, then sure, within the scope of that conversation, we could discuss rental income and housing depreciation and the tax benefits of owning rental properties. But your question fundamentally is, how do I pay for college? And when gamifying the system based on the amount of depreciation left over on an asset enters the picture, it's A, missing the goal, and B, letting the tax tail wag the strategy dog. I'll say this, Paula, I absolutely love thinking about college early, though. It's so expensive.

And you and I had this conversation the other day about a friend of yours that, you know, starting when junior's born, just if you do the math on college and you want to pay for the whole thing, I mean, we're talking about numbers like $400 a month, just these ridiculous, unbelievable numbers. so thinking about it early and often is a great idea. Absolutely. Well, Joe, we did it again. Already, we're done?

We're done. We can't be done. We are. That's fantastic. Family day on the show. Absolutely. Joe, where can people find you if they want to know more about you? You can find me at this crazy show called Stacking Benjamin's, a three-ring circus and

financial planning topics every Monday, Wednesday, Friday. Fridays include our friend Paula Pant and Len Penn. and my co-host OG Monday and Wednesdays, we have great guests. We talk about financial headlines, things going on, and have a crazy trivia question that you can try to answer. So that's stacking Benjments every Monday, Wednesday, Friday. Excellent. Available anywhere where finer podcasts are downloaded.

Only the finest. Well, thank you so much for tuning in. This is the Afford Anything podcast. My name is Paula Pan. If you enjoyed today's episode, please do three things. Number one, share it with a friend or a family member. That's the single most important thing you can do. Number two, hit subscribe or follow in whatever app you're using to listen to this show.

And number three, leave us a review. Thanks again for tuning in. My name is Paula Pant, and I will catch you in the next episode. Just a friendly reminder that the media is never a substitute for seeking professional advice. The financial media is an unregulated industry. You don't need a license to host a finance podcast. And so anything that you encounter in the financial media, and that includes this show, should not be seen as a substitute for seeking a licensed, certified, knowledgeable, trained

professional. That includes, but is not limited to a certified financial planner, a tax professional, legal professionals. You make sure that you're talking to licensed professionals before you make any moves. Afford Anything, including all of the content that Afford Anything creates, including this podcast, the Afford Anything podcast, is for entertainment and educational purposes only. We are part of the financial media space. And the media should never be a substitute for seeking licensed professional advice. Thank you. In-depth, nuanced discussion on life insurance.

We will link to that episode in the show notes. The show notes will be available at afford anything.com slash I don't know what episode number this is. So, Steve, you may as well cut that part out too.