Afford Anything - Ask Paula: How Do I Pick the Right Mix of Investments for My Retirement Portfolio?

Episode Date: July 6, 2020

#264: An anonymous listener, whom we call “Mary,” is curious about the auto-rebalancing feature offered by M1 Finance. Is it too good to be true? J isn’t happy with the target date retirement fund she chose for her 401k. She has limited options and is wondering: should she move funds around? If so, is now a bad time, considering the market volatility? Another anonymous listener is wondering how to choose the right mix of investments for a retirement portfolio. She also wants tips on rebalancing a portfolio. And when should she execute a Roth conversion? Tami has $160,000 in a G fund in her TSP. Should she move this money to a Lifestyle fund to increase her earnings? Andy and his wife contribute the maximum to their children’s 529 accounts, and they have three investment options to choose from. Should they continue with an aggressive managed portfolio, or choose something less risky? My friend and former financial planner Joe Saul-Sehy and I answer these questions on today’s episode. Enjoy! For more information, visit the show notes at https://affordanything.com/episode264 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 your time, your focus, your energy, your attention, anything in your life that is a scarce or limited resource. And that leads to two questions. Number one, what matters most to you? Number two, how do you align the way that you handle your money, your time, your energy in

order to reflect that which matters most? answering these two questions as a lifetime practice. And that is what this podcast is here to explore. My name is Paula Pat. I'm the host of the Afford Anything podcast. Every other episode, I answer questions that come from you, the community. And today, former financial planner Joe Saul Seahy is with me to answer these questions. What's up, Joe? Hey, not much, Paula. You know what's amazing? Every time I sit down and you and I preview the questions, I always think, man, the bar just got higher. Clearly today, everybody who asked, the question deserves a gold star. Wow. Well, you've really sold this show. Let's hope our answers live up to the questions.

That's always the hard part. Well, this first question comes from an anonymous person who is asking about how to evaluate brokerage accounts. Now, we give every anonymous caller a nickname. So what should we call this one? Well, they're going to be talking specifically about M1. So I think it needs to begin with M. So I suppose we call her Mary. Mary. All right. Our first question today comes from Mary. Hi, Paola. Today I have a question about investing with N1 finance. I did some research about this broker's house, and they have very good features of orally balancing by buying fractional shares and things like that. So I'm thinking about opening LOS IRA account and keeping my buy-and-hold investment for the long long,

and that's going to be very easy to maintain since they have features of turning on orderly balance. I'm wondering if there is any caveat that I should aware if I actually implementing it, because it sounds too good to be true and just try to be a little cautious. Thank you so much for your great work and all the support. Thank you. Well, Mary, thanks for that question. What I don't want to do is talk about one brokerage account because it may or may not be helpful for everybody. I think what is far more valuable in Mary's question, Paula, is how to be.

do I choose a good brokerage account, right? She is identified M1 finance is good for her, and she's wondering if it really is. And then, you know, it seems like there's a lot going on there. So is it too good to be true. Yeah, the root of her question, as you said, is how do I pick a good brokerage? Yeah. What do you need from your brokerage account? And for me, and I'll give you example, I like to know how my investments are acting versus each other. What percentage of my investment is in each of my core funds. So if I have a large company index, a small index, maybe a bond fund, an international index, I want to have a screen that will show me not just the amount of money I have and the amount that I made or lost, most of them have that. It will also give me a percentage so that I can

very easily rebalance. Now, M1 Finance has rebalancing tools for an investor like me. That's great. For somebody buying individual stocks, maybe not so great. TD Ameritrade, as an example, has a whole suite of tools for people that like to trade. If you're somebody who is a trader, you get a bunch of tools for you to analyze these individual companies. So for that type of person, TD Ameritrade might be a great place.

And M1 Finance would be absolutely horrible for that type of. a trader. For the person who wants to execute a bunch of individual stock trades. Yeah. So I think, I think it begins with you. And so list out your goals. What do I need to be effective as an investor? And those will be different for everyone. And then that is your lens on how you look at all these different companies. And take all the big ones. You can take M1. You can take Charles Schwab, E-Trade, Robin Hood. Robin Hood, yes. But I think that, Depending on the type of trader you are, you're going to come up with the one that's right for you. Most of the people who listen to this podcast are pursuing financial independence.

And most of the people who listen to this podcast, or at least the people who call in, have an index fund strategy that's based around asset allocation and that doesn't do a lot of individual trading. I think it's fairly safe to say that for that type of person, M1 finance is a pretty good fit. It's absolutely a fine fit. Yeah. It is a great fit. It's made much more for a long-term investor who's looking to rebalance their portfolio a couple times a year. They're not looking to market time. You'll press a button and it will automatically rebalance your funds the way that you wanted them. It doesn't make a judgment on which way is right. You have to bring that to the table. The other thing that I like about M1 is that you can have two or three different investment pies in the same account. So as an example for retirement, if you're going to buy an RV at the beginning of retirement, you can have part of your. IRA in a pie, they call it, of diversified investment specifically for that goal, and then the

rest of it in a different pie that's for the rest of your retirement years. You can slice it however you want. I am a fan of M1. Yeah, so for a very asset allocation based strategy and for a broad market index fund with periodic rebalancing type of strategy, M1 is a really good fit. Two things to know about M1, though, that you have to know. M1 is a fairly young company. And while we've seen them roll out a lot of neat features, which we can get to that aspect of the question, it feels too good to be true, right? I love that part of the question as well from Mary. The thing you have to remember about any new company is that there probably will still be a high rate of change as they continue to try to compete against the big boys. And they've done that very effectively lately.

they also just secured another, I think the number was $30 million of funding to operate the company, which means, Paula, they're still a venture capital-back company, which means, and by the way, so is Robin Hood, which means that in the future there might be some massive change. I mean, the younger the company is, they may not attract enough assets in the future. They may be merged with one of the bigger companies that may get sold to a different company. Things change rapidly. Yeah. And with a smaller company,

That's something I think to watch out for. The piece of this question, though, I found really interesting from Mary was, it feels a little too good to be true, right? M1's got all these slick features that I really like. You have to always be able to answer for yourself. How are these people getting paid? If you can't answer that question,

you need to keep digging. And the cool thing is there are lots and lots of places where Brian Barnes, the founder of M1, has been very open to how they get paid. They have added margin, margin accounts for people that you can take. I don't recommend taking one for a lot of people, by the way,

M1 even very slickly calls it borrowing money against your portfolio, and so you can go out and buy stuff using your portfolio's leverage. Please don't do that. But they make money on that. They also loan out stocks to other traders so that other traders can use stocks that they have. They also do something that every other broker does, which Robin Hood actually got a lot of crap. for and frankly shouldn't have gotten crap for, which is they sell their order flow to

high speed traders. That happens regularly in the business. It sounds awful, probably is awful. That's the thing everybody does. So there are ways that they make money, but you always have to know when you work with any professional or any brokerage house, if it feels too good to be true, I got to figure out how they make cash. Right. Bear in mind, if you do end up opening an account with M1, know in advance that you should ignore all of their marketing around buying stocks on margin or buying investments on margin. Yeah. And not just a single out M1.

I mean, you go to any brokerage house. They're going to tell you, hey, we got this cool new thing. Right. Well, they don't have that cool new thing for you. They have the cool new thing for them. And they will always marketing package it in a way that makes it sound like, wow, this is a huge operate. Really?

I don't have to borrow money from anybody else. I can just use my portfolio as security. And I could go buy that RV on that one's dive. Well, not, nah. And a super low interest rate. Yeah, well, if the stock market goes down, you know what happens, Paula. Margin call. You end up getting a call, yeah.

And you have to come up with a lot of money in a short period of time. Yeah. So thank you, Mary, for asking that question. Our next question comes from Andy. Hi, Paula. My wife and I have three children and are actively contributing to their college 529 accounts, and we've been doing so for the past couple of years. We contribute at least the maximum amount that is tax deductible in our state every year, or $4,000 per child at least

per year. Our children will turn 5, 4, and 2 in one month. There are basically three options when investing for our kids. Number one is a managed portfolio which adjusts risk as the child gets older based on their expected college enrollment date, similar to a targeted retirement account. A subset of the managed portfolios is an aggressive managed portfolio with a higher amount of the investment in equities. Static investment portfolios is the second option, which do not adjust as the child ages and allows us to select what percentage of the investment would be aggressive versus conservative, a mix of equity, principal protected, and or fixed income funds. Number three is a guaranteed investment return, which protects the capital and guarantees a one to three percent return yearly. Our children's 529 accounts are all aggressive managed portfolios right now, and they're heavily invested in equities given their young ages. As you can imagine, their accounts have taken something of a hit in this current market, and like many Americans, I am uncertain what the future holds.

My question, my wife and I are going to make the maximum contribution to each child's fund in the next few weeks. Should we continue the aggressive managed portfolio, or choose a less risk yet? option, such as a regular managed portfolio or even a conservative guaranteed investment return. Their accounts are through Teachers, Insurance, and Annuity Association of America, College Retirement Equities Fund. Thanks so much. Andy, thank you for that question, and congratulations on having the foresight to be able to start saving for your kids college when they are so young. You mentioned that your kids are turning five, four, and two. So they're very young and you're saving for their college already.

That's incredible. So big congratulations to you for thinking so far into the future and for saving for their college at such a young age. Now, you mentioned that there are three options that you're choosing between. One is on the topic of target date retirement funds, which we've been chatting about throughout this episode. One is a managed portfolio that adjusts risk as the child nears college. their college enrollment date. So it's the college enrollment analog to a target retirement date fund. That's one option. Another option you said is a static portfolio. And then another option, which seems to be the most conservative option, is the guaranteed investment return that protects the capital and then essentially keeps pace with inflation, guarantees a one to three percent yearly return. I definitely would not choose that one. because you want your money to do better than merely keep pace with inflation. So I certainly wouldn't choose that last option.

Given the fact that your kids are so young, I think that the aggressive managed portfolio, the managed portfolio that is an analog to the Target Date Retirement Fund is a very healthy option. You know, it's okay for those investments to be more aggressive when your children are so far away from needing to tap that bucket of money. And I also think about the money that he's lost in those accounts. This is clearly a case because we know the endgame here, Paula. We know exactly when hopefully he'll be spending this money. And if that holds true, he hasn't sold the shares.

And any time, volatility works in your favor when children are young. Because if it goes down initially, okay, I lost a few bucks on the first dollars that I put in, but you know what? It allows me to put more money in at a lower price per share. And the thing that we do know, he mentioned during this time of uncertainty, we don't know. We do know. If you take a look at long-term charts, we know that if the economy continues, while it's much different on a daily, weekly, or maybe even yearly basis over long periods of time, and he still has long periods of time with his young children, over long periods of time, if the economy is going to continue, the stock market goes up because it's a reflection of companies succeeding.

And that, by the way, could be a 60-minute discussion about how that all works, but it is. So we do know that there is a very likely chance that no matter what's happening today, 10 years from now, we're going to kick ourselves in the butt if we don't keep our foot on the gas. Because right now, while there's uncertainty historically has always been. a great time to invest. And by the way, that doesn't mean that the NASDAQ hitting 10,000 recently is something that we, you know, that's a sign of good or side of bad. We don't know where the market's going tomorrow. We just know that when his kids go to school, another bet, Paula, I will bet just based on past performance that these funds will be worth a lot more.

You know, we are in a recession. And granted, the market does not always reflect the fact that We are in a recession or in 2020, the market has not reflected the fact that we are in a recession in the way that it has, in the way that it did in 2008. And so understandably, that can be quite confusing. But we're in a recession. And recessions are excellent times to invest for the people who can. Yeah. And I think about, you know, this stock market, even though the stock markets roared, something that I certainly find a little frightening over the short run is Ray Dalio talking about how the stock market. There's a depression on the way.

Ray Dalio's a pretty smart dude. Warren Buffett pulling a lot of money off the table, right? Warren Buffett, a little bit of a track record there. People like Phil Town who use a methodology, much like Warren Buffett's also saying that he thinks there might be more coming. So I don't bet on any of that, Paula, but I follow it because I'm a money geek. And also because much like Phil Town has said recently, that that also represents, while it does represent maybe some bad things if the financial markets perform worse, for those who are ready for it, it also does present, to your point,

an opportunity. And we've come back to this time and time again during the pandemic, the classic principles of personal finance, the classic principles of consistently investing no matter what the market is doing, and not trying to time the market, but instead, focusing on your contributions and your asset allocation, those classic principles are as true now as they ever have been. So, you know, regardless of the volatility, those classic fundamentals of personal finance, ignore the noise and stick with them, particularly when you're investing for a specific goal that has a timeline that is so darn far away. Let's talk about his asset allocation because I do agree with you that staying aggressive is fantastic. But let's talk about the future because this is interesting.

And I need to say this correctly, Paula, because people will go back to my answer to the last question and go, whoa, whoa, you're talking on both sides your mouth, Joe. I'll first remind people that the reason I don't like Target Day funds for retirement is because of the fact that they get conservative more quickly than you will likely need the money. you will probably need to stay invested in equities longer than any target date I've ever seen will keep you there. Even if their glide path, so to speak, is made to reflect the fact you're not going to spend it all in one place. With that in mind, let's take a look at college, Paula. We do know when you're going to spend the money. We do know. I've been there with twins.

I'm wearing a University of Arkansas shirt today. And it's not because I went there. it's because half of my college money went there for my twins. My daughter ran track and cross country for the University of Arkansas. My son went to the University of Texas. A lot of money went over a short amount of time to those two schools. If you know the money's going to deplete quickly, the target date fund is fine. It's great.

You're not going to bet on when it's going to go up or down. And you know, we've said this already. We get in our own way. So I'd much rather have that programmed out in a target date fund. So I think when Andy and his family get maybe four or five years away from college, switch over out of that aggressive, static fund that he's in now to a target date fund and let the algorithm land the plane for you. It still might end up ugly if it's a bad time. There's nothing we can do about that. But at the very least, you're not doing it as an emotional investor that doesn't know anything about the future and has a tendency.

You don't want to bet that maybe tomorrow's a better day than today. Excellent. So thank you, Andy, for asking that question. We'll come back to this episode after this word from our sponsors. The holidays are right around the corner, and if you're hosting, you're going to need to get prepared. Maybe you need bedding, sheets, linens. Maybe you need serveware and cookware. And, of course, holiday decor, all the stuff to make your home a great place to host during the holidays.

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That's your commercial payments of Fifth Third Better. Our next question comes from Jay. Hi Paula, this is Jay in California. And my question is about the investment options inside my 401k at work. I'm wondering if I should switch to index funds and if this pandemic is a bad time for that kind of change. So here's the situation. I'm in my 30s and for the past four years, all my 401K contributions have been going to a 2050 target date fund with John Hancock. And recently I took a closer look at it.

So the expense ratio is 0.79%. I know that's not great, but it's one of the cheapest options inside my plan. So there are two big downsides that I found. And for one, it turns out this fund is actively managed, not indexed, so it could underperform the market. And the other downside is that it's weirdly risk-averse. I found a Morning Star report that says, quote, the overt focus on downside protection results in a conservative equity glide path.

that isn't suitable for most retirement savers. So yikes. I don't plan to use this bucket of money until my 60s, even if I do retire early. So I would rather be more growth-oriented. In fact, I'm aiming for an 8515 asset allocation overall. For context, my husband and I have no debt besides our home mortgage. We have a five-month emergency fund in cash,

plus a separate account for home repairs. And we're maxing out our 401Ks and our Roth IRAs each year. My employer unfortunately does not match a single penny of my contributions, which is obnoxious, but still, I think my 401k is worth using because of the tax advantages. So the first half of the question is, in my 401k, should I switch to a simple two or three fund portfolio that I manage myself, or is the target date fund good enough that it's not worth switching? My index fund choices are pretty limited, but there are a few decent options, like an S&P 500 index fund with a 0.64% expense ratio. So how should I be thinking about this decision? And the second

half of the question is, if I do make a change, is now a bad time. The market is so volatile with the pandemic and the economic slowdown. So what should I be considering here? If it is time to make a move, is it a bad idea to move the whole $70,000 balance into the new funds all at once? Or should I take a staged approach or just start directing new contributions into the new setup. How should I think about that? So thank you for tackling this question. You and Joe always give such clear and nuanced answers. So I really look forward to hearing your thought process. Thanks. Jay, that's an excellent question. First of all, congratulations on managing your money so well. You're debt free other than your mortgage. You've got a great emergency fund. And you are clearly

doing an amazing job of managing your retirement investments. So to your question, should you stick with a target date fund or should you switch to a simple two fund or three fund portfolio? Given the fact that this particular target date fund doesn't have the type of asset allocation that you're looking for, I would recommend either switching to a simple two to three fund portfolio that you manage yourself, that you rebalance, periodically. It could be even as little as once a year. Another option, if you are looking for a more aggressive asset allocation than the one that's in the Target Date 2050 fund, check out the asset allocation that's in Target Date 2060 or if they're offering it Target Date 2070.

It may be that by putting yourself into a Target Date fund that is geared towards a later date, you may be able to get that more aggressive asset allocation. So check out what the asset allocation in those funds are. See if that's something that aligns with the type of asset allocation that you want, the 8515 that you're looking for. If it does, that's a simple and automated way to be able to achieve that same result. But if it doesn't, you can construct that on your own with just a simple two to three fund portfolio. You would drop your expense ratio a little bit and you would only have to rebalance as little as once a year. To your question of if you make a change is now a bad time, absolutely not.

Don't worry about timing the market. If your asset allocation is not where you want it to be, then moving the entire balance in such a way that your portfolio is constructed in the way that you want it to be constructed, that is the prudent next step. So don't worry about the fact that we are currently in the middle of a lot of market volatility because at the end of the day, the single biggest determinant of your retirement portfolio success are your contributions. And the second biggest determinant is your asset allocation.

Market timing falls far down on that list of things that matter when it comes to long-term results. Which, by the way, is also true. And let's get into a couple of the more nerdy things here, Paula, that actually is even true for active versus passively managed. And we're not going to have the same all Paula versus Joe fight that we have here. But while it's important and it's difficult to predict, you can't predict when an active manager is going to have a great year and when they're going to beat the index. So certainly sticking with passive is a much simpler path to success. But having the right investment mix, meaning finding your right asset allocation, your right diversified approach, far more important than having the right fund. You could have a fantastic fund that only invest

in Japanese stocks versus the Japanese index. And if you don't need Japan in your portfolio, even though you have the best one or the worst one, it's not nearly as important as having the right asset allocation. Right. So at the end of the day, let asset allocation be your North Star. Absolutely. Which is interesting. So she said, let's go into the particulars of this John Hancock fund that she has. Number one is she said that it's actively manager, it's listed as actively managed. This fund might be actively managed, but when it comes to a target day fund, active management means something different than it does with just a regular fund. So in a regular mutual fund, if it says it's actively managed, that means that you have a fund manager who is

buying and selling positions in deciding, maybe it's program trading, maybe it's just what they decide they like, but active management means they are doing some decision making. When it comes to a target date fund, it's a little different, Paula, you could have a fun that is completely index funds. But a target date fund will have a manager who maybe uses instead of a set we're going to make the change to the portfolio today, that fund manager says with a lot of data, do I do it today? Do I do it next week? Do I do it three weeks, four weeks from now? They may decide manually to press the button three weeks from now versus today, that little change on a target date from will make it actively managed

versus a passive fund. So when a fund says it's actively managed and it's a target date fund, I actually have to go a little further in a Morningstar, Jay, and look at what the underlying funds are. Because what a target date fund is, it's a fund of funds. They fill it full of a bunch of different mutual funds in the inside. Then they have a manager who decides what funds go in and what funds go out. And by the way, Paula,

they may not even be pushing the button on a different day during that quarter. What they might be doing is just deciding what funds are in and what funds are out. So if there's a fund that's not performing in a sector and they want to put a different fund in that sector instead or the manager changes or whatever it might be, active management might be hiring and firing these different managers inside the sector, but it's still a program trade based on the target date. So active management when it comes to a target date fund, I still need to know a lot more before that means. I think of that line from Princess Bride comes to active management.

That may not mean what you think it means. And you actually know that reference. I do know that reference. I have seen that movie. That is incredible. And so the operative question is what are the underlying holdings of that fund? For Vanguard, the Vanguard Target Date funds, the underlying holdings are a selection of Vanguard Index funds in Equipard. and bonds. So for your fund, for this John Hancock fund, what are the underlying holdings? And are those

underlying holdings index funds? Now, I love the fact that Jay was smart enough to go to Morningstar.com. Yeah. For people that don't know Morningstar, it's a third party rating service, meaning they're not beholden to any of the fund companies out there. They are fiercely independent, and they will tell you exactly along the lines of very stringent, criteria how good your fund is versus other funds. A mistake, though, that people make that are beginners to Morning Star and studies show this over and over, they will just look for five star funds, Morning Star rates, funds on a scale, one to five stars, and they will put their money in five star funds. That is a huge mistake. I love the way Jay looked at it. Use Morning Star to look at what the risks

are of the fund, read the analyst report on your fund, especially if it is an actively managed fund. if in your 401K, that's all you have available. Look at how long the manager's been around, what the analyst has to say, and also, of course, look at the fees. Which brings up the last piece. She said that this fund is 0.8 percent, which is, I agree with Jay, pretty hefty fee for this type of fund. But like she said, it's one of the cheaper funds in her 401K. Right. That's the limitation of an employer-sponsored 401K.

You just don't have the fund selection that you. you have for a non-employer-sponsored account. The fact that the S&P 500 fund has a 0.6% expense ratio, that's a lot for an S&P 500 index fund. Well, let me tell you why, and then I'll also tell you a mistake people make. The reason why it's expensive, I will bet you, Paula, bundles of money, maybe 60 or 70 cents, that Jay's company is a really small company. And historically, when it comes to administering 401K plans, they have all kinds of ERISA requirements they have to meet. They have all kinds of filing they have to do.

And these employers have a choice. They can either not offer a plan at all. Well, they don't want to do that. Employers want to attract good, talented people so they do that. Or they can pay these ginormous fees to manage the 401k themselves and eat all those fees like a big company will. or they pass it on to an employee through hidden charges inside the funds. Companies like John Hancock, by the way, work with a lot of very small employers to help them offer a 401K.

So the reason I think this fund is so expensive is because you work for a small company and your owner has said, we want to offer this as a benefit, but I can't pay all the fees. so everybody's going to have to eat some of that. Which brings up the mistake that people make. I've had people back when I was a financial planner coming to my office and they're like, I don't use my 401K because the fees are high. That's absolutely horrible. I have yet to find a 401k plan where the fees were so ginormous that not using the 401k at all

was a better option than using it and eating the additional fees. If you invest after tax, which is your prerogative otherwise, I mean, some people may still qualify for an IRA. Great. If you can do that, do it. Second thing is, is that you can put money into a Roth IRA as well. You might want to minimize the amount you put in it if you're eligible in other places, but please don't avoid this great tax shelter, especially if there's a match attached, Paula.

If you avoid the match, you know, the way you might think about the match is it pays over and above what the employer's charging you to make sure they have a plan. Well, and Jay's employer does not offer a match, but still, even still, there's still the tax benefit of investing in a 401K for money that you intend to use for retirement anyway. Yeah, the tax benefit still wins. Even these high fees, the tax benefit wins. Keep using it. The second Jay leaves, that company, roll it over to an IRA anywhere else.

Get out of those high fee funds. But while you're there, keep putting money into the fund. And another thing that you can look at too with some employers, and I don't know if it's available or not, you have to ask your HR people or if it's a really small company. You might just have to call John Hancock, the administrators, ask this question, can I make what are called in-service withdrawals? And an in-service withdrawal is where during the time that I work there, I can take a chunk of that money and I can roll it over to my IRA with Vanguard or wherever else where I can get those low-cost funds and avoid some of these fees. If you can do that, that would be fantastic. The sad news is most companies don't offer in service withdrawals. Thank you, Jay, for asking that question.

We'll come back to this episode in just a minute. But first, our next question comes from an anonymous caller. And again, Joe, you and I name every anonymous caller. So what should we call this one? You and I talked about before. We also tried to look at maybe the last movie that we've seen or the last TV show and name it after the actor-actress in that movie. and I have to tell, I've been watching a TV series called Broadchurch.

It's amazing. It isn't good. It is amazing. It's so, so, so, so, so good. And so, Olivia Coleman, who also plays the queen on the crown is in that. So we're going to call her Olivia. All right. Well, then our next question comes from Olivia.

Hi, Paula. Thank you so much for your podcast. I've been learning so much listening to your podcast and really kind of gotten me to reanalyze my retirement investments, budget. and savings, and it's been a great learning experience. I would love your opinion on whether you think it's worth me considering doing a backdoor Roth conversion of my traditional 401k plan. I'd also like to get your take on retirement age target funds and how I should go about rebalancing my portfolio. I'm currently 45 years, started out maxing out my 401k plan about 20 years

ago. At that time, I was only aware of the traditional 401k that seemed to be the only option available to me for 15 years or so. A few years ago, I learned about the Roth 401k option and really liked the idea of diversifying my buckets of retirement. So I immediately started working on maxing that option out. But obviously, the balance of my Roth account is much lower than the balance of my traditional 401k. I want to understand better the backdoor Roth conversion, associated tax implications,

and whether it's worth doing at this stage, or to just leave it as it is. I'm currently in a high tax bracket with an income of $220,000 this year, because I had a bonus of about 50,000 paid out this year for 2019 revenues. I expect 2021. It will be a lower tax bracket due to the crappier 2020 will be. So imagine there won't be any bonus in next year. I'll be in a lower tax bracket. So I'm currently hesitant to do anything that will increase my taxes this year.

But perhaps if the value of my traditional 401k is low, it might be worth doing overall. Here are my stats. My big retirement nest egg is that traditional 401k and it has about $520,000. It's in a Vanguard retirement target fund. I have various Roth accounts totaling about $60,000. I continue to max out my Roth 401K. I previously had an employer match, but that's now been taken, you know, taken away given the crisis. These Roth accounts, about half of it is in another target retirement fund of about 30,000.

that's the employer one, and then I put some in BTSAX and BFIAAX. I also have another 30,000 in a taxable brokerage account invested in BTI. I would love to contemplate the idea of retiring at age 55, but I want to make sure I have sufficient amount of retirement funds that I could access at that point or in a taxable brokerage account at least. My questions are, when is a good time to do a backdoor Roth conversion? Is it worth doing at this time? or should I just keep that 401k in place and just continue to focus on growing my Roth accounts?

Secondly, what do you think about these target retirement funds? I selected those just because I just felt I didn't know any better. And what tips do you have for rebalancing my portfolio? Thank you. Anonymous Olivia, this is a great question. So a couple of things come to mind right away. First of all, you expect to be in a lower tax bracket this year. but the question that I would have for you is how do you expect that that will compare to the tax bracket that you might be in for the next nine years? You mentioned that you want to retire in 10 years. So is this year 2020 going to be considerably lower than what you can reasonably anticipate your tax bracket will be in 2021, 2022, 2023? If so, and for many people, that's going to be the case because many people are taking pay-

cuts as a result of the pandemic, the economic shutdown that's happening in 2020, if you expect that 2020 is going to be an unusually low income year relative to your other years and you will be in a lower tax bracket, then it could make sense to execute a little bit of a backdoor Roth conversion right now just this year to take advantage of the novelty, so to speak, of having one year that is unusually low relative to your norm. Once you execute a backdoor Roth conversion, so once you convert that money out of a retirement account into a traditional IRA and then into a Roth IRA, you will have to wait five years before you touch the converted money.

And so the reason that I tell you to take advantage of an unusually low tax bracket year, if that's what this year ends up being, is because you mentioned that you want to retire in 10 years. if you convert money this year, then you will certainly have exceeded that five-year clock by the time your retirement date comes around in the year 2030. And so you'll be able to withdraw that conversion, tax-free and penalty-free, in the year 2030, the money that you convert this year in 2020. Now, if you want to start creating a ladder in which you can live on more of that converted money in the years, 2031, 2032, 233, well, then you'll have to start making those conversions five years prior to when you intend to withdraw that money. So if you are in a high tax bracket in the year 2027,

but you want that money, you want to be able to withdraw that money during your retirement in 2032. If that's the retirement plan, then despite the fact that you'll be in a high tax bracket, you would want to at least consider doing that if you need to withdraw that money. And if you don't need to withdraw that money, if you have options for other money that you can live on during the first five years of your retirement, then you can wait until you've retired 10 years from now and then start making Roth conversions at that time. So a big part of this depends on when you need to tap that money during your retirement. Do you need to start tapping this converted money in the year 2031, 2032, 233. If so, that's going to influence the date by which you need to

execute these conversions. And if you don't need to live on that money, if you have other sources of money, then the good news is that gives you the ability to wait until you've retired and you're in a much lower tax bracket to start converting more of that money. But in any event, If 2020 is an unusually low tax bracket year for you, then you may as well take advantage of, you know, this one anomaly year because that way you at least have the option of being able to withdraw that if you need. On the other questions, Paula, the one about Target date funds. If anybody has great Targetate funds, it is Vanguard. So no problem there. The issue I always have with Target Date funds is this.

the biggest, most dynamic way that you can help your retirement is to be able to let the market do as much of your dirty work as possible. I'm as lazy as the next person, Paula, maybe lazier, people will say. So if the market can do my heavy lifting and I don't have to save as much, that's a real key. We want our money to double as many times as it possibly can on. its own. A fun way to look at this is, let's say that Olivia only had $10,000 right now, and she's 25 years old. Well, we can use this cool rule called the Rule of 72 to take a look at Olivia's money and see how long it's going to take it to double. And the way we do that,

72 is this mathematical, magical number where if you take the interest rate you think you're going to get, divide it into 72, that will give you the number. That will give you the number. number of years. So at an 8% interest rate, it would take nine years to double. So if she's 25, that means her money's going to double. Let's work through it. See if I can do this on my fingers. She is going to double at 33. That 10 grand will double at 33. Wouldn't it be 34? See, I messed up already. It will double at 34. It'll double at 43. It will double at 52. And it will double again at 61. Let's say she wants to retire 62, so we'll just have it go four times. So the cool thing is for somebody who's 25 that's been able to accomplish the feat of getting $10,000 together, you haven't gotten $10,000 because that first double, so it double four times that first double means you've already got 20.

The second one, you've already got 40. The third one, you've already got $160,000. With that $10,000, if you just get an 8% rate of return. And by the way, a lot of people who are 25, maybe they got their first job at $20,000. They got $10,000 in their old 401K. They either get laid off or they quit, realize they need a new car. There's only $10,000 sitting there.

So guess what they usually do? 25-year-old will take it out. They'll pay a 10% penalty. They'll pay tax as if they earned it today. They'll end up with maybe $6,600 after all the penalties. $6,500, which means they probably still have car payments versus they could have had $160,000. for their retirement. And people don't do the opportunity cost.

So I like that. But my point here is this. Which double of those four was the most important? It was the last one, right? The one that took it from 80,000 to 160,000 was the one that was important. Here is my biggest beef with target date funds. If you have the target date fund so that it gets conservative on the day, first day you think you're going to need it, way, way, way.

way too much of your money is going to get conservative too early. If you're going to retire in 2050, you don't need your money at 2050, which is why I like Paula, you saying maybe 2060 or 2070 or maybe you have multiple target date funds, right? Yeah, exactly. Have one that's 2050, one that's 2060, one that's 2070 because if you can get that last double, that's a huge key to winning when it comes here. So my problem isn't really with, and I know target date funds try to mitigate against that by making it kind of a glide through versus a glide to that date. Okay. It still gets too conservative. I really worry that a lot of people mess up their retirement by number one picking a target date fund and then number two, no matter how good it is, Vanguard Fidelity,

who at John Hancock, it doesn't matter. You pick a target date fund. You set the day that you're retiring as that date, just not getting that last double really messes up a lot of your game plan. So essentially what you're saying is that even though many target date funds are built with the idea that, of course, you're not going to convert the entire fund to cash on the day that you retire. Of course, you know, you're going to be slowly drawing down from that over the span of a 30-year retirement. Still, many target date funds are, in your estimation, a bit too conservative. Yes, but I prefer to give you a big long analogy where we say that in 20 minutes. You know, Wade Fow, Dr. Wade Fow, who's a retirement researcher, a professor of retirement planning, he notes that there is risk tolerance and then there is risk capacity. Your risk capacity is the ability, like the logistical, mathematical ability that your portfolio has to suffer volatility, to suffer losses and ultimately still be able to provide you with the type of spending that you need. at the time in which you need it. That's your risk capacity. Your risk tolerance is the emotional or behavioral side of it. And so that's the other thing I would say, broadly speaking,

when it comes to thinking about target date funds and then, Joe, this conversation that you and I are having in terms of, is it too conservative or is it not for everyone listening, think about not just your risk capacity, but also your emotional risk tolerance. Because as we've seen time and time again, you yourself are the biggest risk to your own retirement portfolio. And if there is something that's going to trigger emotional reactivity or trigger negative behavior, then know yourself well enough to avoid those situations, even if that does mean investing more conservatively than you need to. A closely related aspect to this whole discussion, I love this discussion, is I really dislike the fact that when you walk into a new

employer, the first thing that you get when it comes to your 401K plan is a risk tolerance quiz. I would suggest that when you talk about, and this is where I thought you were going, which is close to, I think, where you were going, I don't think your risk tolerance matters until you know how much risk you have to take. Because it isn't about my feelings today. It's about, okay, if I get an 8% rate of return on my money and here's the investments that have done that historically, here's the spaceship that will get you to the future, Paula. it's these investments, then I look inwardly and I say, can I emotionally accept that risk? Can I be on that ship?

And if I can, great. If I can't, then I have a couple questions to ask myself. Number one is, can I teach myself to be ready for that? I mean, an astronaut on day one doesn't start off as an astronaut. They have to get into physical shape, right? They have to have mental capacity. They go through all kinds of training. Can I train myself to get there?

On the other side is, if I can't, what am I willing to do instead? Am I willing to push the goal back? Or am I willing to spend less every year? Or am I willing to save more money? What am I willing to do if I'm not able to train? So in that way, when you said risk capacity, what capacity of risk do I need to reach my goal? I think is much more important than how do I feel about loss. Still important how I feel, but I think how it feels irrelevant without.

the context of what do I have to do? Right. And in that regard, to a certain extent, there is no reason to take on more risk than is necessary. But then again, on the flip side, as you said, Joe, that last doubling is the one that matters. But it's got to be inside of your risk wheelhouse. Because imagine how hairy that gets that last doubling. You're really close to the goal now, right? And when you stop working, your goal isn't to have to go back to work in a job capacity because you have to. Maybe you go back because you want to, but not because you have to. So that last doubling is really important, but it also is the one where you're most likely to pull your hair out at that time. So it's an interesting time for people, this idea of when do we take the money out

and how do we leave it invested in the right place, especially at a time like now when the markets have been so all over the place and the economic outlook looks to be so much different than the stock market's been lightly. Right. The final thing that I will say about Target Date Retirement Funds, And Joe, I think you said this in the beginning. Vanguard has, in my opinion, the best ones on the market. The Vanguard target date retirement funds are simple, straightforward, low expense ratio. They're excellent, excellent funds. So if you are going to go into a target date retirement fund with any brokerage,

if you have the ability to select any brokerage, Vanguard is absolutely the one. Thank you, Anonymous, for asking that question. Our final question today comes from Tammy. Hey, Paula. I love your podcast and rarely miss an episode. I have a question to ask, but first I'd like to give you a little background information. I'm 56 years old, recently divorced. I'm a registered nurse at the VA Medical Center here in Portland, Oregon. I'd like to retire at my full pension age of 62.

At that time, I'll make about 2,000 a month in pension plus I'll receive Social Security later on. I'll own my home outright in about a year. It's worth a little over 500,000. I have 425,000 in my TSP account, 170,000 in a Vanguard account, and a six-month emergency fund. I max out my TSP at 19,500 a year and contribute $6,500,000. in catch-up funds per year. I live a pretty frugal life besides travel, and I guess I do that pretty frugly too. My question is, years ago when I started investing in TSP, I invested only in the G-Fund. I did convert to a lifestyle fund later on, but I still have 160,000 sitting in the G-fund,

making little interest. Do you think I should move a chunk of that G-fund money into a lifestyle fund in hopes of increasing future earnings. Thanks for taking my call, Paula. I appreciate it. Tammy, first of all, I'm so happy that you enjoy the show. Thank you for listening to almost every episode. I'm flattered. And congratulations on everything that you've built. You are one year away from owning your home outright, free and clear. That's huge. And to be able to go into retirement with your home free and clear is, you know, that's a huge load of off your shoulders. So congratulations on building that. Congratulations on building the balances in your TSP account, in your Vanguard account. Congratulations on the six-month emergency fund. Now, to your question,

you asked about whether you should move money from a G fund into a lifestyle fund. And for people who are listening, a G-fund is a fund, the money in a G-fund is invested in short-term U.S. Treasury securities. And so what I hear, Tammy, in your question, is fundamentally a question about asset allocation. which seems to be, Joe, the theme that we keep coming back to throughout today's episode. To me, this sounds like an asset allocation question and needs to be contextualized with the asset allocation of the overall portfolio. Do you know what G stands for in these government programs? I assume government. It is for God awful in most cases.

That's what the G fund is. For anybody out there listening, that's the way, that's actually the way we think about. That's not what it is. It is government bonds, or government-backed or very, very conservative, where the C-fund, common stock, the I-fund international, right? S is small-cap, a small company fund. This is definitely a financial planning question because the one key piece, Paula, that we don't know is when you're going to spend the money. And where you put the money, which if you choose a lifestyle fund or one of the other funds or a collection of them, the I, the S, the sea, something else, all depends on when you need the money.

It's just like when you're planting a field, you have a certain time that you plant in a year, and you have a certain time that you harvest. And before we know the growing season, we can't pick the plants that we're putting in there. So I like to pick investments once I know what the growing season is for that. So yes, I think moving out of the G is a great idea. but I'd like to know more about when you're going to spend those dollars, how quickly money's going to come. You said that you live frugally.

You said you have the pension money coming in. That's all fantastic news. Sounds like then money will come out fairly slowly out of those funds. But a lot of the time, Paula, when people retire right away, maybe they have some home improvements that they want to make or they buy an RV or something that might be a big expense right away, that might mean that that growing season is fairly short with some of the money. So then this close to the game, you might want to leave it in the G fund at this point. Because G, in that case, stands for not got awful in this particular occasion.

Right. So it depends on when you want to spend it. And yeah. Yeah. I mean, so Tammy, you mentioned you'll be making $2,000 a month from your pension. And you'll have your full pension age when you turn 62. And given the fact that your home, you own your home free and clear, so you're You're not going to have to worry about a mortgage payment. I assume that you probably don't have any other debt. You know, could that $2,000 cover, if not your entire cost of living, at least the majority of it? I don't know. I don't know what your various other expenses are. Or to your point, Joe, also what your dreams are in retirement. Like retirement is not just about scraping by spending the bare minimum, you know, particularly when you're in your 60s, you're young, you're, you've got more, most people in the,

their 60s have more health and energy and vitality than they do as compared to being in your 80s or your 90s. So how do you want to spend your 60s? How do you want to take advantage of those young years of your retirement? I'd love to go against that grain, but I think even saying most people is generous. Pretty much everybody has more ability to get up and go in their 60s than they do in their 80s. Well, I'm thinking of people who like in their 60s, maybe you have some sort of debilitating illness or, you know, something that happens strikes you in your 60s that you then recover from. Yes. And don't have to battle when you're in your 70s or 80s. Yeah, good point. I love this question because it gets back to one of my favorite books, which is seven habits of

highly affected people. And if you begin with the end of mind, as Stephen Covey very famously wrote, Paula, you don't make mistakes. Right. So start with the vision and work backwards from there. And it's more fun that way. It's so much more fun. When somebody would come into my office when I was a planner and I'd say, so what do you want? And they would just say more. Those are the people that made mistakes.

They'd make all kinds of it. Because what do you want when you just want more money and you don't have any goals? What do you do? You chase hot stocks. You pay too much attention to the short term market. You begin betting. You get this betting mentality of, hey, I'm going to.

And look at the number of people that lately have been burned by that. These people, what, just over a month or two ago that thought that oil look fantastic, these oil futures, people were paying you to take oil. And it turned out that all these people that we saw in the news that got burned, they got burned because they didn't understand really what was going on. And they were busy betting. And it's really sad to see when somebody gets caught up in that. So thank you, Tammy, for asking that question. and best of luck with whatever decision that you make. And enjoy your retirement, which is coming up.

It'll be here sooner than you realize. That's so awesome. Yeah. Joe, that's our show for today. No, no. We did it. Come on. Where can people find you if they would like to learn more about you?

Hey, we talk a lot about the Stack & Vegman show, but Paula, I'm on a different show, and I want to bring on this show because I'm on it this season with you. You're joining our cast on a show that Bobby Rebell, and I have, our mutual friend Bobby, have called Money with Friends. And every season, we have eight very diverse thought leaders. And by diverse, I mean people that are from all different points of view. We have a comedian on this time, this season with you. We have a sports expert on with you. We've got Paula on. We've got people that run foundations on. We've got a really neat lineup of people. And what happens is Paula chooses a headline and I choose a headline and we talk about

what they really mean to you. Because a lot of the time, these financial headlines don't seem to mean much. And then we get into it and we have a lot of fun with it. So money with friends is every Monday through Saturday you'll find me there. Right. And to be clear, I'm not on every episode this season, but I'm on two episodes a month. I'm on two episodes a month. Yes, for the next four months. Nice. Yeah. And it's a lot of fun. Recording those episodes. And they're live. We do them live on Facebook. So it's a little intimidating at first, isn't it? It totally is. Yeah. Seeing the commentary come in. Yeah. Yeah. You're like, I'd better make sure that I say it right. But actually, it's a lot of fun. We have a good time. Yeah. Absolutely. Great. Well, thank you, Joe.

Well, thanks, Paula. That's our show for today. If you want to discuss today's episode with other members of the Afford Anything Community, you can meet them virtually, social distancing friendly, at afford anything.com slash community. We have all kinds of groups there. We have people who gather in groups to discuss personal finance and financial independence and early retirement from the perspective of people in their 20s or 30s or 40s or 50s. We have people who gather based on geographic location. We have people who gather to talk about specific interests like debt payoff or index fund investing or rental properties. We have Zoom chats where the community gets together

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