Afford Anything - Ask Paula: Should I Repay Debt or Invest?

Episode Date: November 9, 2022

#412: Taylor recently graduated. She wants to reach financial independence as soon as possible. What should she do first: invest or repay low-interest debt? Carter doesn’t want to pay too much for his investments. He’s worried about the tax drag. He wants to know how to improve cost efficiency in his portfolio. How should he manage decisions about basis points, dividends and capital gains? Our first anonymous caller has been working and investing for a decade. Today her portfolio is large enough that she and her husband can finally take a mini-retirement. They’d like to rebalance their portfolio. They want it to reflect the fact that they won’t be working for a while. They’d also like to calculate how much money they need to travel with their children. How should they handle this? Our second anonymous caller is worried that their portfolio is out-of-whack. Their money is in a target date retirement fund. They’d like to move some of it to a three-fund portfolio. But this is a scary time to sell. Stocks are low. What should they do? Former financial planner Joe Saul-Sehy and I tackle these four questions in today’s episode. Enjoy! P.S. Got a question? Leave it here. 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 to any limited resource that you need to manage. And that opens up two questions. First, what matters most? And second, how do you make decisions that reflect that which matters most?

Answering those two questions is a lifetime practice. And that's what this podcast is here to help you get right. My name is Paula Pant. I am the host of the Afford Anything podcast. Every other episode, we answer questions that come from you. And my buddy, Joe Saul-Sehi, former financial planner, joins me to answer these questions. What's up, Joe? Paula, I am here in Reporting for Duty, and I don't want to spoil this for anybody.

But today, we have no questions about board games, which is unfortunate. and no questions about the Detroit Lions, which is probably good. Joe revealing two of his interests. He's the former Detroit money guy and a big board game nerd, which there are many board games that teach people about money. There are. We do the day after Thanksgiving, Black Friday, I realized a number of years ago, nobody wants to listen to a financial podcast that day that are all blowing cash, right?

So I decided that that day's not for our listeners. for me. So we have on a board game geek every year, somebody who's big time into that industry, believe it or not, there's a whole cottage industry around board games. And they go through, like the top five games that teach you about money or economics and then another top five games because people are starting to play games over the holidays with their family, like that you can find at Target that don't suck. Because most of us just go for the packaging. If we don't know what to buy and then you're disappointed when the game's horrible. So we do that every year.

It's pretty fun now. It's ended up now becoming one of the most downloaded episodes we have every year. That's excellent. And I didn't even mean to talk about that. I was just pointing out a fact. Two facts. No Detroit Lions, which is good. And no board games, which might be bad.

Well, here's what the questions are about. Taylor is 24. Just graduated with a master's in engineering, wants to reach financial independence, and is curious about how to pay off debts and begin to save. That's a good question. An anonymous caller is 36, has two young kids, and is curious about the 4% withdrawal rule. Ooh.

Another anonymous caller is 49, has $750,000 saved for retirement, and wants to transition away from target date funds and towards a three fund portfolio. Sweet. And Carter has a question about efficiency in a portfolio. Game on. We're going to tackle all of these questions right now, starting with Taylor. Hi, Paula. My name is Taylor and I am a huge fan of the show. I'm 24 years old and recently graduated with my master's degree in engineering. I'm starting my first job in a few weeks, and so I would love to get your guidance on how to begin my financial independence journey.

I will be making $135,000 per year and I pay about $900 per month in rent as I share an apartment with my partner. We moved back in February and at the time I only had a part-time job and about $10,000 saved so I got a credit card with a 0% interest offer for 15 months to help with the moving expenses and life expenses since most of my cash has been going towards rent. Now that credit card has a balance of about $7,000, and I have about $3,000 in my savings, which is a position that I'm not super comfortable with being in, but I do still have the 0% interest until May of 2023. My other debts include $25,000 of student loans and an auto loan that has about $20,000 remaining, which I pay $445 per month on. I have about $15,000 in my investment portfolio right now,

and I have not yet maxed out my Roth for the year. My ultimate goal is to reach financial independence as quickly as possible so I can begin starting my family. My question is, with my new job and new income coming, how should I approach paying off my debts and saving? I'm familiar with the snowball method, but with the zero percent interest on my credit card and the pause on student loan payments, I'm not sure if I should prioritize saving and investing more first, or if I should take advantage of the no interest and pay my principles down by a lot. It's super overwhelming being a young person trying to set the foundation for financial independence, especially right now with everything going on with the world in our economy. So thank you and Joe so much for being such a great resource. Taylor, thank you for the question.

Congratulations on getting your master's degree, on making such a great salary, and on building your life in such a way that you now have a huge delta between your expenses and your income. You're paying $900 per month in rent and you're making a six-figure income. That means that the good news is that you are in a great position to pay off your debts, save money, and begin building investments. Let's talk order of operations. The first thing that strikes me, you mentioned that you have about $3,000 in your savings. I would like to see you build that a bit more. Essentially, there are three goals here. There's beef up the emergency fund, pay off the debts, and begin shoveling money into investment accounts.

Between those three goals, particularly given that your debts have low interest rates, We're talking student loans, auto loan, and a 0% teaser rate. My focus right now is on your emergency fund. Oh, that's funny, not mine. Interesting. All right, where's yours, Joe? You know, you think about the biggest check that you would write for most things. It's going to be under $1,000.

So for me, $3,000, I also like beefing that up. But I think that's kind of a background thing. Set a number you're building toward, set a number that you're going to save into that on the side. And I would crush that credit card while it's at zero percent because it's not going to stay at zero percent. That's a time bomb. It'll end up being a waste of money. And I think it's good to get the foundation together immediately. But she has until May of 2023 to pay off that balance. And given the gap between what she's making and what she's spending, after taxes, She's going to be bringing home probably around $8 grand a month.

I don't know her exact tax rate, but she'll be bringing home eight or nine grand a month and she's paying $1,000 in rent. She can wipe out that credit card balance pretty quickly. Three months if she dedicates everything to it? Exactly. So that's May, April, March. So we're looking at three months. Well, if it's due in May, let's go April. I wouldn't push it to the last minute like that.

Right. Well, no, that's what I'm saying. So February is kind of like the deadline for her to start. And stuff's going to come up and we're going into the holiday season, which is why I would blow that out now. Yeah, yeah. I definitely would not suggest that she saves it to the last minute. I would not have her push it to February. But I do want to at least for one month, if she can just throw a giant chunk of money into an emergency fund for the first month and then flip over.

If she's going to get it paid off in full, though, Paula, at a minimum, if she's going to set a pace, She is six months to do it, which means that to pay that credit card off in full, it's still going to be $1,200 a month. Yeah, I would not do it as a monthly bill. I wouldn't chop it up into like six payments and do it as six different things. I would instead, for one month, just throw a gigantic chunk of as much as she can save into her emergency fund. I would do that for the first month. And then after that, throw the next gigantic chunk towards that credit card. So basically it's like the snowball method in terms of you're picking one goal and hurling all of your savings towards just that one goal and wiping out that goal and then moving to the next.

Then I'd flip it. I would flip it because life is going to get in the way. Stuff is going to come up. So I would get rid of the credit card debt. And then I would use that $3,000 buffer while life happens. Something's going to happen in the next six months. I mean, it always does. the dishwasher breaks,

muffler drags behind the car, something happens. The problem I have with the teaser rate and waiting also is that a lot of the time, if you don't pay it all off by X date, all that interest comes back to bite you, right? So she'll have to look at the contract to see if that's the case with this particular debt,

but I would just get out of the credit card company's clutches. Yeah, I agree with that. I guess it kind of, Taylor, is semantics. I see the way Paula's going and I get it and the fact that it's zero percent, I get it. Either way, you seem pretty determined and I think you'll win. I would do the credit card first. But then you know what I'd do next, Paula? What's that? I would not pay extra on the auto loan, but what I would do would be once that loan is paid off, I would keep paying the $4.45 a month. But I would pay that. Make a car payment to yourself? Yeah, into a pay-ahead fund so that you always have

cash available to pay cash for your cars. Right. Exactly. I call that making a car payment to yourself. You set aside that money every month so that that way the next time you need to buy a car, boom, you've already made the payments in advance to you. And it does something else too. It becomes a game. So I've found when I'm putting that money away instead of buying a new car right away. Because what a lot of people do, they get done paying it off and they go, oh, my car's paid off. guess what, I could trade it in and start this bowl over again. But if I begin this game where I'm going to pay myself this car payment, I wait until I have enough money. Like it stretches out the life of my car just because of the fact that I'm playing this game in my head.

Okay, here's another question. Does she make another Roth IRA contribution? Oh, definitely. Between now and then. Definitely, definitely. my order of priorities would be number one beef emergency fund. And I know Joe, you and I disagree on this a little bit. But I'd fling one month's worth of money into the emergency fund.

Then I'd fling the next few months, as many as it takes, into paying off that credit card balance. And then fling the next few months at maxing out the Roth IRA. And remember, she has until the tax deadline of 2023 to retroactively make contributions for the 2022 tax year. so it does not have to be done by New Year's. But you'll notice, and I'm intentionally using the words, fling a month's worth of money, and again, it's because I don't like the practice of hurling or chucking. No, I do. You prefer flinging?

I do. I like hurling. I like chucking. I like all of the above. What I don't like is having a variety of goals and then taking a big bucket of money and chopping it up and pulling it up. putting a small amount, you know, slicing up that money such that you're making incremental progress on a large number of goals every month, I don't like that practice at all because

it's not psychologically satisfying. It's much more motivating, much more satisfying to pick one goal, focus everything on that, achieve that goal, cross it off the list, and then go to the next one. It's the psychology of the snowball method, but applied to all financial goals. I don't think it's all financial goals because I think there's there is a difference between short-term goals and things that you know are going to be long-term in the distance. Because what I don't like, I don't like the Dave Ramsey popularized method of don't save anything into your retirement fund while you're doing all of this stuff. Because a lot of the time your retirement plan has a match and you're giving away this match money. And also the rule of 72 works so much. much better in your favor when you give it time. So while I would hurl, Chuck, and fling toward those

short-term goals, I would still in the background be tiptoeing some money toward retirement at the same time. Oh, yeah. I agree with that. That's why I would place the number three priority after the emergency fund, after the credit card. The number three is maxing out that Roth IRA. I would do that before even starting to think about the student loans or the auto loan. But if she's eligible for retirement plan at her work, she should be doing that at least to the match the entire time. Absolutely. Absolutely 100%. Tipto toward that one while you're hurling, chucking, and flinging.

Yes. And I guess also the making the car payment to yourself. That's another incremental one that I guess I make an exception for that one. But she doesn't tiptoe on that until later. Right. Well, right, because now she still has an auto loan that she has to pay. Yeah. So that one is in the distance.

And don't prepay that. Yeah. Don't prepay that. Yeah, that's going to have a super low interest rate. So there's no reason to hurry that one up. Taylor, I hope that that's provided some guidance. Joe and I are both in agreement that that credit card, despite the teaser 0% interest rate, is a pressing priority.

And we're both in agreement that we're not that worried about the auto loan or the student loans. So once the credit card's taken care of, we're both in favor of then shifting your focus and making sure that your Roth IRA is fully funded, that you're getting your maximum employer match for your 401k, assuming you're eligible for that. Pay off the credit card, then fund your retirement accounts, and then after that you can start looking at the student loans and the auto loan. So, Joe, really, the only place where we disagree is where we would put the emergency fund in terms of that order of operations.

Other than that, we're pretty aligned. And seriously, when you think about the efficacy of choosing one way over the other in that move, it isn't a big deal. Yeah, six of one, half a dozen of the other. More like six and a half a one, my way. All right. I'll give that one to you, Joe. Well, Taylor, thank you for asking that question. We'll come back to this episode after this word from our sponsors.

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at Columbia University. So we are now transitioning where Paula is naming our anonymous, afford anything, community caller inners. I think that's what we call them color iners. I think callers. After a famous, after a famous journalist, something. Clearly, I would never be a famous journalist because I can't find the word for callers. Yes, I am currently getting a master's in business journalism at Columbia University.

And Columbia, fun fact, is where they hand out Pulitzer Prizes. In fact, the- Like candy. Well, no, they're not really passing out Pulitzer Prizes like candy. They are still quite difficult to get. But the building for the journalism school on the Columbia campus is actually referred to as Pulitzer Hall. And during orientation, one of the first things that they did was they brought us into the room where the Pulitzer prizes are given out, which was incredibly inspiring, also very intimidating. When you said they give out Pulitzer's, I didn't understand that that is the physical place where they give out the Pulitzer. Yes, yes. It is the physical place. So Pulitzer Hall has a specific room inside of Pulitzer Hall where they give out the Pulitzer Prize.

I thought you were bragging. What do you know, they give out Pulitzer's? No, yes. The committee that meets to determine who gets a Pulitzer Prize and then they all assemble in this room. Yeah, exactly, exactly. So the first woman to receive a Pulitzer Prize was named Edith Wharton. She received the Pulitzer Prize in 19, for a novel that she wrote called The Age of Innocence. And so in honor of the... Oh, fantastic. Have you read it? Oh, yes. Fantastic book.

Really? I have not read it. Edith Wharton is a badass. She's incredible. Oh, that's all right. If you want some great writing, read anything by Edith Wharton. Edith Wharton's short stories are incredible. Well, in honor of Edith Wharton, the first woman to win a Pulitzer Prize, our next caller,

will be referred to as Edith. Hi, Paula. I love your show and all the actionable ideas I get from listening to it. The Ask Paula and Joe episodes are particularly my favorite as I enjoy the debates between the two of you. Thanks to both of you for breaking down complex topics into digestible information and making these sessions fun and educational. I have a few questions. We are a married couple both 36 years old with two young children, two and five years old. We've been working for the last decade.

and have saved enough to enjoy a mini-retirement. I quit the corporate life three years ago and my husband may leave in the next six months to one year. Then we want to spend at least three years just resting, enjoying time with our children and traveling. We intend to make a little bit of income with some creative endeavors along the way. Our portfolio right now is made up of a lot of funds,

Vanguard Index funds and dimensional funds. We had an advisor for a year from mid-2019 to 2020 and that's why we have these dimensional funds. The total value of this portfolio is around $3 million, 90% of which are stocks, 6% bonds, 2.5% real estate and 1.5% cash. We also have about $700,000 in tax-sheltered accounts like the 401K and Roth IRA and about $800,000 equity in our primary residence. Our current household income is close to $750,000.

My question to you is, when we do take the sabbatical where our W2 incomes will be close to zero, how should we pay ourselves? When someone says, take out 4% from your portfolio, how does that exactly work? Do you take out 4% of each of the fund or choose a subset of funds based on different factors? Do you sell assets once a year or say every quarter or, and is it even possible to automate this process? I'm not even sure if my portfolio as of now is in any kind of balance where the 4% rule applies. How do you suggest I check and balance the portfolio? To prepare ourselves with some cash, I have switched off dividend re-investing and we're not

investing any extra income. That way, we have around $100,000 to fund our first year and then take more money out by selling the assets. Any thoughts and suggestions on this will be truly life-changing for us. So thank you in advance. Edith, thank you so much for the question. Congratulations on everything that you've built. And I love the goal that you have of taking a mini-retirement and spending at least three years

enjoying quality time with your children and traveling. Can we talk for a second, Paula, before we go any further about why that's so important? Because I think that there's a lot of people maybe that are new to the show that don't know why you and I are so geeked about it. I mean, on one hand, it just sounds great, right? Taking three years off now. But you and I both know it's much more important than that. Right. Exactly. In our society, most of us have been taught to follow a linear path in which when we're young, we go to school, when we're in the middle of our lives, we work. And then at the end of our lives, we have a traditional retirement. The problem with that model is that it defers so many goals to the end of your life. If instead you can take many retirements along the way, you don't need to a binary zero one.

I'm financially independent. I'm not, blah, blah, blah. You know, financial independence is in the traditional fire, retire early model is somewhat rigid thinking. people get caught up in this idea that if a retirement cannot be sustained in perpetuity, then it hasn't arrived yet. So people get really caught up in, have I reached FI, have I not? I think it's far better to embrace many retirements so that you don't have to worry about whether or not you've reached FI. So long as you have sufficient funds to be able to take a break, you can enjoy the current moment.

In Edith's case, she's got two kids, ages two and five. These years aren't going to happen again. So to spend this time with her kids while they're young, rather than defer and wait until she reaches some FI number when the kids are much, much older, I mean, I think that's an incredible embrace of the moment and a testament to aligning your decision-making around your priorities. I think it also helps you create much more realistic planning around financial independence because so many people, when they reach financial independence, they suffer from disillusionment. In fact, there have been plenty. There have been tons of very well-researched peer-reviewed studies that show that initially, when people get to, quote, retirement, they experience elation and joy. But then the next period is this huge, huge bout of depression, just a monster bout of depression because now that they realize that this isn't just an extended vacation, this is forever.

And I'm not going back to that job. We realize how much we've mistakenly identified our whole identity around this career path that we'd had. We've identified our identity. We've identified our identity. Yes, once again, not a journalist. Not a journalist. So I think it's important to spend some time along the way, discovering who you are and who you aren't.

And as you know, Paula, I very luckily got to experience this, not because I really wanted to, but Cheryl and I sold our house. We sold all of our stuff. We thought that we were going to an opportunity that Cheryl had in Arizona, and I was just going to pack my stuff, and we were going to be nomads. And I was going to be podcasting from Bali or from Portugal or wherever after this Arizona opportunity happened for Cheryl. And then we found out after we'd sold everything that there was no opportunity.

And because of COVID, it was all gone. And then we realized, hey, we can live anywhere and we can start the nomad process now, which I was excited about. I thought that was amazing. And I hated it. I couldn't stand it. But now that I've been through that and I had the opportunity to try it out, I know much better what I like and what I don't like instead of this fantasy I had built up in my mind that, hey, I'm going to be a nomad. This sounds awesome. It sounds awesome for you.

It sounds awesome for other people. Not for Joe. So basically, Joe, what you're saying is your mini retirement was a chance for you to test drive some of your assumptions. Absolutely. I think that's great for everybody. If you can do that, it's wonderful. And taking three years is a great time to regroup, identify yourself away from your career, who you are besides your career, and spend more time finding out what your values are as a family, which when you're together all that time is going to be a special time to your point, Paula, that you're not going to forget. So love that. To her question, to Edith's question, first of all, Edith, the 4% rule does not apply in your situation. So the 4% rule is,

guidance developed by a researcher by the name of Bill Banken, who discovered through mathematical modeling that if a person were to withdraw 4% of their portfolio in year one of retirement, and then 4% adjusted for inflation every subsequent year, they have a high probability of not outliving their funds, depending on certain assumptions about the way that that portfolio is balanced. But you don't need to optimize for not outliving your funds because we're talking about a three-year mini retirement. So you don't need to create a withdrawal strategy that is built around making sure that this portfolio lasts for 30, 40, 50 years, whatever length of retirement you're planning on having. You are going to be continuing to contribute to.

your retirement portfolio after this three-year sabbatical is over. So the 4% rule doesn't need to apply in this circumstance. And by the way, we interviewed Bill Bengen on this podcast. We will link to that interview in the show notes. You can subscribe to the show notes for free at afford anything.com slash show notes. But for anyone listening who wants to jump to that right away, that interview took place in episode 377. And you can navigate to that by going to afford anything.com slash episode 377.

The withdraw strategy, Edith, that you want to use, I think you nail the first part, which is create as big a cash cushion as you possibly can between now and then. And then withdraw the cash so that you don't upset the portfolio. And because you're taking money out of markets that are actively moving, and as we saw this last year, sometimes not moving in the right direction, we do. don't want to especially take money out of long-term, more aggressive funds. So what a lot of people do in retirement and what a lot of financial advisors suggest is to create what's a bucket approach. And you think about the time frame and the amount of money that you're going to need. So create as much cash as you possibly can and then remove money for what we call the middle

bucket. So you have your short-term bucket, your middle bucket, then your long-term bucket, that middle bucket of money that's going to be for the future years, that will be depleting your most conservative investments. So take that out of your most conservative investments. Now, financial advisors may even tell you, we don't know what the future is. We don't know if the market's going to go up or down, even in conservative investments. So from the time you have that goal, the safest thing to do is to withdraw all that money now and make sure that it is where it is. Then your win condition is set.

it is it is here i'm not sure if you want to do that or not obviously that's going to be up to you the one thing i wouldn't do i'm glad you mentioned that you have dimensional funds you know this fun family is run by Nobel Prize winners they have such a track record and i know that that is a comprehensive strategy i would also try not to remove anything from those dimensional funds if it all possible joe how would edith's strategy differ from the strategy that someone would have if they were actually in retirement? For those people, they create a machine that uses those three buckets where we're consistently moving money from the long-term bucket to the midterm bucket, midterm bucket to the short-term bucket. And how you do that, I think you pick set dates because if you don't pick set dates, you end up betting on the market, which I definitely don't like.

If you dollar cost average out, almost the same way you dollar cost average in, you take the guesswork out of it and you end up avoiding making these horrible decisions. We all think that we're going to know when the market is high and we'll take money out then. What ends up happening is the market's high and we're so busy high-fiving ourselves because we're brilliant. We want to quote, let our winners run. I'm actually thinking back, Paula, to maybe the last six or seven times the market has gone down.

It goes down in a hurry. I think of one time during my professional career, 2000 to 2002, the market just deteriorated for two. I felt like I was going down every damn day for two years. But every other downturn was pretty violent and quick and a knife down. We don't want to keep giving ourselves this big hooray of, yeah, let's see if we can eke out a little more, which we say we're not going to do, but we always try to do. So give that away, dollar cost average out, move some long-term money to mid-term money that you're getting ready to spend. Mid-term money to short-term money. Keep enough.

Most financial planners will say keep two to three years for retiree in cash so that you don't have to worry about the market for the next two to three years if you're at all able to. And think of how reassuring that will feel at the beginning of a three-year mini retirement to know that all of your money for, the next three years is de-risked. It's in cash. It can be unnerving to have a pile of cash that big, but it can also be a relief to not have to think about how to withdraw it over time, because you've got your funds for the entire mini-retirement sitting there. And from that point forward, it's just a matter of budgeting, doling it out. And it's funny you say that because I think most of us can just put ourselves in that spot. A year and a half ago, when you thought to yourself, my goodness, two to three years

in cash, oh, that would stink. That's horrible because we were all on the go, go, go train, right? But then you look at this year, if you've got two to three years worth of money in cash, you're high-fiving yourself right now, Paula, because you don't have to worry about, Are we in a recession? Yes or no. Well, you still need to worry about it. Don't get me wrong.

But you've got this nice cushion where your retirement does not depend on it. You've got the money sitting in cash and you're going to be okay for the next two to three years. And you can ride it out with the rest of your money. How great is that? Exactly. Exactly. So thank you, Edith for that question. Enjoy this three-year sabbatical.

So great. They just keep coming, though, Paul. we have another anonymous caller. So to name this anonymous caller, I'm going to run with a theme of Pulitzer Prize winners. There is only one woman who has won four Pulitzer Prizes in journalism. Four. Four. Four.

Her name is Carol. Carol Goosey. And she has won four Pulitzer Prizes in photojournalism. Wow. So in honor of. of the woman with the most Pulitzer Prizes, our next caller will be named Carol. Hi, Paula and Joe. Thanks for all of the great information you share in this podcast. I've heard both of you, particularly you, Joe, express strong dislike for target date mutual funds. Well,

you've convinced me that they're not the best bet, and I have a portion of my retirement savings in them. For a little background, I'm 49 and have about 750,000 save for retirement between an IRA, Roth IRA, taxable brokerage, and a simple IRA through my job at a small company. I am aiming to retire at 59, but would love to sooner if I crossed the $1.2 million mark before then. I recently moved in with my partner, and our shared living costs are very low, but I still own my condo in another town and rentied out to a great tenant and its cash flow positive. I have about $150,000 of equity in the condo and have no other debt aside from that mortgage, and I have an emergency fund in cash and iBonds. The portion of my retirement savings that's in my simple IRA is all in target date funds.

Please feel free to pause my question here to lament my choices if you need to. We don't need to, but because you said we should stop, Carol. We're going to go ahead and take a moment. Nice job that you recognized the air in your ways. And now we shall continue. I chose these because it was easiest to set and forget when I started with a company. I've been dollar cost averaging into it for years and the balance is now over 100,000 and I'm buying what you're selling about target date funds and want to transition to a three fund portfolio with an 80-20 asset allocation, which is what I already do in my other retirement accounts. My question is about transitioning from the target date funds to this allocation.

This down market feels like the worst time to make this kind of change in my investment choices. I'm a buy-and-hold investor and have never sold during a down market before. I'm hesitant to sell the Target-E funds in my account at a loss and buy the Vanguard funds in one fell swoop. I know there will be no taxable events in doing this since it's within a simple IRA, but I'm supposed to buy low and sell high, right? And I still know that time in the market is better than timing the market, but I'm still hesitating. Am I just overthinking this? Carol, thank you so much for the question.

And Paula, because this is my hot button. Right. I think I'm going to just jump on in. For people that don't know why I'm not a fan of Target Day funds, there are a few reasons. The first reason is, is that most Target Day funds are a little like the Sunday brunch at your favorite restaurant. And Paula, have you read Tony Bourdain's book, Kitchen Confidential? No, I haven't.

In that book, he has a lot of behind-the-scenes things that happen in kitchens. And one is that the Sunday brunch at your favorite restaurant is priced so that you will clean out the back of the freezer. What happens most of the week is that new food generally comes in on a Monday or Tuesday, and the chef and the crew, they go into the refrigerator. in the freezer and they grab food going around the stuff that doesn't look all that good. That isn't phenomenal so that they can please their audience. So by the end of the week, when it comes to Sunday, they're at the back of the freezer and all it's left is this food that they have picked over and decided isn't really fantastic.

And so they turn it into salads. They turn into a buffet. They give it a special price. And they invite you in and you clean out. the freezer for them. We've done that at our house where we'll clean out all the leftovers and refrigerator, right? Left overnight at home. That's what a lot of target date funds are, Paula. Well, Joe, so a little behind the scenes here. We're recording this on a Sunday, and I literally just came from brunch where I ordered a salad.

They turn into salad so you can't see the ugliness of what you are consuming. This is what a target date fund for many companies looks like. It is a salad of these investments that they can't market otherwise. And Morningstar has shown that if you dive into a lot of these target date funds, the pieces of it are junk. Now, that's not all target date funds. There are people yelling at their device saying, I have one through Vanguard. I have one through Fidelity. I have one through two-year-old price that look great. Yes, those are great target date funds. But the second issue I have with Target Day funds is this. You're getting too conservative too soon with your money. And that really frustrates me. You know, this rule of 72 that we need to have our money

double. 72's this mathematical, magical number where if you take the interest rate, you think you're going to divide 72 by that number, that's how many years is going to take your money to double. So at 8% into 72, your money is going to double every nine years. And what's important about that is for most of us, that last double that's the most important one. Because sure, going from 10 to 20,000 is cool. Going from 200,000 to 400,000 is neat. But that last double from 400 to 800,000 or 800 to 1.6 million or 1.6 million to 3.2 million. That last double is the most important one.

And with Target Day funds, we're giving that away because we're landing the plane too soon. we're reducing our ability to do that at a time when we're not going to use all this money in this target date year in most cases now some people solve for that by picking years well beyond their retirement date the problem there is that of course then we might have our money too risky for retirement which brings up my biggest thing which is proponents of target date funds say that target date funds are freedom from worry. When you set up your portfolio your own, it doesn't take that much time. And it's not that hard.

And Paula, it's so much stickier, meaning you're going to stick with your plan. You're going to know why you have the plan. And you're saving a whopping maybe 15 minutes, maybe 30 minutes twice a year by not doing this and going with the target date fund. So there truly is almost no time savings. And the time you spend setting up your own portfolio and making it personalized is going to help you stick with it. So that's the biggest reason I don't like Target Date Funds. So for people catching up.

I should also state for the record, I am not running for political office on an anti-target date fund campaign the way Joe is. There are so many people that like Target Date Funds that I just don't get it. I don't understand. I just think it's so easy to not use them. and there's so many advantages to not using them, the shortcut, the quote shortcut you get, it doesn't make sense. But that's not the big question. The big question is this, is it time now to switch?

So I agree, Carol, with everything that you're saying, but you are misconstrueing, I think, what some of these shorthand phrases mean. When you say, isn't my goal to buy low and sell high? And right now we're low. the answer is yes absolutely that's the goal that's 100% the goal but realize we're not really selling we're just making an asset allocation change that more fits what you want to do and because you're keeping the risk profile pretty much the same you're making lateral moves in this portfolio which means making this move for you is market agnostic it doesn't matter if it's an up market

or a down market you're making a lateral move to a portfolio that fits you better that has pretty close to the same risk profile. So you're not really selling. And by the way, there are people that will keep a suboptimal portfolio for this really bad reason, which is that I don't want to sell when it's low. It's always about having more money. And if I think that my new strategy is going to give me more money than my old strategy is, mark it down, up, middle of the road, make the move.

make the move that gives you the most cash. And I believe not having a target date fund is going to end up giving you more cash. And then second, the other shorthand is it's time in the market versus timing the market. Obviously then, based on my answer, what that means is we're not timing the market at all. Because this move is market agnostic, I don't care if it's up, down in the middle. If I have the same risk profile and I'm moving to a better strategy that fits me more, than I'm still in the market. What you need to do is sell and buy right away.

And so you have minimal time out of the market. So it's not about this fund. It's about the market in general. And you're still in the market if you sell and buy to get your asset allocation the way that you want it. Damn, drop the mic, Joe. That was great. I'm exhausted.

No, I'm not. I'm not. That was fun. Carol, great question. And you know what? People make those mistakes all the time. We're like, I'm not going to sell this fun. I remember, I remember Paul, I was meeting with a couple. And of course, my office was in Detroit. So everybody owned stock in the big three. Everybody own them. And this gentleman worked for Ford and he had 80% of his whole portfolio was in Ford stock. Wow. And as you, as you and I know, that's something that needs to change. Exactly. And Ford stock at the time was

trading at $40 a share. And he said, 40's not a great time to sell it. I'm going to wait for it to get to 45. And then I'm going to sell it. And I said, you shouldn't bet on where the market's going to go. If you think that a different allocation is better for you, we should just make the move. Oh, I got to wait for it to go, for it to go up. I bought a lot of this at 45.

I got to wait for it to come back. It went down to 35. It went to 30. You know the story. Yeah. Went to 25. I went to 20. 2007, 2008 hit.

The stock goes to $5 a share. Yikes. And he never sold. It was sad. I ended up terminating the relationship because I said there's nothing to do. There is, if we're not going to do the right thing because we're too busy betting on one stock coming up versus having more money. When we say buy low, sell high, it's not. about that individual position. It's be buying when the market's low, be selling when we need the

money, which is much, much later, and will always be higher if the economy continues doing what it's doing and you're buying for long periods of time. The story of that man, it illustrates the cognitive bias of loss aversion. The pain of a realized loss is so much greater than the pain of missed opportunity cost, that people will irrationally hold on to a position because they quote unquote want it to come back. A stock does not care what price you bought it at. You make a good point, Paula, especially if we widen that out, that this is why, another of many reasons why buying passive index funds is better for most people than purchasing individual stocks. And it's partly because if this were the S&P 500, this gentleman, I don't think would have

cared about it getting, quote, back to 45. If the S&P were trading at 40, he didn't care, right? If it's the S&P 500, who cares about this index, about the boring stock market? It's boring. boring is good in this case. The problem with individual stock investors is that they get wrapped up in these emotions. I bought my Rivian at X dollars. I bought my Tesla at this number.

I've been holding onto Apple since whenever. So we get wrapped up in this one security instead of the bigger game, which really I think the bigger game by far is Edis game. How do I take three years off with my kids? That's the game. not whether Rivian's at my number. Right. Exactly.

It's what's it all for? Yeah. And so this is another great reason not to own individual stocks. Keep it boring on purpose so your brain doesn't start making these horrible decisions. The same can be said with crypto. People can get very attached to specific coins and invested in the idea that a given coin is going to take off. And again, ultimately the goal, as you said, is to build a portfolio that has sufficient assets such that you can live life the way you want to. And that for the individual investor matters much more than the price of Ethereum.

So thank you, Carol, for asking that question. This was a great discussion, and I think a lot of people in this community benefited from hearing the answer. We'll return to the show in just a moment. Our final question today comes from Carter. Hey, Paula and Joe. My question is this. Which is more efficient in terms of total realized cost in a taxable brokerage account for someone who's in the 24% bracket? Either A, a mutual fund like Fidelity Zero total market, which is going to create a taxable capital gain each year,

due to the distributions, or B, lower cost ETF with an expense ratio of three basis points, for example, ITOT. Same question applies for a foreign fund like FZILX with a zero percent expense ratio versus BXUS with an expense ratio of seven basis points. Also, can you quantify the additional value to getting the dividends quarterly, compounding earlier versus annually? In other words, the quarterly ETF dividend payouts versus the annual mutual fund dividend payout. I have to imagine this would be significant over many years. I know you're going to say this is splitting hairs and either one is great, but which is more efficient in terms of a total aggregate cost?

So pay the three or seven basis points or pay the taxes on the capital gains and get your dividends only once per year. That's my question. Thanks. Love the show. Hope to hear from you guys soon. Bye. Carter, thank you for the question.

And you're right. You're splitting hairs. And you're also right. This truly does not matter. It is number 18 on your list. of things for people to think about. And I just want to frame it that way, Carter, not for you, because I know that you framed it that way.

I just want everybody else listening to realize that this obsession that we have on fees over performance is BS. It's misguided. And it's mostly because of the fact that financial writers don't understand money enough that they have nothing else to write about. And so they've got us all obsessed about fees versus being obsessed. with performance. My goal is always to have more money, not to pay less, period. So I know that you framed it that way. I just want to make sure everybody else knows. Fighting fees is an important dragon. You should,

with two things being equal, choose the one that's less expensive. Duh. I mean, you should do that. But there are so many times I've seen people avoid fees and it hurts their net worth significantly because they don't do the right behaviors and they get smoke because of it. So frustrating. Cutting off your nose just bite your face. Oh, it's so bad. It's so bad.

So, but let's jump into this. I'm not going to do the entire framework you outlined. I'm just going to tell you the basic fundamental things here. A zero fee mutual fund versus an ETF with an extremely low, expense ratio, without getting into individual funds, the ETF will almost always win for two reasons. The first one is, ETFs are allowed to, through loopholes, to trade securities back and forth versus having to buy and sell and mutual funds are not. So mutual fund managers, whether it's a passive or an active fund, have to sell out of a position and then they have to go buy another

position. That creates capital gains that ETFs don't have that drag. That will almost always, in a very low-cost ETF like you outlined, be more money in your pocket than going with a zero-fee mutual fund. I'll give you an example. You know, when Apple at some point ends its huge run, huge huge run of being the dominant stock in the S&P 500 and starts to come down to earth, an S&P 500 fund has to start shedding these shares. Paula, in some cases, the S&P 500 fund may have owned these shares for years and years and years. The thing that's frustrating about a mutual fund is that there's no fair way for them, by the way, to divide that capital gain.

So let's say that they're declaring their capital gain in November, like most funds do, late November, early December, they're declaring their capital gain. I buy on November 1st just before this. I'm going to get a huge capital gain tax bill because mutual funds are like a subway. The door's opening, people are getting on, people are getting off, and they don't know when it is.

So they say, hey, everybody, on this day of record, based on the percentage of shares you own, I'm dividing it. So if I get on the subway in November 1st and the conductor comes through handing out the capital gains, for capital gains that happened 10 years ago, 15 years ago, I'm still on the hook for that crap, even though I wasn't invested in the fund. But there's no good way to do it, so they have to do it that way. Exchange traded funds get around all of that nonsense because they're allowed to just swap versus trade.

How they do that is beyond the scope of the discussion. They just do it. So over long periods of time, the drag on an ETF, the tax drag on a non-qualified ETF is going to be a lot less than it will be on a mutual fund regardless of whether it's free or a higher expense ratio. The second thing, dividends quarterly versus annually, I've never thought about that because, again, I don't think it's hugely relevant to you getting financial security or not. But I have to think through if it's an active fund, what the fund manager would do with that money that they are not disperse quarterly. So the fact that they're taking the money would lead me to believe in an up

market, the active mutual fund is going to continue to create more performance with this money that they would have paid out otherwise. If it's a passive fund, that money still stays in the stocks and the stocks are still going to do what they're going to do. So if the stock's going up quarterly versus annually, I think what you're looking at, Carter, is if the position stays static, then certainly I want my dividend in my pocket more often. But if I'm adding to a position that's going up, the positions themselves are still going up during that time. A mutual fund's going to reconfigure the NAV to pay out the quarterly dividend check

versus they don't have to do that if they just pay it out once a year. An ETF is going to be very similar where the dividend's going to affect the share price because of the fact that they're not keeping that money invested in the fund. Instead, they're paying it out. I haven't thought about it before, Carter, but I think it comes out closer to even than you think it does. Initially, I'm with you where I think that, hey, having my money quarterly sounds better to me because then I get it and I can deploy it.

But if I'm deploying it back in the fund, my question is, what does that do to the performance of that fund, which is why I think it doesn't matter. Interesting brain problem, Paula. Joe, I don't quite think I got that. And if I didn't get it, then I'm sure a lot of the people listening also didn't. So I'll just restate this aspect of Carter's question. It would appear on the surface that if you are getting dividend payments quarterly rather than annually,

that gives you more compounding over the long term. From what I think I just heard you say and tell me if I'm, repeating this correctly, if a person were to not get those dividend payments quarterly, if they instead were to get those dividend payments annually, it's because the fund itself is using what would have been those dividend payments to boost its own performance. Yeah, think about this. I mean, you have to think about where that dividend payment comes from. If you get the dividend payment quarterly, that has to come out of the sum that's invested in the fund.

It doesn't magically just appear. If it comes out of the fund, that's an additional drag. Then on the performance of the fund by paying it out quarterly versus waiting to pay it out at the end of the year. Because I think in our head, we don't think about the drag and where the money's coming from. We think that these two things are equal and I can take it in quarterly payments versus taking it in annual payment. Clearly, if they're equal and there is no drag, and I'm wrong on this front, If I'm wrong in this front, and for some reason there's no drag, then take it quarterly. Hell yeah, I'm with you because the compounding interest makes sense.

But it doesn't make sense in the end because that money has to come from somewhere. So I'm thinking about this. In my head, I'm putting a small business analogy on this, and I'm thinking about this in terms of if afford anything as a company were to pay out a quarterly dividend, that would be money that we could not redeploy back into the growth and operations of our business. business. And that would have an impact, assuming that we are operating efficiently, that would have an impact on the long-term growth of the company. So essentially, Joe, from what I think I hear you say, is that take that analogy, apply it to a fund, and the same principles apply.

I think so. And the problem is, I haven't spent any amount of time studying this. So I don't know. but just thinking through it, that's my thought process. I will say this. If I have two funds that are the same and one pays me quarterly versus pays me annually, my bias is still toward quarterly because of the fact that the money's in my pocket. Nothing to do with anything other than the fact. If I can get my money sooner, I like having my money sooner because then I can decide what to do with the cash versus having somebody else hold on to, my cash. Everything else being equal, I want it to be quarterly. And not even just for compounding,

Paula, but just because as an investor, returning that money to me makes me happier and takes away some risk, right? It makes it less risky, which is why when you look at investments and now we're going to go from Nerdville, where Carter and I are nerd now bring this back down to everybody's level and make it a little more fun. This is why on the risk return scale, things that pay a huge dividend are much less risky and don't go up and down as much. The stocks don't go up and down like a railroad that pays a big dividend because railroads are pretty locked in at this stage of the game. Not going to grow much. Spoiler. Those stocks aren't very volatile. But a biotech company that pays no dividend ever and you're just betting on the fact that they're going to be

able to continue this trend of creating new cool stuff and biotechnology, that stock's going to be all over the place. But it's that back and forth where if I get a big dividend, the share price isn't going to go up and down as much versus being on that, you know, much more betting if I'm not getting that dividend. Right. Well, and that makes sense. Every asset gains value in two ways, capital appreciation.

the income stream that it pays out. So it intuitively makes sense that if a given asset were to bias its returns towards the income stream, then in an efficient market, that means that it could not also simultaneously have the potential, a reasonable potential for massive appreciation. And companies try to attract shareholders the same way that they attract customers, right? A company needs owners. They need people to be interested in owning the company. A railroad looks at a biotech and goes, are you kidding me? They could grow a thousand percent next year. If we grow two percent, we're high-fiving each other. Like, this is fantastic. So what are we going to do? And Paul and Joe sitting at the board table at Union Pacific,

look at each other like, oh, we're going to offer a massive dividend instead. That's how we're going to get investors. So to some degree, there's some marketing going on as well to keep the share price up. Well, Joe, that was a fantastic discussion. So thank you and thank you Carter for asking that question. Carter's making my head hurt. Joe, we've done it. I can't believe it's over already. The time flies, doesn't it? It did fly. It did fly. Joe, where can people find you if they want to hear more of your work? Well, I can't believe this time of year. We have a lot of fun over at the Stacking Benjamin's show every Monday, Wednesday, Friday, wherever you're listening to us now. Coming up on stacking Benjamins, the week before Thanksgiving, we always talk about technology

deals and we talk about Black Friday deals. If you're going to be spending money this year, like most people do, stores have a plan for you. We want to make sure that you've got a plan as well. I mean, stores spend months setting up their operations so that when you walk in or you visit their website, you're going to drop some money. So we want to arm people the other

way, and I get very excited about this week every year. Plus, on Black Friday, it'll be our annual board game episode again. And all of that is at the stacking Benjamin's podcast. Available anywhere where finer podcasts are downloaded.

Finer. Well, thank you. you for tuning in. If you enjoyed today's episode, please subscribe to the show notes for free at Fordenithing.com slash show notes. You'll get a synopsis of every episode with timestamps so that you can easily refer to any question, answer, topic that you want to refer back to. Please make sure that you are following this podcast in your favorite podcast playing app. Open up that app. Make sure you've hit the follow button. And while you're there, please leave us a review. If you want to chat with other members of the community, go to afford anything.com slash community. And remember we have a book club,

fable.c.co. slash afford anything takes you to our book club where we read books written by former guests on this podcast, people like James Clear, Morgan Housel, Ken Honda, Dr. Susan David. We read books and have discussions, and I'm right there, in there with you, chatting about the books written by authors who have been on this show. That's fable.com. slash afford anything. Thank you again for tuning in. My name is Paula Pant. I'm Joe Salci.

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