The Personal Finance Podcast - Is it Worthwhile to Invest in the Top 10 Holdings of an Index Fund?

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Starting point is 00:00:56 Find your advisor at IG Private Wealth.com. What's up everybody and welcome to the personal finance podcast. I'm your host, Andrew, founder of mastermoney.com. And today on the personal finance podcast, we're going to be doing another money Q&A. Now on today's money Q&A, we're going to be talking about a number of things. And if you want to submit your question to Money Q&A, hit me up on Instagram or TikTok at Master Money. And today on Money Q&A, we're going to be talking about some of the pre-tax moves that you can make if you're a high earner and you don't have access to them at your job. We're also going to talk about should you invest in rental properties when you're in college.

Starting point is 00:01:49 And lastly, we're going to talk about is it worthwhile to invest in the top 10 holding of an index fund? So you don't want to miss out on this episode. We're covering a ton of stuff today on Money Q&A. make sure you check it out. Now let's get into it. So the first question, what are some pre-tax moves for high earners who do not have any access through work? So what this person is specifically referencing is what are some things that you can do if you

Starting point is 00:02:19 don't have access to something like a 401k or a Roth 401k or a 403B at your work? And what you want to do is you want to get money into these pre-tax retirement accounts. The reason why is your money can grow faster because you're not paying taxes on money in certain levels. So there are some pre-tax moves that you can make for high earners specifically because they can't make certain moves in terms of investing in a Roth IRA or doing things of that nature. And we'll talk about actually how you can get your money into a Roth IRA here in a second. But what pre-tax moves can you actually make? So let's talk about a few of them. The first one and the main one that I want you to look at first is a health savings account if you qualify.

Starting point is 00:03:01 Now, to qualify for a health savings account, you have to have a high deductible plan. But the health savings account is one of the best accounts that are out there. And if you have a high deductible health plan, it's a fantastic route for you to go in terms of saving for retirement because the money has triple tax benefits, meaning you put the money in tax-free. You can invest those dollars once the money is in that account. The money can grow tax-free and you can pull the money out tax-free. So this is the incredible power of the HSA.

Starting point is 00:03:31 those triple tax benefits. Now, the key to the HSA is you have to have a qualified medical expense. So making sure that you have qualified medical expenses and you're saving the receipts for those expenses over time means that you can draw down that money completely tax-free. Now, the IRS has no limit for the time horizon as to when you actually had that medical expense. So you could say break your leg when you're 21 and draw the money down from your HSA when you're 65 tax-free. It doesn't matter how long ago it happened. As long as you have a receipt for

Starting point is 00:04:06 backup, it's going to be a fantastic way for you to do that. Now, I've talked to me a number of times. How do I track my receipts for HSAs? You can use tools like Dropbox or Google Drive or Microsoft One Drive. There's a number of different cloud ways that you can do that. Just make a folder called receipts, throw all of your receipts in there and you are good to go. Now, if you want to track it on a spreadsheet or something of that nature, that's something else that you can do. But this is a amazing way for you to be able to get those triple tax benefits. Now, the next way that you can do this is with a backdoor Roth IRA. So what a backdoor Roth IRA is, is it's a way for high earners, people who make over

Starting point is 00:04:41 the income limits, which I will leave down in the show notes so you can check out the income limits. But if you make over the income limits of a Roth IRA, then you absolutely should be looking into doing a backdoor Roth IRA because it's one of the best ways for high earners to get their money into tax advantage to. counts. Now, it is not pre-tax like this question asked, but the tax advantages are definitely there, and you can get large amounts into a Roth IRA by utilizing the backdoor Roth IRA. And the cool thing about the backdoor Roth IRA is there's something called a mega backdoor

Starting point is 00:05:11 Roth IRA, which we're going to be talking about coming in the future, where we can get over $60,000 into the Roth IRA by utilizing the mega backdoor Roth IRA. So we'll talk about that in a future episode. Make sure you're subscribed to this podcast so you can hear that episode, because that's going to be a very cool episode. We're going to talk about a bunch of tax loopholes that you can utilize with that mega backdoor Roth IRA as well. But the way the backdoor Roth IRA works is you put your non-deductible contribution into a IRA.

Starting point is 00:05:41 Now, I like to put a contribution into an IRA and then wait for a little while. Some people say you only have to wait a couple of days. Other people say you have to wait for a year. Some of the best financial advisors that I've ever talked to have said wait at least a year so that it looks like an IRA contribution. Then what you do is you convert that IRA contribution

Starting point is 00:06:02 to a rough IRA contribution. So this is something that you can do, and anybody can do this, but it's something that you can do, especially if you're a high earner. And if you are a high earner, then you can get those Roth contributions, so you can still contribute to a Roth IRA

Starting point is 00:06:14 by utilizing this strategy. Now, you can also do this with SEP IRAs, with simple IRAs, with traditional IRAs. You can utilize all of these for the backdoor Roth IRAs. So you have a ton of options when it comes to doing the backdoor Roth IRA. So make sure you look through your personal situation to see if you can do it.

Starting point is 00:06:30 And the majority of folks can do it. They just don't know that it actually exists. Then the third option is to look at a traditional IRA. The problem with the traditional IRA is it does have some certain income limits and it has limitations as to what you can do for those pre-tax moves. But looking at that traditional IRA may be an option as well if you want to get some pre-tax money into traditional IRA. Just check out the income limits that we will have in the show notes

Starting point is 00:06:53 so that you can make sure you understand exactly where those lie. At the time I'm recording this, if you make $66,000 or less, then you get all the pre-tax benefits, or if you make $105,000 as a couple or less, then you get all the pre-tax benefits. So $66,000 if you're single and $105,000 if you're a couple. But for most high earners, this isn't going to be a good enough income limit for them. So make sure you're checking out your personal situation. you can figure that out. Now, one other thing I'll note, and obviously this isn't pre-taxed as well, but if you look into real estate, there is a ton of tax benefits inside of real estate.

Starting point is 00:07:32 If you need more tax benefits outside of what you're doing currently, you can look into a bunch of different real estate options. It doesn't always have to be something where you're owning physical property and putting the sweat equity in. You can become a cash partner and have somebody else to the sweat equity. There's a lot of different options you can get into there. You can buy rental properties and have a property manager, but you're still having to manage that property manager. But thinking through some of these options may allow you to at least defer more taxes. Another way to do this is to buy boring businesses or any business whatsoever within your

Starting point is 00:08:02 expertise because you'll get those write-offs, you'll get those deductions, you'll get those tax benefits as well. It's going to help you on your income statement come tax time. The next question I absolutely love. Would buying a house as a rental property during college be a good decision or even possible? So I absolutely love the idea of doing this. Now there's a couple of obstacles you may have in your way, but I absolutely love the idea if you can figure out how to do this

Starting point is 00:08:30 to buy your first rental property in college because there's a number of strategies that you can use that I'll talk about here in a second that's going to allow you to start building wealth in college. Now this is absolutely fantastic because if you can start building wealth in college, somebody else, your tenants are going to be building wealth for you. They're going to be getting up and going to work

Starting point is 00:08:47 or their student loans are going to be paying it for you or their parents are going to be paying your note for you, and over time, you're going to be building tremendous wealth. Now, what is the obstacle here? The obstacle to buying a house in college is the financing. So when you get traditional financing, like if you want to go to a bank or you want to go to a mortgage broker, you have to have income.

Starting point is 00:09:06 Specifically, you want to have W-2 income. Now, if you don't know what W-2 income is, it's when you work a job and you get a for-income tax time called your W-2. And your W-2 shows how much income you made so that you can submit that to the IRS and they can figure out, hey, here's how much you owe in taxes or here's how much you're going to get back. But your W2 is also used by mortgage brokers. It's used by banks to figure out how much money did you make in the last year so that they can give you a loan based on your income and pre-qualify you. So you're going to have to get pre-qualified.

Starting point is 00:09:37 Now, if you don't have a job, you don't have W-2 income, you're going to have to get creative because getting a house without W-2 income is going to be difficult. But there's a number of ways that you can do that. Now, if you do have W2 income, first way to do it is to go to a bank or get a traditional loan. And what the banks will do is they will verify your income, they will pre-qualify you, then you can go out and start running the numbers on properties and see what actually works in your college town. But if that is not the case and you don't have that option available to you because you don't have a job because you're focusing on school or whatever else and you want this to be your second income, you have a couple of options here.

Starting point is 00:10:12 The first one is finding a private lender. Now, if you haven't heard our episode where we talked to Ryan Paneda, He talks about private lenders in great detail in that episode. It's called From Flipping Couches to Flipping Houses, I'll leave it down in the show notes below. But if you have not heard that episode, he talks about how private lenders are absolutely everywhere. And that's what he uses the most now is private lenders. And he thinks that's the best way to actually buy rental properties or flip houses or whatever else you want to do in real estate. The reason why is there's less hoops to jump through.

Starting point is 00:10:41 And private lenders, especially people who are wealthy, who are looking to invest in real estate, have a number of different options where you can borrow money from them for an interest rate and then you pay that interest rate so they become the bank. So what happens is you go to a private lender. Maybe you have a friend who's really wealthy or your parents have a friend who's really wealthy who's looking to invest in real estate. You find a private lender. They lend you the money and they act as the bank. So you pay them interest every single month and you pay them their mortgage payment every single month as well. So you're actually paying them back every single month. They're making interest on their money so they are happy because otherwise they would have just had their money sitting there.

Starting point is 00:11:17 And then what's happening here is you're paying them down and then your tenants are paying the loan for you. The next option is seller financing. Now seller financing is when you find a seller who is willing to do the same thing. They're willing to be the bank. And traditionally the way seller financing works is you go find a seller who is willing to lend you money in exchange for selling the house. So they act as the bank instead of someone like a private lender or an actual bank. Now the great thing about seller financing is a lot of times you can get into seller financing with zero money down. So if you have no money, seller financing is a fantastic option. And I've done it before. It is one of my favorite ways to get financing for real estate. And it's one of my favorite ways to

Starting point is 00:11:58 get financing for small business loans as well. Because seller financing just gives you a ton advantages. And then if you default on the loan, if you don't pay them back, then the seller just gets the property back. So they win by getting interest. And if you default, they get the property back. you win by getting into a property without having to go through the bank loan process. And essentially, it's a win-win situation for both parties. The third option is if you can find someone with the option to buy. So this is kind of like seller financing as well. And the way this works is you structure the deal to say, hey, I'm going to rent this property

Starting point is 00:12:31 from you for five years. And at the end of that five years, I have the option to buy this property from you at a predetermined price. So you can potentially buy a property for a price that was, five years ago and then potentially buy the property five years later or if you don't like the property and you realize hey i don't like to rent properties very much i don't like to rent real estate this is not my thing i'd rather invest in the market or do some other investment strategy or you're not going to live in that town anymore and you just don't want to manage the property long

Starting point is 00:13:00 distance then you have this option to not buy the property so you can give it a shot hey i'm going to pay you x amount of dollars every single month i'm going to rent out rooms to tenants or my roommates or whatever else, and then if I don't like this process by the end, then I can go ahead and just walk away. I don't own the property yet, but I have the option to buy the property within that five years at any point in time. Now, why sellers like to do this is because they collect rent for an additional five years, so they make that cash flow for five years, and they get the lump sum at the end of the five

Starting point is 00:13:30 years. Now, some people are going to want a price that is the current price at the end of the five years, but the best deals are the ones where you can lock it in at a given price of today's and in the future, what you're doing is you're getting a house in today's dollars. Now, this can also backfire if there's a recession or something of that nature, but it is one of the best options. Think about the last five years what would have happened if you would have locked in a five year option on a house and rented it out to tenants where you're making cash flow that

Starting point is 00:13:58 entire time. The landlord is making cash flow that entire time. In addition, then you can get the property at the end of those five years at five year ago prices. You have a fantastic deal there. The next thing I would do is figure out, okay, what's my strategy? in college. Well, obviously you're probably going to house hack this. You're not going to live there and just be paying every single month for a house. What you want to do is find roommates for that house and rent out each room for X amount of dollars so that you can collect that cash flow. Or if you find a duplex or a triplex, you live in one unit and then you rent out the other unit. So you're basically living for free in college. Now, this is going to reduce the amount if you get student loans of how much student loans you're going to need. This is going to reduce the amount that you need in terms of overall costs for your life. And if you love this property, you can keep this property for 30. 30 years and cash flow off that property over time.

Starting point is 00:14:44 Or if you leave that area and Airbnb, say, for example, do well in that area, you can Airbnb be the property. But the next thought process is, okay, my strategy is to house hack this property, but what is my exit strategy if I don't like doing this? Maybe you graduate from college, you get married, and you guys are going to move far away. What are you going to do with this property? What is your exit strategy? Are you going to sell the property?

Starting point is 00:15:04 Are you going to Airbnb long distance? Are you going to rent it out long distance, get a property manager? Thinking through those options are the other pieces of the puzzle that I would, absolutely think through before you buy the property. Now, making sure you know how to run the numbers is incredibly important and we have an episode on that. So make sure you check out that episode if you haven't checked it out before. And we'll have a calculator that we're putting out as well on running the numbers with rental properties and we'll give courses and things like that as well in the near future. So make sure you check all of those out. But thinking through this process,

Starting point is 00:15:33 how am I going to get financing? What is my strategy? Am I going to house hack this? And then what is my exit strategy as well are the three big things to consider, but I absolutely think you should do it if you can. I remember when I needed to hire someone fast, but finding the right person quickly felt impossible. And if you've ever been there, you know how stressful this can be. That's where Indeed comes in. When it comes to hiring, Indeed is all you need. Instead of struggling to get your job post noticed, Indeed's sponsor jobs help you stand out and hire faster. Your post jumps up to the top of the page, making sure it reaches the right candidates. And it makes a huge difference.

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Starting point is 00:18:51 The next question, this is a really cool question. Is it worthwhile to invest in the top 10 holdings of an index fund? Now, this is a really cool question, and your boy did some research on this one to make sure that we answer this properly. I want to think through this process properly, because you know I love index funds. So what I thought to do was let's look at the difference between each of the top 10 holdings of the S&P 500 versus the actual holding.

Starting point is 00:19:18 How much money would you make if you just bought the stock or if you just bought the index funds? Let's look at the difference between the two because this is the only way to actually think through this process to see if it's worthwhile. Now I ran these numbers based on the last 10 years. So in the last 10 years, what happened with the stock and what happened with the S&P 500. What is the rate of return? So you can do this with other things as well. You can look at QQQ in the NASDAQ. You can do it a number of different ways. But what I did was look at the

Starting point is 00:19:45 S&P 500 because that's what we talked about all the time. And the S&P 500 is the 500 largest stocks in the U.S. stock market. So in the last 10 years, the S&P, specifically VO, has returned 14.6 percent over the last 10 years. So the top 10 holdings are actually a very large weight of that index. Because the way the index fund works is it's a weight. It's a weight. mutual fund that has very low cost and fees and it just mirrors an index. So what happens here is that the top 10 holdings are typically a large majority of what an index holding is. So you're actually owning a large portion of each of these companies when you do that. But what will happen if you bought the individual stocks? Let's look at the top 10. So the first one is Apple. So remember this.

Starting point is 00:20:28 The S&P 500 has returned that 14.6%. So Apple on a weighted average of the S&P 500 index fund or VOO, the ETF is 7.14%. So if you invested $1,000 into Apple 10 years ago, how much would your investment grow by? So your investment would grow by 24.81%. So if you invested $1,000, you'd have $9,100 10 years later. So Apple would win in this situation because it's 14.6% versus 24.8%. Let's look at number two, which is Microsoft, which is 6.1% of the weighted average. in the S&P 500. So if you invested $1,000 into Microsoft 10 years ago, you would now have $12,457,

Starting point is 00:21:14 and it returned 28.69% over the last 10 years. That's absolutely incredible. Microsoft's been on an incredible run. So Microsoft would be worthwhile in the last 10 years because it returned more than the S&P 500. Now let's look at Amazon. Everybody's favorite store. You get the box at your front door.

Starting point is 00:21:31 There's probably 10 of them at my front door right now. Amazon is at 3.8% is how much of a, a holding it is in the S&P 500, and it has returned 33.17% in the last 10 years. So if you invested $1,000 into Amazon 10 years ago, you would have $17,541. That's absolutely incredible. Because if you think about that for a second, every $6,000 that you invested 10 years ago would now be worth over $100,000. It's incredible.

Starting point is 00:21:58 Number four is Tesla. So Tesla is weighted at 2.5% of the S&P 500. So if you invested $1,000 into Tesla 10 years ago, you would now have, Is that right? It is right. If you invested $1,000 in Tesla 10 years ago, it's returned 67.4%. So you'd have $172,804. So Tesla's been on an incredible run.

Starting point is 00:22:20 A lot of people 10 years ago didn't know who Elon Musk is like they do now. So Tesla's run has been, and all of their growth have been within the last 10 years. So that's an incredible run if Tesla would win that argument as well. So so far the top four, Apple, Microsoft, Amazon, and Tesla would have all won. Now let's look at Alphabet, which is Google. If you invested $1,000 into Alphabet, how much would it have grown by now? It would have grown 26.46% so right around another 9 grand. So the top five win.

Starting point is 00:22:49 Let's look at Invita. So Inveda is 1.8% of the S&P 500. So if you invested $1,000 into Avita 10 years ago, how much would your investment have grown by? It would have grown by 59.45% or you'd have 106,2,2,000. $29 if you invested in that individual stock. Now let's look at number seven, Berkshire Hathaway, which is Uncle Warren's company,

Starting point is 00:23:14 our boy, Warren Buffett's company. So if you invested $1,000 into Berkshire Hathaway 10 years ago, you'd have 11.39% return, or your money would have turned into $2,940. So the S&P 500 would have beat Berkshire Hathaway in this situation. Number eight is meta or Facebook. Now, Facebook is 1.4%. and it has returned over the last 10 years, 19.93%.

Starting point is 00:23:39 So $1,000 would have grown to $6,100. So Facebook would have won as well. Number nine is United Healthcare Group. So if you invested $1,000 in the United Healthcare Group 10 years ago, it would return 26.2%. And you'd have $10,246. And the last one is Johnson and Johnson. And Johnson and Johnson has grown by 13.6% in the last 10 years,

Starting point is 00:24:04 which is $3,598. So this is not bad. The top 10 holdings in the S&P 500, eight out of 10 have returned more than the S&P 500. Now here's the thing to understand about this experiment and why this is a little bit flawed. Because you don't know what's going to be in the top 10 of the S&P 500 in the next 10 years.

Starting point is 00:24:24 Unless you have a crystal ball, you don't know. A lot of these companies were not in the top 10 of the S&P 500 at that time. It was very different 10 years ago. You can look at companies like, Tesla was definitely not there, Invita was definitely not there. And a lot of these other companies were not there. So it changes all the time. And that is why it is so important to just invest in the index fund, because you can always have a piece of what is in the top 10 of the S&P 500, no matter

Starting point is 00:24:48 what happens, because it just mirrors the index. So is it worth it? It absolutely can be, if you know how to evaluate stocks and you have a great predictor in terms of figuring out what is going to be in that top 10. But if you don't have that and you're not comfortable figuring out what stocks are going to be in the top 10 in the next 10 years because it's going to look very different than this does right now, that I would stay away from trying to do that. Now, do I own some of these companies? I absolutely do personally. I own some of these individual stocks.

Starting point is 00:25:15 So it's something that I do personally. I love to scratch that itch. I love to invest in individual stocks, but I do a lot of research and a lot of work to do that. So making sure you understand how to do that is incredibly important if you're going to get in to doing this. Thank you guys so much for listening to this episode of Money, Q&A. If you have a question, hit me up on Instagram or TikTok at Master Money Co. Or you can leave a comment on our YouTube videos of Money Q&A underneath the video. And you can ask a question underneath a YouTube

Starting point is 00:25:45 video of Money Q&A as well. Thank you guys so much for listening to this episode. And we will see you on the next episode. Rosen lasagna, medium power, 15 minutes. Sounds like Ojo time. Let's play. Feel the fun with Playojo. The online casino with all the latest slot. and live casino games. What you win is yours to keep with no wagering requirements, instant payouts, and no minimum withdraws. Hey, I just won. Woohoo! Feel the fun! Play Ojo! Honey, forget about the lasagna! Let's celebrate! 19 plus Ontario only please play responsibly. Concerned about your gambling or that of someone close to you, call 16-3-1-260 or visit connexontera.ca.

The Personal Finance Podcast - Is it Worthwhile to Invest in the Top 10 Holdings of an Index Fund?

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