Is Real Estate a Better Investment Than the Stock Market?

00:00:00.000 | Welcome back to Portfolio Rescue, where we always appreciate your questions, comments,

00:00:20.760 | feedback, or email us. Askthecompoundshow@gmail.com. Today's show is sponsored by AcreTrader. AcreTrader

00:00:27.760 | allows you to buy farmland across the country. A few benefits here. Inflation, coming down,

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00:00:36.920 | it does have a positive correlation with inflation going back all the way to the 1960s. A couple

00:00:40.680 | other benefits here. Low fees, no use of leverage. I think we've seen, we've learned this year,

00:00:45.960 | leverage is not very great, right? No leverage use here. If you want to learn more about

00:00:50.720 | investing in farmland, go to AcreTrader.com, and to learn more about the risks, it's AcreTrader.com/company/terms.

00:00:57.640 | Duncan, tough year in the markets. We've been talking about it a lot here, right? Yeah.

00:01:02.320 | But if you look at the returns now, it's not that bad. John, throw up my chart here. Speak

00:01:07.040 | for yourself. Well, obviously, I'm saying this after the seventh bear market rally we've

00:01:12.080 | had, but these are year-to-date returns. Okay, so value stocks, I'm using the Vanguard value

00:01:17.480 | fund here. It's up like more than 1% on the year. It's positive. The Dow, this is all

00:01:21.480 | through close on Thursday, okay? So whatever's happened today, not on here. Dow's down just

00:01:26.920 | 3% on the year. Total returns, small caps, Russell 2000, usually pretty risky. Down less

00:01:31.640 | than 9%. International stocks, huge comeback here, even with the dollar in a strong year.

00:01:37.080 | Down like 12.8%, actually outperforming the S&P now, which is down 13 and change. Growth

00:01:41.160 | stocks, the one bad performer, down 27%. So as long as you're not all in on tech stocks

00:01:45.760 | or all in on oat milk stocks this year, it's a down year correction, but not a calamity

00:01:51.840 | anymore, right? Now, obviously, again, I'm saying this during a bear market rally, so

00:01:55.400 | maybe I'm jinxing things here. Merely pointing out where we are in context of where we've

00:02:00.320 | been, not all that bad, right? If we get some sort of Santa Claus rally here, I can't imagine

00:02:06.840 | if the Dow closes positive for the year. It's going to add to how bizarre this year has

00:02:12.880 | been. But really, if you've had a diversified portfolio, it's not been fun, but where we

00:02:17.280 | are today, not nearly as bad as where it was. How's that?

00:02:21.120 | Are you wanting to make a call? No, no, I'm providing context where we are.

00:02:28.260 | I'm not good at predicting the future. It's hard enough to tell what happened in the past.

00:02:32.080 | So there's no opinion on where the Dow is going to be at the end of January or anything

00:02:35.880 | like that? I'll give you my 2022 Dow point forecast on

00:02:39.280 | December 29th. How's that sound? Other than that, I got nothing. Let's do a question.

00:02:45.200 | Okay. First up, we have a question from Nick who writes, "We own a cash-flowing rental

00:02:49.320 | property with a sub-3% mortgage and 28 years remaining. On the August 18th episode of Portfolio

00:02:55.720 | Rescue, Barry said real estate more or less returns zero net of inflation. However, does

00:03:00.960 | this statement take into account the leverage provided by a mortgage? Return comparisons

00:03:05.280 | between stocks and real estate seem to favor stocks, but it's not clear whether these comparisons

00:03:09.520 | ever take into account mortgage leverage. Also, how does one factor a mortgage rate

00:03:14.480 | that is below current inflation into the calculus? On a 20-year time horizon, would it really

00:03:19.320 | theoretically be better to sell the property and invest the proceeds into some combination

00:03:24.520 | of stocks and bonds?" We talk a lot here about the types of questions

00:03:28.140 | we get, and we've mentioned we get a lot of questions on bonds lately. We've effectively

00:03:31.920 | gotten no questions on the stock market for like the past six months. People have stopped

00:03:35.040 | asking about the stock market. It's true.

00:03:36.880 | But there's a lot of questions about the housing market lately too. So unfortunately, the return

00:03:42.240 | stream for housing is very difficult to understand. So John, throw up my first chart here. This

00:03:47.840 | is from Robert Shiller. Before the late '90s, early 2000s, no one really knew what the long-term

00:03:53.700 | returns for housing as a whole were until Robert Shiller put this together. Now, this

00:03:56.720 | is real home price index, which means after inflation. He took this back to 1890. I don't

00:04:02.600 | know what housing in America looked like in 1890, so I don't know how relevant this all

00:04:07.760 | is, but this is what he did. The returns after inflation are probably not as good as most

00:04:12.720 | people would assume. So from 1890 to 2022, the latest update, the housing market in the

00:04:17.700 | United States is up a total of 120% and change. That's 0.6% per year over the rate of inflation.

00:04:25.320 | Most of that return, as you can see from this chart, has come in the last three decades.

00:04:29.480 | So from 1890 to 1989, 100 years, the U.S. housing market appreciated 30% in total, less

00:04:36.520 | than 0.3% per year. Again, that's after inflation. So you've got an inflation hedge, not much

00:04:41.680 | of a kicker. Then from 1989 to 2022, so the last three decades and change, it's up more

00:04:46.800 | than 70% or like 1.6% per year above inflation. Now, some people may look at these numbers

00:04:52.920 | and think that's god-awful. I thought it would have been way better than that when you look

00:04:56.220 | at the big numbers for housing. I personally think beating the rate of inflation while

00:05:00.920 | holding a fixed-rate mortgage and having a roof over your head is not that bad of a deal.

00:05:05.280 | But it's also important to note that Shiller's data doesn't take into account the actual

00:05:09.180 | experience of someone buying and selling a home. Let's say you timed the housing market

00:05:12.920 | pretty good, and 10 years ago you bought for $300K in Boise, Idaho. Now you can sell that

00:05:16.960 | house for $500K. At the time, you put 10% down, so you put $30,000 down. You sell that

00:05:23.160 | house today for $500K, what's your return? Well, some would say it's $200K, right? $200K

00:05:29.640 | over $300K, so we're talking like a 67% return. But wait, what about the leverage involved?

00:05:34.040 | You only put $30,000 down, right? So is your return more like almost 6X because you turned

00:05:39.680 | $30,000 in 200K? Again, not really, because each month you paid a mortgage, you paid insurance,

00:05:45.540 | you probably did some upkeep, maintenance, landscaping, you probably bought some furniture,

00:05:49.480 | maybe hired an interior decorator, made some improvements. So then when you bought the

00:05:54.640 | house, you probably paid some closing costs. When you sell the house, you pay some realtor

00:05:57.600 | fees and other closing costs. So I'm not sure that anyone actually knows what all the all-in

00:06:03.280 | costs are for their house. I don't think anyone really keeps track of them. Maybe a few spreadsheet

00:06:07.280 | warriors do. The other thing is, you have to live somewhere, so wait a minute, why don't

00:06:11.200 | we net out what my rent payments would be, what my mortgage costs would be, and I just

00:06:16.000 | guess no one on the planet knows what their all-in return is, because it's not like a

00:06:18.640 | stock or a mutual fund where you just buy it and you know the expense ratio every year,

00:06:22.880 | and you can just calculate it easily, right? Plus, housing is a form of consumption. That's

00:06:25.960 | why it's so difficult to compare housing to other financial markets like stocks and bonds.

00:06:31.840 | Now this question is more about a rental property, right? So maybe that's a little easier to

00:06:35.480 | figure out, but I think there's still a lot of unknowns. And I think a lot of this comes

00:06:38.960 | down to your, we talked about this in recent weeks, your talents for complexity. Now, rental

00:06:42.640 | houses can offer a decent yield on your investment, right? You have the ability to raise rents

00:06:47.300 | over time, so that's an inflation hedge. Hopefully the price is gonna go up a little bit, even

00:06:51.120 | if it's like Shiller long-term data says, a couple percent over a little bit, a smidge

00:06:56.920 | over the inflation rate. You're building equity through accumulation and then paying down

00:07:01.240 | your principal. We've talked about the big risks before, concentration, illiquidity,

00:07:05.840 | plus there's a headache risk involved if something breaks, or you can't find a tenant and can't

00:07:09.940 | fill it, the pipes burst, that sort of thing. I guess you could pay a management company

00:07:13.720 | to handle a lot of that heavy lifting for you, but that eats into your returns as well.

00:07:19.080 | I guess it really depends on the trade-offs you want to have. Your index funds are never

00:07:22.920 | gonna call you in the middle of the night and say, "Hey, my AC broke on the unit. Come

00:07:25.600 | fix it for me." I do think, though, there are benefits to owning real estate. Like,

00:07:30.040 | you don't have five days a week where you have a bunch of crazy people trading your

00:07:34.640 | house day in and day out and telling you the price. "The price is down 1% today." "No,

00:07:37.960 | it's up 1%." "No, it doesn't move a lot." So, I think it's a lot easier to think and

00:07:42.000 | act for the long-term real estate, even if it does have lower returns than the stock

00:07:45.120 | market. But I think for a lot of people, there's just so much more idiosyncratic risk because

00:07:49.800 | of your local economy and all these things, and you have not only the macro stuff to deal

00:07:53.480 | with inflation and interest rates and economic growth, but you also have the local economy

00:07:56.760 | and the location and tenants and all this stuff. So, I wouldn't try to talk someone

00:08:00.700 | out of it, but I think making the comparison between stocks and real estate is gonna be

00:08:04.920 | very difficult to do, unless you're really tracking this stuff. And so, I think a lot

00:08:09.480 | of it comes down to how much you're willing to put in to being an actual landlord.

00:08:13.520 | Also, this might be a first-world problem, but I would think that there are things that

00:08:17.800 | you wouldn't expect to encounter that you might encounter. Like, if you have a really

00:08:21.440 | cool vacation home, suddenly you have a bunch of friends and family wanting to stay there.

00:08:25.360 | You were planning to rent it out and make money off of it on Airbnb or something. Next

00:08:29.280 | thing you know, you have a bunch of weeks of the year taken up by friends and family,

00:08:31.880 | right?

00:08:32.880 | Yeah, those leeches. What are you doing? You're not using my summer vacation home. Come on.

00:08:35.540 | You give them a 20% discount, right?

00:08:37.720 | There you go. Yeah, that's true. So, yeah. So, I know people who ... People like the

00:08:42.640 | tangible nature of owning a home and owning rental properties, and I understand that.

00:08:47.640 | And some people just don't trust the stock market. I don't think there's any one way

00:08:50.280 | to succeed. I think you just have to understand the trade-offs when you get involved in something

00:08:52.900 | like this.

00:08:53.900 | Yeah. That makes sense.

00:08:54.900 | Let's do another one.

00:08:55.900 | Okay. Up next, we have a question from Matt, who starts off with, "Love the podcast. Keep

00:09:02.180 | up the great work." Thank you, Matt.

00:09:04.740 | Yeah, thanks.

00:09:05.740 | Also, this is a good ... This is an opportune time to mention, if you use Spotify, they're

00:09:09.580 | doing the yearly Spotify year-in-review type thing, where it shows your top-listened podcasts

00:09:16.340 | over the year. If we're one of them, or the Compound Friends, Animal Spirits, whatever,

00:09:21.140 | share that with us.

00:09:22.140 | I'm not sharing it. They have the same feature on Apple now. They just stole it from Spotify,

00:09:25.900 | and it did all the music I've played. It was all Disney songs and zombie songs for my kids.

00:09:31.060 | It was ... It just totally screws up everything, because all my kids want to listen to. They

00:09:34.660 | listen to more music.

00:09:35.660 | You should still share it. I'd like to see that.

00:09:37.860 | Not great. Zombies 3 soundtrack from Disney.

00:09:40.460 | Okay. So, Matt writes, "Recently, I've been hearing that the wealth effect is more tied

00:09:45.260 | to people's homes than stocks. This argument seems to be related to the fact that a large

00:09:49.100 | percentage of stock ownership is in the hands of so few. However, it seems like average

00:09:54.700 | 401(k) balances versus average home equity are fairly close. I would imagine that most

00:09:59.620 | people that own a home would also likely have a 401(k). I would also tend to think that

00:10:04.800 | home equity and 401(k) balances would trend together, as both are likely to increase over

00:10:09.020 | a lifetime. But to be honest, neither of these things affects how I personally spend. That

00:10:13.940 | part has much more to do with how secure I feel in my job and my expectations about raises

00:10:18.500 | and bonuses. So, is the wealth effect just nonsense? Maybe it's just correlated because

00:10:23.400 | when housing and stocks are going up, pay and bonuses are likely going up, too."

00:10:27.460 | I like this question mostly because I kind of agree with the premise. So, the wealth

00:10:31.060 | effect, for those who don't know, is just, if your stock portfolio is going up, or your

00:10:34.860 | house price is going up, maybe you feel better about yourself, and you spend more money.

00:10:38.100 | And there's this idea where that's just a self-fulfilling thing. And then, when those

00:10:42.380 | prices go down, maybe you don't spend as much money.

00:10:45.700 | I do disagree with the idea that the stock market and the housing market are similar

00:10:49.340 | for most people. So, John, throw up the first table here on net worth by different levels

00:10:53.240 | of wealth. A lot going on here. Allow me to explain. The top 10% in this country, in terms

00:10:57.660 | of wealth, holds 70% of the net worth. The bottom 90% accounts for 75% of the debt in

00:11:04.140 | this country, which doesn't sound like a great trade-off there. The reason for this is because

00:11:08.260 | the top 10% owns most of the financial assets, while the bottom 90% has more of their net

00:11:12.340 | worth tied up in things like real estate. So, John, go to the next table here. This

00:11:17.220 | is just looking at real estate and stocks. So, the top 10%, in terms of wealth, owns

00:11:21.620 | almost 90% of the stocks. The bottom 90% owns more than 55% of the real estate. It's interesting,

00:11:26.780 | when you look at the top 1%, they own almost more than 50% of the stocks, and less than

00:11:31.380 | 14% of the real estate. So, it's not completely balanced, but the lower and middle classes

00:11:37.260 | have most of their wealth tied up in their home, while the wealthy class has the majority

00:11:41.460 | of their wealth tied up in stocks and bonds, on a relative basis. So, if you think about

00:11:45.100 | only, again, the top 10% own 90% of the stocks. I think it's something like 50% of people

00:11:49.060 | in the households in the U.S. own stock in any form. The homeownership rate is 65%. So,

00:11:53.220 | I would argue the housing market has a far greater impact on wealth than households than

00:11:57.700 | the stock market does. If you think about the 2008 disaster, that's why it was so bad,

00:12:01.180 | because that's why the middle class got hit so bad, because the housing market got hit

00:12:04.620 | so bad. I do agree that the wealth effect is probably overstated. It's kind of like

00:12:09.380 | a correlation is not equalization thing. When the stock market is rising, the margin debt

00:12:15.620 | is up, too. And people think, "Oh, the margin debt is so large, people are overleveraged,

00:12:19.940 | that has to fall, and that's going to wreck the stock market." But actually, it's like

00:12:22.420 | a concurrent thing. The margin debt is up because the stock market is up. And then,

00:12:25.860 | when the stock market goes down, margin debt goes down. I think the same thing is true

00:12:29.940 | of the wealth effect. So, let's say in the next year, the housing market goes down 10%,

00:12:34.700 | and so does the stock market. But you can still pay your mortgage, you still have a

00:12:37.820 | job, you're still saving money. Does that 10% decline in financial assets really change

00:12:42.100 | your life in any meaningful way? I guess maybe you can't take as much out of your home equity

00:12:45.460 | line of credit to potentially do some upgrades on your house or whatever. Maybe you could

00:12:50.620 | make the case that people save less when their investments are doing well, because they assume

00:12:54.060 | the returns of doing the heavy lifting for them. I think it's probably more about confidence

00:12:57.980 | than anything. When the stock market and the housing market are doing well, the economy

00:13:01.280 | is doing well, too. So, people are probably making money and feel more confident. And

00:13:04.340 | when those things are doing poorly, the economy is doing poorly. It's not a perfect one-to-one,

00:13:08.780 | but I think this year is a perfect example. The stock market has been in a bear market

00:13:12.700 | pretty much since the beginning of the year. The stock market peaked on January 3rd. People

00:13:15.620 | are still spending money like crazy. People are still traveling, they're still spending

00:13:19.240 | tons of money on stuff. Black Friday was a boom again this year. And I don't think those

00:13:25.140 | 401(k) balances are really stopping people from spending money. So, I think it probably

00:13:28.700 | does have more to do with employment picture and raises and bonuses and all that stuff.

00:13:34.140 | And a lot of times when the economy is doing well, the stock market isn't. It doesn't always

00:13:37.440 | work like that, obviously, this year. But I think as long as people have jobs, they're

00:13:40.260 | going to be willing to spend some money.

00:13:42.460 | Yeah, it seems like it. New York is certainly booming right now. I look out over Bryant

00:13:47.520 | Park and it's full.

00:13:49.260 | Right. Do they care that their growth stocks are down 27% this year? Probably not, right?

00:13:53.460 | They're still going to pay for those ice skate rentals?

00:13:55.420 | Yeah, seems like it.

00:13:56.420 | Pay for those $13 beers in New York?

00:13:58.620 | Sure.

00:13:59.620 | Do another one.

00:14:00.620 | Okay, up next, deja vu, we have a question from another Matt. So, Matt writes, "Why would

00:14:06.260 | the 10-year T-bond pay out a lower rate than the 2-year? Or would the 30-year pay less

00:14:11.420 | than the 10-year?" I realize this is a bit of a Google-it question, but I can't get a

00:14:15.620 | straight layman's term answer on this. I've always associated longer term with getting

00:14:19.500 | paid more yield, as it means I potentially lose access to my money for a longer period

00:14:23.520 | of time and should be paid accordingly. This is a good question. We have a lot of people

00:14:27.900 | who wonder about this kind of thing. This is the inverted yield curve, right?

00:14:31.260 | Yes, it is a perfectly reasonable question to ask from a textbook perspective. All else

00:14:34.260 | equal, you would assume that you would get a higher yield from a bond that takes longer

00:14:39.300 | to pay off versus one that takes shorter, because so many more things can happen in

00:14:42.180 | terms of interest rate changes and inflation and economic growth over 30 years than, say,

00:14:46.500 | 30 months. So, in a normal economic environment, if there is such a thing, you would expect

00:14:50.800 | 30-year Treasuries to yield more than 20-year, which you would expect to yield more than

00:14:54.020 | 10 and 5, and all down the line. That just seems like common sense. But, at times, we

00:14:57.180 | find ourselves in the current situation, where short-term yields are higher than long-term

00:15:00.620 | yields. So, John, throw up the chart of Treasury yields here. You can see, three 6-, 12-month

00:15:07.020 | Treasury bonds, or bills, are now paying more than 5-, 10-, and 30-year bonds, which seems

00:15:13.820 | to make no sense. Those ones are way more volatile, way more risky, yet you're earning

00:15:18.380 | a higher yield at the shorter end of the curve, and by a pretty decent margin. So, why does

00:15:22.180 | this happen? Bond yield spreads, the difference between certain maturities of bonds, are typically

00:15:27.540 | used to gauge the health of the economy. So, wider spreads, when longer-term yields are

00:15:31.180 | higher than shorter-term yields, lead to an upward-sloping yield curve, which would indicate

00:15:35.300 | healthy economic prospects. So, you'd think higher economic growth in the future, higher

00:15:39.060 | inflation. Narrower spreads, which is a flatter, even an inverted yield curve, they call it

00:15:43.700 | inverted, when it's lower, when the shorter-term are higher than the longer-term. We really

00:15:49.460 | missed our opportunity to use a Top Gun picture here, being inverted. That's most likely a

00:15:56.820 | sign that growth is going to be slower in the future, and inflation. So, the bond market

00:16:00.860 | is predicting that inflation is going to be lower in the future, and maybe growth is going

00:16:04.420 | to be lower. And typically, they think this means that we're heading toward a recession.

00:16:08.940 | So, John, throw up the next chart. This is the 10-year and the 2-year. This is just the

00:16:11.580 | 10-year minus the 2-year. You can see, as long as it's below that black line, that means

00:16:15.300 | it's inverted. And you can see, I circled the parts on the chart here, the gray bars

00:16:20.260 | after it are recessions. So, you can see, when this happens, historically, over the

00:16:22.980 | last 40 years or so, every time the bond market gets inverted, when shorter-term yields are

00:16:27.880 | higher than longer-term yields, then we've gone into a recession. And, John, fill the

00:16:31.620 | next little table up here. I looked at the last few times this has happened. The start

00:16:35.540 | of the yield curve to the start of the recession. You can see it ranges anywhere from 10 to

00:16:38.980 | 24 months, and the average is about 17 months. So, if we believe the bond market, what it's

00:16:43.660 | really saying is growth and inflation are probably coming down in the future. Does the

00:16:46.860 | bond market always get this right? Historically, with the yield curve, yes. Does that mean

00:16:51.780 | it's always going to happen in the future? I don't know. Even if the yield curve does

00:16:55.180 | predict a recession, we can't predict when it's going to happen, how the stock market

00:16:58.820 | will react to it, the magnitude of the recession or the stock market's impact, and what the

00:17:02.300 | Fed will do in the meantime. The Fed piece is probably the most important part here right

00:17:04.980 | now. The Fed is effectively inverting the yield curve on purpose. They're raising short-term

00:17:09.700 | rates, and the long end of the bond curve is saying, "We don't care. We don't think

00:17:13.900 | inflation is going to be high in the future. We're stuck here below 4%." So, I really don't

00:17:19.460 | know if there's any predictive power in this anymore, but that's why short-term rates are

00:17:24.100 | higher than long-term rates right now. The Fed is raising short-term rates, and the bond

00:17:28.100 | market that is not controlled by the Fed is saying, "That's fine. Go ahead. We're going

00:17:31.620 | to stay where we are." So, I don't know who's going to blink first. It's Jerome Powell versus

00:17:35.620 | the bond market.

00:17:36.940 | O'Reilly: Yeah, who knows? Do you think that COVID completely ruined the yield curve as

00:17:42.380 | an indicator? I know we had Campbell Harvey on to talk about that a long time ago.

00:17:46.620 | Lewis: Well, if you think the yield curve can predict a pandemic, it's pretty darn smart

00:17:50.260 | then. I'm just not going to get in the way anymore, then, if it can do that. But it did

00:17:53.580 | invert, and then we had a recession. So, I think that's, again, a coincident indicator.

00:17:57.140 | It was kind of lucky. And if the Fed keeps raising rates and the long end of the curve

00:18:04.540 | keeps going down because it thinks inflation is going to be coming lower, it's just going

00:18:07.260 | to get more and more inverted. And we're closing in. It's the most inverted it's been since

00:18:11.640 | the 1980s, when you had really fast-moving rates by the Fed. So, we shall see. Hasn't

00:18:18.460 | been wrong yet.

00:18:19.460 | O'Reilly: Ominous.

00:18:20.460 | Lewis: Fun times. Let's do another one.

00:18:23.280 | Up next, we have a question from Brennan. "Does tax-loss harvesting have to be done

00:18:27.800 | in the same year? For example, I sold stock earlier in the year for a loss. Do I have

00:18:31.880 | to sell my winners in this calendar year in order to offset the capital gains?"

00:18:36.640 | O'Reilly: Alright, a question that's beyond my level of expertise. Let's bring in the

00:18:39.600 | tax man, Bill Sweet, yet again to get to the bottom of this.

00:18:42.360 | Hi, Bill.

00:18:43.360 | Sweet: Gentlemen, I'd like to welcome you and the listeners and viewers to my kitchen,

00:18:47.360 | where the coffee is hot and the beer is cold. Welcome.

00:18:49.800 | O'Reilly: I notice you have coffee and not a beer, though.

00:18:52.480 | Sweet: Yeah, well, it's not noon yet somewhere, and I was thirsty, so I went to town.

00:18:57.440 | O'Reilly: Alright, Bill, there are some weird tax timing issues. Like, you always tell me,

00:19:00.840 | "Hey, Ben, you have until April to put money into your SEP IRA." So, there are some weird

00:19:04.800 | things where you can go past the end of the calendar year. Does tax-loss harvesting look

00:19:08.080 | like this, or not?

00:19:09.080 | Sweet: Yeah, well, I'm going to correct you there. You've got until October, if you file

00:19:10.080 | an extension.

00:19:11.080 | O'Reilly: October? Oh, okay.

00:19:12.080 | Sweet: Let's get really crazy.

00:19:13.080 | O'Reilly: Alright. Does tax-loss harvesting work in the same way, or not?

00:19:16.080 | Sweet: So, it does. So, great question. And in order to get your tax losses in for the

00:19:20.880 | year, so let's start here, for Brennan. You do need to execute by December 31st of 2022,

00:19:26.640 | so that's the most important thing. And this year, Ben, that happens to fall on a Saturday,

00:19:30.620 | so I might recommend doing that at least a day before, getting in during the workday

00:19:34.040 | on the 30th. And I think the market's closed after noon on the Friday before New Year's.

00:19:39.360 | Correct me if I'm wrong. Ben, do you know that off the top of your head? I do not.

00:19:43.080 | Sweet: I've got nothing. But by that time, I'm totally checked out, Bill, for the last

00:19:46.560 | 50 years. I'm sorry.

00:19:47.560 | O'Reilly: We've moved on. So, and just a point of emphasis, too, the tax law generally

00:19:52.100 | recognizes the trade date, not the settlement date, so that's important, the legal date

00:19:55.480 | that it falls out. But Ben, I've got two neat things to point out for Brennan. Number one

00:19:59.200 | is everything that's out for the calendar year. So, if you do a trade on January 2nd,

00:20:03.040 | you do a trade on December 29th, all that just gets mushed into a giant bowl of spaghetti

00:20:07.600 | when you're trying to calculate, "What is my capital gains tax?" So, that's extremely

00:20:11.160 | important to understand, that it's really the full year that matters, and then each

00:20:14.980 | year the calendar flips over, and we move on. You cannot file on a fiscal year basis

00:20:20.240 | from June to July as a U.S. taxpayer. They're like, "Nope, January 1, December 31." So,

00:20:24.840 | that's the neat thing. And you only pay tax on the net. And so, you can generate short-term

00:20:30.240 | capital losses, offset long-term capital gains, and everywhere in between, you add it all

00:20:34.800 | up and what's left, that's what you pay tax on in April. So, that's the first key point

00:20:39.160 | to understand. What are your questions about that, gentlemen?

00:20:42.240 | That makes sense to me. I see someone in the chat here says they're a farmer because they've

00:20:45.420 | been harvesting losses all year long, and I think this is definitely the year for it.

00:20:51.940 | The problem for a lot of people this year is, "Do we have gains to offset those losses

00:20:55.440 | and actually use them?"

00:20:56.440 | Yeah. And so, that brings us to the second part of Brent in question, is he's like, "Well,

00:20:59.980 | look, if I've got my losses, do I need to generate gains in a year or do these go away?"

00:21:04.160 | The answer is no. You can deduct up to $3,000, only $3,000 of capital gains, excuse me, capital

00:21:11.660 | losses against your ordinary income. And that's a neat thing. It's been set in the tax code

00:21:16.020 | since 1978. Fun fact with inflation, that would be indexed to $13,700 today, an increase

00:21:22.400 | of 360%.

00:21:23.400 | You know what we should index it to? Bear markets. If there's a bear market, you can

00:21:26.380 | take more losses.

00:21:27.380 | That would be great. That'd be great. But ultimately, any amounts that you don't use

00:21:31.500 | against gains, and then any amounts that you do not apply above $3,000 against your ordinary

00:21:36.500 | income, those carry forward to the next year. And so, Brennan, hypothetically, if he realizes

00:21:41.580 | $9,000 of net capital losses, he uses $3K against his ordinary income. Now, $6,000 starts

00:21:48.060 | on his balance sheet on January 1, 2023, and then he can recognize the gain next year and

00:21:53.020 | still be offset against the loss. And that's a neat thing. And I would recommend thinking

00:21:57.740 | about arbitrage there, because ultimately, if my ordinary income rate is 24%, if it's

00:22:02.220 | 32%, that $3,000 generates some arbitrage opportunities versus the 15% capital gains

00:22:09.580 | rate.

00:22:10.580 | So I think in a year like this, Ben, one way to make lemonade out of lemons or make regular

00:22:15.020 | coffee out of decaf coffee, throw some caffeine in it, is try to hit that $3,000 loss limit,

00:22:20.420 | push your gains off until January. I think that's a great thing to think about.

00:22:23.300 | That makes sense. All right.

00:22:24.620 | I love a good arbitrage.

00:22:25.620 | Yeah, it's good. It's good stuff.

00:22:27.220 | Let's do another one.

00:22:28.220 | Let's do it.

00:22:29.220 | All right. Up next, we have a question from Rob. I just retired this year, congrats, at

00:22:33.940 | age 55, and I'm looking into various--

00:22:36.100 | That's our not-to-brag-of-the-day, to retire early.

00:22:37.540 | Yeah.

00:22:38.540 | Good for him.

00:22:39.540 | Yeah, at 55, that's good. And I'm looking into various tax planning strategies. One

00:22:43.460 | plan would be to withdraw money from my 401(k) and then deposit the max allowed into my HSA.

00:22:48.740 | I qualify for the rule of 55, so there would be no 10% penalty. No idea what they're talking

00:22:53.560 | about. Wouldn't this be tax-neutral in the current year? 401(k) withdrawal is taxable,

00:22:59.180 | but HSA deposits are deductible. This seems like a no-brainer, or am I thinking about

00:23:03.500 | this wrong? I would also like some clarification on paying taxes on Roth conversions. If I

00:23:08.020 | convert some money from my 401(k) to my Roth in January, would the tax for that amount

00:23:13.340 | be due in the first quarter of the year, or could I spread out the payments throughout

00:23:16.580 | the year?

00:23:17.580 | All right, Bill, you're going to have to send this guy a bill after this one, I think.

00:23:21.260 | Yeah.

00:23:22.260 | All right. So this is, I mean, there's no cross-currents in terms of going from one

00:23:26.440 | retirement account to another, as long as, I mean, the money is kind of just switching

00:23:30.440 | hands. That's doable? He can go from the 401(k) to the HSA?

00:23:33.960 | I mean, yes. I mean, not directly, so that's the key. But, Rob, you've got a lot going

00:23:37.840 | on, my man. I might stop what I'm doing, pick up the phone, dial 1-800-CFP. And we can't

00:23:43.320 | give you specific advice. This is our business, after all. It's helping people like Rob navigate

00:23:48.760 | these things. But we can riff on general topics. So let's start there, Ben. Yes, an HSA, $8,300

00:23:56.120 | contribution for a family HSA, that can directly offset up to $8,300 of a 401(k) distribution.

00:24:02.720 | So if you time that, both in the same tax year, those net out to zero and you're good

00:24:06.840 | to go. And the HSA, we don't need to go into, but ultimately, if you're using that for medical

00:24:10.760 | expenses, you don't ever pay tax on that amount. So that, I think, is a neat thing. I think

00:24:15.520 | it's a great place to start, Rob.

00:24:17.280 | And the rule of 55 thing is just, he's talking about not having any penalty for taking money

00:24:21.160 | out of a retirement.

00:24:22.160 | Yeah, that's it. That's it. So 59 and a half. Why a half-year? I have no idea. Just some

00:24:26.320 | genius in the tax code back in the pre-war days.

00:24:28.680 | That is bizarre. It seems like a five-year-old made this, because my five-year-olds celebrate

00:24:31.840 | their half-birthdays. They're always like, "When's my half-birthday?" They think it's

00:24:33.880 | a real thing. It seems like someone in the tax code did this, too.

00:24:37.180 | We want our politicians to focus on kitchen table issues, and maybe that one literally

00:24:41.000 | came from the kitchen table. But it does really complicate things, because if my birthday

00:24:44.880 | is July 2nd, I have to wait until the next year in order to get to that 59 and a half?

00:24:51.480 | It's insane. Can we just get to 50? Call your congressperson.

00:24:55.680 | But ultimately, what the rule of 55 allows you to do is access distributions before age

00:25:01.460 | 59 and a half. And the 55 just refers to, there's a four-year window where that's possible.

00:25:07.120 | And basically, you do have to actually be retired. There's a couple of other ways that

00:25:10.880 | it goes. But ultimately, it ends up being a relatively small amount of money. And so,

00:25:14.320 | I wouldn't necessarily rely on that to save the bacon if you're planning on retiring at

00:25:18.840 | 56 or later.

00:25:19.840 | All right. And let's also tell Rob, if you're getting this much into the minutiae, you probably

00:25:25.100 | might need to talk to someone, a CPA or an advisor.

00:25:28.040 | Yeah. We're doing this for fun here. But yeah, there are spreadsheets involved. But Rob's

00:25:32.120 | second question was relating to conversions, right? And so, the second part of his question

00:25:38.160 | was if I do a Roth conversion in January, is that spread evenly throughout the year?

00:25:42.600 | And let's go back to the capital gains conversation. It's the same thing that a conversion in January

00:25:48.320 | is going to be taxed the same for tax purposes. I'm going to get to the distinction in a second.

00:25:52.400 | All the way out to December, it really doesn't matter. Your tax is calculated on your total

00:25:56.480 | income for the year. So, where that happens in the year is not relevant as long as it

00:26:00.160 | happens Jan 1 to December 31.

00:26:02.200 | However, what Rob might be getting at is there are estimated taxes due potentially on when

00:26:07.520 | you take the distribution. And if you're timing something in January, that falls in Q1. Q1

00:26:12.880 | estimated tax is due in April. And that does need to be spread more or less evenly throughout

00:26:17.240 | the year. There are two rules of thumb. One is you need to have at least 90% of your current

00:26:21.360 | year income, or there's a safe harbor 110% of the prior year income. So, if you're doing

00:26:26.320 | a conversion in January, I think it would make sense to withhold at least a quarter

00:26:29.960 | of that amount by April 15 to avoid the estimated tax penalty.

00:26:33.700 | At least taxes aren't complicated, right?

00:26:36.360 | It's almost like people get paid to do this. So, fun fact for you both gentlemen. The federal

00:26:42.060 | budget for estimated tax purposes, the quarters go January through March, April to May, put

00:26:47.820 | a pin in that, June, July, August, and then the Q4 is September, October, November, December.

00:26:53.860 | Ben, why is this the case? Why did this kitchen table nonsense happen? Why do I have a quarter

00:26:59.100 | involving Q4?

00:27:00.100 | I always forget when I'm supposed to make my payments. I have to remind myself.

00:27:02.660 | Yeah, it's June 15th. The reason, and I'll give you a hint, the federal budget turns

00:27:07.500 | over on September 1, or October 1. So, they do this thing where they shorten the quarters.

00:27:14.140 | They have this extra long quarter at the end. In just one year, they needed to make some

00:27:17.660 | budget and they were like, "You know what? Let's have a two-month quarter so we can get

00:27:20.860 | the payments in time."

00:27:21.860 | Well, I know this. My brother works for the government. He says-

00:27:23.820 | Oh, so it's his fault.

00:27:25.740 | Well, no. When they get to September, he says, "Listen, we have this much left in our budget

00:27:28.780 | and we have to spend it. Otherwise, we don't get our new budget."

00:27:30.980 | Yeah, yeah. In the Army, that was it. That, I think, is actually the explanation for a

00:27:34.860 | lot of efficiency. It's one thing when I counsel people on business types. One of the beauties

00:27:38.900 | of the pass-through LLC structure, for example, Ridd-Holtz Wealth Management LLC, the net

00:27:43.300 | profits are the net profits, right? So, there's no incentive to spend the money because it's

00:27:47.640 | your money. So, I think that's a great way to run a business.

00:27:51.060 | All right, we got one more.

00:27:53.060 | Okay. Last but not least, we have a question from Hadley. "My wife is taking," and this

00:27:58.020 | is a two-parter, so stick with us. "My wife is taking a year off from work to care for

00:28:02.580 | our child, which means our income is way down. We are both 45 and I have about $300,000 in

00:28:08.580 | long-term capital gains and a salary of $65,000. What are some strategies I can use to try

00:28:14.580 | to minimize our current year taxes while also reaching the goal of harvesting as much capital

00:28:19.300 | gains at the 0% rate as possible? I've increased my contributions to my employee-sponsored

00:28:24.740 | 401(k) with no match to lower my taxable income as much as I can, given our expenses. I plan

00:28:30.820 | to use some of the gains to max out our Roths this year, $3,000 left, as well as next year."

00:28:36.180 | Page two. "Is there some rough formula for figuring this out? What I have landed on is

00:28:42.260 | $83,349 max for 0% capital gains plus the standard deduction of $25,900, giving me a

00:28:50.900 | max AGI of $109,249 for the 0% capital gains rate and 12% tax bracket. Is that correct,

00:29:01.220 | or am I just some idiot reading too much on the internet who needs to talk to his CPA?"

00:29:05.860 | These are some next-level questions from listeners this week.

00:29:08.340 | I know, yeah, this is a lot. "As an aside, if I figure this out, would it potentially be better

00:29:13.300 | for my wife to stay out of work for the rest of the year due to the one-off tax benefits,

00:29:19.700 | or maybe take a job the last month or two, which would bump up our income $4,000 to $5,000 a month?"

00:29:25.460 | Yeah, this one's a lot. Getting out of the minutiae here, the whole idea is

00:29:30.100 | we have these gains. They'd never even mentioned how they got the $300,000 gains, so kudos to that.

00:29:36.180 | That's enough to brag, yeah. Yeah, we've got some tax ninjas that work here, obviously, but

00:29:40.260 | they want to lower their taxable income. So how do they do this? Because the idea would be lowering

00:29:46.180 | the taxable income means paying less on those capital gains. Is that the idea? I think so,

00:29:50.340 | but Hadley's on to ... The first Hadley I've run into in my career, by the way. A strong name,

00:29:54.900 | I enjoy it. Is that like a Scottish name? I wish I'd had it for my son. Maybe, yeah.

00:29:58.420 | That sounds like a Highlands name or something. Yeah, that's some good stuff. What he's getting

00:30:02.980 | at is how there is a neat thing that happens if you happen to be in the 12% tax bracket,

00:30:08.900 | and Hadley mentions the dollar amount where that happens, about $89,000 of taxable income,

00:30:14.660 | and then you can add a standard deduction on top of that. The capital gains rate at that

00:30:19.300 | income range is zero. It's 0%. So we, as a short form, say 15%, the capital gains rate,

00:30:25.860 | if you're not making a whole poop ton of money, is actually 0%, and that's a great thing. I think

00:30:31.460 | that's an awesome thing for you as taxpayers. And what Hadley appears to be getting at is how do I

00:30:35.860 | maximize the benefit of that 0% tax rate? I was not prepared to do a chart, so I just wrote one

00:30:42.100 | down, and it's not going to work at all, but what I want to illustrate here is the effect of

00:30:46.100 | stacking. Did you draw that on a napkin, Bill? I did. This is a kitchen table conversation we're

00:30:50.660 | having here, guys. But ultimately, it's the effect of stacking. So let's start with a 401(k). Hadley

00:30:55.300 | mentioned he made $65,000 pre-tax. Let's say, hypothetically, he gets close to the 401(k) target.

00:30:59.540 | Duncan is going to lose it on the production value. This is not professional. I think it's

00:31:04.340 | working, though. And so his net income after 401(k) is about 45k, right? So that's stack one.

00:31:10.340 | Let's think about that. You're taxed on your taxable income. 401(k) is the deduction, guys,

00:31:15.620 | right? So that's super cool. Now let's flip this puppy over. I calculated that Hadley can realize

00:31:20.980 | about $64,000 of capital gains tax tax-free. That sounds pretty awesome, right? So if you're

00:31:26.820 | sitting on 300k, a 0% tax rate is pretty awesome. How does the math work? First, you have to stack

00:31:33.140 | that on top of your ordinary income. We just calculated that. Then we get to deduct a standard

00:31:38.660 | deduction of $25,900. And then the tax rate gets calculated as this. The $19,000 that's left after

00:31:46.020 | the standard deduction, that gets taxed at 10%. That's pretty awesome. And because Hadley's below

00:31:52.100 | the $83,349 limit for the 12% tax bracket, the capital gains is all taxed at zero. If he crosses

00:32:00.580 | this threshold, the amount above it, $1,000, is going to get taxed at 15%. So maybe you want to

00:32:06.100 | leave some wiggle room there. But ultimately, stay below this line, and you pay $1,900 of tax

00:32:12.740 | on $129,000 of income. That calculates to 1.5%. That's what I think he's getting at. And that's

00:32:19.300 | more or less the way it works. The key here-- Hadley's going to write us in and say, "Bill,

00:32:22.340 | can you mail that to me, please?" Stacking. I guess he can always pause it. This is it.

00:32:26.180 | So again, we do need to send invoices. This is next level stuff that we're talking about here,

00:32:30.180 | guys. Good work. But impressive for, again, that level of gains.

00:32:35.300 | And good for you for asking the question, Hadley. Yeah. Can I hit on something at the end? Hadley's

00:32:40.580 | like, "Hey, my wife's thinking about going back to work." Yeah, I didn't get that part.

00:32:44.180 | That is a family decision. Ultimately, yes. This would screw up all my beautiful tax math,

00:32:49.060 | right? But the tax rate is-- these questions drive me insane. Because your tax rate is never

00:32:53.940 | 100%. You are always better off going out and earning the money. And so even if it's $1,000,

00:32:59.860 | $5,000, whatever it is, go out, earn that cheese, bring that bread home, sit down,

00:33:05.300 | upgrade your coffee, put it into a Rotary-- Right. That's saying, "Should I not earn $5,000

00:33:10.020 | because I have to pay $1,000 of it in taxes or whatever it is?" Exactly. So your tax rate is

00:33:13.700 | never going to be 100%. And ultimately, I think economically, everybody's better off when folks

00:33:18.900 | are out there in the workforce making stuff happen, making things move and shake. But taking

00:33:22.580 | care of a child is no small feat. I think we all know that. So I would make a family decision and

00:33:27.140 | ultimately bend the tax math around what you guys want to do with your life. I think our new rule

00:33:31.860 | is going to be anytime we have more than four numbers in a question, Bill's sending you an

00:33:35.700 | invoice. Sorry. He's a CFO. He has that right. I'm going to scan this puppy. Yeah. And you will

00:33:40.180 | hear from QuickBooks Online. Let's do it. All right. We have a few more shows this year. What

00:33:45.860 | do we have? Three more shows, Duncan? So we're out of here? Yeah. All right. Remember, if you're

00:33:49.860 | listening to the podcast, leave us a review. Thanks to Bill again for coming on. Leave us

00:33:54.020 | some comments in YouTube here. Compound merch is idontshop.com. Keep those questions and comments

00:34:00.100 | coming. Ask the Compound Show at gmail.com. Maybe ask us a question about the stock market,

00:34:04.500 | right? We're sick of questions about bonds. Yeah. I never get sick of questions about tax.

00:34:09.460 | Tax ninjas, unite. Let's do this. See you next time. Thanks, everyone.

00:34:25.780 | Transcribed by https://otter.ai

Is Real Estate a Better Investment Than the Stock Market? | Portfolio Rescue 54

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