How Does a Bear Market End? | Portfolio Rescue

00:00:00.000 | Welcome back to Portfolio Rescue after a little hiatus. Remember, our email is askthecompoundshow@gmail.com.

00:00:22.880 | Today's Portfolio Rescue is sponsored by Innovator ETFs. So, Innovator has these defined outcome

00:00:27.000 | ETFs, Duncan, right? Now, they can be a little tricky to understand. So, let's say you have

00:00:30.680 | an ETF with a cap of 15% and you have some downside protection to 10%. But what if your

00:00:35.860 | stocks rise 15% and you're capped out, what do you do? So, you probably have to switch

00:00:39.800 | over to another fund, right? Same thing if you have the loss cap. If you're down 10%

00:00:43.560 | and you have that cap, maybe you want to switch over to a different fund that has another

00:00:47.040 | downside protection, right? So, what they have is they've actually made it a little

00:00:50.880 | easier for people who don't want to switch to a different fund. So, they have this laddered

00:00:53.520 | allocation buffer ETF, BUFB. And just equal weights across the different 12 months, because

00:00:59.120 | they have a new one of these each month that kind of resets. And it basically diversifies

00:01:03.800 | you. It's like a ladder of these buffers. So, if you look at the caps over the past

00:01:06.560 | year from all the 12 different funds that make up this fund, you could have a cap ranging

00:01:10.400 | from 13% in one fund to 23% in another. So, that depends on market conditions, like volatility

00:01:16.220 | and options trading, because these options, they become more or less valuable depending

00:01:20.200 | on when you buy them and how volatile the market is. So, this is kind of an easier way

00:01:23.840 | for people who don't want to have to really get in there and do some things, because the

00:01:28.240 | market can move pretty fast, as we've seen in the last few weeks. Obviously, we've seen

00:01:30.920 | in the last few years, for sure. So, anyway, this is an easy one for people who don't want

00:01:35.320 | to -- who just want to have a little diversification. Ladder their holdings. They don't want to

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00:01:42.620 | more about this and more other Defined Outcome ETFs, remember to visit InnovatorETFs.com.

00:01:46.280 | All right, Duncan, you're back from your honeymoon. Welcome back. I have an important question

00:01:50.200 | for you.

00:01:51.200 | Thanks. Okay.

00:01:52.200 | Which city is more expensive, London or New York?

00:01:54.640 | Hey, Michael.

00:01:56.000 | Hawaii.

00:01:57.000 | Which city?

00:01:58.160 | Which city is more expensive, London or New York?

00:02:03.120 | I would say New York, in my experience.

00:02:07.000 | Okay, even more than London. Okay, interesting.

00:02:09.880 | Sorry, that really threw me off there. I was like, who's walking in? Oh, Michael. Yeah,

00:02:15.240 | I would say New York. I was actually surprised by how affordable a lot of stuff was in London.

00:02:20.960 | Okay. I guess it probably helps, being that you're converting from dollars, too, right?

00:02:25.160 | Yeah, yeah.

00:02:26.160 | Pink dollars. See, this is where the strong dollar helps, right?

00:02:28.800 | Yeah. Like, beers, for instance. It's easy to pay $8-12 for a beer, depending on where

00:02:34.360 | you go in New York City. A lot of places there, I was paying like four pounds for a beer kind

00:02:40.120 | of thing.

00:02:41.120 | Yeah, I don't want to do the calculation in my head for how many dollars that is, but

00:02:44.760 | four is less than eight. We know that. Okay.

00:02:46.720 | Yeah, exactly.

00:02:47.720 | All right, John, let's look at the chart here of the S&P 500. Look where we're at now. So,

00:02:51.040 | at the worst of it, the S&P 500 was down almost 24%. We've made back more than half of that

00:02:56.920 | in this little bounce here. I think the S&P is up 16% from the lows. The NASDAQ 100 is

00:03:00.880 | up well over 20%, although it was down much more in the trough. It was down well over

00:03:05.520 | 30%. So, of course, everyone wants to know, was that the bottom? Is the bear market over?

00:03:08.520 | We're going to get into that a little bit today on the show. I don't know. I really

00:03:11.960 | don't. I wouldn't want to put my neck out either way on this. Here's the thing, though.

00:03:16.360 | If you're a saver, you should hope this wasn't the bottom. Right? You should want more volatility

00:03:20.600 | to the downside. Now, this is always easier to say when stocks are going up than when

00:03:23.760 | they're going down. A few weeks ago, six weeks ago, eight weeks ago, people would not want

00:03:27.480 | to say that. But now, just remember, when stocks are going up, it's good for your current

00:03:32.000 | holdings, but it's not great for your future contributions. So, I'm kind of in a weird

00:03:36.480 | spot. I'm approaching middle age. I think I can safely say I'm almost there. I'm going

00:03:40.280 | to be, you know, let's see, a week. A week? Oh, wow. Less than a week. It's my birthday.

00:03:45.160 | Yeah. I just realized that. I don't think about this stuff anymore. We should do a joint

00:03:48.400 | birthday show because my birthday is the 27th. So, like, we're relatively close. Ten days

00:03:52.720 | before you. Nice. Okay. So, I have more money in my portfolio than I did when I was in my

00:03:58.200 | 20s, of course. But I still have, I don't know, a couple decades to save. So, I'm kind

00:04:01.360 | of in the middle ground where I'm diversified. If stocks go up, it feels good for my current

00:04:04.900 | portfolio, but bad for my future savings. And if stocks go down, it feels bad for my

00:04:08.160 | current portfolio, but pretty good for my future savings. So, I should hope that the

00:04:12.760 | market goes back down. Right? I'm making more money now than I did when I was younger. I'm

00:04:16.360 | saving more. I have a higher savings rate. I should want it to go down. It doesn't feel

00:04:19.480 | that way, but it's true. And especially if you're young, it's okay. You've had two bear

00:04:23.580 | markets in the last three years. I hope young people were saving in those and kept making

00:04:27.520 | their contributions. It's an unpopular opinion, but this is the way it should work. We should

00:04:30.800 | hope for a little more volatility to the downside. Now, if you have all your money in your portfolio

00:04:34.760 | and you're not saving anymore, obviously, you want new all-time highs. And guess what?

00:04:39.240 | I don't control these things, but this is my unpopular opinion. I'm hoping for more

00:04:43.720 | downside in the years to come. Either way, you have plenty of material for social media.

00:04:47.760 | You can always make cracks about how bad your portfolio is doing, or you can talk about

00:04:52.800 | how well you're doing, and dunk on people and stuff. So, either way. It's a 60/40. I'm

00:04:57.880 | well-diversified. Alright, let's get into a question. Speaking of which, this is a good

00:05:01.840 | one from a young person. Yeah, exactly. Yeah, no, that was a good weed. Okay, so up first

00:05:06.840 | we have a question from, did they give us a name? Kamal. Kamal. I have a quick question

00:05:13.600 | that I think is pertinent to the current season we are in. Like me, a lot of fresh graduates

00:05:17.600 | are looking for a job commencing this September. I would like to know how much of your salary

00:05:21.840 | you should save every month, and how much you should invest in the stock market. For

00:05:25.920 | example, suppose you have $500 left of disposable income, what percentage should be saved and

00:05:31.480 | what percentage should be invested? You know, this one got me thinking. There's a lot of

00:05:35.840 | questions in finance that begin with how much, right? How much money do I need to save? How

00:05:39.880 | much do I need to retire? How much money should I be spending each month? How much do I need

00:05:43.360 | for a down payment? How much house should I buy? How much money should I invest in stocks?

00:05:47.560 | How much is enough? All these things. Of course, this person is thinking about it the right

00:05:51.760 | way. They're coming from graduation. They want to save. It makes sense to begin saving

00:05:55.640 | from a young age, right? We've seen the, I'm going to use this example that a lot of people

00:06:00.080 | use. It's totally unrealistic, but it makes the point. So, I did this for one of my books.

00:06:04.840 | Sarah begins saving at 25, sets aside $500 a month until 35. At that point, she stops

00:06:09.920 | saving and just lets compound interest take the wheel, right? John waits until he's 40

00:06:13.880 | to start saving, but he keeps saving every month $500 a month until he's 65. Sarah only

00:06:18.120 | saved $66,000. John saved well over $150,000. Sarah ends up with way more than $700,000.

00:06:25.800 | At the end, when she's 65, John ends up with $412,000. Now, we're using the same $500 a

00:06:30.600 | month saving, 7% on your investments, and Sarah ended up with more. Why? Because she

00:06:34.500 | started early. This is completely unrealistic, but it makes the point, right? I hope no one

00:06:38.720 | is starting saving at 25 and stopping at 35. That doesn't make sense. But the point is,

00:06:43.160 | the earlier you start, the better you are, right? That's pretty simple. Now, when it

00:06:47.820 | comes to saving and budgeting, I do think it makes sense when you're just coming into

00:06:51.480 | the working world to think about this, that there's generally two ways to approach saving

00:06:55.720 | money, right? One is like the manual approach. You track every single item that you want

00:07:00.600 | to budget for. You have a spreadsheet or some sort of tool that you follow, and then you

00:07:05.680 | make sure you track every last penny, and then at the end of the month, you have $500

00:07:09.800 | left over, and then you decide to save it. That sounds great in theory, but not many

00:07:14.040 | people can make that work in practice. I think the autopilot version is much better, where

00:07:18.400 | you automate as much of your saving and spending as possible and bill pay and all this stuff,

00:07:23.920 | and then whatever's left over, you can spend on anything you want, right? But I think you

00:07:28.060 | treat saving like a bill payment. It's like Netflix subscription or a gym membership,

00:07:31.960 | right? That saving is like a bill pay. It's like your utilities. So you take that saving

00:07:36.760 | first, and then anything that's left over, spend it on anything you want, especially

00:07:40.560 | when you're young. Now, my rule of thumb in terms of how much should you save, I think

00:07:46.760 | you should set yourself a savings goal, and it should probably be, my goal is always,

00:07:50.040 | I want 10% of your gross income, at least. That's what I want you to work up to. Now,

00:07:53.520 | when you're young, you might not be able to get there. When I, my first job out of school,

00:07:57.400 | I wasn't making anything. I think I could save $50 a month. I was trying to save, I've

00:08:01.000 | had all these bills for the first time, I'm paying for my own car and all my own insurance

00:08:03.800 | and rent, and I'm trying to save for an engagement ring for my wife, and I could only save $50

00:08:09.560 | a month. But then every time I got a raise, I would save at least half of that raise and

00:08:13.120 | work up to it. So I think I want you to work up slowly to that 10% at least. 15% would

00:08:17.160 | be great. 10% I think is a good savings goal. So what you do is you figure out how much

00:08:20.720 | you want to spend, and I think it's okay if you're young to balance that a little bit.

00:08:24.680 | Still have some fun, have some guilt-free spending, but again, make that savings come

00:08:29.420 | out automatically at first, and don't wait until the end to try to save. Set a savings

00:08:33.440 | goal, increase the amount you save over time, especially every time you get a raise, save

00:08:36.640 | at least half of it. You'll never even notice it in your lifestyle. Then the rest of it,

00:08:41.000 | you can kind of bump up a little bit. That's my ideal, is just get to that goal, but start

00:08:46.120 | small and build up over time.

00:08:48.060 | And to clarify, you're talking about something different than like an emergency savings.

00:08:53.860 | What's the rules on that?

00:08:54.860 | He's talking about stock market. I mean, people say, there's a lot of personal finance people

00:08:59.300 | who'll say six to 12 months. I think that is ridiculous for young people. I don't know

00:09:02.540 | how you can ever get to that point. It's huge. I don't think that makes sense. I think you

00:09:06.620 | have to have a decent amount. I would set more of an amount on that. I want to get to

00:09:09.780 | a goal of having $1,000 saved or 2,000, whatever makes you feel comfortable where you can have

00:09:13.940 | some sort of...

00:09:14.940 | For emergency.

00:09:15.940 | Emergency, yeah. I remember my first job, I was three months out of school. I had no

00:09:20.260 | money to my name and my car broke down. And I'm like, what do I do? Hello, credit cards,

00:09:24.260 | right? So you have to have something, right? So I assume this person's talking about saving

00:09:28.740 | for retirement.

00:09:29.740 | Yeah, they are. I was just for our viewers clarifying that they were just talking about

00:09:35.220 | general savings.

00:09:36.220 | And Kamal, if you're listening, send us an email. I will send you, because I think I

00:09:39.660 | wrote it for young people, my book, Everything You Need to Know About Saving for Retirement.

00:09:43.300 | I'll send you a copy. Send us an email and let us know where to send it. Let's do another

00:09:49.460 | one.

00:09:50.460 | Awesome. Okay. So up next, we have a question from Robert. So I know you guys have talked

00:09:55.420 | a lot about whether or not we're in a recession now and being in a bear market, equity is

00:09:59.620 | declining 20%. When is a bear market by definition over? For instance, if we just trade flat

00:10:05.000 | for the next year and then enter a recession, does this correction still count as part of

00:10:08.900 | that?

00:10:11.020 | And you guys kind of definitively on Animal Spirits this week said like, yeah, we are,

00:10:14.660 | we have not been in a recession, right?

00:10:16.820 | Right. Yeah, this one's more about a bear market, though. And this one's probably even

00:10:20.020 | harder than a recession. But I think, yeah, if we didn't get back to all time highs, and

00:10:25.260 | the market kind of just treads water for a while, then goes down again, because we go

00:10:27.700 | to recession in 2023 or 2024, people are going to count that as one bear market. That's the

00:10:32.660 | problem, though. You never know this stuff until after the fact. And so this is another

00:10:36.700 | one of those things that there aren't any really good definitions about. I mean, most

00:10:40.980 | people believe there was a bull market from 1982 to 2000. Right? When the tech bubble

00:10:45.340 | burst, that's when the bull market was over. But I'm sure a lot of people assumed that

00:10:48.780 | bull market was over in 1987, and stocks crashed 33% in like a week, right? So, you have cyclical

00:10:54.660 | and secular bull and bear markets, and they last at varying lengths. We have dead cat

00:10:58.620 | bounces and V-shaped recoveries and all this stuff in between. Let's look at the 2008 scenario

00:11:03.100 | as an example. So, this is the 2008. We were down 56%. You can see it took a while to get

00:11:08.420 | back to those all-time highs that were reached in October 2007. It wasn't until like early

00:11:12.060 | 2013. But this is price only. No dividends included, right? So, if we look at what happened

00:11:19.340 | in that time, including dividends, go to the next chart, John. This is the total return.

00:11:24.280 | Stocks were up 150% from the lows by the time we hit all-time highs again. That's, again,

00:11:28.020 | including dividends. So, I don't know. Did the bear market last from peak to peak? Did

00:11:31.740 | it end at the trough in March 2009 when it stopped? I don't know. Barry Ritholtz has

00:11:38.620 | some very strong opinions. He's going to be on the show again, I think, next week for

00:11:41.880 | us. He has some very strong opinions. He likes to say, "We hit new all-time highs again.

00:11:45.740 | That's when the bull market starts." I don't really have strong feelings about this. They

00:11:50.060 | can both last much longer than you'd think, or be over much quicker than you'd think.

00:11:52.740 | Eddie Ardeni from Ardeni Research has these really cool bull and bear market tables on

00:11:56.020 | his website, and it's free. So, I think people should check these out. So, John, pull up

00:11:59.820 | the first one. This is corrections in bear market since 1928. You can see there's a lot

00:12:04.020 | of them. I think there's like 55 or 56 on this list. It's a lot. Go to the next one

00:12:07.940 | now. This is bull markets. There's not as many bull markets as you can see. The bull

00:12:10.820 | markets tend to last longer, bear markets are shorter, and bull markets have much bigger

00:12:15.340 | gains, right? Because the bull markets outweigh the bears. It's kind of interesting. I think

00:12:18.180 | there's like 25 bull markets on here versus 55 corrections in bear markets. So, obviously,

00:12:23.020 | the negative stuff hits a lot more often. And Eddie Ardeni defines a bull market as

00:12:27.780 | a 20% gain or more from a bear market trough. So, right now, if we're using his definition,

00:12:32.580 | you could say the NASDAQ 100 is in a new bull market, even though it hasn't reached the

00:12:36.160 | all-time highs yet. I don't know. I don't think it really matters. The thing to know

00:12:41.900 | is downtrends are typically more volatile than uptrends. And this is the kind of thing

00:12:45.820 | that you can probably only know in the rearview mirror. But it's probably easier, as much

00:12:49.740 | as we're arguing about it right now, about a recession or not a recession, it's probably

00:12:52.920 | easier to define that than it is to define the end of a bear market. But I think, definitively,

00:12:57.740 | once we hit all-time highs, yeah, sure, no more bear market. But if we don't, then this

00:13:01.580 | is still part of that same correction. How does that sound? Does that work?

00:13:04.780 | Yeah, that sounds fair. And I think, based on what you're saying, it really shouldn't

00:13:08.380 | impact what you're doing with your savings and investments either way, right?

00:13:12.380 | No. Although, again, people feel a lot better right now that the stock market has bounced

00:13:16.340 | 15%, 20% than they did seven weeks ago, right?

00:13:19.700 | I'm glowing. I mean, just seeing some green in my portfolio feels great.

00:13:24.500 | You do have a goal about you. You went on your honeymoon, stocks are up. I don't know

00:13:28.220 | how Beyond Meat's doing, but it's got to be doing better, right?

00:13:31.500 | Yeah, still down a lot. Yeah, it's up, it's up.

00:13:35.580 | All right. Speaking of down a lot, let's look at another one who's got a quitter or a closer.

00:13:40.740 | Yeah, I can relate. Not amount-wise, but percentage-wise. "My background is in fintech and e-commerce,

00:13:46.420 | and during the 2020-2021 boom, I took some extra cash I had laying around from the sale

00:13:51.300 | of a boat," humblebrag, "and a side business and dumped it into the high flyers that were

00:13:57.540 | benefiting greatly from the pandemic. We're talking a basket of the most painful assets

00:14:00.980 | to earn in 2022, PayPal, Square, Alibaba, Shopify, Coinbase, and some Bitcoin and Ethereum.

00:14:07.820 | This $100,000 portfolio soared to $200,000 in 2021 and then crashed to $50,000 in 2022.

00:14:14.620 | If I sell and take the loss, I'll still have $50,000, which would provide plenty of additional

00:14:19.340 | peace of mind to quit and focus on finding a specific opportunity that I'm looking for.

00:14:23.460 | But at the same time, I hate being forced to sell at a big loss when this pile of stocks

00:14:28.100 | are beaten down to a pulp." This is a two-slider. "The losses wouldn't be bothering me too much

00:14:35.140 | if it wasn't for my recent desire to quit my job and focus on finding a new one. Prior

00:14:39.100 | to that, my only worry was that I'd have to wait a year or two to get another boat. Either

00:14:43.900 | way, these stocks are getting trimmed, sold, diversified at some time in the future. There's

00:14:48.540 | just something about selling at a big loss that's painful, especially when it is needed

00:14:52.060 | to free up money for something that comes with a completely different set of risks and

00:14:55.820 | uncertainties. I'd love to hear your thoughts on my situation." So, they're just kind of

00:14:59.500 | wanting some comfort, I feel like, here, you know?

00:15:02.100 | Sometimes, what you need is not data and spreadsheets. Sometimes, what you really need is a financial

00:15:06.700 | therapist. I'm here to do that. I'm here to provide that to the people. I'm not a PhD,

00:15:10.740 | but I play one on Portfolio Rescue. So, I think, this is the opposite of a not to brag,

00:15:16.220 | right? They were doing great for a while. I'm sure there's a lot of people like this,

00:15:18.900 | that high-flying stuff. And I think that's, sometimes, path dependency in the way that

00:15:23.700 | you invest matters a lot, because if you saw your money go from $50 to $200, right? And

00:15:30.020 | then all the way, or was it, what did he start with, $100?

00:15:33.020 | Yeah, he doubled, went from $100 to $200, and then down to $50.

00:15:36.020 | $100 to $200, then down to $50. If you'd have just gone from $100 to $50, that'd be painful.

00:15:39.660 | But I think it's doubly painful to go from $100 to $200, then back to $50, because you're

00:15:44.020 | anchoring to that high level, no matter what. In your mind, people think, "Okay, I'm going

00:15:48.860 | to sell once I break even." And for him, I'm sure breaking even is $200, not $100, right?

00:15:54.820 | So, there's a lot of these ... Daniel Kahneman has some of these stories. So, there's the

00:15:58.980 | San Francisco Exploratorium, where they have all this data about redwoods. And they asked

00:16:03.660 | these group of people, "Is the height of the tallest redwood tree more or less than 1,200

00:16:08.500 | feet tall?" And then they said, "What's your best guess of the tallest redwood tree?" That's

00:16:12.820 | one group of people. The next group of people, they said, "Is the height of the tallest redwood

00:16:16.140 | tree more or less than 180 feet?" And then they said, "What's your best guess?" So, they're

00:16:19.460 | anchoring these people to these numbers, right? These numbers are meaningless. They pulled

00:16:22.380 | them out of thin air. The average guesses in the first group were 844 feet, and in the

00:16:26.220 | second group, it's 282 feet. So, people take that high number and they anchor to it, and

00:16:30.540 | the low number, they anchor to it, right? This is just the way that our brain works.

00:16:33.940 | I think this is why people assume, when they save money on clothing, that, "I just saved

00:16:38.180 | so much money. I bought this $100 shirt for $80. Can you believe it?" This is what my

00:16:41.380 | wife says, "Do you know how much money I saved you this week? I bought stuff on sale." So,

00:16:46.260 | anchoring and investing, I think, works a little different, because we anchor to the

00:16:48.620 | high and the lows, right? If I would have just bought at the lows, I would be making

00:16:51.340 | so much money. If I would have sold at the highs, oh my gosh, I would be doing so great.

00:16:54.580 | I think hindsight can play some massive head games with you. So, I think this is why defining

00:17:01.000 | your time horizon matters so much. So, again, this person sounds like, this is almost the

00:17:04.240 | kind of thing that went from an investment to a trade, right? They sold their boat, I'm

00:17:08.420 | going to put it in here, and if I can just buy another boat with it, I'll make a little

00:17:10.660 | money. Maybe I can buy a bigger boat and a better boat with a bigger motor or whatever.

00:17:14.820 | Now, the goal has changed, and that's fine, because this happens sometimes. You can say,

00:17:18.980 | oh, an investment turned into a trade, but that's okay if your goal changes. This person's

00:17:23.940 | goal changed from, "I've got a little bit of extra money from selling a boat," to, "Oh,

00:17:27.980 | wait, I might want to quit my job and try something new." I think, at that point, throw

00:17:32.900 | that original thesis out the window, right? What matters more to your happiness in life?

00:17:36.460 | A missed opportunity? Let's say you turn this $50 into $100, because the stock market screams

00:17:40.220 | higher from here. Is that going to make you feel better than going for your desired career

00:17:44.540 | goal? Of course, how much joy do you get if you hold that $50 to $100, or $150, whatever

00:17:49.300 | it is, versus how much happiness do you get from pursuing your dream job? I think you

00:17:52.740 | can't put a price on that. If that money is going to make you feel good and allow you

00:17:56.900 | to pursue your career aspirations, I don't know why you would, it's a pretty simple choice

00:18:02.980 | for me. It's going to sting if you see, "Oh, this stock doubled after I sold it." I don't

00:18:08.660 | think you can look at the opportunity set that way when you have this type of goal in

00:18:13.220 | mind. Yeah, and I think that they could still have plenty of fun with a jet ski, you know

00:18:17.980 | what I mean? They could join the jet ski lobby. If they can get one, right? I'm in the process

00:18:23.460 | of selling mine. I'm out. I'm totally out of the jet skis. Sorry. Really? I didn't use

00:18:27.580 | it enough. Wow, okay. Sorry. Well, I figured you could rent it out or something, right?

00:18:32.900 | Yeah, Uber for jet skis. Is there an Uber for jet skis? Maybe. People are paying up,

00:18:37.180 | so I'm just going to, I'm selling it. I'm out. I'm going to be like this guy. I'm going

00:18:40.260 | to sell it and put it on the PayPal and Square and Shopify. Maybe not. All right, let's do

00:18:44.620 | another one. Okay. So up next, we have a question from Rishi. "My dad has about two million

00:18:50.340 | in a traditional IRA and is working five more years to get Medicare. He does not want to

00:18:55.020 | have a high RME, so he wants to take money out now, but with him working, it will lead

00:19:00.580 | to a higher taxable income. He wants to invest in real estate and buy a bigger property,

00:19:05.220 | logic being that if he is going to take money out, he would like the money to go to interest

00:19:09.400 | and property taxes to write off his income rather than straight to the government. What

00:19:13.860 | are your thoughts on the best ways to reduce taxes, specifically regarding RMDs?" Got to

00:19:18.360 | be honest, I don't understand a whole lot of that question. Do you remember RMDs? Required

00:19:23.020 | minimum distribution. Yeah. So for an IRA, at a certain point, you have to take a certain

00:19:26.140 | amount out. Okay. Let's bring in a tax expert on this, because this is a tax question, retirement.

00:19:30.580 | So let's bring in one of my top two favorite bills who works at Redults Wealth Management

00:19:34.500 | in the tax department. He's in the top two. Bill Arts. I don't have a definitive ranking

00:19:37.940 | system. Bill Arts, you're in. Top two. I love it. All right. Bill, I can't put my finger

00:19:42.660 | on this one, but it doesn't seem to add up. So the idea here is I know I'm going to have

00:19:46.060 | to take this money out of my IRA. I'm just going to take the tax hit now, and I'm going

00:19:50.820 | to buy some property with it, and that way my RMDs will be lower in retirement. I won't

00:19:54.740 | be forced to take this money out. This seems like a little backwards way of thinking to

00:19:58.700 | people. What are we missing here? Yeah. I don't love this. First of all, well done to

00:20:04.380 | Rishi. You're pops. He's 60. He's got $2 million in an IRA, and he's looking to reduce his

00:20:09.580 | future income. He's looking at a pretty comfortable retirement. So just general lesson on RMDs,

00:20:15.580 | required distributions. They start at age 72 from retirement accounts. That first year

00:20:19.580 | is about 3.6%. If your dad's worried about higher income in the future, higher RMDs,

00:20:28.040 | he's in the minority. Most savers, once they hang it up and call it quits from work, they're

00:20:32.300 | immediately pulling out from their retirement accounts to live on. Rishi, I think your instincts

00:20:37.360 | are correct here. What IRA withdrawals while your dad is working, what that's going to

00:20:42.460 | do is it's going to stack income on top of income, and it's going to cause him to pay

00:20:45.900 | a higher rate on these IRA withdrawals than he probably will in the future. This is probably,

00:20:53.140 | based on the information we have, this looks like an optimal Roth conversion case for your

00:20:56.700 | dad. As my man, Bill Sweet, always puts it, all roads lead back to a Roth conversion.

00:21:01.620 | We talk about him a lot around here. I should have known it was coming. Yeah, every time,

00:21:06.900 | every time. The reason for this is it sounds like dad's targeting at age 65 retirement

00:21:12.820 | if he's looking to target Medicare upon retirement. Based on his savings rate that we can assume,

00:21:20.820 | he may be able to defer Social Security until age 70, and his RMD start at 72. Between 65

00:21:27.020 | and 70, he may have this period of five years where he has super low income. During this

00:21:33.900 | five years, John, could you throw that chart on? I've always wanted to say it. Here's a

00:21:39.940 | look at some ordinary income tax and long-term capital gains rates. This was built by the

00:21:44.340 | team at Kitsis.com a few years ago. I updated it for 2022 rates. Based on dad's IRA balance

00:21:50.540 | of $2 million right now, I think it's safe to say he's at least in this 22% tax bracket,

00:21:56.500 | maybe 24, maybe higher. Then at age 72, this IRA is going to be worth $3, $3.5 million,

00:22:04.500 | so that first-year RMD is going to be north of probably $125,000. At 72, he's probably

00:22:11.500 | in the 24% rate. There may be an opportunity, starting at age 65, to withdraw, to convert

00:22:19.620 | IRA money to Roth at maybe 12%, maybe 22%. What you're doing with the Roth conversion

00:22:25.420 | here is you're choosing to pay tax early, but at a potentially lower rate than you will

00:22:29.980 | in the future. I guess the point, too, is that if you're going to pull it out to pay

00:22:34.300 | the taxes anyway, you might as well put it in a vehicle that's still tax advantage, right?

00:22:38.700 | That's the point of the Roth conversion. That's right. The Roth conversion gives you kind

00:22:42.680 | of three benefits. Number one is that IRA money is going to be taxed at some point,

00:22:47.300 | so you might as well take advantage and pay at the lowest tax rate possible. Number two

00:22:50.820 | is the amounts that are converted to Roth are all going to grow tax-free. Rishi, this

00:22:56.620 | may benefit you. If dad is really comfortable living at a low rate, this may go to Rishi

00:23:02.120 | as an inheritance, and he could have tax-free money. Then to dad's point-

00:23:06.900 | Say, "Dad, the Roth is for the grandkids." Well, yeah. In theory, you want to leave that

00:23:11.140 | Roth alone to grow tax-free as long as possible. For dad, his goal was to reduce his RMDs and

00:23:18.300 | the amounts converted to Roth. The Roth account doesn't have a required distribution date,

00:23:22.540 | so he is lowering his future RMDs. One more thing here. Does it ever make sense?

00:23:27.700 | Is real estate a good, taxable vehicle for retirement? There's a lot of pain points when

00:23:34.220 | you own real estate if you're renting it out, but are there any pros for investing some

00:23:39.700 | money in real estate in retirement? Yeah, this is a big "it depends." If it's

00:23:44.300 | not a rental property, you're pretty limited in what you can write off. If it is a rental

00:23:49.020 | property and you're age 70+, you may not want to manage a rental property when you're retired.

00:23:55.340 | It's not my favorite for retired people, and if you're not renting it, the tax benefits

00:23:59.300 | just aren't as strong as if you are renting. Counterpoint if we're trying to help Rishi

00:24:02.980 | out here. If he says, "Dad, buy a place in Florida on the beach," maybe that's a good

00:24:07.780 | idea. Some place for me to come visit. I'd sign off on that.

00:24:12.900 | Sounds good to me. Also, Rishi said they listen to our show on

00:24:18.420 | their evening walks, so thanks for listening. Colin writes, "My wife and I recently got

00:24:28.100 | married and are trying to figure out the best way to navigate the tax portion of things.

00:24:32.300 | So romantic. Especially with getting married halfway through the year."

00:24:36.140 | Duncan, is this what you talked about on the Air Flight over to your honeymoon? What tax

00:24:39.100 | bracket are we going to be in, honey? Yeah. "Filing jointly this year, we are going

00:24:43.940 | to be borderline between 32% and 35% tax bracket. Our salaries put us close to that limit. However,

00:24:49.900 | I also have a few side hustles, like personal training. With personal training, I work for

00:24:54.700 | a company and receive a W-2, minimal amount, approximately $2,000. And the other, I claim

00:25:00.320 | at the end of the year as it's my own business. Is there ever a scenario where it makes sense

00:25:04.260 | not to work in order to avoid being bumped up a tax bracket? If it's something where

00:25:09.500 | I would not want to miss the income of the company I'm training for, is there more

00:25:14.700 | upside in stopping that side hustle?" Now, this is the kind of thing where people

00:25:21.700 | say, "Why would I want to make a million dollars? I've got to pay 50% taxes on it."

00:25:26.780 | Does it ever make sense to have that theory, if you say, "Why would I make more money

00:25:30.460 | because I'm going to pay taxes on it?" Doesn't it always make sense to make more money?

00:25:32.460 | Yeah, this is kind of like, "Do people turn down raises to avoid more taxes?" You know

00:25:36.220 | what I mean? I mean, I know if you're really, really close,

00:25:38.900 | I don't know. Does it ever really make sense, Bill?

00:25:41.660 | General rule of thumb, no. Earning a dollar is better than not earning a dollar. Even

00:25:46.020 | after paying taxes, you're going to have more money net than you otherwise would. In Colin's

00:25:52.300 | case, we're talking about a side hustle, so that could change his math on this. The big

00:25:57.100 | reason why you still want to earn the dollar is ordinary income tax rates are marginal.

00:26:03.360 | If Colin jumps from 32% to 35%, all of his income isn't taxed at 35%. It's only the amount

00:26:09.460 | over that threshold. John, can we throw that chart up one more time? For reference, these

00:26:14.340 | are- Bill, chart on. Come on. Chart on.

00:26:16.460 | Chart on. My mistake. I'll get used to it. There you go.

00:26:19.900 | These are ordinary income rates. If Colin's side hustle, his personal training pushes

00:26:24.420 | him up from 32% to 35%, only the amount over that threshold is taxed at the higher rate.

00:26:30.060 | I think to answer Colin's question, "Should I stop my side hustle?" It's really not about

00:26:35.300 | tax. I think with a side hustle, we should think about this with two different questions.

00:26:39.260 | Number one is, "Colin, are you relying on this income?" If you're pushing the 35% tax

00:26:44.220 | bracket, you're $400,000, $500,000 plus in the income. Is a side hustle earning a few

00:26:50.620 | thousand bucks, is that material to your income and your wealth? Maybe not. Everybody's financial

00:26:55.900 | plan is different, but that might not move the needle for you.

00:26:59.740 | Question two is, "Do you enjoy the side hustle?" Since this is not moving the needle financially,

00:27:05.860 | do you value the side hustle income more than your free time? In a highest tax scenario,

00:27:11.660 | Colin lives in California, and if he's pushing 35% on the Fed rate, he's at 9.3% in California,

00:27:17.740 | so effectively, he's going to earn $0.56 for every dollar. He's going to net $0.56 for

00:27:23.460 | every dollar that he earns. For Colin as a side hustle, is $0.56 on the dollar worth

00:27:29.260 | it?

00:27:30.260 | That's a good point. Him and his wife are already making decent income. The side hustle

00:27:35.540 | is not bringing in that much on top of it. Is the time worth it to go ahead and keep

00:27:39.780 | doing that personal training on the side?

00:27:41.740 | Right. I would never tell somebody, "Turn down a raise," or, "Stop working in December

00:27:45.540 | to not go over a tax threshold," but for a side hustle, it's really a matter of how

00:27:49.980 | much do you value your time versus how much income are you getting off of the side hustle?

00:27:53.540 | Based on their income, I'm guessing they do this more because they enjoy it, right? That's

00:27:56.980 | what it sounds like to me. I think they probably just enjoy the personal training is my bet.

00:28:03.380 | I'm just happy seeing all this data that Bill is sharing. I'm just happy our tax code is

00:28:08.140 | so simple and easy to understand. That's what I'm always grateful for.

00:28:13.260 | Yeah, always. If you're listening to this in podcast form, leave us a review. Duncan

00:28:23.060 | wants you to hit the subscribe button on YouTube. If you're not, compound merch, idontshop.com.

00:28:27.460 | Tomorrow, Duncan will be back with Compounded Friends. Yes, after a little hiatus?

00:28:34.740 | We have Alex from The Science of Hitting.

00:28:38.660 | Oh, yeah. That's a very good sub stack. Thanks again to Bill for coming on, sharing his tax

00:28:43.900 | expertise. Remember, if you have a question, email us, askthecompoundshow@gmail.com, and

00:28:49.380 | we will see you next time.

00:28:50.420 | Thanks, everyone.

00:28:51.660 | [music]

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