Where Should I Save For My Down Payment?

00:00:00.000 | Welcome back to our show, Portfolio Rescue. This is our show where we answer questions

00:00:21.860 | directly from you, the viewer. I am Ben Carlson. Joining me, as always, is our producer, Duncan

00:00:26.240 | Hill. Quick reminder, this show is for informational purposes only. It should not be relied upon

00:00:31.440 | for innovative decisions. We have to get that out of the way. Remember, we're just providing

00:00:34.560 | context and perspective here. If you have a question, email us, askthecompoundshow@gmail.com.

00:00:40.420 | We got a ton of good emails last week. I think we're going to be full up for a long time.

00:00:44.600 | And remember, this is not just going to be me answering questions here. Each week, I'm

00:00:48.160 | going to be bringing on an expert, and I have an expert waiting in the wings here who's

00:00:50.360 | going to help me with some questions later on. But first, Duncan, what's going on? Question

00:00:54.080 | number one. Hey, Ben. Good morning, everyone. So first up today, we have the following.

00:01:04.460 | So first up, I have a question about saving versus investing. I'm a 26-year-old medical

00:01:09.260 | student and my wife and I are looking to buy a house in the next year or two. She's a teacher

00:01:13.280 | and makes around $50,000 pre-tax. I will be a resident next year and will make around

00:01:18.160 | $55,000 pre-tax. We currently have about $5,000 in a Roth and $11,000 in a Marcus account.

00:01:25.000 | My wife has $7,000 in her 403(b) and we have no kids. Should I risk more of my savings

00:01:31.220 | in Marcus and invest it given how low rates are? Maybe a higher dividend ETF short-term?

00:01:35.800 | Okay, so this is a question that we get in some form or another dozens of times every

00:01:43.960 | month. It's partially because of the low-rate environment we're in, right? If you go to

00:01:48.640 | a savings account, so I also have an account at Marcus. They are currently paying 0.5%,

00:01:53.640 | half a percent in interest. So it's not like you can just get in your money market or savings

00:01:57.220 | account 4% or 5% like you could in the past. The way that I look at this is, what's your

00:02:02.760 | upside and what's your downside? Because we know risk and reward are attached to the hip.

00:02:06.080 | So let's say you go out and take a little more risk and you can earn 5% extra per year

00:02:10.440 | as you're saving for down payment over the next year, two, three years. On $10,000, that's

00:02:15.080 | an extra $500 a year. So that's your upside if you can increase by 5%. Obviously, if you

00:02:20.000 | can increase by more than that, it's more. So if you're saving for a $20,000 down payment,

00:02:24.920 | we're talking $1,000 a year that you could get extra by investing that money. So that's

00:02:30.200 | the upside. What's the downside? All right, Duncan, put up the S&P 500 table here that

00:02:35.160 | shows the amount of times it's positive and negative. So what I did here, I took the S&P

00:02:39.520 | 500. So let's say you want to take more risk. Put this money in stocks instead of cash.

00:02:43.780 | I looked over one, three, and five-year time horizons, rolling returns going back to 1926.

00:02:49.160 | So on one-year basis, roughly three-quarters of the time, you're going to see positive

00:02:52.880 | returns historically. Three years, it's almost 85%. Over five years, you're getting closer

00:02:57.200 | to 90% of the time. So the odds are in your favor that if you hold even for five years

00:03:03.040 | if you're saving for a down payment, it's pretty good odds that you're going to see

00:03:06.520 | a positive return. Unfortunately, the downside here is, I looked at the worst returns in

00:03:11.680 | these periods, so the times you did have negative returns. The worst one-year return in history

00:03:16.160 | for the S&P 500, -68%. Over three years, you could have lost 81%. Over five years, 61%.

00:03:23.720 | Now, to be fair, those returns are from the Great Depression. It's not exactly the best

00:03:29.640 | analogy here. That's the worst, worst, worst-case scenario. So let's say if you look more in

00:03:33.080 | modern times. This is since 1960, what I'll call the modern stock market. The worst one-year

00:03:38.200 | return was -43%. Over three years, the worst return was -41%. Over five years, still, you

00:03:43.760 | lost close to 30% in the worst return. So, stocks are still risky. If you want to spend

00:03:49.920 | that money when you need it and the stock market is crashing, you're kind of out of

00:03:53.320 | luck. So let's say, instead of the S&P 500, we looked at a 50/50 portfolio. So now I took

00:03:58.200 | the returns of the S&P 500, put them against the five-year Treasury, which is just an intermediate

00:04:03.920 | term government bond, and looked at a 50/50 portfolio. Now things look a little better.

00:04:08.200 | So you split the difference. You do some in a safe bond. You do some in the stock market.

00:04:12.360 | Over one year, you're positive 82% of the time. Over three years, 93% of the time. And

00:04:16.600 | over five years, you're only down roughly 4% of the time. So your odds increase more,

00:04:21.600 | kind of splitting the difference here. Again, you can have bad returns, though, in those

00:04:25.080 | negative times. The worst one-year return was 38%. The worst three-year return was a

00:04:29.040 | loss of almost 50%. And over five years, you still could have seen a 25% loss in a 50/50

00:04:35.120 | portfolio. Again, that's all Great Depression stuff, so let's look at the more modern times.

00:04:40.160 | Since 1960, the worst one-year return for a 50/50 portfolio was close to 20%. Over three

00:04:44.560 | years, 8%. And surprisingly, over five years, you've never seen a down year for a 50/50

00:04:50.360 | portfolio over a five-year period since 1960. Not bad.

00:04:56.840 | I understand why people want to take more risk here when they're saving for a down payment.

00:05:01.480 | You think you have all this money, it's just sitting there earning nothing. But I think

00:05:06.480 | you have to ask yourself, is the risk of potentially having a lower down payment worth it for having

00:05:11.920 | a potential to have a little bit more on the upside? If you can handle seeing that money

00:05:19.280 | evaporate 10%, 20%, 30% of it, when you need to spend it and have a lower down payment

00:05:23.840 | for the potential to have it be higher, I think that's kind of the balance you need

00:05:27.660 | to make. But you have to ask yourself, is it really worth it? For me, personally, if

00:05:30.960 | I have something that's coming up in three or four years, I don't like to put it in the

00:05:33.840 | stock market, because for me, it's not worth the risk.

00:05:36.380 | Alright, Duncan, what have we got? #2.

00:05:38.680 | Duncan: I was just going to add, a while back, Nick Majuli did a good post, I can't think

00:05:44.080 | of the name of the title, you might remember it, but where he was breaking all this down,

00:05:48.760 | saving over the long haul and the best allocation.

00:05:53.300 | Over the long term, you're much better off in the stock market. Over the short term,

00:05:57.000 | who knows? If you had to spend your money in March 2020, the stock market was down 35%

00:06:02.480 | in a handful of weeks, and then you're out of luck.

00:06:05.560 | Yeah. Alright, so next up, if I believe that the baby boomers are shifting from net investors

00:06:11.320 | or savers to net withdrawers, what is the investment strategy that I should take? Should

00:06:15.920 | I favor bonds and gold over the stock market, or try to pick the winners that boomers will

00:06:19.900 | direct their money towards? Healthcare, golf courses, Russian nesting dolls, etc. I have

00:06:26.200 | been going through this thought experiment, but I want to see if my thinking is on the

00:06:29.080 | right course.

00:06:30.080 | Alright, here's my next big short for baby boomers, when they're sort of out of the picture.

00:06:36.160 | I'm shorting whitey tighties. Duncan, do you think that there is a single male in America

00:06:41.320 | under the age of 60 who still wears white underwear with the blue and gold around the

00:06:45.960 | elastic band, right?

00:06:46.960 | Yeah, I would short that.

00:06:47.960 | I'm going mega short on whitey tighties. Okay. For real, though, this is an interesting question,

00:06:54.200 | because we've never really seen anything like this. In the year 1900, there was 3.1 million

00:06:58.040 | people over the age of 65. By 2030, it'll be closer to 70 million, because that's the

00:07:02.760 | whole baby boomer generation. By 2030, we'll be over 65. 20% of the population will be

00:07:08.560 | over the age of 65 by 2030. Duncan, throw up this demographic chart I got from the U.S.

00:07:12.760 | Census here. Look at this growth in people that are older in their years, so in the '60s,

00:07:19.400 | '70s, and '80s, where we're headed from 1960 to 2060. We've just never seen anything like

00:07:25.600 | this before. Not only having such a large cohort of a demographic be this old, but people

00:07:29.880 | live this long. Here's why I'm not worried about baby boomers crashing the stock market.

00:07:36.760 | There's this report from Stanford Center on Longevity. They say one-third of baby boomers

00:07:40.560 | have no money saved for retirement. And those who do have a positive retirement balance,

00:07:44.360 | the median balance is around $200,000. Baby boomers are living longer. They're going to

00:07:48.240 | need two, three, maybe four decades for their money to last in retirement. They're going

00:07:53.200 | to need to hold more stocks, because interest rates are so low. So, people are worried about

00:07:58.280 | them selling all their stocks. I'm not worried about that. I think a lot of people are going

00:08:01.080 | to have to either work longer or invest their money more aggressively. And you have the

00:08:05.240 | fact that the top 10% -- there was a new study in the last couple of weeks -- the top 10%

00:08:09.320 | in this country own 89% of the stocks. Unfortunately, most of that money is going to be passed down

00:08:14.240 | to their rich kids. It's not going to be sold. A lot of these people that own the stocks

00:08:17.440 | aren't going to have to sell it. And also, someone's going to have to buy those assets

00:08:21.000 | from the boomers that do sell. Millennials are now the biggest generation. Gen Z is going

00:08:25.640 | to be bigger than the baby boomers by the end of 2030. And if we break up the population

00:08:31.020 | into these five-year age brackets -- the census does this -- the top 10 ages in 2030 will

00:08:36.120 | all be under the age of 50. So, even though we have so many more people getting older,

00:08:39.440 | we also have millennials and Gen Z coming in to buy those stocks from them. So, I'm

00:08:43.880 | more worried about how we're going to care for this aging generation that's going to

00:08:46.640 | have a long retirement. Again, back in 1900, when there was only 3.1 million people over

00:08:51.480 | the age of 65, their retirement plan was to die on the farm. Now, people actually have

00:08:56.320 | decades ahead of them in their working years, if they retire in their 60s or even 70, where

00:09:00.320 | they could have two, three decades ahead of them. So, I'm more worried about how we're

00:09:02.600 | going to take care of these people than them crashing the stock market. I'm not that worried

00:09:06.560 | about that. What do you think, Duncan? How do we short whitey tighties? Is it Hanes?

00:09:11.160 | Yeah, I guess. But they make a lot. I feel like we could find a more concentrated bet.

00:09:16.760 | That's true. Plus, Michael buys all of their white V-neck, so that might offset it. Alright,

00:09:20.520 | next question.

00:09:21.520 | Okay. So, next up. I recently secured an interest-only loan for my first home in L.A. It required

00:09:33.960 | 30 percent down, but I have 2.125 percent locked in for seven years. I find this attractive

00:09:39.360 | as I believe I can meet or beat that with returns in the stock market without having

00:09:43.480 | to pay down the principal yet. And it gives me more flexibility to potentially move in

00:09:47.440 | seven years if this isn't my forever home. Assuming the ROI on appreciation would be

00:09:52.600 | greater than the interest paid during this window. What are your thoughts on interest-only

00:09:56.100 | mortgages versus building equity in a traditional 30-year mortgage?

00:09:59.440 | Alright, I personally have always been a fixed-rate guy, because I'm a planner. But I'm going

00:10:04.920 | to bring in someone else here. So, one of our financial advisors, a member of our investment

00:10:08.240 | committee, Blair Ducanet, to help me on this. Because I know she's talked about interest-only

00:10:11.040 | loans. She's worked with this. She's talked to clients about this. Blair, what are some

00:10:15.120 | pros and cons of the interest-only loan versus a fixed loan? That's the only thing I really

00:10:18.560 | have experience with personally.

00:10:19.880 | Yeah, absolutely. Hey, guys. Great to be here. Thanks for bringing me in. Duncan, good to

00:10:24.720 | see you. Yes, absolutely. Interest-only loans get a really bad rap because a lot of people

00:10:30.240 | got into trouble in 2008-2009 when home prices declined. But putting 30 percent down gives

00:10:36.800 | you a really nice cushion in equity. And with rates so low and the fact that home prices,

00:10:44.680 | yes, they've had a big jump recently. But over the long term, we expect home prices

00:10:48.840 | to kind of match the rate of inflation, not necessarily keep pace with inflation. A lot

00:10:53.440 | of people are asking, "Why would I park more of my capital in home equity if I expect other

00:10:59.160 | things to grow faster?"

00:11:00.160 | Right. So, the idea is you literally are only paying the interest, right? You're not paying

00:11:03.800 | down the principal at all.

00:11:05.400 | Exactly.

00:11:06.400 | So, you're not building equity. But then maybe your payment is a little smaller, so you can

00:11:10.520 | put that money to use elsewhere. That's kind of the idea here, right?

00:11:13.920 | Yes.

00:11:14.920 | We have to stop putting our net worth into different buckets. It's all one balance sheet.

00:11:20.120 | And if your idea, if your goal is to increase your net worth, you might not want to be parking

00:11:26.760 | more and more of your capital into home equity with the expectation that home prices are

00:11:31.080 | going to basically increase with the rate of inflation. So, 30 percent down gives you

00:11:36.320 | a very nice cushion. Your home price would have to decline by more than 30 percent for

00:11:40.480 | you to "lose money on the sale." And this questioner points out another good point,

00:11:46.520 | which is the seven-year time period is the average holding period for a house. Very few

00:11:51.720 | people are staying in a house for 30 years. So, this 30-year fixed-rate mortgage really

00:11:57.040 | doesn't make sense for a lot of people.

00:11:58.440 | And I want to give you a personal example. I am, this actually tomorrow will be seven

00:12:03.200 | years since I purchased the current house I live in. I knew it was not my forever house.

00:12:06.840 | It's a smaller home. I thought that I would be moving to a bigger house now. It might

00:12:11.560 | be a year from now. I did a seven-year adjustable rate mortgage. So, I got a lower rate than

00:12:17.120 | the 30-year rate at that time, fixed for seven years. And oh, by the way, it's adjusting

00:12:22.740 | next month and it's adjusting down over one percent because interest rates went down.

00:12:27.840 | Now, that's the thing. If you looked historically, you would have been better off doing this

00:12:31.180 | almost every year. Duncan threw up the chart on mortgage rates because all they've done

00:12:34.560 | is go down, right? So, you'd have been better off doing this in recent years, correct?

00:12:38.720 | Now, I'm not saying that I knew what interest rates were going to be doing. In fact, I kind

00:12:42.720 | of baked in the fact that I thought interest rates would be higher in seven years. However,

00:12:46.640 | the interest that I have saved over the last seven years would more than make up for paying

00:12:50.280 | a little bit more, right? Because remember, that seven-year adjustable rate that I got

00:12:54.880 | seven years ago was lower than the 30-year fixed rate, right? So, I've already saved

00:12:57.920 | the money. Even if I pay a little bit more for the next two years, I don't have a crystal

00:13:01.760 | ball. I do have a magic eight ball. So, if you guys want to ask a yes or no question

00:13:05.720 | about interest rates, we can. Nobody knows the future, but when you're shopping for a

00:13:10.140 | mortgage today, generally, you get a lower rate on interest only. You get a lower rate

00:13:14.480 | on adjustable rate loans. Be realistic about your holding period for this house and be

00:13:20.640 | a little bit more sophisticated with your choice in interest in mortgage loans.

00:13:24.960 | Yeah. So, obviously, pros and cons. I do like the idea of if you know you're a younger person

00:13:29.240 | you're going to be trading up in a number of years. This seems to make more sense because

00:13:32.520 | most of that mortgage payment is going to go to interest in the first few years anyway.

00:13:36.080 | So, that makes sense. Correct.

00:13:37.080 | All right. Duncan, what do we got next?

00:13:40.160 | Okay. So, last question. So, question four. This is an interesting one, and I'm going

00:13:47.000 | to ask you to explain to everyone what this acronym even means after I read this. But,

00:13:51.720 | "I work for an employee-owned company with an ESOP benefit and may generously give each

00:13:56.080 | employee 10 to 15 percent of their salary in company stock/shares each year. It varies

00:14:01.240 | every year, but it's typically at the higher end of that range. So, if I'm making $100,000

00:14:05.160 | in salary, my employer will give me around $10,000 in stock on top of that. I also have

00:14:11.200 | the option of contributing to a 401(k), which I do. Assuming the ESOP contribution from

00:14:15.840 | my employer will be taxed after retirement, would you recommend that I put all of my 401(k)

00:14:20.920 | contributions in after tax?"

00:14:22.440 | Okay. So, ESOP stands for Employee Stock Option Plan. And this is, if you have the ability

00:14:28.300 | to work for a company that pays out stocks, this is nice. I just had a family member recently

00:14:31.960 | start working at a new public company, and she told me, "They're going to offer me a

00:14:36.520 | 10 percent discount off of my shares in the company." So, what's the mix I go between

00:14:39.960 | my 401(k) and company stock? So, Blair, what are the things that you should be looking

00:14:43.800 | for here? What are the considerations when thinking through this idea of splitting between

00:14:47.520 | a 401(k) or taking stock in the company?

00:14:50.760 | Yeah. So, it sounds like in this case, the employee doesn't have a choice. They're going

00:14:54.680 | to receive 10 to 15 percent of their salary in employer stock. Generally, an ESOP plan

00:15:01.000 | is for a private company, and it's a very tax-efficient way for the owners to sell off

00:15:06.120 | a portion of their shares and also, by the way, enrich their employees. So, it's a wonderful

00:15:11.020 | benefit if the company is successful. I've actually seen this work out to clients' favors

00:15:16.600 | many times, and they end up with a net worth much higher than they ever would have assumed

00:15:20.160 | just from saving on their own. So, this is a wonderful benefit. You are right. All of

00:15:25.640 | your shares in the employee stock ownership plan, the ESOP, will be taxed when you take

00:15:30.160 | it out later in retirement. You have no Roth option here. We always talk about in financial

00:15:35.000 | planning building these different buckets of savings, and by buckets, we mean regular,

00:15:39.240 | deferred, going to be taxed when you take it out in retirement, Roth after tax, free

00:15:44.420 | and clear, no tax inside the account and no tax when you take it out later, and after

00:15:49.240 | tax savings, no deferral of any income. You pay taxes on the interest that comes in along

00:15:56.440 | the way. So, the question is getting to building the different buckets here. The Roth option

00:16:02.280 | in the 401(k) may be the right decision to try to build more of that Roth bucket because

00:16:08.260 | you have no choice in the employer stock option plan.

00:16:11.000 | Right. So, the Roth offsets the stocks you're getting, which, again, I think is a good problem

00:16:16.960 | to have if you're someone who's getting this, because, as you mentioned, this isn't something

00:16:20.420 | everyone can receive, whether you're for a public or private corporation. This is a good

00:16:24.760 | problem to have. But yeah, you're looking at an offset, right? Because you know you're

00:16:27.200 | going to be paying taxes on the stock for the company, which is a good problem to have

00:16:30.040 | if that grows, you're doing great and you're working out better than most people, but you

00:16:33.680 | still want to have some sort of an offset, so you're not paying taxes on the Roth 401(k).

00:16:37.440 | I told, in our last episode, I told Bill Sweet, our CFO and tax expert, he talked me into

00:16:42.880 | switching to a Roth this year for the first time because I have more traditional retirement

00:16:47.240 | assets. So, it seems to make sense to have -- the way I look at it, you talk about buckets,

00:16:51.320 | it's like diversifying your tax base, right? You have some options.

00:16:54.240 | Yep. It gives you more flexibility in retirement as to where to take your income. The questioner

00:16:59.480 | also noted their age, which is important. The younger you are, the more beneficial to

00:17:04.460 | making the Roth contributions, because keep in mind, when you make a regular 401(k) contribution,

00:17:08.840 | you take a tax deduction this year. You get a tax write-off, you get that benefit, right?

00:17:13.400 | With a Roth, you don't. You're paying the tax up front today, and you need more time

00:17:18.040 | for those dollars to grow, so it is important. It makes less sense as you get older. It also

00:17:23.520 | makes less sense if you have a really high income, you're in the top federal bracket,

00:17:27.620 | maybe you also live in a high state income tax state, so you also have to look at what's

00:17:32.920 | your income tax rate today, what is it likely to be in the future. Again, we can ask the

00:17:37.560 | eight ball. We don't know, so there is a trade-off there, but generally, it's a good idea to

00:17:43.720 | be building these three buckets, regular deferred, Roth, and after-tax savings.

00:17:48.680 | Perfect. By the way, in the comments here, someone says that Duncan still has the newly-wed

00:17:52.960 | glow. Duncan, one of these episodes, we're going to have to do some financial advice

00:17:58.880 | for newly-weds here. For coming on the show and helping us out here.

00:18:02.040 | Yeah, thanks for having me. It's a fun time.

00:18:03.360 | These questions are a little outside of my area of expertise. Duncan, as always, remember,

00:18:06.880 | if you have some thoughts about the questions today, leave us a comment below. I personally

00:18:11.080 | read everyone, even the ones that call me an elitist. If you have a question for the

00:18:14.680 | show, email us, askthecompoundshow.com. My seven-year-old said, "It's really thirsty

00:18:19.880 | if you ask people to subscribe and like your channel," but I don't care because that's

00:18:22.880 | how I find life validation, so subscribe, hit the like. Check out idontshop.com. We've

00:18:27.800 | got this new sweatshirt here on the compound logo. Duncan, what's the guy's name? The artist?

00:18:32.480 | Peter Paid.

00:18:33.480 | Peter Paid. This is a sweet, new champion hoodie. Thanks, everyone, for joining the

00:18:37.800 | live stream. Feel free to ask questions in the chat sometime. Maybe we'll get to those

00:18:40.640 | even live sometime. We'll see you next time. Thanks, everyone.

00:18:44.080 | See you.

00:18:44.600 | [music]

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