Is Real Estate the Best Inflation Hedge?

00:00:00.000 | Welcome back to Portfolio Rescue. Portfolio Rescue here is the Ask the Compound show at

00:00:21.220 | gmail.com. Today's show is sponsored by Innovator ETFs. Duncan, this is an interesting one.

00:00:25.360 | It came out hot off the presses, a new ETF from Innovator ETFs that actually allows you

00:00:31.040 | to hedge an individual stock position. They do Tesla on a quarterly basis. You could buy

00:00:36.320 | this TSLH, and it caps your losses at 10% per quarter, and it also caps your gains at

00:00:43.160 | right around 10%. If you say, "I want to invest in Tesla, but I cannot handle the volatility,"

00:00:48.440 | because I think the volatility is three to four times that of the S&P 500. You say, "I

00:00:53.320 | want to invest in this company, but I can't handle it," you're actually protected, and

00:00:57.440 | your floor of losses is 10%. Of course, it caps you on the upside, too. They're using

00:01:00.960 | options to do this at Innovator ETFs. It's really interesting, the fact that you can

00:01:06.440 | do this. A lot of the money is actually invested in T-bills, and then the rest is invested

00:01:09.520 | in options on Tesla. Basically, help you contain those really deep drawdowns, because obviously

00:01:14.640 | some of these individual stocks can do that, and take a little bit of advantage of their

00:01:18.360 | growth. What do you think?

00:01:20.280 | That's pretty cool. It's like your own little hedge fund, kind of sounds like.

00:01:23.240 | Yes, it really is. The stuff that they're able to do these days with options and ETFs

00:01:26.360 | that we just couldn't do in the past is pretty interesting. If you want to learn more, go

00:01:29.400 | to InnovatorETFs.com. We got a lot of good questions. I just want to start out with one

00:01:35.800 | for you today, Duncan. Just some housekeeping here. Next week, we're not going to have a

00:01:42.400 | show. A lot of people at the compound are taking some vacations. I'm going up to God's

00:01:45.960 | Country in Northern Michigan for a few days. I'm going to go to Mackinac Island, the place

00:01:49.120 | where you take a ferry there, and then no cars. It's only horse and carriage. You ever

00:01:53.080 | heard of this place?

00:01:54.080 | I have not heard of this.

00:01:55.080 | It's got a lot of history, a lot of tourists there. It's good for about one day. Duncan

00:01:58.680 | is going on his honeymoon. Here's my question for you, Duncan. You're going over to London.

00:02:03.440 | What are you most looking forward to spending your money on? Because I think it's important

00:02:05.840 | for people to spend their money on things they enjoy. You're going on your honeymoon.

00:02:07.980 | What are you most looking forward to spending your money on?

00:02:10.640 | That's a tough one.

00:02:11.640 | Food, beverages?

00:02:12.640 | Probably the food. We were talking in the chat with some people a week or two ago, but

00:02:18.060 | London is the vegan capital of the world, pretty much.

00:02:21.080 | Oh, really?

00:02:22.080 | There's going to be all kinds of great food that I'm looking forward to.

00:02:25.960 | What are the big tourist attractions you're going to go see?

00:02:29.160 | I'm going to see the Tower Bridge. I'm a big Whistler fan, so I want to go see where he

00:02:36.200 | painted a couple of scenes around the city. Then we're going to Liverpool for a night.

00:02:42.600 | We're going to Glasgow and Edinburgh. I'm Scottish on one side of my family, so I'm

00:02:48.360 | going to go connect with my homeland kind of stuff.

00:02:50.520 | It should be fun.

00:02:51.520 | Cool. All right. You've seen National Lapoon's European Vacation?

00:02:55.520 | I don't think so, actually.

00:02:56.520 | Look, kids, Big Ben. They get stuck in a circle looking at Big Ben over and over.

00:02:59.080 | No, I haven't seen that.

00:03:00.080 | Put it on your airplane list. All right. No show next week. We'll be back the following

00:03:04.080 | week. We're all taking some vacation here. Let's get right into it and do a quick question.

00:03:09.980 | First up today, many are saying -- this kind of made me laugh, because isn't this what

00:03:13.980 | Trump always said? Many are saying that real estate is the only way to get a real return

00:03:19.320 | in a safe manner. Will you post some data on real estate versus bonds versus stocks?

00:03:24.120 | Intuitively, this one makes sense. I've talked in the past about how real estate is a good

00:03:30.040 | hedge against inflation if you have a fixed rate mortgage. But even going beyond that,

00:03:33.900 | if you think about the fact that when inflation is spiking higher, materials costs go up because

00:03:38.400 | the cost of commodities are going up and then wages go up.

00:03:41.320 | So if you think the cost of building a house is up because material costs are up and wages

00:03:45.240 | are up for construction workers, that would make sense that houses now are more expensive,

00:03:50.480 | but also the house that you own in relation is probably worth more just to meet that level.

00:03:56.160 | So that makes sense. But let's dig into the numbers, because I've looked at this through

00:04:00.140 | stocks before in the past. So if we look at -- I got data from 1928 to 1921 from Robert

00:04:05.960 | Shiller. So the annual nominal returns for stocks and bonds is like 10 percent. Bonds

00:04:10.260 | is 4.8 percent and housing is 4.1 percent. Now, this shows what happens when inflation

00:04:15.060 | is rising or falling from one year to the next. You can see when inflation is rising

00:04:19.600 | from one year to the next, stock and bond returns are below average. Housing is above

00:04:23.720 | average. When inflation is falling, stock and bond returns are above average and housing

00:04:28.120 | is below average. Same thing. Inflation I put here at above or below average is 3 percent

00:04:32.640 | because that's a long term, like a hundred year average. And kind of the same thing for

00:04:36.340 | stocks and housing. Inflation is above average. Stocks do poorly. Housing does well. Inflation

00:04:41.320 | is below average. Stocks do well. Housing does poorly. Bonds are a little different.

00:04:46.720 | I think the biggest reason for bonds when inflation is above 3 percent doing better

00:04:50.540 | is because in the 80s and 90s rates were so high and inflation was actually a little higher.

00:04:55.980 | So this actually bears out. When inflation is falling below average, stocks outperform

00:04:59.240 | the long term averages. When inflation is rising and above average, housing outperforms

00:05:02.600 | long term averages. Now, these are nominal returns. Let's look at it by an inflation

00:05:06.360 | regime. So, John, focus next chart. This shows by decade on a real basis what the annual

00:05:12.940 | returns were for stocks, bonds and housing. Stocks is the S&P 500. Bonds is 10 year treasuries

00:05:17.460 | and housing is the Case-Shiller data, which he has going back to like the 1800s. But you

00:05:21.640 | can see on a real basis when inflation has been high, 1940s inflation was 5.5 percent.

00:05:26.740 | Housing had the best real returns of any decade. 70s inflation was 7 percent. Housing outperformed

00:05:32.780 | by 1.3 percent when stocks and bonds were down on a real basis. This doesn't always

00:05:36.100 | work because in the 2010s inflation was very low and housing still did well. But that probably

00:05:40.780 | says more about the timing than anything, because that's when the housing market bottomed

00:05:45.460 | pretty much. So housing is a really good inflation hedge. Now, here's the caveat this time around.

00:05:52.900 | There may have been so much pull forward. I don't know if it's going to work going forward

00:05:55.760 | from here. So I looked at the decades, the 30s through the 2010s. So if we look at just

00:06:00.620 | the 2020s. So it's 2020 to Robert Shiller's data is only updated through February of 2022.

00:06:07.820 | He's a little slow, frankly, for my taste in updating his data. But he's a Nobel Prize

00:06:12.420 | winner. He's got other stuff to do. So in those 26 months on a real basis after inflation,

00:06:19.220 | housing is up 21 percent. That's higher than seven out of the last nine decades in just

00:06:26.300 | a little over two years. So we've already had an enormous gain above inflation for housing.

00:06:32.340 | And so bigger than anything we've ever seen in that shorter period of time. And and so

00:06:37.620 | you could say it's about inflation. A lot of it is probably more about the pandemic

00:06:40.580 | and demographics and household formation. But it's hard to see it going forward, keeping

00:06:45.060 | that that inflation hedge. But yes, housing historically has been a very good inflation

00:06:49.500 | hedge.

00:06:51.060 | You know what has not seemed to be that great of an inflation hedge is the housing stocks

00:06:55.300 | like Zillow and Redfin. You guys on Animal Spirits were talking about that.

00:07:01.420 | Redfin is down like 92 percent. Zillow, yeah, was down 70 or 80 percent. This is why I like

00:07:06.760 | the disconnect between corporations in the stock market versus the real thing in housing.

00:07:11.340 | It's not even close to the same thing. Right. But yeah. But an individual house, if you're

00:07:16.900 | and if you're someone who's doing this on, like if this person is thinking in terms of

00:07:20.180 | rentals, obviously you can raise your rent as well. So that that's what makes housing.

00:07:24.660 | It's that imputed rent. That's a big thing, too. So, yeah. And some people enjoy being

00:07:28.100 | a landlord. Right. Yeah, I wouldn't personally, but I don't think I would. Yeah. All right.

00:07:34.420 | Let's do another one. OK.

00:07:38.580 | So up next, we have a question from Michael and some people might recognize this one from

00:07:42.700 | what are your thoughts, but we're doing a deeper dive. As a long term investor with

00:07:46.180 | a 10 to 20 year horizon, is it a good idea to sell portions of a stock when it's up and

00:07:50.500 | take some profits, maybe reinvest when the price goes down or just pocket the gains?

00:07:56.060 | Or is it best to stay all in regardless of the ups and downs?

00:08:00.420 | This question is basically asking, should I rebalance? Right. Should I take a little

00:08:05.220 | of what's done well and trim a little bit, take some profits? What's the quote? No one's

00:08:08.620 | ever gone broke taking a profit. Right. I think Kramer says that it's a it's a trader

00:08:12.520 | thing to say. It sounds it sounds intelligent or just let things ride and just go with it.

00:08:17.620 | Obviously, there's a difference between individual stocks and owning the market as a whole. So

00:08:24.380 | William Bernstein wrote the original blog post way back in the day. This is from like

00:08:27.340 | 1996 and his blog called The Efficient Frontier. And he wrote this post called The Rebalancing

00:08:32.380 | Bonus. And he calculated that the bump in return from rebalancing, looking at it, look

00:08:36.300 | at how old this is. William Bernstein was like the OG financial blogger. He wrote this

00:08:39.340 | way back in the day. By far my favorite financial writer of anyone. I've learned more from him

00:08:43.020 | than I have from anyone, I think, in the in the investing world. So he calculated the

00:08:46.300 | bump in returns from rebalancing your portfolio is like point five percent annually, which

00:08:50.140 | doesn't sound like a lot. But over the over the long term compounds pretty well. The way

00:08:54.780 | that I look at it is the reason that you diversify in the first place and set an asset allocation

00:08:59.740 | is because it matches your risk profile and your time horizon and kind of gives you a

00:09:03.140 | portfolio you can stick with over the long term. So why set an asset allocation in the

00:09:06.580 | first place if you're not going to rebalance over some time frame? Right. And even if rebalancing

00:09:12.260 | doesn't provide some sort of bonus over time, because sometimes the timing could be off.

00:09:16.560 | It's a way to control for risk. Unfortunately, the reason that you rebalance in the first

00:09:20.980 | place is because nothing grows to the sky. Right. Markets are always in forever cyclical.

00:09:25.940 | Things go up, things go down. And that's why you rebalance, because nothing that nothing

00:09:30.060 | works forever. Right. Tech stocks. Everyone said, why don't I put all my tech stocks for

00:09:34.340 | 10 years and then look what happened on the other side of that. You want to take some

00:09:37.100 | of those profits eventually by selling a little bit of what's gone well, buying a little bit

00:09:41.300 | what hasn't gone well and putting it back into into sort of symbiosis in your portfolio.

00:09:45.860 | Now, the problem with the regression to meet regression to the mean as a concept is it

00:09:50.120 | sounds beautiful until you actually look at the data, because sometimes it just doesn't

00:09:53.820 | work. It doesn't follow a set pattern. So I looked at the 10 best and 10 worst years

00:09:57.620 | in the stock market history. So, John, pull up the 10 best. This is the 10 best years

00:10:01.380 | since 1926. And what I did was I looked at the prior year and then the following year

00:10:05.820 | to see what happens. You can see sometimes the best years are followed by some really

00:10:10.620 | bad years. So 1975, that was following a really nasty turn in 73 and 74. 1958 was followed

00:10:17.100 | by it was following an 11 percent down draft. But sometimes those best returns come after

00:10:21.920 | a really good return. So in the 1920s, you had a really good return. It was followed

00:10:26.100 | up by an even better return. Right. Sometimes after a really good return, you see a nasty

00:10:30.820 | loss. Right. 1936 was really good. 1937 was a crash. 1945 was really good. Then you had

00:10:37.600 | an 8 percent downturn. Same thing for 1928. And then sometimes you have a really good

00:10:41.260 | return that just keeps going up. So it's kind of the same thing in the worst year. So, John,

00:10:46.380 | put the chart on the worst years. Right. So these are the 10 worst years since 1926. See,

00:10:51.700 | sometimes they follow a really good year. Sometimes they follow bad years. Sometimes

00:10:54.500 | those really bad years are followed by good years. Sometimes they're followed by even

00:10:56.780 | worse years. Duncan, can you imagine? So these are like the who's who of worst returns ever.

00:11:02.640 | So this year, let's say the stock market is down 15 to 20 percent, depending on what day

00:11:06.820 | you're looking at. Right. And what what time frame you're looking at. So let's say we finish

00:11:11.020 | the year down 15 percent. Can you imagine being down 20 percent again next year like

00:11:15.300 | that? It's rare for it to happen, but it's not out of the realm of possibilities. It

00:11:19.620 | happens on occasion. There are times when you can have two double digit down years in

00:11:23.020 | a row, maybe three down years in a row. It's not. But so the problem is, there's no pattern.

00:11:27.380 | So the question is, I'm going to rebalance. What is my interval? And the answer is, it

00:11:31.020 | doesn't matter. You could do semi annually. You could rebalance on an annual basis. You

00:11:35.340 | could even wait two to three years sometimes to allow momentum to take effect. The problem

00:11:38.980 | is or you could do the bands. You say, I'm going to let my asset weights go 5 percent

00:11:44.980 | or 10 percent outside of their band. So if I say 50 percent allocation to U.S. stocks,

00:11:49.660 | if it goes to 45, I'm going to buy. If it goes to 55, I'm going to sell. The thing is,

00:11:53.300 | whatever you choose, you just have to pick a strategy that you're going to follow without

00:11:56.580 | hesitation. And probably you should probably automate it, whatever one you choose, because

00:11:59.940 | sometimes rebalancing is going to make you look a genius and you're going to you're going

00:12:02.700 | to buy stocks and they're down. Sometimes you're going to sell stocks when they're up

00:12:06.380 | and then they keep going up. So the thing is, you just have to kind of be consistent

00:12:09.700 | and stick with it. And again, with individual stocks, all bets are off the table as far

00:12:15.540 | as regression to the mean. It doesn't work quite as easily or quite as good. So yeah,

00:12:20.460 | probably taking profits there makes more sense. But I think if you can find a fund or a strategy

00:12:26.260 | that automatically rebalances, that's probably the best case scenario.

00:12:29.380 | Yeah, I think also the individual and what their goals are, it matters so much for this.

00:12:36.460 | You're obviously not necessarily talking about a college student who took $50 and doubled

00:12:41.740 | it on Robinhood or something. That's a little different scenario than, "Oh, should I take

00:12:46.060 | profits?"

00:12:47.060 | Are there certain stock picks that you could say, "This is going to be a buy and hold forever"?

00:12:51.140 | That's fine. But just the point is to set that strategy ahead of time and don't try

00:12:54.940 | to figure it out when it's happening. If your stock is down 50% today and you said, "Well,

00:13:00.300 | it's a buy and hold forever when I bought it." Now today you go, "Eh, maybe I should

00:13:03.100 | sell and rebalance." That's the problem, is wavering and going back. That doesn't mean

00:13:06.620 | you can't change your mind, but it's just important to have a strategy going into it.

00:13:11.820 | Even a bad plan is better than no plan at all, is what I say. All right, let's do another

00:13:17.340 | one.

00:13:18.340 | Okay. Also, someone complained about me saying, "Okay," too much. It's a transition. You and

00:13:23.620 | Michael were talking about transitions yesterday on Animal Spirits. It's my transition as we're

00:13:27.900 | waiting on the next question to pop up. So, chill out. It's okay.

00:13:33.540 | Next up, we have, "Hi, Ben. In early January my portfolio was $150,000. In February I received

00:13:39.820 | $200,000 and did a lump sum investment into an index fund. Now I'm down 25%. Can I still

00:13:46.020 | reach my goal in 20 years from now, or did I make a mistake?"

00:13:50.260 | The important thing is here, nice job for you for more than doubling your portfolio

00:13:55.540 | with some sort of inheritance or bonus or whatever it is. Twenty years is a long time.

00:14:00.140 | I want to talk about process over outcome. So, there's this book, The Power of Habit

00:14:03.620 | by Charles Duhigg. It's seven or eight years old, probably. One of the better non-fiction

00:14:09.260 | books I've read in a while. He had this chapter on Tony Dungy. He was a former coach at the

00:14:13.660 | Tampa Bay Bucs, then he went on to win a Super Bowl in Indianapolis Colts. He talked about

00:14:17.620 | how when he first got to the Bucs, they were like a laughingstock. They were a terrible

00:14:21.940 | team. What he tried to instill in them was this idea of process over outcomes. Every

00:14:28.500 | day in practice, they would do the same thing over and over again. They said, "We don't

00:14:31.660 | care what everyone else does. We're going to do what we do, and we're going to do it

00:14:34.300 | well." Then they would get into the games, and that's stuff that they tried to hammer

00:14:37.420 | home in practice that guys wouldn't do. He'd ask his team, "You did this in practice every

00:14:42.100 | single day. Why did you do something different in the game?" The players would be like, "Well,

00:14:46.540 | I kind of felt like I had to step it up, and I had to really try harder. It was a critical

00:14:50.060 | play, so I went back to my gut instinct." He said, "No, no. This is the quote." What

00:14:55.740 | they were really saying was, they trusted our system most of the time, but everything

00:14:58.300 | was on the line. That belief broke down.

00:15:00.660 | I think thinking in terms of process over outcomes is really important when investing.

00:15:05.320 | You can't be outcome-oriented. Obviously, unfortunately, there is a scoreboard there.

00:15:09.900 | You can see, if you make a decision in an investment, you buy something, you sell something,

00:15:13.420 | you can see that you're either happy about it, or you regret it, or whatever, because

00:15:16.260 | that scoreboard is there. I think making these decisions like that, you use probabilities.

00:15:21.940 | If you decided that a lump sum was the best one for you, a decision at the time, I don't

00:15:25.780 | think you can say, "The stock market fell, so it was the wrong decision."

00:15:29.940 | I did this little list of what it means to be a process-oriented investor. I did a blog

00:15:33.980 | post about this in the past, and I kind of summarized it here. I think being process-oriented

00:15:38.340 | means that you diagnose problems before you prescribe solutions. A lot of people don't

00:15:42.620 | do this. They say, "This is exactly what you need to invest in right now, no matter what."

00:15:45.900 | I think that you can't give that advice to everyone. I think you have to focus on the

00:15:49.420 | present as opposed to fighting the last war. I think a lot of investors do that, and that's

00:15:52.720 | probably going to happen with inflation in the years ahead. People are going to be creating

00:15:55.820 | portfolios to fight inflation for years and years, even after it goes away or comes down.

00:16:00.780 | I think you have to have a plan in place instead of just having tactics. I think tactics sound

00:16:04.920 | great in the moment, and most of the time, they're useless unless they're not in the

00:16:08.760 | concert of a whole plan.

00:16:09.780 | They're usually, it seems like they're reactionary, usually, right?

00:16:12.900 | Yes. I don't think, that's not the way that you want to invest. Not everyone here is a

00:16:17.980 | hedge fund manager, right? Then I think you have to define your investing philosophy before

00:16:22.340 | implementing specific investment strategies. Again, I think if you decided at the time,

00:16:27.300 | "This was the best move for me," I don't think you can say, "The stock market goes up 20%,

00:16:31.380 | I was right. If it goes down 20%, I was wrong." Again, if you have 20 years, so my most famous

00:16:38.500 | blog post is about a guy named Bob who invested at the peak of the market every time. He made

00:16:42.460 | four invests over the course of his 40 years, and every one of them was at a peak. He still

00:16:46.180 | retired with a million dollars because he kept his money in.

00:16:48.500 | I think as long as you keep that 20-year time horizon in the stock market, even though you

00:16:53.340 | did it right before a bear market, you're going to be fine. You just have to wait it

00:16:56.820 | out a little. Patience is the ultimate equalizer when it comes to investing.

00:17:01.380 | Yes. It's something that is so personality-driven. I think it's hard for some people to wrap

00:17:05.980 | their heads around. Yes, it feels bad. When you're beyond or whatever, drops 50% over

00:17:13.620 | the course of a couple of months, you want to start making a bunch of moves and that

00:17:18.060 | kind of thing. In hindsight, I probably should have. Anyway, for the sake of the point, it's

00:17:23.340 | not necessarily the best option to be changing up your thesis every time a stock drops.

00:17:28.340 | Unfortunately, there's no 0% or 100% when it comes to investing. There's no always or

00:17:34.020 | whatever. It's always somewhere in between. You just try to make high-probability bets

00:17:39.900 | as much as you can. Sometimes it works, sometimes it doesn't. But I think that doesn't mean

00:17:43.380 | you give up on it because it's a high-probability bet and it didn't work out once.

00:17:47.260 | That's why I only pick winners now. That's easy.

00:17:51.020 | Up next, we have a question from Greg. "My wife has a six-figure IRA recently converted

00:17:57.620 | from an employer's 401(k). She won't be obligated to take RMDs, that's Required Minimum Distributions."

00:18:03.620 | Is that right?

00:18:04.620 | Lewis: That's right. You got it.

00:18:06.220 | "She won't be required to take those anytime soon, but in the interest of minimizing taxes

00:18:10.240 | over the long haul, would it make sense to transfer in kind some portion of the IRA balance

00:18:15.440 | into a taxable account and take the taxable income hit now, while the IRA's investment

00:18:20.100 | value -- target-day funds -- has been substantially reduced by the bear market?"

00:18:24.540 | Lewis: Let's bring in everyone's favorite tax advisor for this one, Bill Sweet.

00:18:29.460 | Bill, not many investors are looking to pay taxes ahead of schedule. Is a bear market

00:18:37.860 | the only time to do this, or do you simply allow those tax deferrals to compound and

00:18:42.860 | say, "Okay, I see what you're trying to do. You're trying to game the system, but it probably

00:18:46.300 | doesn't matter if you have a certain time horizon."

00:18:48.100 | Yeah, this is a great question from Mr. Fitz, but I want to start with where you guys started

00:18:52.740 | the show, talking about ferries to private islands, horses and carriages, Big Ben Parliament.

00:18:58.300 | Once again, with this Midwestern bias, looking down at us humble, purple-collar workers here

00:19:03.660 | in New York City, it hurts.

00:19:05.580 | Lewis: Hey, I'm saying, Mackinac Island, you would like it, because it used to actually

00:19:09.900 | be a fort. There's a lot of military history there.

00:19:12.380 | You're coming out of this.

00:19:13.380 | Well, now you're speaking my language. Yeah, a lot going on there in the French and Indian

00:19:16.960 | Wars. But no, I love this idea from Mr. Fitz, and I hate to just twist everything and take

00:19:22.700 | a listener's question and just modify it based on what I want to talk to, but I'm going to

00:19:26.060 | do exactly that right now. Ben, what's the tattoo on my back?

00:19:28.940 | Roth IRA.

00:19:30.180 | Roth IRA conversion. Why would you take assets in a tax-deferred account and convert them

00:19:35.100 | into taxable future dollars if you don't need the money right now, right? So this, to me,

00:19:39.340 | Mr. Fitz, this is the perfect scenario for a Roth IRA conversion, so let's talk about

00:19:43.460 | it.

00:19:44.460 | As you know, if we have a traditional IRA, a traditional 401(k), that is tax-deferred,

00:19:48.340 | right? You do not pay tax on any of that income until you distribute it out of the account,

00:19:53.500 | and that's what Mr. Fitz is contemplating here. What Roth conversions allow you to do

00:19:57.500 | is time when the taxes happen. Maybe you want to pay some of that tax now, as Mr. Fitz said,

00:20:02.380 | for one of two reasons. Let's say the market's declined. That's a pretty good reason to me

00:20:06.540 | if you expect to have a rebound in the future, or if your tax rate is low now, you expect

00:20:10.580 | it to be maybe a little higher later. That makes a lot of sense to me. And Ben, what

00:20:14.540 | has the last six months of investing been for your average investor? It's not been a

00:20:18.260 | fun time, right?

00:20:19.260 | Not great.

00:20:20.260 | Yeah, so I think this is a great opportunity for Mr. Fitz. And to sort of illustrate why,

00:20:25.660 | John, let's go to the charts, man. Let's do this thing. So this is a very quick scenario

00:20:30.140 | that I want to illustrate of, let's just say, a half-million-dollar account divided by 10

00:20:34.140 | if you have 50,000, multiply it times 10 if you're very fortunate. The math still works.

00:20:38.620 | So let's just say from 2021 to now, we had a 20% decline, right? I think that's more

00:20:43.260 | or less the median account, given what's happened here in the last year. And now we're 20% lower.

00:20:49.640 | So now we have this opportunity to convert. But let's say we don't convert. I want to

00:20:52.480 | lay that scenario out first. And then five years from now, just for hypothetical reasons,

00:20:57.040 | we distribute all the assets. What happens? Our account grows to $644,000. We have to

00:21:02.460 | eat $230,000 of deferred tax. That's $400,000 net after tax, right? Not a terrible deal

00:21:08.300 | in the grand scheme of things. Let's flip over to chart two.

00:21:12.180 | So all the same investment returns. The conditions are the same. The difference in this scenario

00:21:16.420 | is you convert half of the assets. You basically take $200,000 of your $400,000, you pay the

00:21:20.940 | tax now, you eat some of that now by $80,000, and then you distribute the entire balance

00:21:25.740 | again to get an apples-to-apples comparison after five years. You have now increased your

00:21:30.040 | after-tax return by almost 21% just by leveraging the tax code.

00:21:35.020 | All right. So my wife has a 401(k). She's been sitting on it for a while. I need to

00:21:43.780 | roll it over. I just haven't done it because inertia. So we need you to run the numbers

00:21:49.500 | for me on whether that makes sense when I roll it over to do a Roth conversion, or at

00:21:53.780 | least partial Roth conversion, right? I'll pay those taxes.

00:21:56.700 | We'll show you in the next episode. What I would need to know is how much is this

00:21:59.940 | private island costing you? That's the key question that I would need to understand.

00:22:05.740 | That's the key thing. I can't believe I missed this one. So the

00:22:07.780 | Roth is a way better option than going to some sort of taxable account?

00:22:11.660 | Yeah, definitely. Definitely. And this is a very common theme. I mean, nine out of 10

00:22:15.740 | questions, right, that I end up answering this show have to do with Roth conversions.

00:22:18.780 | So hence the tattoo. All right.

00:22:21.020 | How long until they crack down and stop this? Because it sounds too good to be true.

00:22:25.940 | I'm glad you asked that, Duncan. The answer to that is coming up later. But yeah, that

00:22:29.460 | was actually something that we were nervous about, that they would basically sort of stop

00:22:32.700 | this, particularly for high-income taxpayers. But it looks like the answer is no time soon.

00:22:36.540 | OK. All right. You're not going to believe this,

00:22:39.380 | though. This next question is about Roth IRAs. People love their Roth.

00:22:43.260 | Yeah, me too. All right. Up next, we have a question from

00:22:45.860 | Austin. "I'm 25 and fortunate to max out my Roth 401(k), HSA, and Roth IRA contributions

00:22:52.540 | each year through Vanguard, who is also my employer. I have $35,000 in pre-tax 401(k)

00:22:58.620 | holdings and $40,000 in a Roth. How can I best transition into more Roth exposure, especially

00:23:04.460 | in the IRA, since I plan to use these funds for first-time home purchases or expenses

00:23:09.700 | and a future college fund? Would converting traditional 401(k) to a traditional IRA and

00:23:14.540 | using a backdoor Roth conversion be the best option during this downturn? I understand

00:23:19.140 | five years is needed prior to withdrawal for backdoor route."

00:23:22.980 | First of all, Austin is my personal finance hero. He's a boglehead. He's maxing out his

00:23:28.060 | retirement accounts. I just want to remind Austin to enjoy some of your money, too. Don't

00:23:30.900 | save it all. But really nicely done at 25. Bill, since you're third born, is going to

00:23:35.820 | be named Roth Suite. I'm sure you can get on board with this one. But when do you think

00:23:40.660 | it's a good strategy to use Roth for these types of goals? So they're talking about first-time

00:23:44.460 | home expenses and future college funds. Does that make sense? Because I know you can take

00:23:48.220 | the contributions out tax-free. Is that a good savings vehicle for something like that?

00:23:52.380 | Yeah, it's interesting because it's really flexible. And I think that's the key benefit

00:23:56.420 | that you would have of using that in that, you're right, Ben, any basis that you have

00:24:01.300 | in a Roth IRA of your contributions, conversions are a little different. I'm going to talk

00:24:05.660 | about that in a second. But your contributions, you can access those completely income tax-free

00:24:10.780 | due to the very favorable ordering of how Roth IRA distributions occur on the tax code.

00:24:16.060 | I don't want to get too much into the details, but the idea is you can always get your basis

00:24:19.480 | back tax-free. And so if you use it for a home purchase, if you use those assets for

00:24:24.860 | a college or any other expense that you end up not paying any tax, you just have to leave

00:24:29.080 | the earnings alone. I think that's the key thing to think about. But time value of money,

00:24:33.340 | we do expect assets to appreciate over time. I don't think it's a bad strategy. The problem

00:24:37.680 | is if you have other tax advantage vehicles, I think you should consider those. I think

00:24:42.700 | I would use the Roth distribution as a plan, as a backstop, because ultimately that future

00:24:48.100 | tax-free compounding is very, very valuable. And as the taxpayer is realizing, it's hard

00:24:53.600 | to get assets into Roth. That's difficult. I have a couple of ideas for them, though,

00:24:57.340 | to talk about. But does that answer that question, Ben, that you asked about? Yeah. How? What

00:25:01.340 | are you thinking? So the first thing I would think about is like, look, we just went through

00:25:07.140 | the benefits of conversion, right? We don't have to discuss that anymore. I think in a

00:25:10.500 | down market and if you expect assets to rebound, you have a good thing going there. Let's talk

00:25:14.600 | about what we've in the past referred to super, mega, ultra, pick your moniker, Roth 401(k)s.

00:25:22.620 | And so $20,500 is the 402(g) salary deferral limit in 401(k) plans. However, there's another

00:25:28.600 | limit, $61,000, that applies to all the contributions, including your employer match. Vanguard, great

00:25:34.340 | company, great partner to Ritholtz Wealth Management. I'm a company man. We are big

00:25:37.720 | fans of Vanguard. Ben, has any company, I think, done more to kind of change the investing

00:25:41.760 | world than Vanguard? They're at the top of my list. No. I love Vanguard, yes. They've

00:25:45.240 | saved investors countless billions of dollars over the years, trillions maybe. I don't know.

00:25:49.200 | It's, yes. John Vogel is a saint. Yeah, more so the impact on, yeah, on, and they should

00:25:53.120 | be sponsoring Portfolio Rescue. We need to have a chat with the marketing folks. But

00:25:56.980 | moving that aside, the, some certain plans, certain 401(k) plans do allow you to contribute

00:26:02.100 | up to that $61,000 limit in excess of your salary deferral limit. The mechanics are a

00:26:06.900 | little funky, but the idea is if you can fund up to that 61(k), you do that, you immediately

00:26:12.140 | convert those assets to a Roth 401(k) if that's allowed, and now you've more or less tripled

00:26:16.760 | your 401(k) contribution every year. And the added benefit is that additional after-tax

00:26:20.980 | money, if you roll it over quickly, can be completely tax-deferred into a Roth, and then

00:26:25.500 | you can roll that into IRA. It's a really super-charged way. Not every plan offers it.

00:26:30.360 | I would sort of look at the Vanguard SPD to see if it's allowed. Given how smart Vanguard

00:26:34.860 | is, I would guess that it's allowed. So I would point the taxpayer in that direction.

00:26:38.340 | That's a great way to supercharge. The other quick answers, though, for college expenses,

00:26:42.700 | 529s are great. I'm in New York State. I get a $10,000 a year tax deduction if I max fund

00:26:47.820 | a 529. Many states offer that. And then all of the distributions are completely tax-free.

00:26:52.780 | You don't have to worry about threading the needle with things like, "What is my basis

00:26:56.480 | in this Roth?" which is very difficult when you get to the distribution phase.

00:27:00.860 | My eight-year-old tells me she's going to become a YouTube influencer someday, so she

00:27:03.580 | doesn't need a college fund anymore.

00:27:05.700 | Wow. That's aggressive. I would advise her to have a backup plan. Maybe get a CFA or

00:27:12.660 | something like that.

00:27:13.660 | Duncan asked about the Roth stuff potentially going on. I've heard that for years from people

00:27:16.420 | at WURT worried about that. So we had a surprise bill from the Democrats yesterday that included

00:27:20.540 | some tax provisions. Anything big or interesting to note in their bill?

00:27:24.980 | Yeah. So again, I think, Duncan, to answer your question before, this is what I was alluding

00:27:28.780 | to. The proposal, and it's just a proposal, we do have text that came out last night.

00:27:33.220 | You bet your bottom dollar, me and Bill Arts and our new hire, Tariq Silliman, were digging

00:27:37.900 | into that thing and chewing it up for breakfast.

00:27:40.780 | But it's more known that this bill, which it's a slimmed-down version of the Build Back

00:27:44.220 | Better bill. I think it's Build Back Biden, Build Back Better Back brought to you by the

00:27:47.580 | National Association of Chiropractors. This new bill is a very small version of it, and

00:27:52.780 | it's mostly what's not in the bill that's interesting. It does not extend SALT. It does

00:27:56.460 | not extend net investment income tax. It does not tax unrealized capital gains. It does

00:28:00.460 | not tax corporate buybacks, and it does not alter the Roth IRA framework, which is probably

00:28:05.860 | good for investors who want to use this.

00:28:08.060 | A couple of neat goodies. It does extend Obamacare ACA subsidies for another couple of years.

00:28:14.220 | Taxpayers are probably looking at a 10 percent increase instead of a 30 or 40 percent increase,

00:28:17.300 | so that's great for the 14 million Americans who are participating there.

00:28:21.800 | Interesting thing, electric vehicle extension credits, but these new ones are income-limited,

00:28:27.060 | and that's interesting. Energy credits for your house, a couple of goodies here, but

00:28:31.940 | a lot of the more pernicious changes happen on the corporate side, which is probably not

00:28:37.540 | the purview of your average portfolio rescue listener.

00:28:41.140 | Nothing huge as far as taxes go for individuals.

00:28:43.140 | No, and I think compared to the Secure Act of 2019 compared to TCGA in 2017, I wouldn't

00:28:48.700 | say it's a snoozer, but not a lot of headlines here if you're not planning on buying an electric

00:28:52.900 | vehicle.

00:28:53.900 | No help for homeowners on the coasts, right, for the SALT tax?

00:28:57.220 | Yeah, and Joe Manchin very much against private island trade that's coming out of pocket for

00:29:01.620 | the Carlson family.

00:29:02.620 | Hey, I live in a flyover state where housing is actually affordable.

00:29:05.260 | Midwest bias, again, Midwest bias, just raining down on us.

00:29:10.700 | Sounds like a dream.

00:29:11.700 | All right. Reminder, remember, again, next week, no show. Duncan's going to be Abbey

00:29:18.180 | Road.

00:29:19.180 | No nothing except for Animal Spirits next week, right?

00:29:20.180 | Animal Spirits will be the only thing. We'll be carrying the compound next week. Duncan's

00:29:22.740 | going to be gone. I'm going to be gone.

00:29:24.860 | Private Island tweets and tweets of Duncan swinging from Big Ben. Is it still 1,000 degrees

00:29:30.020 | in the UK right now?

00:29:31.020 | I think it is. Yeah.

00:29:32.020 | Wow.

00:29:33.020 | Good luck with that. Duncan, have fun spending some money over there. If you're listening

00:29:37.060 | in podcast form, give us a review on YouTube. Leave us a comment. Leave us a question. Maybe

00:29:42.200 | we'll use it on a future show. If you want to email us, askthecompoundshow@gmail.com.

00:29:47.380 | For some of that compound merch, idontshop.com. Remember, there's the Ben doesn't drink coffee

00:29:51.180 | mug. Still never had a cup in my life. It's not changing. Keep those comments and questions

00:29:55.580 | coming.

00:29:56.580 | We're going to change that one day.

00:29:57.580 | We'll see you in--

00:29:58.580 | Maybe at Future Proof. Will you drink a cup of coffee at Future Proof maybe?

00:29:59.900 | Never. I've got to keep my ref up, Duncan. I can't say that anymore. At this point, I'm

00:30:03.980 | just--

00:30:04.980 | Yeah, that would be like me not pitching a Roth ARE conversion. It ain't happening.

00:30:07.500 | That's true. All right. Thanks, everyone. We'll see you in a couple of weeks.

00:30:10.220 | See you, everyone.

00:30:27.860 | you

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