Bogleheads University 101 2023 - Investing Basics Q&A

00:00:00.000 | [ Applause ]

00:00:06.400 | Okay. So we have a bunch of questions that have come in.

00:00:11.400 | Alan, Mike, and Christine will be answering them.

00:00:15.600 | And we're going to try and go through them fairly quickly

00:00:19.600 | because there's quite a bit.

00:00:23.600 | So starting off, we have a question

00:00:25.800 | as to why ETFs are considered more tax efficient

00:00:29.500 | than mutual funds.

00:00:30.800 | And I guess I would add to that,

00:00:33.400 | are there particular asset classes or types of assets

00:00:37.100 | where that difference is significant or not significant?

00:00:42.400 | >> The reason gets pretty technical.

00:00:45.700 | Also, this reason, by the way, doesn't apply to Vanguard.

00:00:48.300 | You can ignore it for Vanguard.

00:00:49.400 | Because with Vanguard specifically,

00:00:51.200 | and this might change in the near future,

00:00:53.500 | as Vanguard had a patent on a way of creating their funds.

00:00:57.700 | That patent expired, so now other companies are copying it.

00:01:00.700 | And so at Vanguard, the ETFs

00:01:03.500 | and mutual funds are literally the same fund.

00:01:05.700 | They're just different share classes.

00:01:07.100 | So the taxes are going to be the same.

00:01:08.700 | So at Vanguard, it's not true

00:01:10.900 | that ETFs are more tax efficient than mutual funds.

00:01:14.200 | At other companies, it often is.

00:01:16.200 | And the reason for that is when a mutual fund needs

00:01:21.300 | to raise cash, it has to sell stuff often.

00:01:26.000 | And the mutual fund often has to raise cash

00:01:29.100 | whenever investors sell shares of the fund.

00:01:31.600 | So investors sell shares of the fund, which happens sometimes.

00:01:34.200 | So the fund has to sell stuff.

00:01:35.700 | So you've got capital gains.

00:01:37.400 | And then the remaining shareholders are stuck

00:01:39.700 | with the tax bill for those capital gains.

00:01:42.300 | With an ETF, that's not how it works.

00:01:45.000 | With an ETF, we have what we call authorized participants

00:01:49.600 | who are huge, like investment banks, Goldman Sachs, Chase,

00:01:53.500 | things like that, and the fund company can basically swap giant

00:02:01.000 | shares of the ETF -- so this is a bit of a simplification --

00:02:04.600 | giant shares of the ETF for securities with one

00:02:08.000 | of those other companies.

00:02:09.800 | And when they do that, that's a way to --

00:02:14.100 | they can raise cash without having to sell something.

00:02:16.900 | They can hand over the securities to another company,

00:02:22.000 | and that's not considered a taxable event, essentially.

00:02:26.600 | And they can, in fact, pick the securities

00:02:28.700 | that have the lowest cost basis.

00:02:30.600 | So those would be the ones

00:02:31.900 | that if they sold them they would have the highest gains.

00:02:33.400 | So they can just kind of periodically get rid of those

00:02:36.100 | without actually having to pay tax.

00:02:37.700 | And so it's just like a neat trick that ETFs have

00:02:40.000 | that mutual funds don't, although we're probably going

00:02:43.100 | to see that change as other companies copy the thing

00:02:45.300 | that Vanguard's doing.

00:02:46.600 | >> Okay. I think that was a great way

00:02:47.900 | of dealing with a complicated topic.

00:02:50.000 | Alan, you spoke about selling high and buying low.

00:02:54.700 | The question is how do you know when to rebalance a portfolio?

00:02:59.600 | >> You know, as long as you rebalance, it's a good thing.

00:03:02.300 | Some people say every six months, every year, whatever.

00:03:05.500 | My personal opinion is to set a tolerance.

00:03:08.800 | So, for instance, if you set a 60% stock portfolio,

00:03:13.800 | you might want to set a tolerance

00:03:15.400 | of six percentage points.

00:03:16.800 | Below 54, you have to buy.

00:03:19.300 | Above 66, you have to sell.

00:03:22.400 | Now, the main reason to do that is

00:03:24.100 | so that you're keeping your risk level relatively constant.

00:03:28.800 | Now, it happened to work out brilliantly

00:03:31.000 | because of the March 2020.

00:03:33.400 | Between February 19th and March 23rd,

00:03:36.400 | 33 days in 2020, stocks fell 35%.

00:03:41.000 | As I mentioned, I was out of tolerance.

00:03:43.500 | I had to buy.

00:03:45.000 | I'd be lying through my teeth if I said it was easy.

00:03:48.200 | So, as long as you rebalance, I think it's a good thing.

00:03:51.100 | I personally believe in setting a tolerance

00:03:53.900 | so that on average, it's once or twice a year.

00:03:59.600 | >> Okay. We had a question talking about index funds.

00:04:05.400 | But we know, we all see, that there are always some funds

00:04:10.300 | that beat the market in any given year and sometimes for longer.

00:04:13.500 | So, why not choose the funds that beat the market?

00:04:17.600 | >> If I had a crystal ball, I would.

00:04:19.400 | I would also be a billionaire.

00:04:21.400 | There's no persistence.

00:04:22.900 | And Bill Miller's value trust beat the S&P 500 for 25 years

00:04:29.500 | in a row and he ended up losing more people

00:04:31.500 | than he ever made for others.

00:04:34.400 | >> I can just add a little bit of color to that.

00:04:38.000 | We have a ton of data at Morningstar.

00:04:39.600 | And when we mine that data to look at the factors

00:04:42.500 | that contribute to good or bad fund performance,

00:04:44.900 | it comes back to costs much more than performance.

00:04:48.400 | And so, index funds have that built-in advantage

00:04:51.700 | of very low costs.

00:04:53.200 | Costs also tend to be persistent.

00:04:55.100 | If a fund has low costs, it tends to continue to have low costs.

00:04:59.100 | And so, the benefits accrue to index funds for that reason.

00:05:03.500 | I would also say as a caveat, when we slice and dice our data,

00:05:08.200 | what we see when we look at the subset of active funds

00:05:11.400 | that have very low costs,

00:05:12.700 | so I would add Vanguard's active funds into the mix,

00:05:15.700 | we start to see a much more competitive universe.

00:05:19.600 | So, if you do want to own some active funds around the margins

00:05:23.300 | or, you know, even as core holdings,

00:05:25.200 | I would just do yourself the favor of starting

00:05:27.800 | with the very inexpensive subset.

00:05:30.500 | Because that is-- at least that group has a fighting shot

00:05:34.600 | at performing reasonably well relative to an index fund.

00:05:39.300 | >> This one is for Mike Piper.

00:05:40.700 | Can you talk about when you should consider converting funds

00:05:45.900 | from a traditional IRA to a Roth,

00:05:48.300 | given that you'll need to pay taxes when you do that?

00:05:51.000 | Should it be during the accumulation years

00:05:53.600 | or during retirement years?

00:05:55.700 | >> Yeah. So, a Roth conversion is when you take money

00:05:58.700 | from a tax-deferred account and you move it to a Roth account.

00:06:01.900 | And when you do that, you have to pay tax on the money

00:06:04.200 | that you move over.

00:06:05.600 | And the general idea is that you would do

00:06:07.400 | that whenever your income is unusually low,

00:06:10.400 | because an unusually low income typically means an unusually

00:06:13.200 | low tax rate.

00:06:14.500 | And so, the idea is you're taking advantage now

00:06:17.100 | of this temporarily low tax rate that you have.

00:06:20.400 | Pay tax now at this low tax rate on a part

00:06:22.900 | of the tax-deferred money.

00:06:24.800 | Then it's in a Roth account going forward

00:06:26.300 | and you don't have to pay taxes on it later.

00:06:27.700 | So, most of the time, the times

00:06:30.100 | that we have an unusually low tax rate

00:06:31.900 | in our lives are we've retired

00:06:34.700 | and Social Security hasn't started yet.

00:06:37.100 | That's the typical window.

00:06:38.400 | There are some years during the accumulation stage

00:06:40.700 | where you might have an unusually low tax rate,

00:06:42.500 | like if you take a sabbatical or something like that.

00:06:44.500 | But typically, Roth conversions are more likely

00:06:46.600 | to be a retirement tax planning tool.

00:06:49.900 | >> We had a question about something

00:06:51.600 | that was mentioned almost in passing at the session.

00:06:54.800 | What is factor investing?

00:06:57.400 | >> Can you hear me?

00:07:05.900 | Okay. It's active investing.

00:07:09.100 | It's picking certain stocks that you think will outperform.

00:07:13.700 | So, for instance, small companies

00:07:15.900 | and value-beaten-up companies had a very long history

00:07:19.900 | of beating the market.

00:07:21.200 | Again, that was backward-looking.

00:07:24.600 | And it did not work going forward.

00:07:26.800 | And by the way, it was never billed by Eugene Fahm

00:07:30.200 | and Ken French as a free lunch.

00:07:32.300 | It was compensation for taking on more risk.

00:07:35.200 | And that risk has really shown up.

00:07:37.600 | And the only way to guarantee that you're going

00:07:40.500 | to get the full return of the market

00:07:42.000 | and beat most investors is to have every factor.

00:07:45.900 | So, in other words, not tilt, own every stock,

00:07:49.100 | taking all the knowledge of the investors

00:07:52.900 | and buying a total stock index fund or total international.

00:07:57.000 | >> I would just add a quick point on that front.

00:08:00.000 | I agree with everything Alan just said.

00:08:02.400 | One subset that I'm interested in from the standpoint

00:08:06.300 | of factor investing would be kind

00:08:08.300 | of a dividend growth strategy.

00:08:10.300 | So, Vanguard has a couple of great funds in this realm,

00:08:14.000 | Vanguard Dividend Appreciation, which is the pure index fund,

00:08:17.200 | and Vanguard Dividend Growth, which is an active fund.

00:08:19.700 | And the reason why I find them intriguing,

00:08:22.200 | especially for retirees or people who are moving

00:08:24.600 | into draw-down mode, is that they have a pattern

00:08:26.900 | of much lower volatility, not much,

00:08:29.100 | but meaningfully lower volatility than the total market.

00:08:32.800 | So, I feel like if they help a retiree make peace

00:08:36.300 | with the equities that they should have

00:08:38.500 | to outrun inflation over time, I feel like, you know,

00:08:41.600 | maybe adding a bit of that

00:08:44.200 | to a total market index is not a bad factor to tilt toward

00:08:48.800 | because it is a way to bring down the volatility

00:08:53.300 | in the portfolio.

00:08:54.000 | This tends to be a higher quality subset

00:08:56.700 | of the whole market.

00:08:57.800 | So, that would be one factor that I would be like,

00:09:00.600 | "Eh, that kind of makes sense to me."

00:09:05.200 | >> And a somewhat related question,

00:09:07.900 | what are your thoughts on market-weighted

00:09:10.100 | versus equal-weighted indexes?

00:09:13.100 | >> It's active investing.

00:09:16.800 | It was really hot a long time ago.

00:09:18.900 | It is really underperformed.

00:09:21.200 | Guess what?

00:09:22.000 | It's something like well over a quarter

00:09:25.200 | of the US stock market are now in the fantastic seven.

00:09:29.100 | The conventional wisdom was

00:09:30.500 | as large cap growth companies were way overvalued.

00:09:34.700 | Guess what had just about all of the return

00:09:37.600 | of the global stock market this year?

00:09:40.400 | Those seven.

00:09:42.800 | >> So, just to be clear, you're saying

00:09:44.500 | that an equal-weighted index is active management

00:09:48.200 | because it's not following the market weight.

00:09:51.400 | >> Yeah, exactly.

00:09:52.300 | Because you're underweighting the Apple and Alphabets

00:09:57.100 | and NVIDIA and underweighting those that are at the bottom.

00:10:02.500 | I'm sorry, overweighting those that are at the bottom.

00:10:04.800 | So, in other words, passive investing is taking all

00:10:08.000 | of the knowledge of millions of investors around the world

00:10:12.000 | and harnessing that knowledge and guaranteeing

00:10:14.700 | that you're going to beat most people in that stock market.

00:10:20.000 | I'm not opinionated.

00:10:23.400 | >> A question for Mike on 529 plans.

00:10:27.200 | Can you invest in what you want in a 529 or is it only

00:10:31.400 | in predefined portfolios?

00:10:33.800 | >> It's generally going to be predefined portfolios.

00:10:36.400 | So, firstly, there's state-specific plans

00:10:40.600 | and sometimes you might have some state tax benefit

00:10:46.100 | for contributing to the plan that is run by your state.

00:10:48.600 | Like maybe you get a state tax credit.

00:10:50.400 | And so, then you're kind of just stuck

00:10:52.200 | with whatever investment options that they provide.

00:10:54.800 | Otherwise, you can, if there isn't a state tax benefit

00:10:58.400 | that you're trying to get, then you can pick any 529 plan.

00:11:02.100 | And so, while you can't literally invest in anything

00:11:05.100 | in the plan because you're still limited

00:11:06.500 | to whatever options they make available, the fact

00:11:08.900 | that you can pick from so many different plans sort of means

00:11:12.400 | that you could pick whatever you want.

00:11:15.400 | >> Thank you.

00:11:16.500 | Here's a sort of a specific scenario,

00:11:19.100 | but I think maybe it has broader implications as well.

00:11:22.500 | The question is my husband and I will have two kids

00:11:25.400 | in college for a two-year overlap.

00:11:28.000 | We have stocks that have done well over time.

00:11:30.900 | If push comes to shove and we need dollars for tuition,

00:11:34.900 | do we sell the stocks or do we take out a loan?

00:11:40.900 | >> I would say evaluate the tax consequences,

00:11:43.400 | but my bias would be to, especially

00:11:46.900 | with interest rates going up and loans getting more,

00:11:49.800 | much more expensive than they were, my bias would be to use

00:11:55.400 | that appreciation to help pay for school.

00:11:59.600 | >> I would concur.

00:12:00.400 | I mean, it does depend.

00:12:01.800 | Investing is simple, taxes aren't.

00:12:03.500 | It depends on a whole lot of things.

00:12:05.400 | But, in general, you would not want

00:12:07.400 | to take out a loan, in my opinion.

00:12:10.800 | >> Okay.

00:12:12.000 | [ Inaudible ]

00:12:17.100 | >> Yeah, there are some tax strategies

00:12:19.100 | like gifting if the kids aren't on your tax return.

00:12:23.900 | And they may be in a 0% long-term capital gains rate,

00:12:27.100 | and that's a wonderful strategy.

00:12:29.300 | But there are just zillions of permutations

00:12:31.600 | and combinations of tax strategies.

00:12:34.500 | >> One thing, it wasn't super clear from the phrasing,

00:12:37.100 | but it sounded like maybe the stocks there are individual

00:12:39.800 | stocks, in which case, if that is the case,

00:12:43.300 | I'd be extra inclined to say, hey, this is a great excuse

00:12:46.500 | to diversify away from that,

00:12:48.100 | to eliminate that risk in our portfolio.

00:12:50.600 | >> Or an expensive active fund.

00:12:54.100 | >> Which relates to the next question, is if someone wants

00:12:58.900 | to lighten up on their high-fee funds and move the money

00:13:04.600 | into low-cost funds, such as Vanguard index funds,

00:13:09.000 | how do you manage a transition like that?

00:13:13.000 | >> Carefully.

00:13:14.100 | You want to look at marginal tax brackets.

00:13:16.500 | You want to look at how expensive those active funds

00:13:19.600 | are, you want to look at, you know, all the details

00:13:23.500 | of the taxes that you're going to pay.

00:13:24.900 | Now, and it's really a timing issue,

00:13:26.700 | because eventually you're going to pay taxes unless you die,

00:13:30.100 | and step up basis.

00:13:32.400 | So, it's a security by security analysis.

00:13:35.800 | And a lot of what I do are the, you know,

00:13:39.800 | trying to deal with the complexities

00:13:42.000 | of moving towards simplicities and lower costs.

00:13:45.200 | >> Can I just jump in, too?

00:13:46.300 | I would say, you know, obviously, if it's,

00:13:48.500 | or maybe not obviously, if it's in some sort

00:13:50.300 | of tax-sheltered account, just prune away

00:13:53.400 | at that high-cost investment and not worry about it,

00:13:56.700 | because you won't pay taxes to make that trade.

00:14:00.400 | The other thing I would say about high-cost active funds is

00:14:03.600 | that many of them have been serial capital gains

00:14:06.500 | distributors, especially active funds.

00:14:09.300 | And so, if you've been receiving those distributions and having

00:14:14.000 | to pay taxes on them, you're able to step

00:14:16.700 | up your cost basis to reflect that.

00:14:19.900 | So, you may have sort of, it's not ideal, but you may have kind

00:14:23.000 | of prepaid your tax bill that would be due

00:14:25.600 | on making those changes.

00:14:27.800 | So, check your cost basis to see where you are, and you may find

00:14:33.300 | that you're fairly close to the fund's current NAV, and selling

00:14:38.200 | and getting into a lower-cost investment portfolio might also

00:14:42.600 | be tax-efficient going forward,

00:14:44.900 | and it will also potentially not cost you

00:14:47.900 | that much in terms of a tax bill.

00:14:49.700 | >> Okay. I want to thank the three of you very much

00:14:52.400 | and give us a few minutes to wrap

00:14:54.500 | up with a few final remarks from Christine.

00:14:57.600 | [ Applause ]

00:14:59.400 | >> Well, thanks, Karen.

00:15:00.400 | I want to thank all of you for being here for day one

00:15:03.400 | of Bogleheads University.

00:15:04.700 | I want to thank all of our instructors,

00:15:06.800 | and just have a couple of parting comments.

00:15:10.300 | One is that we have a cocktail reception in an hour,

00:15:13.900 | so starting at 5 o'clock, it'll be in this room,

00:15:17.000 | but the hotel staff will get it all changed

00:15:19.500 | out to suit a cocktail reception.

00:15:22.700 | We'll have someone at the door handing out tickets.

00:15:25.100 | Each person will get one drink ticket

00:15:28.100 | that you can use however you see fit or give it away

00:15:30.500 | if you don't want it, and then we will switch to a cash bar

00:15:34.000 | if you want additional drinks beyond that one drink ticket.

00:15:37.600 | So just grab your ticket when you come in,

00:15:40.900 | and I think that's all I had.

00:15:43.400 | Thank you all for being here today.

00:15:45.200 | We really appreciate it.

00:15:46.800 | [ Applause ]

00:15:49.800 | [ Background Sounds ]

Bogleheads University 101 2023 - Investing Basics Q&A

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