How Do I Max Out My Retirement Accounts?

00:00:00.000 | We'll come back to Portfolio Rescue, where we take questions straight from you, the viewers.

00:00:20.360 | Duncan, it feels like there's a lot of people drowning these days in the markets. I have

00:00:25.940 | two main questions people need to ask themselves right now. This is Ben Carlson's two-part

00:00:32.260 | risk tolerance questionnaire. I don't have a big list of questions, I've got two. When

00:00:36.040 | do I need the money? How much can I afford to lose in the meantime, both mentally and

00:00:40.360 | financially, before you cry uncle and have to tap out? I think every decision you make

00:00:44.820 | when investing more or less branches off of these two questions. Unfortunately, it's way

00:00:49.660 | easier to answer these questions in a bull market than a bear market, because our perception

00:00:54.280 | of risk changes in up markets and down markets. There was a study done where they looked at

00:00:59.500 | professional institutional investors and how they felt about the market being either overvalued

00:01:03.540 | or undervalued based on the weather. And when it was cloudy outside, more institutional

00:01:08.000 | investors were apt to say, "The markets are overvalued." And when it was sunny outside,

00:01:12.180 | they were more apt to say, "It's undervalued." And it actually showed that they traded more

00:01:16.340 | when things were cloudy than when they were sunny.

00:01:18.340 | Interesting.

00:01:19.340 | So, I guess maybe there needed to be more traders in California.

00:01:21.100 | I guess it makes sense, right? You're inside more, I guess.

00:01:24.320 | Yeah. Yeah. See, this is why I live in Michigan, because it's crappy part of the year and I

00:01:28.480 | have to balance things out a little bit. But this is why I think it's so important to not

00:01:31.920 | only have an investment plan in place, that seems obvious to most people, but I think

00:01:35.520 | this is also why you need rules in place to guide your actions. You need to set good decisions

00:01:40.240 | ahead of time, beforehand, so you're not making these decisions right now. Because if you're

00:01:44.240 | trying to come up with a plan on the fly right now, it's going to be way harder, because

00:01:49.040 | your emotions are either good or bad. They are. That's what makes us human. So, you can't

00:01:54.640 | really ignore those emotions and push them to the side. They're going to happen regardless.

00:01:58.480 | I was out jogging the other day, and I jogged through this neighborhood, and there was a

00:02:03.200 | kid running out of his house. I think he must have been trying to get to his parents' car

00:02:06.240 | or the bus or something. And you know when you see something out of your periphery? And

00:02:09.560 | this kid is running right at me. He didn't see me. And he's about to run into me. He's

00:02:13.560 | about three feet away. And you know you get your fight or flight instinct? I kind of did

00:02:18.100 | this and jumped. And the little kid looks at me like, "What are you jumping for, dude?"

00:02:21.400 | And it's like, because I thought I saw danger coming out of the savanna or whatever. So,

00:02:25.400 | like those emotions you have, that flinch reaction is going to be real. So, if you don't

00:02:29.560 | have something in place ahead of time that's rules-based that you can follow, come hell

00:02:33.040 | or high water, I think it's really difficult to invest in a market like this. That's just

00:02:36.680 | all over the place. One day, it seems like things are fine. The next day, it's things

00:02:39.560 | like, "Okay, the world is coming to an end again." It's just really tough if you don't

00:02:43.720 | have a process in place.

00:02:45.080 | See, I think I was that little kid, but I never looked up and I ran right into the street.

00:02:51.260 | That's how I feel.

00:02:52.460 | I think I saved his life. All right, remember, if you have a question, askthecompoundshow@gmail.com.

00:02:56.940 | Let's get into our first one.

00:02:59.220 | Okay. So, first up, we have the following. "I'm 50 years old and just started investing

00:03:05.020 | for the first time in February. I was promptly kicked in the private parts as a welcome to

00:03:09.100 | the party from the stock market. With little to no knowledge of investing, it looks like

00:03:13.940 | ETFs and index funds are safer than individual stocks. Is this the way to go for newbie investors

00:03:18.700 | like me who really don't know anything more than the basics, or is it better to be buying

00:03:22.600 | the dip in individual stocks now and holding for the next 10 years?"

00:03:26.020 | Hey, whoever this is, tell them to send us their address. Send them a copy of my book,

00:03:30.580 | because I have a whole chapter here about starting late. So, start at 50. My advice

00:03:34.420 | is, it's not really the end of the world. You can still do it. You just have to remember

00:03:37.760 | that saving matters more than investing. So, I think it's the perfect time for this kind

00:03:41.340 | of talk. If you just started investing at 50. The first thing to understand is that

00:03:45.940 | professionals have a much harder time beating the market than almost anyone, right? So,

00:03:51.080 | if professionals can't do it, according to Standard & Poor's, the 10 years through the

00:03:54.700 | end of 2021, 86% of all domestic stock mutual funds underperformed their benchmark.

00:03:59.260 | These people do this for a living. They went to good schools. They got their CFA designation.

00:04:03.000 | They look at this stuff all the time. They're talking to company management. They're doing

00:04:05.780 | channel checks and supply chain checks, and they still underperform the market. I understand

00:04:10.760 | why people want to pick stocks. It's fun. I mean, it's not fun now, but it can be fun

00:04:15.140 | when things are going up. It's entertaining. It can help you learn, but it's not easy.

00:04:19.100 | I think a lot of people are finding that out right now, because Duncan, we're frankly getting

00:04:22.580 | a lot of questions from people who are realizing this and saying, "Hey, I thought I was going

00:04:25.100 | to be a stock picker. I'm not." I think everyone has to go through that in some way. I thought

00:04:28.060 | I was going to be ... I read The Intelligent Investor when I first started investing. I

00:04:31.340 | thought I was going to be the next Warren Buffett or Charlie Munger. It's not easy.

00:04:36.540 | Index funds, listen, they're boring, right? But boring is beautiful when it comes to investing.

00:04:40.140 | So what do you do? I have a three-word plan for this person. Dollar, cost, average. That's

00:04:45.920 | it. This is the perfect market for it, right? The market is down and it's extremely volatile.

00:04:49.140 | It's all over the place. This is the perfect environment to add to your account periodically.

00:04:53.660 | And especially if you're 50 years old, and you have 10, 15, maybe 20 years left to really

00:04:59.200 | jumpstart your savings and your retirement, your savings are going to matter way more

00:05:02.220 | than your retirement, than your investment returns, because you don't have as much time

00:05:05.520 | to go out compounding to kick in. So, let's say you decided to put $100 a week every Friday

00:05:10.640 | into the S&P 500. It started this year. No matter what, you're a buyer. Put up the first

00:05:15.380 | chart here, John. The amounts don't matter, but this is SPY. Just put in the S&P 500 index

00:05:20.620 | fund. This is the amount of shares that $100 would have bought. You can see it's going

00:05:24.720 | up over time. And the number of shares isn't important here, but the only thing that matters

00:05:30.300 | here is that it's going up. And that's the great thing about dollar, cost, averaging,

00:05:35.060 | is that in a down market, you're going to be buying more shares. You were talking about

00:05:38.060 | this a couple of weeks ago, Duncan, maybe last week, right? That you're paying more

00:05:41.800 | attention to your shares than everything. That's the beauty of dollar, cost, averaging.

00:05:44.780 | All right. I wrote this one in April, 2020, about like when dollar, cost, averaging matters

00:05:49.180 | the most. So, John, pull up this other chart about dollar, cost, averaging. I wrote this

00:05:52.700 | in April, 2020. So, the numbers will be higher now, but I just said, let's say you put $100

00:05:57.100 | a month every month, starting in 2007 through 2020. And then this graph shows the growth

00:06:03.220 | of each of those $100 purchases. How much did it turn into? So, each of those one individual

00:06:07.940 | dollar, cost, averaging purchases into the stock market, the S&P, what did it grow into?

00:06:11.980 | You can see the spike there in 2008 and 2009, when you were buying towards the bottom. But

00:06:16.960 | even as you were buying into the teeth of it, the growth of those dollars is much higher.

00:06:21.640 | You can see it goes down over time because the stock market was going up and you're buying

00:06:24.220 | fewer shares. And again, this is into the teeth of the March 2020 correction, so these

00:06:28.900 | numbers would all be higher. But the beauty of dollar, cost, averaging is that you're

00:06:32.340 | diversifying across time, you're diversifying across market environment and economic environment.

00:06:36.420 | And the other thing to remember is that most normal people, dollar, cost, average, not

00:06:40.060 | because they want to, but because they have to, because they're saving out of their paycheck.

00:06:43.340 | And then they naturally invest periodically over time. And that's a good thing, because

00:06:48.660 | it's a really hard strategy to beat when you're just buying periodically. And when markets

00:06:52.460 | are high, you're buying fewer shares and markets are low, you're buying more shares. And guess

00:06:56.220 | what? Right now you're buying more shares. That's actually a good thing. So, instead

00:06:59.980 | of trying to outsmart the market and pick stocks and jump in and out right now, just

00:07:04.860 | pick a timeframe. Every two weeks, every week, every month, whatever it is, I'm going to

00:07:09.340 | be buying stocks. And that's the rules-based part of this I was talking about, where you

00:07:13.580 | can shut your brain off a little bit and worry about other stuff because you know you have

00:07:16.500 | this plan in place to just buy, buy, buy over time. And over the long term, that's a really

00:07:20.980 | hard strategy to beat.

00:07:22.100 | Right. And yeah, I mean, this is one of those things where people overthink it too. People

00:07:26.580 | are like, "Well, aren't there certain days of the week that are better traditionally?

00:07:29.800 | Certain months of the year that are better?" And I feel like people sometimes really, really

00:07:33.700 | overthink the dollar-dollar strategy.

00:07:34.860 | We got a question from someone a couple weeks ago that was like, "Listen, on the 15th of

00:07:39.380 | every month and the last day of every month, aren't there a bunch of 401(k) purchases?

00:07:43.260 | So, what if I invested ahead of those and tried to get ahead?" And it's like, if that

00:07:47.140 | stuff's not already priced into the market, I'm sorry. And if Jim Simons hasn't figured

00:07:51.020 | it out yet, then you're probably not going to. But yeah, I think trying to overthink

00:07:55.260 | these things and make it more complicated.

00:07:57.220 | The beauty of dollar-cost averaging is that it's simple. Right? It doesn't require a lot

00:08:01.020 | of heavy lifting on your brain. And that's what you need right now. You want to give

00:08:04.300 | your brain a break during markets like this, because you're in that tense position, like

00:08:08.460 | I was when the little kid was running after me and I was running for my life.

00:08:13.180 | Speaking of which, did you see, talking about the timing, Eric Balchunas shared the other

00:08:18.100 | day that there's a new ETF that is literally buying at the close and selling at the open.

00:08:23.260 | Like, that's what the strategy behind the ETF is. It's kind of interesting.

00:08:28.340 | That's a problem. I always say that complex solutions don't require complex problems.

00:08:33.420 | And the market at times is very complex. Right now, I've been saying for recent weeks, if

00:08:37.460 | you're not confused, then you're not really paying attention. And it's very confusing

00:08:41.260 | right now, what's going on. And so, I think in that instance, it's not like you want to

00:08:45.180 | press and try harder and make things more complicated. You want to actually simplify

00:08:48.620 | and make things easier.

00:08:49.620 | Right.

00:08:50.620 | We have another one.

00:08:53.540 | Okay. Up next, we have a short and sweet one, but probably one that's going to piss some

00:08:57.380 | people off.

00:08:58.380 | "The data against crypto being an inflation hedge has been mounting for over a year now.

00:09:02.780 | Can we finally put the argument to bed and call it a myth?"

00:09:05.700 | Alright. John, throw up the chart here first of inflation rate vs. Bitcoin vs. gold. Because

00:09:10.580 | I think we have to pull gold in here a little bit, too. So, over the last year, you can

00:09:15.220 | see inflation is 8.3%. Bitcoin is down 35%, call it, depending on how you look. Gold is

00:09:22.420 | down 3% over the last year. So, finally, we get the highest inflation we've had in 40

00:09:27.860 | years. Inflation finally bursts out. And what everyone wanted to think was an inflation

00:09:32.220 | hedge, gold and Bitcoin, haven't really worked that well. Gold worked for a little bit. Bitcoin,

00:09:36.700 | for a little bit. It's not really happening.

00:09:38.260 | I think the problem here, of course, some people are trying to dance on the grave of

00:09:42.660 | Bitcoin and say, "Haha, we told you." But, crypto is a risk asset. It's still relatively

00:09:47.260 | new. It's still almost in the growth/startup phase. So, I think that's part of it that

00:09:54.100 | I think a lot of people are realizing. It's like, okay, when risk happens, then this stuff

00:09:57.740 | is going to get hit, too. That shouldn't surprise too many people.

00:10:02.420 | There's this old saying that -- I want to talk about gold again real quick, because

00:10:05.060 | I think gold and Bitcoin are a good analogy here. It took gold a while to get to that

00:10:09.460 | point where it was this really store of value. But there's this old saying that an ounce

00:10:11.940 | of gold could buy a fine men's suit when Jesus walked the earth, and it can still do so now.

00:10:16.940 | I think if you go to a men's warehouse, you can buy six of them for one.

00:10:20.140 | But, John, show the real gold price since 1980 here. This is inflation-adjusted gold

00:10:26.300 | since 1980. You can see the high in, I think, 1981. We're still below those same levels

00:10:30.620 | on an inflation-adjusted basis. So, even over the long term, gold has been a great store

00:10:34.860 | of value, but that long term can be really, really long. So, it doesn't always work like

00:10:40.060 | this. I think sometimes there's these misconceptions about assets like this. The problem is, especially

00:10:44.220 | over the short term, there's really no asset that gives you one-to-one inflation hedge.

00:10:48.420 | Tips are pretty good for inflation because it tracks it, but even then, you're really

00:10:51.500 | only hedging against unexpected inflation. So, expected inflation is reflected in the

00:10:55.380 | yield. So, tips are up 6% in 2021, which is great, because the ag, which is like, if you

00:10:59.420 | owned a bond index fund, like the ag or BND at Vanguard, that was down 2%. So, tips did

00:11:04.940 | great in 2021. But this year, they're down 6% because rates are rising, and because that

00:11:10.060 | expected inflation was built into the yield. The yield got negative on a nominal basis,

00:11:14.460 | even though you're getting that kick from inflation. Tips are down this year. So, stocks

00:11:18.140 | offer a wonderful hedge against inflation long term. I've said this comment before,

00:11:23.380 | dividend yields grow 2% over the rate of inflation over the long term. Earnings grow over the

00:11:26.860 | rate of inflation. Stocks do, too, of course. But unfortunately, over the short term, sometimes

00:11:31.680 | it doesn't work. People get spooked by inflation.

00:11:35.060 | I think the problem with trying to hedge any macro risk like this over the short term is

00:11:39.860 | that you have to be right twice. One, you have to be right about the macro data. That's

00:11:43.020 | not easy, but it's not impossible, right? Some people can predict what's going to happen

00:11:46.400 | with GDP and unemployment and inflation. But then, the second one is, you have to be right

00:11:50.420 | about the reaction from investors, and the reaction from central banks, and what the

00:11:54.460 | market environment is. So, this is the really hard one. What is the reaction going to be?

00:11:58.660 | Because if you had told people in 2020, going into 2020, the government is going to spend

00:12:03.600 | more money than they ever have, trillions of dollars are going to print, there's going

00:12:06.880 | to be supply chain problems, there's going to be a war, there's going to be a commodities

00:12:10.000 | spike and oil from a war, all this stuff, you would have said, "Okay, gold's going to

00:12:13.880 | be up 30%." And gold is basically flat since then or down, right?

00:12:19.160 | And I think a lot of people were saying, "Bitcoin can be this hedge against chaos and craziness."

00:12:23.120 | And maybe it was. It took off in early 2020, during the pandemic, but it's come down since

00:12:29.060 | then. And I think people realize, "Okay, right, there are no one-to-one inflations." Even

00:12:33.020 | something like cash has been a good hedge against inflation in the past, because if

00:12:36.700 | you have short-term rates that are rising, those get reflected in shorter-term bonds

00:12:40.940 | quicker. So, if we talk about cash, we're talking about three-month T-bills for a money

00:12:45.060 | market or something, like a savings account. That should be reflected faster in short-term

00:12:48.940 | rates. But guess what's not happening? I got my email yesterday from Marcus, my online

00:12:53.840 | savings account. They increased my yield by 10 basis points. So, from 60 to 70 basis points.

00:12:58.500 | Thanks, I guess.

00:12:59.160 | Maxfield: They're still wagging Robinhood, though. Robinhood's up to 1% now.

00:13:02.500 | Lewis: That 1% is great against an 8% inflation rate.

00:13:06.020 | Maxfield: It's a little consolation when your portfolio's down 40%.

00:13:09.460 | Lewis: (laughs) Well, that 1% looks pretty good then, doesn't it? But my whole point

00:13:13.940 | is that, every environment, there's going to be a different sort of hedge that makes

00:13:18.540 | sense and sounds good. Honestly, the best hedge for this time around has been a house.

00:13:22.100 | Because the cost of materials has gone up, the cost of labor has gone up, all these things

00:13:25.860 | in a house has done well. Could there be a time when there's an inflationary period and

00:13:29.340 | housing does poorly? It's possible. You never know with these things. But right now, a house

00:13:33.500 | has probably been the best one-to-one inflation hedge, where housing prices have gone up and

00:13:36.980 | your fixed payments stay the same. But there really aren't many where you can say, "This

00:13:40.780 | is going to hedge inflation no matter what." That's hard for people to understand, to wrap

00:13:46.260 | their mind around and accept, but it's true.

00:13:48.580 | Maxfield: Right. Whenever I need a little crypto pick-me-up, I just look at the Winklevii

00:13:52.940 | twins, I look at their Twitter, or Scaramucci, Pomp, all those accounts. They make me feel

00:13:58.820 | a little better.

00:13:59.980 | Lewis: Okay. The way to survive a bear market, I tweeted this last week, is not to look at

00:14:04.820 | your portfolio, it's to look at the portfolio of someone else who's doing worse than you.

00:14:08.100 | That makes you feel better. We go from FOMO to, "Oh god, thank god I don't own that."

00:14:13.180 | I think it's why so many people were gleefully enjoying the Tara Luna thing. "Oh, someone

00:14:18.660 | did worse than me."

00:14:19.660 | Maxfield: Yeah. Alright, let's do one more.

00:14:22.300 | Lewis: Up next, we have a question from Kyle. "Could you please explain to a dullard how

00:14:26.700 | capital gains impact your AGI?"

00:14:29.220 | Maxfield: That's a word you don't hear too often, right? Dullard?

00:14:31.180 | Lewis: I know, yeah. I can't not laugh when I read that. "Anyway, can you please explain

00:14:36.100 | to a dullard how capital gains impact your AGI and taxable income? I have a taxable account

00:14:40.900 | and I'm wondering if it is advantageous for me to be selling the long-term portion of

00:14:44.900 | my account and rebuying immediately to realize gains for the year, as my taxable income is

00:14:49.780 | under the $80,800 limit for married couples. I see sources saying this won't affect my

00:14:55.480 | regular income, but when I look at the 1040 tax form, it appears it would still be counted

00:15:01.500 | towards my taxable income." I have no idea what they're talking about, so we're going

00:15:04.460 | to need help.

00:15:05.460 | Maxfield: It sounds like you're reading hieroglyphics here. Let's bring in our tax expert, Bill

00:15:09.580 | Sweet. It's possible I had to ask him, "Bill, what does AGI mean?" You can try to interpret

00:15:15.140 | for us all this means. What are we trying to get out of this here?

00:15:18.460 | Sweet: Great, great question from Kyle. Generally, the questions today are just hotter than a

00:15:23.180 | blowtorch. I love it. What Kyle's getting at is he's trying to hunt the mythical, the

00:15:28.780 | magical 0% long-term capital gains rate. That, to me, is like the kid that was hunting Ben

00:15:34.660 | on the Grand Rapids Savannah over the weekend. Best way to answer this question, let's pull

00:15:39.220 | up a chart.

00:15:40.220 | John, can you pull up number one? I need to do this in graphic form. Let's take a taxpayer

00:15:45.020 | that happens to have $50,000 of ordinary income. This is a married filing joint taxpayer. Let's

00:15:50.660 | take off a standard deduction. Everybody gets that for free. That leaves $24,000 of taxable

00:15:56.020 | income. That equates to roughly 10% income tax, so roughly $2,400 of tax. Let's add on

00:16:03.020 | top of that $50,000 of capital gains. What do we do now? Guess what? The tax is the same.

00:16:09.820 | Because as the taxpayer indicates, long-term capital gains tax rates, if your total income,

00:16:15.380 | your taxable income, is below $80,800, you are not going to pay anything on long-term

00:16:21.460 | capital gains or tax-qualified dividends. That is one of the best deals in the tax code.

00:16:27.160 | It obviously requires you to make a relatively small amount of income. Medium household income

00:16:31.820 | in the U.S. is about $70,000 today. But that's a great tax planning tool for somebody who,

00:16:37.260 | let's say, is young. Let's say you take a pause from work. Let's say you've retired

00:16:40.760 | and you have not filed for Social Security. That long-term capital gains rate is extremely,

00:16:45.620 | extremely tasty.

00:16:46.620 | John, can we pull up chart three? What happens if you go over that threshold? Capital gains

00:16:52.600 | only applies to the income on top of that threshold. That's what the taxpayer is getting

00:16:58.300 | at. What your AGI is doesn't matter, particularly if it depends on the nature and the type of

00:17:04.740 | income that you have underneath. What I'm trying to display here is the stacking effect.

00:17:09.740 | You get long-term capital gains on top of the rest of your income. It all depends at

00:17:13.820 | the end of the year. It's kind of difficult to plan for. This is what good tax planners

00:17:17.180 | do. But that's a great, great, great question for my man, Kyle.

00:17:20.580 | So this person, they're talking about selling and then trying to realize gains. When does

00:17:25.540 | that ever make sense to take that? Isn't it almost always better to just push those taxes

00:17:29.760 | out into the future and defer, defer, defer?

00:17:31.460 | See, I think it depends. I think he's on to something pretty interesting because each

00:17:34.840 | year you get that standard deduction of $25,200. Each year you get that $80,000 up to of long-term

00:17:43.420 | capital gains rate at 0%. So I think it's actually a really insightful point. Why wouldn't

00:17:48.060 | you fill up those 0% tax brackets? Effectively, if he's able to pull it off, he's stepping

00:17:53.400 | up his basis every year, Ben.

00:17:55.380 | So I'd actually say no. If you just defer and you, let's say you have $100,000, you

00:17:58.620 | have $200,000 of gains, you rip that all off all in one year to buy a house, retire, take

00:18:03.540 | a vacation, you're going to pay tax probably at 15% on most of that. So I think the taxpayer's

00:18:07.920 | on to, so Kyle's on to something really interesting. And again, it's something I think that good

00:18:11.380 | tax planners can see. It's not each year what matters. It's what is your tax rate over the

00:18:16.300 | next 10 years, over the next 20, or even over a lifetime?

00:18:20.180 | Difficult to nail. The tax code changes. It can be kind of slippery. My man, Wes, down

00:18:23.860 | there in Puerto Rico, maybe he wishes he hadn't realized those gains two, three years ago

00:18:27.860 | before he moved. But I think it's a great point by Kyle. And it's something I think

00:18:31.660 | that good tax planners think about.

00:18:32.980 | Kyle is not a dullard then. He knows what he's talking about, kind of.

00:18:35.540 | No, I think he graduated straight from dullard to tax ninja.

00:18:38.460 | So I guess to your point, if you have that 80,800 limit or whatever it is, and potentially

00:18:43.860 | his income is going to rise over time, take advantage of it now if your income is going

00:18:47.840 | to rise and take some of those gains, and then you're not paying as much taxes on them.

00:18:51.620 | Potentially, yep, got to thread the needle. And do not forget about state income tax.

00:18:55.340 | That's something that there's no capital gains rate that I'm aware of on most state taxes

00:18:59.020 | outside of Tennessee.

00:19:00.020 | All right, Duncan, next question.

00:19:03.580 | Okay. Question four is from Victor. How does an individual investor get more money into

00:19:09.980 | their IRA accounts if they've already met their contribution limit for the year? With

00:19:13.900 | the market sell-off intensifying, I think this is a great opportunity for long-term

00:19:17.380 | index investors like myself. I fund a Roth IRA and a spousal traditional IRA each year.

00:19:23.420 | I want some investment, tire them out immediately, so I'm fully contributed and invested for

00:19:27.540 | 2022. Is it possible to make another contribution this year and classify it as a 2023 contribution?

00:19:33.100 | All right, I'm going to give -- this may not be applicable here, but the advice Bill has

00:19:37.260 | given me in the past, since I have some income outside of my employer, then Bill told me

00:19:42.500 | four years ago, maybe five years ago, "Ben, what are you doing? Set up a SEP IRA. You

00:19:47.180 | can increase your limit that you can give for tax deferred gains." And now every year

00:19:49.980 | I fund a SEP IRA in addition to my 401(k). So that's one way. So this person may not

00:19:54.620 | have a side hustle or whatever it's called, but that was one thing you did for me. And

00:19:58.860 | you said, "What are you waiting for? Fund a SEP IRA."

00:20:00.980 | Yeah, I mean, you nailed it, Ben. You got to the answer. I mean, just the quick answer

00:20:05.900 | is no.

00:20:06.900 | Oh, sorry. Did I steal your thunder there?

00:20:07.900 | No, definitely not. You set me up great with the thunderbolt.

00:20:10.980 | For the noobs watching, though, can you explain what a SEP is?

00:20:14.100 | Yeah, definitely. But just to answer the question quickly, unfortunately, no, you cannot make

00:20:18.620 | a 2023 IRA contribution in 2022. You can do so retroactively, right? And so in 2023, you

00:20:25.340 | can make one for 2022, but the contributions to traditional Roth IRAs are limited per year.

00:20:30.860 | So unfortunately, unless you've crossed age 50, you're limited $6,500 per year. So that's

00:20:36.700 | the total limit there. So let's shift gears. Let's talk about a SEP. Ben, you set me up

00:20:40.460 | great. If you happen to have your own business or side hustle, if you're doing something

00:20:45.820 | that involves self-employment income, you can fund on top of your regular IRA contributions

00:20:51.380 | and your spouse contribution, a SEP IRA. The limit is calculated differently, and it's

00:20:56.500 | tied to 20% of your net taxable income adjusted slightly for self-employment taxes. And so

00:21:03.180 | that is an option if this taxpayer has other types of income coming in. Another thing that

00:21:08.660 | you could do with self-employment income is set up your own solo 401(k). And if you're

00:21:12.980 | not funding your $20,500 limit at work, that's another place to go. You can set up also a

00:21:18.900 | solo 401(k) tied to your small business income. And so both of those things are an option

00:21:24.220 | for a taxpayer with that type of income. I've got two other options, but any questions on

00:21:28.300 | that, guys?

00:21:29.300 | Nope. Duncan, do you know what a SEP stands for? What is it? What is the acronym stand

00:21:35.060 | for? I can't even think of it.

00:21:36.060 | I think it's a self-employed pension. I think that's what it's called.

00:21:38.580 | OK, that makes sense.

00:21:39.580 | Yeah, it's just tied to the IRA rules. But two other quick options for our taxpayer here.

00:21:43.820 | Great, great, great question, by the way. Another thing is an HSA. If you happen to

00:21:48.100 | have access to a high deductible health care plan at work, HSAs function a lot like super

00:21:52.860 | IRAs in that you can sock away up to $7,300 for a married couple per year, take that completely

00:21:59.340 | off your income tax in addition to an IRA. And then if you happen to use that money,

00:22:04.220 | if you don't use it for medical expenses, it just functions like an IRA, and you get

00:22:08.180 | penalty-free distributions once you hit age 65.

00:22:11.940 | The last option I would throw at this taxpayer, I'm a company man, so I'm going to talk about

00:22:15.460 | low-cost ETFs in a basket. Liftoff is our platform. Go to liftoffinvest.com. It's built

00:22:20.940 | on Betterment's back engine. Extremely tax-efficient investing option. Or you can think about a

00:22:26.260 | direct indexing option. These are non-qualified. They're not IRAs. They don't come with these

00:22:30.660 | tax bells and whistles. And we're going to discuss direct indexing on the next question,

00:22:34.940 | I believe.

00:22:35.940 | That's called a transition. Spoiler alert.

00:22:38.020 | Spoiler alert.

00:22:39.020 | Yep.

00:22:40.020 | I'm a pro.

00:22:41.020 | Okay. Up next, we have a question from Brian. I have a question on direct indexing and its

00:22:45.900 | benefits versus passive indexing in a taxable account. By the way, we get a lot of questions

00:22:50.340 | on direct indexing, so I'm excited to hear your answer to this. I'm planning to open

00:22:54.560 | a taxable account with Fidelity and have been researching their direct indexing tool. I

00:22:58.260 | currently max out 403(b) and 457(b) accounts through work. I'm planning on investing in

00:23:03.860 | this taxable account annually for my working career, which will probably be for the next

00:23:08.340 | 30 years. And I'm currently in the highest tax bracket. Is there any way to quantify

00:23:13.060 | the tax savings and potential benefit of a direct indexing approach over a long time

00:23:17.100 | horizon? How do the fees compare? Also, I worry that deciding to change course in the

00:23:22.220 | future would leave me stuck with many individual stocks to sell and manage. What are your thoughts?

00:23:26.780 | Lewis: We have a lot of experience with direct indexing on our side of things. We use Canvas,

00:23:32.140 | which is a platform started by Ashaunus, the asset management, recently sold to Franklin

00:23:36.860 | Templeton. The number of levers you can pull on this are pretty cool. I think a lot of

00:23:43.660 | the ETF people are not fans of direct indexing. They think, "What's the point? We have ETFs.

00:23:48.540 | They're already tax-efficient. What's the point of it?" There are some interesting things

00:23:51.940 | you can do with it. You can do unique investment strategies, because it costs nothing to buy

00:23:57.220 | and sell a stock now. I think that is something that a lot of our advisors were concerned

00:24:00.520 | about when we first rolled this out, is, "But I'm going to be holding 5,000 stocks or something.

00:24:05.500 | What does that mean? How hard is that to handle?" I think a lot of these places, if they have

00:24:09.540 | it at Fidelity or Vanguard or T. Rowe Price or whatever who's going to do these, and they're

00:24:12.680 | going to be coming everywhere soon, so you're going to have the option. But I think for

00:24:16.620 | this conversation, the tax-loss-harvesting side of things is probably the easiest, Bill.

00:24:21.620 | My way of explaining it to people is that even in a good year when stocks are up, so

00:24:24.780 | last year, the stock market had a booming year. There's still probably 20% to 25% of

00:24:29.620 | stocks in the market that are down, those individual names, and you can use some of

00:24:33.180 | those losses to offset gains. Why don't you talk about that, the tax-loss-harvesting portion,

00:24:37.700 | because that's probably the main selling point for us.

00:24:39.940 | Yeah. Love this question from Brian. Brian, I think you're right to be skeptical. My opinion

00:24:45.180 | is direct indexing ain't for everybody. It's not this solve for all the problems of investing,

00:24:52.540 | but it does come with some really neat features. Ben, you set me up perfectly. Brian mentioned

00:24:57.100 | that he's in the highest income tax bracket, and that's 37% for ordinary income. When I've

00:25:02.180 | done the math on the benefits of direct indexing model, and these are all back-tested, unfortunately,

00:25:07.100 | I've only been running this live for two, three years, the primary benefit comes from

00:25:11.700 | the ability to deduct $3,000 per year of capital losses against your ordinary income. And when

00:25:18.180 | you happen to be fortunate, by the way, to be in the highest possible income tax bracket,

00:25:23.140 | that's worth about $1,100 per year. You're able to deduct $3,000 against ordinary income

00:25:27.740 | at the highest rate. And over time, assuming at the end of the model, whatever sample period

00:25:33.140 | you've used, it's worth roughly about 40 basis points relative to a non-tax-loss-harvested

00:25:39.580 | model. I don't want to get into too much of the details because it's really wonky. Hit

00:25:43.020 | me up on email if you really want some charts coming your way. But in general, that's the

00:25:48.180 | idea. And it all comes from the ability to potentially deduct that $3,000 per year. That's

00:25:54.100 | limited by the tax code. The IRS hasn't touched it, I think, since '74 or '78. And back then,

00:25:59.620 | that was worth about $15,000 in today's dollars. And so I do expect that benefit to shrink.

00:26:04.900 | But that's more or less where it comes from. And I do think it's a really powerful thing.

00:26:08.580 | Wealth indexing doesn't really solve a lot of tax problems today. But in my opinion,

00:26:12.380 | it solves a lot of distribution problems in the future. But I do want to talk about the

00:26:16.780 | specific concern that the investor mentioned, Ben, which was what happens over time. And

00:26:21.740 | so, Ben, do you remember-- there was a great Longbird Asset Management study that showed

00:26:25.060 | where the market returns come from. Do you remember that chart that just sticks in my

00:26:28.900 | head? Yeah. It's all in the tails, right? Yeah. Can you describe it just briefly? Where

00:26:32.860 | does it come from? Well, it's basically just that the majority of gains in the stock market

00:26:37.580 | come from a handful of stocks. And there's a lot of stocks that do really poorly and

00:26:41.500 | go out of business, or just they crash 70%, 80% and never come back, more or less. Yep.

00:26:46.820 | And that's my memory, too. And I remember it roughly at a 2/3, 1/3 ratio. And so everybody

00:26:52.220 | knows about the Apples and Amazons, the big winners, over time. But there's this churn

00:26:56.580 | that happens on the bottom end of the market, right? And a direct index model allows you

00:27:00.420 | to unlock potential tax losses from that segment. But one great criticism of direct indexing

00:27:06.580 | is over time, you just end up owning the winners, right? Those become a bigger and bigger part

00:27:10.340 | of your portfolio. Yes, you're offsetting losses with gains over time. But my bias is

00:27:15.400 | there's always going to be underperforming segments of the market. There's always going

00:27:18.600 | to be a part of that. And especially if you're continuing to add to a direct index model,

00:27:22.780 | it's not static, right? You're adding cash. You're buying a house. You're sending kids

00:27:26.380 | to college. That, to me, is a really powerful part of direct indexing, because you can predetermine

00:27:32.060 | ahead of time, what is my taxable exposure? What do I want to see in gains each year?

00:27:37.020 | And back to our first question, in a year that your ordinary income is relatively low,

00:27:41.100 | hey, I kind of want to realize $100,000 of capital gains this year, right, to fill up

00:27:45.380 | on a 0% capital gains bracket. And the final point is, you're going to own those stocks

00:27:52.920 | if you own them through an ETF or a mutual fund anyway. You just won't be able to segment

00:27:56.940 | them for tax purposes when the time comes. They'll be embedded in a broader portfolio.

00:28:01.740 | So the problems in investing are there. There's really no way to avoid them. But I think directing

00:28:07.020 | that indexing offers a lot of solutions, specifically for folks at the higher end of the tax bracket.

00:28:11.380 | I do think the hard part about direct indexing for a lot of people is going to be, this is

00:28:14.340 | not like a humble brag, but we have advisors working on this in concert with clients. And

00:28:19.340 | there's a lot of back and forth in this. And I think people trying to do it on their own

00:28:21.740 | is going to be very difficult. So I think some of these places are going to be in trouble

00:28:25.020 | if they try to have people do this on their own and pull the levers themselves, because

00:28:28.580 | there is a lot more than one or two decisions that go into this kind of thing.

00:28:31.620 | Yeah, that's a great point. And that was something we realized very early on, was that we needed

00:28:35.940 | to spend a lot of time with our folks, with our operations folks, Patrick Haley, Erica

00:28:39.740 | Morrow, and our team to kind of get it right for clients up front. And that's where the

00:28:43.940 | heavy lifting was. And I don't know anything about Fidelity or anybody else's model. But

00:28:48.980 | I'm skeptical, because I think it's something, to bend to your point, that I think needs

00:28:52.460 | a lot of thought ahead of time before you implement.

00:28:55.020 | All right, one more question.

00:28:56.340 | I'm really good at the tax loss part of it.

00:29:01.940 | Everybody is this year, man. Lock them in.

00:29:04.260 | One follow-up question, though, for people that are a little confused. If you have a

00:29:09.100 | $10,000 loss this year, you can write off $3,000 over the coming several years, right?

00:29:15.660 | Against your income, yeah, per year, right? And then it carries forward, right? So the

00:29:18.580 | benefit of direct indexing in theory is that you're stacking those losses up. You're building

00:29:23.020 | them up over time to offset a future gain.

00:29:25.620 | Cool.

00:29:26.620 | All right, OK. I want to thank Bill for coming on again. Thanks for wearing a tie. Bill,

00:29:29.780 | I decided, I think, in the pandemic, I'm throwing all my ties out. I'm never wearing a tie again.

00:29:34.380 | So I thank you for carrying the torch.

00:29:36.820 | It's a choice. It's a choice. I'm a company man. I'm the CFO. I got to play the part,

00:29:40.380 | man. Come on.

00:29:41.380 | That's true. You are a suit. All right. Keep those questions and comments coming.

00:29:44.820 | Ouch.

00:29:45.820 | One of these weeks. You wear the ties. Duncan wears the hats.

00:29:51.220 | Your Midwest bias looking down on us New Yorkers from the pedestal.

00:29:54.580 | I like how we are like we're like a progression, you know, like dressed up, casual, t-shirt

00:29:59.740 | and hat.

00:30:00.740 | All right.

00:30:01.740 | I'll pull a Fetterman next time, a hoodie, a beard. I'll pull it off.

00:30:04.660 | Thanks for everyone who comes to the live chat. We always will take some of the questions

00:30:07.420 | from there. Occasionally, we'll have questions from the comments on YouTube. Email us, askthecompoundshow@gmail.com.

00:30:13.680 | The inbox continues to be full every week. So we appreciate it. And thanks, everyone,

00:30:16.680 | for watching.

00:30:17.680 | Thanks.

00:30:19.140 | Thank you.

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00:30:22.140 | Thank you.

00:30:23.140 | Thank you.

00:30:24.140 | Thank you.

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00:30:26.140 | Thank you.

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00:30:31.140 | (upbeat music)

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