What’s the Best Inflation Hedge Right Now?

00:00:00.000 | Welcome back to Portfolio Rescue. We always appreciate your questions, comments, feedback.

00:00:21.440 | Email us, askthecompoundshow@gmail.com. Duncan, hit us with that liftoff video. We have to

00:00:27.000 | see it. Gotta fade the music first. Okay, let's do it. 5, 4, 3, 2, 1, 0. Liftoff. Liftoff.

00:00:43.200 | 30 minutes to after the end. So I get the koala bear. You know, well, that's what people

00:00:52.120 | like about it. You know, I thought that people would be tired of it. There's a lot of requests

00:00:55.720 | for the koala bear now. I'm bullish on koalas. We've got a new one at our zoo here. Today's

00:00:59.320 | Portfolio Rescue is sponsored by Liftoff. Duncan, I created a Liftoff account for myself

00:01:03.800 | and my wife two or three years ago. And since it's powered by Betterment, what you can do

00:01:08.020 | is create your own goals. And I just created a goal for each one of my children. So there's

00:01:11.360 | a George, a Kate, and a Libby, all three of my kids. And I created a sub-account for each

00:01:15.480 | of them because I want to teach them the value of compound interest. I want to show them

00:01:18.740 | like cost and value over time. So I'm investing just a little bit in there, 50 bucks a month,

00:01:22.760 | let's call it, each month for them. And then I'm matching anything that they put in there.

00:01:26.520 | So I told my daughter, "Listen, you get 40 bucks for your birthday. Take half of it.

00:01:30.800 | Spend it on yourself. Buy your little toys. But then take 20 bucks, and I'm going to match

00:01:34.000 | 20 bucks. That's 100% return." So I'm trying to incentivize them to save. I'm trying to

00:01:38.600 | introduce them to the financial markets to show, maybe I should show them now. I should

00:01:41.560 | show them their accounts now to show them they're down. Then I want to establish a little

00:01:44.400 | baseline for them. So when they go out into the real world, they're 18 or 21 or however

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00:02:13.080 | It's pretty sweet.

00:02:14.080 | So last week, we kicked off the show with a question from a young viewer who said, "This

00:02:17.680 | is my first bear market. Are they all like this?" And we gave some advice to young people,

00:02:21.800 | which is actually relatively simple in these times. It's just Nick Majulia, his book, Don't

00:02:26.200 | Stop Buying or Just Keep Buying. That's pretty much it. You don't stop investing because

00:02:30.720 | there's a bear market. You actually want to keep investing for sure then.

00:02:34.320 | So the advice for young people is pretty simple. Keep saving. Don't get scared out of the market.

00:02:38.840 | And then, of course, we had a couple retirees who said, "That's great. That's easy for young

00:02:43.200 | people. Not easy. Simple, but not easy for young people." What do you say to retirees

00:02:47.360 | dealing with this? "I don't have the human capital anymore. I'm not saving. I don't have

00:02:51.200 | as much time. And I'm dealing with this bear market in stocks and bonds. What do you think?"

00:02:57.020 | And so, here's what I tell a retiree. The good news is, the returns for a diversified

00:03:02.000 | investor have been lights out coming into this year. So I just looked at the simple

00:03:05.640 | three-fund Vanguard portfolio. So you have U.S. Stock Market Index Fund, International

00:03:10.620 | Stock Market Index Fund, Total Bond Market Index Fund. That's a three-fund Vanguard portfolio.

00:03:15.960 | Through year-end 2021, before this year, over ten years, that portfolio of a 60/40 three-fund

00:03:22.320 | Vanguard was like 8.5% per year. For 60/40. And that's a time when bonds did pretty terribly.

00:03:27.960 | So obviously, if you had more stocks, you did much better. That portfolio was down almost

00:03:31.640 | 20% this year. So that's what people are saying. "This is terrible. I just retired. What now?"

00:03:36.960 | Even if you include the 20% down this year, over the last ten years, it's still up 5%

00:03:41.060 | per year. That's with two bear markets and bonds giving you basically nothing. So, if

00:03:46.460 | you are more heavily in stocks, since 2012 the S&P is up like 12.5% per year. That's

00:03:50.340 | with this bear market. At the lows. Russell 2000 is up almost 10% per year. International

00:03:55.700 | stocks haven't done quite as well. So, here's the thing. If you're a retiree, you've been

00:03:59.100 | building up financial assets for a while, you did pretty well heading into this thing.

00:04:03.120 | So this is just kind of the other side of those wonderful returns that you experienced

00:04:06.580 | to this point. If you own your home, you have a massive amount of equity in it. Right? Maybe

00:04:11.420 | housing prices roll over a little bit. You've seen such huge gains there. You're doing fine.

00:04:16.300 | It's no fun to see the value of your portfolio, of your house go down a little bit, but the

00:04:19.340 | gains you've experienced in the last 10 or 15 years should more than make up for any

00:04:23.140 | losses you've seen this year. Plus, there's some silver lining to the carnage this year.

00:04:27.380 | It's no fun, because that other side of your portfolio, the anchor bonds, have not helped

00:04:30.400 | much, if you've had any duration on. But yield was back for the first time in a long time.

00:04:35.420 | So a year ago, these are the yields for short-term bonds, corporate bonds, and high-yield bonds.

00:04:40.780 | Short-term government bonds yielded about 30 basis points. Corporate bonds were a little

00:04:43.980 | over 2%. High-yield bonds, 4.4%. One year ago from today. Today, short-term government

00:04:49.740 | bonds yield 4.4%. So in one year, short-term government bonds now yield what high-yield

00:04:55.100 | bonds were earning a year ago. High-yield is now 9%. Corporate bonds are approaching

00:04:59.500 | 6%. Muni bonds, you can probably get anywhere in the 5 to 7% range, on a tax equivalent

00:05:05.340 | basis. And you have these Treasury Inflation Protected Securities tips that we're going

00:05:11.900 | to talk about in a question in a minute here. So, as a retiree, you finally have higher

00:05:15.340 | expected returns in the safe part of your portfolio. So, yes, you've had to deal with

00:05:18.660 | some losses to get there. But now, I think you can actually look at this, and for the

00:05:22.740 | first time in, I don't know, 12, 15 years, say, "There's a safe part of my portfolio

00:05:27.460 | I can actually put some money in that's giving me some yield, where I don't have to take

00:05:30.500 | all this volatility." So, as a retiree, yes, you're dealing with losses, but you're actually

00:05:34.180 | in a much better position today than you were a year ago, taking away the losses. So, going

00:05:39.060 | forward, you're in a much better position today.

00:05:41.180 | Yeah. It's crazy to see the way that the questions change over time. We're seeing a lot more

00:05:47.140 | bond questions, a lot more tips questions now. There, for a while, it was like, bonds

00:05:52.500 | were so uncool, left for dead, no one wanted anything to do with them.

00:05:55.780 | And they were kind of dead. And bonds didn't do much. And obviously, now they've lost money.

00:05:59.380 | But now, finally, you can have some 4-6% yield in relatively safe bonds. Obviously, if interest

00:06:05.740 | rates keep going up, that's going to ding you a little bit. But if interest rates keep

00:06:09.420 | going up, guess what? Your future returns are going up as well. So, I think the first

00:06:12.780 | one here we have about tips, actually, we've talked about them a little bit in the past.

00:06:16.360 | Let's get into the first one here.

00:06:18.180 | Yeah. This is a segue. Okay. So, Seamus writes --

00:06:22.020 | I'm a pro, Duncan. I'm a pro.

00:06:24.420 | Seamus writes, "I'm a new investor and still building up my emergency fund and paying off

00:06:28.060 | debt. I just discovered Treasury Inflation Protected Securities, or TIPS, and I'm thinking

00:06:32.940 | of diverting my monthly emergency fund payments going forward into a TIPS ETF in my Roth IRA

00:06:38.060 | account. I'm not currently maxing out my Roth, and I see this as a good low-risk way to max

00:06:42.020 | it out, but the yield seems too good to be true. Am I missing anything? For context,

00:06:46.580 | I'm a government employee with a solid pension that would pay out 76% of my final take-home

00:06:52.340 | pay every year once I retire at 62, 2% for every year worked. I'm also starting to put

00:06:57.820 | money into a 457(b), so any money in the Roth would be a bonus." I don't know what a 457(b)

00:07:04.340 | is, I've got to be honest.

00:07:05.980 | No. 457 is like a 401(k) for non-profits, essentially.

00:07:09.060 | Oh, I thought that was 403(b). So, there's another one. Okay.

00:07:13.460 | Oh, yeah. Okay. I think it's more of a government one.

00:07:15.300 | I don't know what this one is.

00:07:16.580 | Also, Seamus, great name. Duncan, you went to Scotland, right, for your honeymoon a little

00:07:20.180 | bit?

00:07:21.180 | I did.

00:07:22.180 | There had to be a lot of Seamuses there, right?

00:07:23.180 | Probably.

00:07:24.180 | Okay. All right. So, if you missed out a few weeks ago, I think it was the episode we did

00:07:28.420 | with Josh. We did a tutorial on tips, and someone asked us at the time, "Why are tips

00:07:32.140 | down when inflation is higher?" We did a whole thing on that. The short answer is, interest

00:07:36.780 | rates have risen. But the nice thing about rising rates for bonds, as I kind of mentioned

00:07:40.100 | a little bit ago, is eventually those higher yields turn into higher future returns.

00:07:43.980 | So, John, let's do a chart on for the five-year tips yield. So, this is from the Federal Reserve.

00:07:48.620 | You can see this is since 2010. And these are the yields on tips. And what this essentially

00:07:54.340 | is showing you is a yield on tips with, again, this is Treasury Inflation Protected Securities.

00:07:59.300 | The yield you get here, you tack on inflation to it. So, you can see, throughout from 2020

00:08:04.500 | through late 2021, you were getting negative yields in tips. And so, it was close to -2%,

00:08:11.380 | and then you could add inflation on top of that. So, if your yield was -2%, you're basically

00:08:15.420 | buying that bond at a discount. And then, if inflation was 3%, your total return would

00:08:19.820 | be 1%. Well, now, yields in tips, because interest rates across the board have come

00:08:23.780 | up, they've gone from -2% to almost +2% in a hurry, because rates are rising everywhere.

00:08:29.540 | So, what does this mean? It means tips are way more attractive. We haven't had yields

00:08:33.220 | this high since pre-Great Financial Crisis. So, why does this matter? Well, back when

00:08:39.500 | yields were -2%, even higher inflation would be eaten up by that. So, now you have +2%

00:08:44.700 | plus inflation. So, that means your starting point is 4% higher from expected return level

00:08:50.360 | in a little less than a year. That's how much rates have come up. So, let's say the Fed's

00:08:55.380 | able to bring inflation under control, and they get it down to 3% or 4%. Interest rates

00:09:00.220 | just stabilize. They don't go down, they don't go up. We're talking about a 5% or 6% expected

00:09:05.980 | return in tips, taking away the variability of interest rates and inflation and all these

00:09:10.020 | things. That's amazing, when you think about it. Or, let's say they're not as successful.

00:09:14.900 | Inflation is 4% or 5%. I think this is a wonderful -- so, the general rule of thumb for tips

00:09:19.820 | is, if they get to a 3% to 4% nominal yield, that's like a screaming buying opportunity.

00:09:26.700 | Because if you add inflation onto that, that's about as good as you're going to get. That's

00:09:30.140 | very rare. The last time it happened in the last 20 years or so was 2008, and that was

00:09:33.740 | a brief period, because people were throwing the baby out with the bathwater. I don't know

00:09:39.620 | how that became a financial saying. Does that happen?

00:09:43.500 | I think it must have happened. For people to say it, it must have happened at some point.

00:09:48.140 | Back in the day. So, it's very rare. And even 2% is relatively rare. I honestly wouldn't

00:09:54.500 | expect these yields to last very long. 2% in tips is pretty darn attractive for me.

00:09:57.820 | Now, there are some caveats, because Seamus is asking, "Should I use this for my emergency

00:10:02.100 | fund?" There is some variability here. We talked about this. Tips can lose money. The

00:10:05.340 | thing is, with a 2% yield and inflation as the kicker, you have a much bigger margin

00:10:10.740 | of safety now if rates continue to rise. So, yes, inflation protection is nice, but these

00:10:15.860 | securities can be volatile. So, I've mentioned this before. It probably makes sense to stick

00:10:19.420 | with a short-term tips fund. You can get these at any fund provider, iShares or Vanguard

00:10:22.700 | or Charles Schraub or whatever. It's also possible these rates would fall during a recession,

00:10:27.420 | which would actually help push prices up, but then it could hurt your yield from there

00:10:30.460 | after that. So, I don't know. We're in a very weird place right now in the markets, but

00:10:35.540 | this is the first time in a long time I've actually felt pretty good about bonds. And

00:10:41.180 | at least in the short to intermediate term, if I ever get bullish on something, which

00:10:46.500 | is rare, I'm probably more bullish on bonds than anything, which maybe is a reason to

00:10:51.860 | go against me here. But there's a lot of places to park your cash now. You have a lot of options.

00:10:57.020 | So, tips as an inflation hedge makes sense, even though it can be a little volatile.

00:11:01.860 | You're kind of looking like a hedge fund manager today. Maybe you should launch a bond hedge

00:11:06.220 | fund?

00:11:07.220 | I told you. The only reason I'm wearing my vest today is because it's a little chilly

00:11:10.660 | out, which, let's be honest, a vest, it's a useless article of clothing. I mean, it

00:11:15.700 | keeps your chest and your stomach warm, but your arms are just free. Your arms are still

00:11:20.380 | cold.

00:11:21.380 | In New York, I feel like it's useful because I see people and I'm like, "Oh, they probably

00:11:24.900 | work in finance."

00:11:25.900 | The only reason I'm wearing -- I had a little chicken, egg, and cheese sandwich from Chick-fil-A

00:11:33.580 | this morning, and I looked down right before we did this and I had a piece of cheese just

00:11:37.180 | all over my shirt. So, that's why the vest is on.

00:11:39.380 | We appreciate the vest.

00:11:40.380 | All right. Next question.

00:11:42.940 | Up next, we have a question from Webb, who writes, "The setup. In 2020, my wife and I

00:11:48.420 | bought a home and took out a $550,000 jumbo loan at 3.25%. Part of that loan required

00:11:54.920 | us to give additional financial info so we could get a lower rate and our mortgage could

00:11:59.620 | be sold individually. Basic finance tells us that interest rates and bond prices are

00:12:03.780 | inverted and as interest rates are mooning, that would theoretically devalue our single

00:12:09.180 | home mortgage bond. The 30-year treasury is 3.6% risk-free. Who's going to want our mortgage

00:12:15.520 | on the books? The idea, if we were able to come up with the funds, we could go into the

00:12:19.820 | market and buy our own mortgage at an increasing discount, if we could, it would essentially

00:12:26.300 | end our mortgage, right? And the value we would gain would be the 3.25% interest, original

00:12:34.020 | loan amount, minus current market value of loan. Am I big-braining this too much?" I'm

00:12:37.940 | going to say yes, because I don't even understand what this question is, hence me having trouble

00:12:41.460 | even reading it.

00:12:42.740 | Lewis: All right. The general idea here -- and I've heard a lot of people actually say something

00:12:46.900 | like this. The general idea is, interest rates on government bonds and all these other things

00:12:51.260 | are now higher than the mortgage rate, right? That puts you in a great position. John, do

00:12:56.220 | the chart on. This is from John Burns, they're a realty research company. The distribution

00:13:00.940 | of primary residences with different rates for their mortgage, and you can see 73% of

00:13:05.620 | outstanding mortgages are locked in at below 4%. A third are below 3%, and 40% or so are

00:13:12.820 | 3-4%. So, the idea that government bonds are now yielding more than your mortgage puts

00:13:18.840 | you in a good position. A lot of people think, "Well, geez, if I just bought a 3.5-4% mortgage,

00:13:24.180 | I could essentially pay myself for free, and the income I earn on that bond would essentially

00:13:29.780 | pay for my mortgage." Which sounds awesome in theory. I think they are big-braining this

00:13:33.740 | a little bit too much, because, I mean, let's just think about this here. First of all,

00:13:40.100 | you probably couldn't get in there and buy your own mortgage, and I don't know why. That'd

00:13:43.980 | be kind of weird, because they package these together. But let's say you could. A 30-year

00:13:49.940 | treasury is yielding around 3.5%. You buy that bond, and the income pays for your mortgage.

00:13:57.580 | But here's the thing you're not thinking about. You have to pay taxes on that income. So,

00:14:00.620 | every year, you're paying taxes, so that kind of eats into your yield a little bit. You

00:14:03.700 | think you could probably make more. The other thing is, you have to actually have that amount

00:14:07.980 | of money. So, you have your $550,000. You have half a million dollars sitting in cash.

00:14:13.660 | Now we're talking opportunity cost. So, you could invest in those bonds, and the income

00:14:18.740 | would pay you. I mean, you could tell your friends that at dinner. I don't know how many

00:14:21.820 | people are going to be really excited about a bond, but, "Hey, I bought this thing that's

00:14:24.780 | paying for my mortgage." Isn't the simpler option, if you have the cash, just pay the

00:14:28.980 | mortgage off, if you really want your mortgage paid for? Right? Because then you're taking

00:14:33.380 | the payment away, and it's just simpler. It takes the middleman out. It takes a step

00:14:37.820 | out. The other thing is, what else could you do with that $550,000? Because you're paying

00:14:43.300 | for your three and a quarter percent mortgage. What if, instead, you invested in the stock

00:14:47.260 | market and earned seven or eight percent? We're talking about leaving three to four

00:14:49.700 | percent on the table, right? Three percent per year, over 30 years, the life of this

00:14:53.220 | loan is, I don't know, on a half a million dollars, it's like three million bucks. Right?

00:14:57.620 | You earn an extra three percent in the stock market. That's like three million bucks you're

00:15:00.900 | leaving on the table. So, obviously, you can reinvest the money that you're not paying

00:15:04.260 | for your mortgage right now, and maybe you don't care about opportunity cost, but in

00:15:07.500 | that case, if you have the cash, just pay the mortgage off. Don't buy the bond to then

00:15:11.900 | pay yourself back for the mortgage. I think, as always, less is more in these things. So,

00:15:18.060 | I think the question is, if you have that much money, and not everyone has a half a

00:15:21.180 | million dollars just sitting around to buy their own mortgage or buy a bond that pays

00:15:25.100 | for it, just pay the loan off or invest that money in something else that can earn a higher

00:15:30.060 | return. Yeah. I feel like if this question was a film director, it'd be Christopher Nolan.

00:15:35.860 | This feels a lot like an Inception type thing or something.

00:15:40.620 | It's interesting because I think a lot of people, the movements we've seen in interest

00:15:44.020 | rates have been so fast and so big that people go, "Wow." I think just count yourself lucky

00:15:48.780 | you have that low interest rate and do everything you can to hang on to it. And so, maybe don't

00:15:53.180 | pay it off at all and invest in something else because that low rate is being eaten

00:15:57.420 | up by inflation. It's a great asset to have. And I would just -- yeah. Don't overthink

00:16:06.060 | it. Yeah. Good advice. Let's do another one.

00:16:09.460 | Okay. Up next, we have a question from Adam. "Can we start a movement to set the Fed funds

00:16:14.620 | rate using a blockchain smart contract? Unemployment rate, inflation data, housing data, retail

00:16:20.300 | sales, and industrial production ought to be enough to set up an algorithm that at least

00:16:25.280 | does halfway reasonable things all the time. The idea that we can cut rates to zero, then

00:16:29.260 | leave them there unnecessarily long, then raise them too quickly, and then too high

00:16:33.500 | is just crazy." All right. They have a point.

00:16:37.580 | The Fed is not very popular right now. The question is like -- I went on a little rant

00:16:42.060 | on the Fed this week on Animal Spirits. The question is, why was the Fed created in the

00:16:44.820 | first place? All right. From 1853 to 1933, the United States experienced a recession

00:16:50.140 | or depression once every 3.9 years. The average contraction in GDP during that time was 23%.

00:16:55.180 | It was -- I mean, we were essentially an emerging market back then, but that's why the Fed was

00:17:00.780 | -- one of the reasons the Fed was established in 1913 was to be the lender of last resorts.

00:17:04.580 | Because we kept having all these bank runs. And it was actually the panic of 1907, which

00:17:08.300 | -- I got some visuals. Pretty good book on it here, of the same name. This is when J.P.

00:17:14.300 | Morgan had to step in and essentially personally guarantee the banking system and kind of stop

00:17:18.900 | it. And then, in 1913, they finally set up the Fed to help -- and essentially, the Fed

00:17:23.420 | is the lender of last resort.

00:17:25.580 | Now, I'm guessing an algorithmic Fed on the blockchain is probably not going to fly these

00:17:29.740 | days. But a lot of people think a rules-based framework with the Fed would make more sense.

00:17:34.020 | Like you said, some sort of rolling average of the unemployment rate or some other economic

00:17:38.420 | data. I mean, John, throw the chart on. Just look at how closely the Fed funds rate follows

00:17:42.140 | the two-year Treasury yield over time. Now, you could say, well, the two-year is getting

00:17:47.320 | its marching orders from the Fed funds rate. But you can see, actually, the two-year starts

00:17:50.740 | rolling over a lot of times before the Fed funds rate, and maybe they're just kind of

00:17:53.860 | predicting what the Fed's going to do. But market interest rates have done a pretty good

00:17:58.180 | job predicting what the Fed is going to do with short-term rates. And you can see right

00:18:01.780 | now, the short-term rates are, in the two years, much higher than the Fed's rate, assuming

00:18:05.900 | that -- that assumes the Fed funds rate is going to keep coming up.

00:18:09.060 | But even if a rules-based framework like this worked 95% of the time, it's probably that

00:18:15.640 | other 5% of the time that you want a governing body like this, and that's in a crisis. So,

00:18:19.940 | I think, as bad as I think the Fed has done recently trying to snap the economy's neck,

00:18:26.260 | I think they did an admirable job of keeping the financial system afloat during the pandemic.

00:18:29.620 | That easily could have been, the credit systems completely blew up and blew apart, the innerworkings

00:18:34.820 | and the piping of the financial system could have easily gone under, and we could have

00:18:38.580 | had a Great Depression because of the pandemic, when the government was still trying to figure

00:18:42.480 | out how to send out checks and give people money. I think the Fed stepping in there was

00:18:46.540 | big. So, I think you have to have them in those kind of times, where, again, they are

00:18:51.020 | the lender of last resort, when no one will step in.

00:18:53.260 | That happened with the Bank of England this week. It looked like a bunch of their pension

00:18:56.020 | funds were going to blow up. And because interest rates have been rising, and because of the

00:19:00.260 | way that these pension funds are set up, do you really want mom and pop to have their

00:19:03.780 | pension blow up because there's inflation? No. So, the Bank of England stepped in, and

00:19:09.300 | they put a stop to it. That's what you want them for. Some people say, "Well, moral hazard."

00:19:13.580 | Well, guess what? That's what they're there for. They're the lender of last resort. They

00:19:16.380 | don't want a disorderly thing to fall apart, just so some hedge fund manager can say he

00:19:20.060 | bought bonds for pennies in the dollar, or whatever. So, you could quibble with how the

00:19:25.780 | Fed handles the other 95% of the time. But I think for the 5% of the time that really

00:19:29.860 | needed in a crisis, that's probably why they're here. Anyway. So, unless you want to go back

00:19:35.340 | to a system where we have a depression or a panic every three years, the Fed is probably

00:19:39.380 | better than a blockchain contract. Because the original blockchain contract was the gold

00:19:44.540 | as a global reserve currency. We had to back up dollars with the gold. And that's part

00:19:49.220 | of the reason that we got this, because it was such a hard line, and the rules were too

00:19:52.260 | hard to fast. Yeah. And it should have been palladium, right? That would have made more

00:19:56.460 | sense. I don't really know my Fed history. Is there a Fed chair that is looked back at

00:20:00.420 | as being someone beloved in general? Or do they always end up making people mad? Well,

00:20:05.780 | the funny thing is, it's different. Alan Greenspan was beloved at the time, and now he's kind

00:20:09.820 | of hated, because everything he does is blue bubbles. And then Paul Volcker was absolutely

00:20:14.660 | hated in the late '70s and early '80s for jacking up interest rates, and now he's loved.

00:20:18.380 | So it kind of depends on when you're talking about. If he throws us into a recession, Jerome

00:20:24.420 | Powell is definitely going to be hated, I think. People are going to hate him for missing

00:20:28.340 | inflation and sending us into a recession. So he's not going to be the most loved guy

00:20:32.580 | there is. Got it. All right. Let's do another one. Next question. Okay. Tyler writes, "I'm

00:20:39.580 | 35 and work for the government. I'll be able to retire at the age of 55 in 20 years, and

00:20:44.220 | my pension should pay me $80,000 to $100,000 a year. I'm still able to invest in a 457(b)

00:20:49.740 | and max it out, as well as my Roth IRA. Does it make sense to go all Roth for the 457(b),

00:20:55.580 | since my pension will be taxed as normal income when in retirement, since my pension money

00:20:59.540 | will act as fixed income bonds?"

00:21:02.540 | So this is actually our second question with someone who has a pension, which is very rare.

00:21:05.500 | I think from my research I found from my retirement book, in the 1960s, like 60% of workers had

00:21:10.060 | pension that covered at least part of their income, and today it's like 17% and falling

00:21:13.500 | fast. So we put out the bat signal here because there's a word "Roth" in here. So let's bring

00:21:18.900 | in our favorite tax guy, Bill Sweet.

00:21:21.500 | Bill Sweet.

00:21:22.940 | William Roth, my dad.

00:21:25.180 | All right. So the idea is they know they're going to have some income coming in, and they're

00:21:32.100 | trying to figure out asset location here, and maybe asset allocation. How does pension

00:21:36.460 | income impact tax planning here? And does that actually make it more sense for going

00:21:41.060 | all Roth? By the way, 457, was I right on that? Is that a nonprofit thing or is that

00:21:44.740 | a government thing?

00:21:45.740 | Yeah, it's a government. In some states, agencies use them. Different than a 457(f). If you're

00:21:50.700 | not in the comment section, there's some hot traffic going on about 457(f)s. Can we just

00:21:56.140 | skip back, though? Can we go back to question three? Is really the solution to today's problems

00:22:00.420 | an algorithmic stable fed? Because that's never gone wrong. Look at Google, Tara, and

00:22:07.100 | Luna.

00:22:08.100 | But let's get back to Tyler. People are always asking me if I know Tyler Durden. Duncan,

00:22:12.820 | are you a Fight Club guy on the Fincher rankings where you were Zodiac, Gone Girl?

00:22:17.780 | Yeah. I mean, no, it's good. I'm not crazy about it like a lot of people, but it's a

00:22:21.900 | good movie.

00:22:22.900 | I pictured you to be a mankhead. But no, great question, and congrats, Tyler. I think the

00:22:27.420 | interesting portfolio question is, would you treat a government pension as a bond? Because

00:22:32.820 | more or less, it's a very high amount of fixed income that's coming in monthly. But super

00:22:37.180 | duper interesting question, and a really great place to be. If you can max out a 457(f),

00:22:43.140 | that means you have the potential to save $20,000 a year, which is fantastic. So ultimately,

00:22:48.700 | 457(f)s work a lot like 401(k)s. The concept there is the same. And the questioner, Tyler,

00:22:53.580 | is thinking about, do I take this pre-tax, save the tax money now, or do I eat it as

00:22:58.140 | a Roth, take the tax now, and then I get tax-free distributions in retirement?

00:23:02.820 | So just some quick setting the stage. Let's just say Tyler's earning about $120,000, assuming

00:23:08.860 | this is all checks out. So he's probably at a 24% tax rate today, let's say 6% for a state.

00:23:14.540 | In the future, this is a great place to be, $100,000 pension, right? Plus $30,000, let's

00:23:19.660 | say, Social Security, plus, let's say, $15,000 are RMDs. He's going to have about $145,000,

00:23:24.460 | $150,000 of future income. That's just obviously fantastic. And Tyler's made some good decisions

00:23:29.240 | to get there where he is in life.

00:23:31.020 | So ultimately, my diagnosis, though, is his current tax rate is probably going to be identical

00:23:36.060 | to his future tax rate. There's probably some nuance there in the state level we can debate

00:23:40.260 | and discuss, but I think it depends on very much. So ultimately, it's just a question.

00:23:44.420 | Do I want to pay tax on $20,000 of income, $6,000 of tax? Do I want to pay that now,

00:23:49.260 | or do I want to pay it in retirement? And I think it's more of a moral question, like,

00:23:54.360 | do you want to have an account that is $500,000 30 years from now tax-free, or let's say,

00:23:59.380 | a $750,000 that you have to pay 100% of tax on? Without knowing everything, it's very

00:24:04.340 | hard to say, but I'm a big Roth guy. William Roth, my dad, my father, that's where I'd

00:24:08.900 | go with this. And I think a Roth IRA for somebody with 35, my bias is we're in low-tax nirvana.

00:24:15.600 | So that's the direction I'd go with this. But I think it's a toss-up. Ben, what would

00:24:19.140 | you prefer? Well, you always tell me, you made me switch my 401(k) to a Roth, so I'm

00:24:24.480 | going to defer to you here. Yeah, do yourself a favor. And your kind of thing that you set

00:24:29.920 | up to me was, at my stage in life, I'm in my early 40s now, you said, you're getting

00:24:33.440 | to that point where you're going to reach up to higher levels of income. A Roth makes

00:24:37.180 | way more sense. And I guess, I think about it too, if you can save the same amount on

00:24:41.140 | a Roth as a regular, it feels like you're saving more. That's it. That's it. Because

00:24:44.820 | ultimately, yeah, the after-tax value of that Roth is 30% higher, in my math for Mr. Tyler,

00:24:51.460 | than it is if it's pre-tax, right? So ultimately, he would have access to $6,000 extra of taxes

00:24:57.020 | that he wouldn't have paid. But ultimately, people usually don't take that into account,

00:25:00.460 | Ben, as you know. I think personal finance-wise, pay yourself first, pay the tax now, and ultimately,

00:25:05.460 | you can enjoy that tax-free benefit later. And will he be paying taxes on his pension

00:25:09.220 | in 20 years?

00:25:10.220 | Yeah, I mean, yes. Again, if you buy my argument, we're in low-tax nirvana, government spending

00:25:15.840 | a trillion dollars a year in excess of income. Ultimately, that'll get recaptured at some

00:25:19.780 | point, inflation or not. So ultimately, yeah, I would expect his pension's going to be taxed.

00:25:23.740 | Probably some nuance in the state, but I think it can be worked out. But I think at age 35,

00:25:27.540 | I'd still push into Roth now.

00:25:28.820 | Yeah, it seems like a good point in life. And as far as the thing about pension income

00:25:33.060 | as a bond, it certainly allows you to take more risk because your portfolio doesn't have

00:25:37.740 | to fulfill as much of your income. So that's the way I look at it. It's not necessarily

00:25:40.700 | bond. It is income, but it's almost like you have a job that you're not working at. So

00:25:45.700 | you have less income that has to come out of your portfolio. So does that-- for some

00:25:48.780 | people, that gives them the peace of mind where they can take more risk. Other people

00:25:51.460 | say, why would I have to take more risk if I had this income? So it depends on your risk

00:25:55.080 | tolerance, basically.

00:25:56.080 | Exactly. And this is the value of a financial planner. It's almost like we're in this business.

00:25:59.680 | We answer these questions for our clients every day and give them specific advice. But

00:26:02.980 | this is a great place for Tyler to be. Good luck to you.

00:26:05.620 | Yeah. Next question.

00:26:07.980 | OK. Up next, we have a question from Mike. Not to brag, but I'm a 64-year-old married

00:26:15.340 | retiree with $3.6 million of investments. I retired at age 59. No debt and a $60,000

00:26:23.420 | pension. We have been doing Roth conversions up to the top of the 24% bracket for the past

00:26:29.660 | four years, which usually results in about $180,000 Roth conversion per year. Currently,

00:26:36.700 | we have $1.15 million in IRA and $1.657 in a Roth. Plan is to continue conversions for

00:26:44.780 | at least the next five to six years. Goal is to have very little taxable income at 70-plus

00:26:49.340 | years of age. Roth conversion taxes calculated out to be about 1.4% of our investments. Can

00:26:55.300 | we withdraw around 5.5% to compensate for the Roth tax burden? I haven't attempted the

00:27:00.500 | math, but speculate we can safely take out more than 4% since future retirement accounts

00:27:05.140 | will essentially be all tax-free Roth.

00:27:08.000 | Duncan, I think we need a not to brag t-shirt that we send to the person who does the best

00:27:11.660 | not to brag every week.

00:27:12.660 | Yeah, this is a pretty good one.

00:27:13.940 | I like this question. It's basically, how do taxes impact withdrawal rates? I've done

00:27:17.900 | the research on Bill Bengen's 4% rule. The guy has been dining on that his whole life.

00:27:22.260 | I'm sure he goes to every financial conference he goes to, the guy never pays for a drink.

00:27:25.260 | That's great.

00:27:26.260 | Right?

00:27:27.260 | Yeah.

00:27:28.260 | So I've never really seen any work with this in terms of taxes. So Bill, this can be your

00:27:31.100 | corner. You have to do the white paper on this and be the person, but I don't think

00:27:34.700 | I've seen any work on this. If you have the majority of your retirement assets that are

00:27:39.260 | tax-free coming out as a Roth, and you originally were going to go for the 4% rule because you

00:27:43.340 | were worried about paying some taxes too, could you take a higher percentage out because

00:27:46.260 | you're not paying those taxes?

00:27:47.740 | Yeah. This is a great problem to have for Mike, first off. But secondly, just thinking

00:27:52.420 | about it esoterically, the question I want to answer is, how much Roth is too much? Right?

00:27:58.180 | But I think to answer Mike's specific question, yeah. I mean, I wouldn't factor in the Roth

00:28:01.260 | conversion because you're not consuming those assets. Right? If you're converting assets

00:28:05.660 | from a traditional IRA to a Roth IRA, that's really just future spending. You're just choosing

00:28:10.580 | to prepay your tax. Right? And if ultimately, if the only debit there is the 1 point whatever

00:28:15.100 | percent of living expenses that are going to pay the taxes, all you're doing is just

00:28:18.500 | accelerating the tax that you would be paying in the future. When you've got R&Ds, when

00:28:21.900 | you've got other stuff going on, maybe your pension is higher there, God willing, it's

00:28:24.860 | COLA adjusted, and compounding at 9% a year, that thing could double, right, in the next

00:28:28.700 | seven years, God willing. Or maybe not, because I don't want that inflationary environment.

00:28:32.320 | But moving back, ultimately, all he's doing is just prepaying tax. Right? And ultimately,

00:28:36.860 | he's just pushing that consumption out into the future. I think this is very valid, and

00:28:40.780 | I would think about it. But Ben, the question I want to look at is, if he's got 1 point

00:28:44.820 | 6-- again, great for him-- $1.6 million in Roth and $1.1 million in IRA, is that too

00:28:50.060 | much? Is that too much of a balance for somebody at 64? What do you think?

00:28:53.420 | Right, so I guess you're saying the idea is, since he's paying the taxes now, his balance

00:28:58.180 | could be bigger in retirement if he didn't pay the taxes now, because he'd be saving

00:29:01.100 | that money and investing it.

00:29:02.100 | Yeah, but it depends on what game he's playing. Yeah, so I think my general theory-- and this

00:29:06.140 | is the problem that I think Roth solved-- is that people tend to optimize for their

00:29:09.180 | net worth. What I really think they should be optimizing for is after-tax spending. Right?

00:29:13.500 | And so if I'm 64, just actually, how much time do I have left? 20 years? And ultimately,

00:29:19.900 | I'm doing these Roth conversions. I think it's wise to do that up to 24%. But what for?

00:29:24.780 | Right? What am I doing this for? And ultimately, at some point, you would want to think about,

00:29:28.980 | am I doing this because I want to pass on these assets to my children tax-free? This

00:29:33.100 | is a great thing to do. If it's a charitable intent, I would stop Roth conversions now,

00:29:37.700 | because you can just give that IRA to charity and make the charitable a beneficiary, a

00:29:41.860 | university, a public library, or something like that. And they can get all that money

00:29:44.760 | without you paying the tax. Right? So I think, ultimately, I would sit down and maybe think

00:29:48.220 | about, why am I doing this at this point? And I think somebody that's got 2/3 or, let's

00:29:53.180 | say, 55% of their assets in Roth, it almost strikes me as that's the limit. That's about

00:29:58.060 | as far as I would want to go. Right. They're almost like a 60/40. That seems like they've

00:30:01.580 | got plenty of cover, especially with the pension, too. Yep. Yep. Because ultimately, when you

00:30:05.220 | get to 72, you have RMDs start to kick in. You are going to have continued tax issues

00:30:10.300 | going forward. And ultimately, if you have that very large Roth bucket, what is the plan?

00:30:14.500 | What are you going to do with that? And I would start having some fun. After you sit

00:30:17.400 | down and knock it out your 10-page dissertation on how taxes impact withdrawal rates, we'll

00:30:23.060 | have the introduction here on Portfolio Risk. The good stuff. Again, Mike, you need a financial

00:30:26.940 | planner, my man. You need to sit down with somebody competent, maybe a CFP. Yeah. And

00:30:30.100 | he's in a great spot. But yeah, that's the time when you-- you're right. What's the point

00:30:34.420 | of doing this? Are you doing this just for the sake of doing it because it makes you

00:30:36.700 | feel better? Or is there actually a point to it? Yeah. And he's won the game. So I think

00:30:40.260 | when you win the game, you stop playing. Speaking of winning the game, we've got one more here.

00:30:44.660 | Yeah. Let us know in the chat who wins, but not to brag of the day. Also, someone in the

00:30:50.320 | chat said, I have a supermodel wife who wants a bigger home. What should I do? Not bad.

00:30:57.800 | Portfolio Rescue, where the salmon flock like the Capistrano and all the beer tastes like

00:31:02.760 | wine. And it's good stuff. OK. So up next, we have a question from Mark. I'm 43 and I've

00:31:08.960 | done pretty well. I have about $3 million in real estate with very little debt, $1.2

00:31:14.440 | million, which was $1.5 in equities, but only about $30,000 in a Roth IRA. At some point,

00:31:21.600 | should I just even taxes and do a backdoor Roth? All right. Mark's doing pretty well

00:31:27.540 | here. Pretty well. The majority of his net worth is tied up in real estate. Does that

00:31:33.320 | tie into this at all? Does that matter at all? Or do you think if he's got the majority

00:31:37.320 | of this money in taxable accounts, he should just suck it up and do it at this point? Can

00:31:42.160 | I do a quick thing? These are great questions for big problems for millionaires, and I don't

00:31:47.260 | know what percentage of the Portfolio Rescue audience, but I think we need some questions

00:31:50.680 | from the people. I think we need to get populist with this. Here's the way that I think about

00:31:56.680 | it, though. I worked in the institutional world, and I was dealing with-- Is that where

00:32:00.640 | you got that vest? Where did that come from? But I was working with portfolios that had

00:32:04.920 | 8, 9, 10 figures. And the way I thought about it, after a certain point, is it's just an

00:32:11.480 | extra zero. These people are all dealing with the same problems. Same questions. In a lot

00:32:15.720 | of ways. Obviously, there's more comfort here when you have a seven-figure portfolio when

00:32:19.660 | you're in your 40s. But it's still the same questions and the same worries. The math is

00:32:23.560 | more fun when it's big numbers. It's true. Yeah. Let's just pretend Mark has $3,000 in

00:32:30.280 | real estate. OK. So yeah. A backdoor Roth isn't going to solve your problem, right?

00:32:35.960 | You can stick $6,000 into a backdoor Roth IRA. So I think he's asking a different question,

00:32:40.360 | actually, than what he said. I think he's saying, should I Roth convert? And the year

00:32:44.080 | that I would Roth convert would maybe be a year-- I don't know-- US equities are down

00:32:47.480 | 20%. And maybe our bonds have taken a hit, too. And maybe we're-- oh, I'm describing

00:32:50.920 | this exact scenario, right? Where we've had a punishing year, and ultimately, the cost

00:32:55.360 | of converting is going to be lower if we expect our future returns to be higher. So yes. Without

00:33:00.400 | knowing Mark's full situation, again, I would urge him to hire a financial planner to help

00:33:04.400 | answer this. But yeah. He's probably got a 40-year runway on life, maybe 45 years. Ultimately,

00:33:10.320 | this is a great time to think about it, because we've been punishing-- unless he's been in

00:33:14.160 | cash this whole year, he's probably down 20%, 30% in his equities. And ultimately, this

00:33:18.800 | is a great year to consider it, because the taxes are going to be low today on any amounts

00:33:22.640 | he chooses to convert. Let's go back to question 3. The questioner was thinking, OK, I'm going

00:33:27.440 | to fill up my 24% bracket. I think that's the thing to think about, Mark. If you count

00:33:31.640 | in all your income this year, where are you going to be in the tax code? Where does it

00:33:34.400 | make sense? And that's the starting point that I'd look at. And you've got about three

00:33:38.880 | weeks, three months to figure it out between now and the end of the year. But I think you've

00:33:42.280 | got a golden opportunity in 2022. All right. Roth wins again. Someone asked if this is

00:33:48.160 | actually an official Federal Reserve vest. And it's not, because if it was a Fed vest,

00:33:52.640 | I would have already lost my shirt, and I'd be wearing just the vest, because the Fed

00:33:55.280 | has made everyone lose money this year. Yeah. It's puffy, but it's not inflated. The inflation

00:34:00.020 | is not very high. All right. One more announcement here. This was sent to us yesterday. I've

00:34:04.680 | been pounding the table on this all year. U.S. Senator Deb Fischer, introduced yesterday

00:34:09.440 | with Senator Mark Warner, raising the annual IBON purchase limit for individuals to $30,000

00:34:14.840 | when inflation is over 3.5%. Now, I got an email from someone in one of the offices of

00:34:19.760 | these senators. And they said, like you've said over and over in many of your now classic

00:34:24.540 | rants to Michael and Duncan about IBONs, the Treasury Department's lack of action raising

00:34:28.120 | the arbitrary limit. We doubled the limit for individuals to $30,000, returning the

00:34:31.460 | purchase limit to where it was originally when IBONs were first introduced in the Clinton

00:34:34.920 | administration, which I didn't realize. Business and trust accounts would not be eligible for

00:34:38.480 | the increased cap. We keep the focus on inflation relief for families and individuals. I'm not

00:34:43.000 | saying I helped craft bills in the Senate, but I'm not not saying that. I pounded the

00:34:50.120 | table, and we got it done. Sean Patrick Maloney, Chuck Schumer, I hope you're listening. We

00:34:54.280 | did it. Carlson 2024. We need confetti. We did it. This hasn't gone through yet, but

00:34:58.840 | it sounds like we're going to get $30,000. And I love the rule. Someone asked if we could

00:35:02.600 | have an algorithmic Fed. We have an algorithmic IBONs. When inflation is high, you increase.

00:35:08.080 | I think that's great. Ease the pain of the people. Although, backstage we were talking,

00:35:12.520 | ironically, this could potentially increase inflation by getting more money out there

00:35:16.760 | into the economy, which is interesting. Hey, let's just take a win while we have it. Hey,

00:35:21.360 | this actually increases savings, though, Bill. It's less spending. Yeah, that's true. That's

00:35:24.800 | true. I hope this goes through. It sounds great. All right. Thanks again to Bill, as

00:35:30.320 | always, helping us on those Roth questions. We get like 45 Roth questions a week. I love

00:35:34.280 | it. Keep them coming. Thanks, everyone, for watching live in the chat. We always appreciate

00:35:38.120 | it. Leave us a review. Hit that subscribe button. If you're in YouTube, leave us a comment

00:35:42.960 | or a question. We always look at the questions there. If you got a question for us, askthecompoundshow@gmail.com,

00:35:49.400 | and we'll see you next time. Also, to our Florida viewers, be safe. It's scary down

00:35:54.320 | there. Seriously. Thanks, everyone.

00:35:55.800 | [Music]

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