What’s the Historical Return on Housing?

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00:00:19.000 | Welcome back to Ask the Compound.

00:00:22.000 | A show where you, the audience, provide the questions, we try to provide the answers.

00:00:26.000 | I gotta give the audience credit, I laughed at a few of the questions this week.

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00:02:09.000 | No offense, that doesn't surprise me.

00:02:12.000 | I don't know how to take that, but sure. Okay.

00:02:15.000 | Let's do some questions.

00:02:17.000 | Okay. Up first today we have a question from--

00:02:20.000 | That's why you drink oat milk because it keeps you healthier

00:02:22.000 | and keeps you away from the doctor.

00:02:23.000 | I mean, it's probably not because of that necessarily,

00:02:26.000 | but, yeah, I definitely try to stay out of the doctor.

00:02:29.000 | Okay. So up first today we have a question from Pete.

00:02:32.000 | Ben, I love reading your work.

00:02:34.000 | Stocks, bonds, and cash are categories to compare, but it hit me.

00:02:38.000 | As a retired boomer, what about home ownership as a comparison?

00:02:41.000 | Stay warm.

00:02:43.000 | I'm trying to stay warm.

00:02:44.000 | It's so cold here.

00:02:46.000 | I think one of the things in middle age

00:02:47.000 | is that I've learned to appreciate the seasons more, though.

00:02:50.000 | Every year around February or March when there's still snow in Michigan,

00:02:52.000 | I complain, but we had our first big snowfall the past week or so,

00:02:56.000 | like 24 inches.

00:02:57.000 | It was, like, 6 degrees yesterday.

00:02:59.000 | It's pretty. I kind of like it.

00:03:01.000 | Ask me again in a month and I'll hate it.

00:03:03.000 | You said 6 degrees?

00:03:04.000 | 6, yes.

00:03:06.000 | It was, like, -10 wind chill.

00:03:08.000 | Very cold.

00:03:09.000 | Kids like it. They have a lot of snow days.

00:03:11.000 | All right. This question is in response to my recent piece

00:03:13.000 | on historical returns for stocks, bonds, and cash.

00:03:16.000 | Aswath Damodaran has this website for NYU where he updates every year

00:03:20.000 | the annual returns for each.

00:03:22.000 | John, throw up my chart here.

00:03:23.000 | I update this one every year.

00:03:25.000 | Average returns, best return, worst return for stocks, bonds, and cash.

00:03:30.000 | There are typically a fair number of requests for other asset classes

00:03:32.000 | whenever I post this kind of data, and as luck would have it,

00:03:36.000 | Damodaran actually added housing and gold this year to the mix.

00:03:41.000 | So I now have from 1928 to 1923 annual returns for stocks, bonds,

00:03:47.000 | cash, housing, and gold.

00:03:49.000 | Here they are.

00:03:50.000 | Stocks are around 10% per year.

00:03:51.000 | Bonds are closer to 5.

00:03:53.000 | Cash is 3.3%.

00:03:54.000 | Real estate, which is the Case-Shiller Index.

00:03:57.000 | John, you can do a chart off.

00:03:59.000 | Case-Shiller Index is 4.2% per year.

00:04:02.000 | Gold is 4.9%, and then inflation of 3% per year.

00:04:05.000 | So you can do the real returns on your own.

00:04:07.000 | I don't have to do the calculations for you.

00:04:09.000 | So real estate is kind of between a little bit less than gold and fixed income.

00:04:15.000 | Not the greatest.

00:04:16.000 | John, do the next chart on.

00:04:17.000 | I broke this down by decade because I find this stuff interesting.

00:04:20.000 | So I did all these asset classes again.

00:04:23.000 | Stocks, bonds, cash, real estate, gold, and inflation.

00:04:26.000 | The one interesting thing about real estate,

00:04:28.000 | the only down decade it's ever had was the 1930s during the Great Depression era.

00:04:32.000 | Every other decade has been positive,

00:04:35.000 | while these other categories have all had negative.

00:04:39.000 | The 2020s is the aberration, right?

00:04:41.000 | So we've already had 10.2% annualized returns for housing.

00:04:45.000 | We've never had an annualized return that high before.

00:04:47.000 | The highest return we've ever had was the '70s when it was up 8.7% per year,

00:04:51.000 | but there was also 7.5% inflation during that decade.

00:04:56.000 | So the total return of close to 50% that we've seen in nationwide housing prices this decade

00:05:02.000 | is already higher than what we saw for the whole decade of the '90s, the 2000s, and the 2010s.

00:05:07.000 | So we've pulled forward a lot of gains.

00:05:10.000 | So look at these historical returns and you think, well, wait a minute.

00:05:13.000 | The stock market crushes housing returns.

00:05:16.000 | I thought housing was supposed to be the best investment.

00:05:18.000 | Does this mean housing is a lousy investment?

00:05:21.000 | Not necessarily.

00:05:22.000 | The Case-Shiller Index does a good job of tracking housing prices on a national basis,

00:05:26.000 | but I don't think that necessarily means it's realistic for most people

00:05:29.000 | in terms of the proxy for their returns or housing in general.

00:05:34.000 | Calculating returns on stocks, bonds, and cash is pretty straightforward.

00:05:37.000 | You take the starting value, the ending value, add in any cash flows.

00:05:40.000 | Gold is really easy.

00:05:41.000 | It's the starting value and the ending value, and that's your total return.

00:05:47.000 | None of these historical returns include taxes and fees, of course,

00:05:50.000 | but the frictions are so much lower these days because fees and bid-ask spreads,

00:05:54.000 | and that stuff's all lower, tax-deferred retirement accounts, all that stuff.

00:05:57.000 | What are you chuckling about?

00:06:00.000 | Nicole just logged on to the compound chat handle.

00:06:04.000 | It's confusing because multiple people from the same account.

00:06:07.000 | She types in all caps.

00:06:10.000 | Housing is the most unique of all financial assets in a lot of ways.

00:06:14.000 | First of all, there's the leverage component.

00:06:16.000 | Sure, some people may pay cash for their house, but most people borrow.

00:06:19.000 | Let's say you put 20% down, dunk it on a $450,000 house.

00:06:22.000 | Then it subsequently rises 20%, 25%.

00:06:26.000 | You have a house that's worth $560,000, $2,000, and $500.

00:06:29.000 | What's your return on that asset?

00:06:31.000 | It's up 25%.

00:06:33.000 | Oh, I don't know.

00:06:34.000 | I was just thinking about what year I'd have to time travel back to

00:06:36.000 | to find a house for that price.

00:06:38.000 | Okay, what if it's actually 125%?

00:06:41.000 | Because you put 20% down, that's $90,000.

00:06:44.000 | Your house went up by over $100,000.

00:06:46.000 | Technically, the money you put down is a 125% gain.

00:06:50.000 | So maybe housing is even better than most people think.

00:06:52.000 | Well, it depends.

00:06:53.000 | In the life of your loan, you have to pay interest expense, insurance,

00:06:56.000 | property taxes, maintenance, upkeep, people refinance, which costs money.

00:07:01.000 | Wait, I'm sorry.

00:07:02.000 | Did you just say interest expense?

00:07:04.000 | Well, the interest expense on your loan.

00:07:06.000 | Oh, okay.

00:07:07.000 | I thought you meant there was another mortgage insurance type thing,

00:07:10.000 | another fee.

00:07:11.000 | It's a secret.

00:07:12.000 | Well, there's a lot of other bank fees you have to pay when you buy

00:07:14.000 | that they kind of make up.

00:07:17.000 | Plus, like I said, the bid-ask spread for ETFs and index funds

00:07:20.000 | are infinitesimally small these days.

00:07:22.000 | For the housing market, the frictions are still really high.

00:07:24.000 | So moving costs, closing costs, inspections, title insurance,

00:07:28.000 | and all these other fees that banks more or less make up.

00:07:30.000 | Selling your house requires these same fees along with realtor costs.

00:07:33.000 | So there's a lot of ancillary costs as well.

00:07:36.000 | So even if you were the kind of person like me who would track all these

00:07:39.000 | expenses in a spreadsheet -- I don't actually do this,

00:07:41.000 | but someone like me probably does.

00:07:43.000 | Even if you had all of these expenses to tell at your true cost

00:07:46.000 | of home ownership, right?

00:07:47.000 | I have everything.

00:07:48.000 | I know my outlays for my mortgage, for insurance, for all this stuff.

00:07:51.000 | If you weren't paying your mortgage, you'd be renting somewhere,

00:07:54.000 | and you have to live somewhere.

00:07:56.000 | So how do you calculate the difference between, well,

00:07:58.000 | what I'm paying in my mortgage versus what I would be paying in rent,

00:08:00.000 | plus the inflation component of that?

00:08:02.000 | So adding it all up -- and I don't think there's a single person in America

00:08:05.000 | who knows what their actual return on their house is.

00:08:07.000 | I think it's basically impossible to calculate.

00:08:09.000 | So I don't think you'd have to make so many assumptions

00:08:11.000 | to come up with the actual number.

00:08:13.000 | You can look at the price numbers.

00:08:14.000 | Sure, it's 1% or 2% above inflation,

00:08:16.000 | but the Robert Shiller numbers are probably directionally right,

00:08:19.000 | but that says nothing about the actual return most homeowners get

00:08:23.000 | because of leverage and all these other costs and stuff.

00:08:26.000 | If you're buying and selling rental properties, it's probably easier.

00:08:28.000 | To track your expenses, you know what's coming in for rent,

00:08:31.000 | and you can net it out.

00:08:33.000 | I think you can calculate what the return is.

00:08:35.000 | For some people, it's probably much higher than they assume,

00:08:38.000 | because, again, if you're doing it out of that initial investment

00:08:40.000 | and there's leverage involved, even a small, steady stream of returns,

00:08:44.000 | when you have that leverage and you're only putting 20% down,

00:08:48.000 | that can juice those returns big time.

00:08:50.000 | For a lot of people, it's probably worse than they think

00:08:52.000 | because they don't realize the frictions for buying and selling.

00:08:56.000 | They put too much in for renovations.

00:08:57.000 | They buy in the wrong location, all this stuff.

00:08:59.000 | So I don't think we should be comparing the roof over your head

00:09:02.000 | to a Vanguard S&P 500 Index Fund.

00:09:04.000 | Vanguard doesn't give you a place to live.

00:09:07.000 | Vanguard does not provide mudrooms or open spaces to entertain

00:09:10.000 | or walk-in closets.

00:09:12.000 | If I had to guess, it's probably closer to the stock market

00:09:15.000 | than the bond market for true returns for most people,

00:09:19.000 | but I think it's far too circumstantial to put an actual number on it.

00:09:22.000 | So I'd like to look at my house as more of a home than a financial asset,

00:09:25.000 | but it does provide a really nice hedge against inflation

00:09:28.000 | because my mortgage is fixed, and then I can borrow against it if need be.

00:09:31.000 | And for most people, it's just really a form of forced savings

00:09:33.000 | because most of the middle class, that's their biggest financial asset by far.

00:09:36.000 | But I don't think you compare it to stocks or bonds or crypto

00:09:38.000 | or anything like that.

00:09:39.000 | I think housing is so much more of an emotional asset

00:09:41.000 | that it's impossible to gauge what that actual return really is.

00:09:45.000 | Do most people who seriously invest in real estate,

00:09:49.000 | do they have some equation where it breaks down with square footage

00:09:52.000 | and how much they expect to have to pay in general upkeep and maintenance?

00:09:56.000 | Well, the biggest thing is they call it the cap rate.

00:09:59.000 | But yeah, you could put a number on it like the fees are going to be

00:10:02.000 | 1% to 2% a year of the cost or whatever.

00:10:05.000 | You could estimate that somehow depending on the location.

00:10:08.000 | And yeah, someone who's doing rental properties, that's much easier.

00:10:11.000 | They look for a cap rate on what they're getting and what they're netting out,

00:10:15.000 | and then I guess you could add some equity in there somehow.

00:10:17.000 | But yes, it's way more complicated than most people think.

00:10:20.000 | So I don't think there really is a number.

00:10:22.000 | I don't think you can just take the price you paid for it

00:10:25.000 | and then the price you get when you sell, and that's your return.

00:10:27.000 | There's so much more that goes into it than that.

00:10:29.000 | Do you say "ruff" or "roof"?

00:10:32.000 | I don't know. What did I-- "ruff"?

00:10:34.000 | I just corrected myself. I said "ruff," and then I said "roof."

00:10:37.000 | I don't even know which I'm supposed to say.

00:10:39.000 | Let me know in the comments.

00:10:40.000 | I guess I'm a "ruff" guy.

00:10:42.000 | Okay. Cool. Good advice there.

00:10:46.000 | And that's a popular one too.

00:10:48.000 | I think part of what's happening just as a layman is I think a lot of people

00:10:53.000 | are paying up for housing right now and are trying to justify it as being like,

00:10:56.000 | "Okay, well, it's at least an investment."

00:10:58.000 | I think that's why we're seeing more and more of these questions.

00:11:00.000 | And again, I think it's more of a forced savings vehicle

00:11:03.000 | than an investment for most people, but that can be a good thing too.

00:11:06.000 | I don't think it's necessarily a bad thing, but you're right.

00:11:08.000 | The fact that prices have been going up so much in the last couple of years,

00:11:11.000 | more people are looking at it that way.

00:11:13.000 | And I think there's just a lot of stuff you have to take into consideration

00:11:16.000 | that most people don't.

00:11:19.000 | All right. Up next we have a question from Mike.

00:11:23.000 | "I've got a bunch of 2020 stocks."

00:11:25.000 | I can relate to this one so much it hurts.

00:11:27.000 | I should just say right off.

00:11:29.000 | "I've got a bunch of 2020 stocks"-- may give a couple examples--

00:11:32.000 | "down upwards of 70% all the way to 99%

00:11:35.000 | "with the losses representing maybe 8% of the value of my portfolio.

00:11:39.000 | "Psychologically, they bother me, but I have no immediate need to sell.

00:11:43.000 | "No capital gains to offset.

00:11:45.000 | "Is it best to hold and just see if they recover in some years

00:11:49.000 | "or just cut bait, take the ordinary income deduction,

00:11:52.000 | "prevent further losses, and reinvest the tax savings into an index fund?

00:11:56.000 | "With the $3,000 win, I'd have carryover losses to claim

00:12:02.000 | "for a decade or more. #NotToBrag."

00:12:05.000 | All right.

00:12:07.000 | Mike here included some of the tickers, and I've got to be honest,

00:12:10.000 | I've never heard of this one company, SKLZ, is skills with a Z.

00:12:14.000 | I've heard of it, but I don't know anything about it.

00:12:17.000 | My first point of advice would be never buy a company

00:12:20.000 | that trades out the S for the Z.

00:12:22.000 | There's no way that it's going to end well.

00:12:24.000 | SKLZ, I'm sorry.

00:12:26.000 | In what world is a company with a Z in the end of it

00:12:29.000 | instead of an S going to outperform?

00:12:31.000 | That's just never going to happen.

00:12:33.000 | This company is down like 99%.

00:12:36.000 | Funny enough, the Russell 3000, which is essentially

00:12:39.000 | the entire liquid U.S. stock market,

00:12:42.000 | so that's the S&P 500 plus the small and mid-caps,

00:12:46.000 | there's nearly 2,700 stocks in it, which is kind of false advertising

00:12:49.000 | because the Russell 3000 doesn't have 3,000 stocks.

00:12:51.000 | On white charts yesterday, I ran a screen for historical drawdown

00:12:54.000 | from all-time highs for these stocks, Duncan.

00:12:56.000 | Out of 2,700 stocks that make up the U.S. stock market,

00:12:59.000 | how many were down 70% or worse from all-time highs?

00:13:02.000 | What's your guess? Percentage of a total.

00:13:05.000 | 25%?

00:13:07.000 | That's actually pretty close, 26%.

00:13:10.000 | He mentioned a stock, he owns stocks down 99%.

00:13:13.000 | Again, 25% of stocks, and we're right near the all-time highs,

00:13:17.000 | a quarter of stocks in the index, in the market,

00:13:20.000 | are 70% or worse off of all-time highs.

00:13:23.000 | There are more than 40 stocks that are down 99% or worse.

00:13:26.000 | That would put our guy Mike here in the bottom 1.5% of stock pickers,

00:13:29.000 | I guess we want to look at it that way, for these stocks, which is nice.

00:13:33.000 | 10% of stocks are down 90% or worse.

00:13:36.000 | One out of every 10 stocks is down 90% or worse from all-time highs.

00:13:40.000 | 44% of them are down 50% or more.

00:13:43.000 | Almost half of all stocks in the index are down 50% or more from their highs.

00:13:46.000 | Tons of big losers, which is a feature, not a bug, of the stock market.

00:13:49.000 | One of my favorite research pieces that I come back to all the time,

00:13:53.000 | and I think it's worth repeating, is called "The Agony and the Ecstasy"

00:13:56.000 | by Michael Semblis from J.P. Morgan, who's been on the Compounded Friends before.

00:13:59.000 | Yeah, he was great.

00:14:00.000 | John threw up the first chart. I love looking back at this data.

00:14:03.000 | Semblis found that more than 40% of all companies that were ever in the Russell 3000 index

00:14:07.000 | experienced a catastrophic stock price loss, which was defined as a 70% decline

00:14:11.000 | from a price in peak levels, which is not recovered.

00:14:14.000 | It's 70% and you don't make it back.

00:14:16.000 | You can see he broke it down by sector as well.

00:14:19.000 | Show the next one, John.

00:14:21.000 | Around 40% of the time, a single stock experienced negative absolute returns,

00:14:25.000 | which would have underperformed a simple position in cash.

00:14:27.000 | So holding T-bills, 40% of stocks underperformed cash.

00:14:30.000 | 2/3 of the time, those stocks underperformed the actual index itself.

00:14:34.000 | So holding the index, you'd think, well, half of the stocks are going to do well

00:14:37.000 | and half of them are going to underperform. That's not the case at all.

00:14:40.000 | It's mostly mega-winners, which they define as these huge, huge winners,

00:14:43.000 | and there's 10% of them since 1980 that are defined as mega-winners in the Russell 3000.

00:14:47.000 | So most stocks don't do very well.

00:14:49.000 | John, one more. Show the next one.

00:14:53.000 | Wait, why don't we just focus on buying the mega-winners?

00:14:55.000 | Yeah, that's it. So it's 10% of them.

00:14:57.000 | John, fill that chart back up.

00:14:59.000 | The winners generate these enormous returns,

00:15:01.000 | but the median stock ends up underperforming the index itself.

00:15:05.000 | So that's the thing.

00:15:07.000 | If you were the world's greatest stock pick, you'd say,

00:15:09.000 | "I'll just hold the best stocks. Good luck with that."

00:15:12.000 | The problem is, what if you own some of these stocks that end up being mega-winners?

00:15:15.000 | Amazon was down 95% during the dot-com bubble and it recovered.

00:15:19.000 | One of the biggest, best stocks ever.

00:15:21.000 | NVIDIA was down almost 70% at one point in 2022.

00:15:24.000 | Facebook, not meta. I'm never going to call it meta.

00:15:28.000 | Just like Google is not alphabet and Twitter is not X,

00:15:32.000 | I will not call them that. It's Facebook.

00:15:34.000 | Facebook was down 70% in 2022 and recovered all its losses.

00:15:38.000 | Netflix has experienced three separate 70%-plus drawdowns in its history.

00:15:44.000 | Career? Yeah, it works.

00:15:46.000 | It's recovered from the first two.

00:15:48.000 | It's still 30% away from the most recent highs in the new one.

00:15:51.000 | But history says you're better off just cutting bait, right?

00:15:54.000 | Do you actually believe in any of these companies?

00:15:56.000 | I don't know. Maybe you could hold on to one of them as a lottery ticket or as a reminder.

00:16:00.000 | I have one stock in my fund portfolio account in Robinhood that I picked.

00:16:04.000 | I'm not going to name names, but someone at our company actually recommended it to me.

00:16:08.000 | It immediately went up 100% and now it's down 75% from where I bought it.

00:16:12.000 | I think I have the same one.

00:16:14.000 | I think I know who you're talking about.

00:16:16.000 | It didn't kill me because it's such a small percent.

00:16:18.000 | I kind of hold it there just as a reminder of just keep buying index funds, Ben,

00:16:21.000 | because the big winners will be in there and the losers won't matter.

00:16:25.000 | So I prefer index funds because it is extraordinarily difficult to pick stocks.

00:16:29.000 | But it's probably just best to move on.

00:16:31.000 | I don't think you'll regret it.

00:16:33.000 | If one of these really turns around after falling 99%, it'll be a miracle.

00:16:37.000 | Unless you think that it's literally going to be the drink of the future or something,

00:16:41.000 | I see no reason to hold on to something when you're down big.

00:16:46.000 | What was Oatly down from all-time highs at the worst point?

00:16:49.000 | Like 98% probably.

00:16:52.000 | If I pull up the chart, basically, yes, you can't even see it.

00:16:56.000 | It's pretty brutal.

00:16:57.000 | If you get cut in half and cut in half, you're approaching zero,

00:17:00.000 | but you can never actually hit zero, that's Oatly.

00:17:02.000 | Yeah, that's what it feels like.

00:17:05.000 | Something on this note that is kind of funny is back when I was in college,

00:17:08.000 | in like 2008, I guess, 2008, the market wasn't doing so well.

00:17:13.000 | And so I was like, "I should buy some stocks."

00:17:16.000 | And so I took a little bit of money and bought a couple of things.

00:17:18.000 | I bought Microsoft, which I still own, the same share.

00:17:22.000 | I bought one share of Microsoft.

00:17:24.000 | And then I bought some shares of a company called Hemp

00:17:28.000 | that was supposed to be like weed stock and, "Oh, this is the future,"

00:17:32.000 | which is what people are still saying.

00:17:34.000 | No, no, no, it was supposed to be like cannabis, I guess.

00:17:37.000 | Microsoft, that's a pretty good purchase, though.

00:17:39.000 | Microsoft has worked out great.

00:17:40.000 | Hemp did not work out.

00:17:42.000 | And several others that I bought did not work out.

00:17:45.000 | Kudos on the Microsoft purchase.

00:17:47.000 | That data, though, for real, that's basically an argument for cap weighting

00:17:51.000 | versus equal weighting, right?

00:17:53.000 | Yes.

00:17:54.000 | I mean, equal weighting, I guess, it's diversification.

00:17:57.000 | The whole point about cap weighting is that the mega winners

00:18:00.000 | really help offset the losers.

00:18:03.000 | Right.

00:18:04.000 | Equal weighting is the kind of strategy, though,

00:18:06.000 | that just has a little more turnover, probably.

00:18:09.000 | But it can still make sense, too.

00:18:12.000 | All right, next question.

00:18:16.000 | Up next, we have a question from James.

00:18:20.000 | I'm in my late 20s, married, and expecting our first child this year.

00:18:24.000 | I have over $100,000 cash saved, but over $50,000 in student loans

00:18:28.000 | with a 4% rate.

00:18:30.000 | I have a large bonus coming in Q1, greater than my student loan amount.

00:18:34.000 | My bonus is nearly half of my total compensation,

00:18:36.000 | making traditional budgeting difficult.

00:18:38.000 | I'm doing my best to max 401(k), IRA, HSA, and 529,

00:18:43.000 | but I really want to put my family in a house that is more comfortable

00:18:46.000 | and safe, even though it wouldn't be the end of days if we stay where we are.

00:18:50.000 | I'm having difficulty balancing my desire to super save and pay off debt

00:18:55.000 | with my desire to get a house I truly feel like my family needs.

00:18:59.000 | On top of this, I would like to be charitable

00:19:01.000 | and help those who are not as fortunate.

00:19:03.000 | How do I balance all these desires when I'm not quite at the level

00:19:06.000 | where my total compensation is large enough to just do it all?

00:19:09.000 | As a podcast host, I'm legally obligated here to say

00:19:12.000 | there's a lot to unpack here.

00:19:14.000 | Right, because that's what you say when you host a podcast.

00:19:17.000 | There's a variable income component, student loans, buying a house,

00:19:20.000 | tax-deferred retirement accounts, charitable giving.

00:19:23.000 | This is certainly a financial planning question

00:19:25.000 | with a little bit of everything, so let's bring in an expert

00:19:28.000 | who's used to helping people make better financial decisions,

00:19:31.000 | Mr. Kevin Young.

00:19:32.000 | Hey, Kevin.

00:19:33.000 | Kevin's a CFP.

00:19:34.000 | Hey, guys.

00:19:35.000 | Kevin, I think there's this idea that once you have some money

00:19:37.000 | or make a good income, your financial problems magically disappear,

00:19:40.000 | but it's much like investing where you can never completely take risk away.

00:19:44.000 | Risk just changes shape.

00:19:45.000 | That's the same thing when it comes to finances.

00:19:48.000 | I think all this stuff can be overwhelming.

00:19:53.000 | So where to begin?

00:19:54.000 | I guess how do you help people rank order their financial goals

00:19:58.000 | and decisions?

00:19:59.000 | Because as with a lot of this stuff, there's no right or wrong answer here.

00:20:03.000 | A lot of it just depends on what you want to focus on.

00:20:08.000 | Yeah, I think for me the thing that popped out was what he mentioned

00:20:13.000 | about buying a house.

00:20:15.000 | That seemed to sort of be the top of mind.

00:20:18.000 | And the other thing to consider is where you are in your life, right?

00:20:23.000 | Our colleague Nick Maggiuli, yeah, he talks about just keep buying,

00:20:28.000 | but he also talks about flexibility.

00:20:31.000 | He wrote a blog post, I think it was last year

00:20:33.000 | or maybe the year before, talking about not maxing your 401(k)

00:20:37.000 | and sort of how that kind of flies in the face of conventional

00:20:41.000 | financial planning 101.

00:20:44.000 | But for this person, if he's got other goals and he's in his late 20s,

00:20:49.000 | you've got plenty of time to max out your 401(k).

00:20:53.000 | So maybe it makes sense to not max out the 401(k)

00:20:56.000 | and give yourself a little bit more flexibility by saying,

00:20:58.000 | "Hey, instead of putting away $23,000 in the 401(k) this year,

00:21:02.000 | maybe I'll put away $17,500, or maybe I'll put away $15,000,

00:21:06.000 | or I'll match what my company puts in."

00:21:09.000 | I do think there's a big psychological hurdle for that

00:21:12.000 | because if you max out your 401(k) and then you pull it back,

00:21:15.000 | you feel like you're doing less or you're losing something.

00:21:18.000 | So I think it's really hard for people to go backwards

00:21:21.000 | after you've crossed that line in the sand.

00:21:23.000 | It is.

00:21:24.000 | And I always say that with the caveat that you've got to be purposeful

00:21:28.000 | with the money that you're not contributing, right?

00:21:31.000 | So if you are getting an extra couple hundred bucks in your paycheck,

00:21:34.000 | are you just spending that or are you putting it into the account

00:21:37.000 | that you're going to use to put the down payment on in your house?

00:21:40.000 | Right. You're still getting ahead financially if you're using that money

00:21:42.000 | for something else.

00:21:43.000 | Absolutely.

00:21:44.000 | As long as you're not blowing it on something, then you're still saving.

00:21:47.000 | Absolutely. And he also mentioned an IRA.

00:21:49.000 | I was definitely not maxing out my 401(k) and an IRA when I was in my 20s.

00:21:54.000 | So, I mean, frankly, I'm not even doing it now, but that's another story.

00:21:58.000 | Kids are expensive, right?

00:22:00.000 | So there's all these different things, and that's actually part of it, right,

00:22:03.000 | is that maxing out an HSA is great if you're starting a family.

00:22:06.000 | Doctor's appointments are insane.

00:22:09.000 | So all these things that he wants to accomplish, I think--

00:22:13.000 | and, again, I just leaned towards the house because he mentioned it.

00:22:16.000 | If the house is something that really will give you a lot of peace of mind

00:22:20.000 | and you'll feel really good about that, then it's okay to say,

00:22:24.000 | "Hey, I'm not going to put $23,000 away in my 401(k)

00:22:28.000 | or $30,000 combined between the 401(k) and the IRA."

00:22:30.000 | Especially with that first kid coming along, you know that the house

00:22:33.000 | is such an important piece of the family and not just a financial plan.

00:22:37.000 | And he talks about paying off the student loans.

00:22:39.000 | The rates are still relatively low.

00:22:41.000 | To your point about flexibility, I don't see the need to pay those off,

00:22:44.000 | especially if you have all these other goals.

00:22:46.000 | I think that one in the hierarchy of the goals,

00:22:48.000 | if you said the rates were 8%, maybe I would reconsider.

00:22:51.000 | But at 4% rates, I think you push that one down,

00:22:53.000 | and that's one of the last goals you have to worry about.

00:22:56.000 | 100%.

00:22:57.000 | Yeah, I wonder if they refinanced to get that low.

00:22:59.000 | 7% is around where mine are.

00:23:03.000 | Sounds like you need to email James back.

00:23:07.000 | Yeah, luckily I don't have a massive amount.

00:23:09.000 | But yeah, and then the other thing is the charitable giving.

00:23:12.000 | I guess the thing is, yeah, give yourself a little bit of a break.

00:23:15.000 | If you're in your 20s and you've got all this stuff figured out already

00:23:18.000 | and you're maxing stuff out and you're trying to buy a house,

00:23:20.000 | give yourself a break if you're not completely optimizing everything perfectly

00:23:24.000 | and there's going to be some give and take and some course corrections along the way.

00:23:27.000 | And sometimes if you have a huge goal like this, like buying a house,

00:23:31.000 | the other goals have to take a back seat for a while.

00:23:34.000 | And then the house is purchased and you're done saving for the down payment,

00:23:36.000 | now you can shift things around.

00:23:38.000 | And it's okay to make those changes.

00:23:40.000 | I know for people who are blinders on with the financial stuff,

00:23:44.000 | it can be tough to make those changes.

00:23:46.000 | But that's the whole point of a financial plan is that it's going to change.

00:23:49.000 | Yeah, perfect is the enemy of good, right?

00:23:52.000 | And so we come across this a lot with people trying to optimize

00:23:55.000 | every single thing that they do.

00:23:58.000 | And it can cause more stress than is good for you.

00:24:03.000 | So I think your advice of just kind of taking the big goal first

00:24:09.000 | and then trying to kind of waterfall it down from there.

00:24:13.000 | Yeah. And my thing on the charitable giving side of things,

00:24:16.000 | I treated it like it was a dollar cost average where I put it on automatic

00:24:20.000 | every month I give to a couple organizations.

00:24:22.000 | And then once a year, usually around Christmas time,

00:24:25.000 | I'll look at that again and change it and increase it a little bit.

00:24:28.000 | But I think that's the kind of thing too that you can put just like your

00:24:31.000 | contributions where you can kind of put it on automatic

00:24:34.000 | and not have to think about it all the time.

00:24:36.000 | Yeah. And if there's some part of you that just feels like you should be doing

00:24:41.000 | something from a charitable sense, maybe it's not writing a check.

00:24:47.000 | Maybe it's writing a smaller check and volunteering.

00:24:49.000 | There's a lot you can do that isn't necessarily writing a check

00:24:52.000 | when it comes to charitable endeavors.

00:24:54.000 | So that might be a good proxy for now while you're feeling like the dollar

00:24:58.000 | should be going elsewhere.

00:25:00.000 | Cool. And I also noted here,

00:25:02.000 | is there anything else that they're not thinking of that they should consider

00:25:05.000 | with a child on the way, financial tips or any planning they should do?

00:25:11.000 | Just be ready to throw your financial plan out the window multiple times

00:25:14.000 | with kids because Kevin's right, kids are expensive.

00:25:17.000 | When I told my brother out we were having twins,

00:25:20.000 | he had twins six months before us and he laughed and he said,

00:25:23.000 | "Yeah, throw your financial plan out the window because kids are expensive."

00:25:27.000 | So I think you have to be a little more – be willing to be more flexible.

00:25:31.000 | The good thing about kids is that you spend way less money on yourself

00:25:34.000 | because you have no time to spend on yourself anymore.

00:25:36.000 | It's the beginning, right?

00:25:38.000 | There's always another expense coming up that you didn't think about.

00:25:42.000 | Yes.

00:25:43.000 | And at what age can you get them going with an IRA if they do something for you?

00:25:49.000 | You can do that, right? You've talked about it before?

00:25:52.000 | Yes, I think they technically have to have some type of income, right?

00:25:57.000 | Ben had talked about how people have their kids –

00:26:00.000 | I've heard people who work around – there was a blogger I knew

00:26:04.000 | who would show pictures of his kids in his blog and pay them an income.

00:26:07.000 | I don't know how the IRS feels about that.

00:26:09.000 | There you go. Probably not good.

00:26:12.000 | Yes. I don't know if my kids are cracked up for that yet.

00:26:16.000 | I don't know if they –

00:26:17.000 | Well, and remember, now the 529 rules, right?

00:26:20.000 | You can eventually convert that to a Roth if it goes unused.

00:26:24.000 | Yes, 529 is actually pretty – all right, let's do another one.

00:26:27.000 | Good to know.

00:26:28.000 | Okay, up next we have a question from Harry.

00:26:33.000 | I was let go from my construction job in October, but I landed on my feet

00:26:36.000 | and was back to work in November.

00:26:39.000 | What should I do with my old 401(k)?

00:26:41.000 | It seems like you can roll it into another account or do a cash withdrawal.

00:26:44.000 | Are there penalties associated with each?

00:26:47.000 | If I do a rollover, should I open a new IRA or just move it to my existing Roth IRA?

00:26:52.000 | We own our home, but this could be a good down payment for the lot behind our house,

00:26:56.000 | especially if there are no tax penalties.

00:26:58.000 | We're young newlyweds and very financially secure.

00:27:01.000 | I feel like you don't hear that phrase a lot.

00:27:03.000 | I have a feeling the answer is to wait and roll half to my new 401(k) when it's open

00:27:08.000 | and take the resting cash for an emergency or down payment.

00:27:11.000 | But I would love to hear your thoughts.

00:27:13.000 | You usually don't hear that from someone who's just let go from their job too,

00:27:15.000 | so kudos for being – and this also shows how dynamic the U.S. economy is, right?

00:27:19.000 | This person was let go from their job one month.

00:27:22.000 | The next month found another one is already thinking.

00:27:24.000 | I do think there's another psychological component to this where you leave a job

00:27:28.000 | and you have some 401(k) money and you look at it and you say,

00:27:30.000 | "Well, I've been saving for a few years."

00:27:31.000 | It's almost like found money.

00:27:33.000 | People treat it differently than they would otherwise.

00:27:35.000 | If they would have stayed at this company and kept putting money into the 401(k),

00:27:39.000 | they would never think about pulling it out.

00:27:41.000 | But now that it's there and it's like, "Well, you know, it's just like $15,000.

00:27:45.000 | What if I just pulled it out and used it to make a down payment or change it to this?"

00:27:50.000 | I take a pretty hard line on retirement savings, like using for other purposes.

00:27:54.000 | Unless there's an emergency or there are no other options,

00:27:57.000 | if it's earmarked for retirement, keep it for retirement.

00:28:00.000 | I think, Kevin, you can correct me if I'm wrong.

00:28:02.000 | If he's taking it out for a down payment for something, there's going to be a penalty on it.

00:28:05.000 | There's going to be some taxes to pay.

00:28:07.000 | Yeah, you're going to get hit with taxes and penalties on that

00:28:11.000 | unless it's a first-time home purchase and there's some rules around that.

00:28:13.000 | It doesn't sound like that's the case here if you're just buying another lot.

00:28:17.000 | Yeah, so you're going to pay ordinary income tax on that plus a 10% penalty.

00:28:23.000 | And so it's definitely, unless you really need it, which sounds like you don't,

00:28:29.000 | the options are, yeah, you're either going to roll it into your new company's 401(k).

00:28:33.000 | If they have a decent plan, that's probably a perfectly fine option,

00:28:37.000 | generally going to be really low cost.

00:28:40.000 | You can borrow against it if you really needed to access it.

00:28:44.000 | Again, that wouldn't be the first place to go for liquidity.

00:28:49.000 | Or you're right, you could roll it into an IRA, whether it's a Roth or a traditional,

00:28:53.000 | depending on how the 401(k) is set up.

00:28:56.000 | But those would be the two options.

00:28:58.000 | I would really try to avoid cashing it out because you're going to pay quite a bit.

00:29:02.000 | Yeah, you probably give yourself more options by just rolling it over into an IRA.

00:29:05.000 | And I don't think you have to be in a rush, too.

00:29:07.000 | A lot of companies will let you keep it there for a while.

00:29:09.000 | And as long as the costs and fees are not egregious,

00:29:12.000 | you can keep it there while you try to figure out what you're going to do with it.

00:29:15.000 | Yeah, I mean, most 401(k)s are not going to boot you off the platform.

00:29:18.000 | They're happy to have your assets and cliffhanger basis points.

00:29:21.000 | Yeah, they don't want you to leave, probably.

00:29:23.000 | I feel like I have heard there that sometimes they start charging you an additional fee

00:29:26.000 | if you're no longer employed. I feel like I've heard that.

00:29:29.000 | Good point. Yeah, that can happen.

00:29:32.000 | And, you know, I would just take a look at what the, you know,

00:29:35.000 | some company 401(k) plans are not as good as others.

00:29:38.000 | I mean, there might be the only options you have in the new company 401(k)

00:29:42.000 | might be really expensive mutual funds.

00:29:44.000 | And in that case, you'd be better off just putting into a self-directed IRA

00:29:47.000 | and buying low-cost ETFs.

00:29:49.000 | Or they might only have a couple options to invest in.

00:29:52.000 | But again, you cannot take a loan against an IRA.

00:29:56.000 | You can take it against a 401(k).

00:29:58.000 | So there's one little piece that the 401(k) might make some more sense

00:30:02.000 | if you ever think, you know, you might need to borrow against it.

00:30:05.000 | Yeah, but Harry's saying that he's financially secure.

00:30:09.000 | I would just roll it over. Don't overthink it.

00:30:12.000 | Probably best to have the control than anything else.

00:30:15.000 | Is there any reason to roll his traditional 401(k) into a Roth IRA?

00:30:19.000 | Or is that not worth the taxes that they would end up paying on that?

00:30:24.000 | Or should I just open a traditional IRA?

00:30:27.000 | Yeah, well, it sounds like you might have a Roth, given the question.

00:30:30.000 | Or maybe there's a combination of the two.

00:30:32.000 | A Roth 401(k) potentially?

00:30:33.000 | Yeah. But, you know, yeah, you could.

00:30:35.000 | But just generally speaking, you could do a conversion.

00:30:37.000 | Again, you're going to pay taxes to do it.

00:30:41.000 | But, you know, the gamble on that is that you are paying, you know,

00:30:45.000 | if you're in a lower tax bracket now, it's less painful to do.

00:30:48.000 | And that money is going to be tax-free in the future.

00:30:52.000 | But, you know, if he is, you know, on the upwards trajectory in his career,

00:30:57.000 | it could be a good time to take advantage of that.

00:30:59.000 | But, you know, given that we obviously don't know what tax rates are going to be,

00:31:02.000 | it's probably fine to just keep it as it is.

00:31:04.000 | Congrats on finding a new job so quickly.

00:31:06.000 | But I would not treat this as found money.

00:31:08.000 | It's set aside for retirement for a reason. Keep it there.

00:31:12.000 | Good advice.

00:31:13.000 | All right. One more.

00:31:14.000 | Okay. Last but not least, we have a question from Nick.

00:31:18.000 | I'm a 40-year-old investor with roughly $2 million in investable assets

00:31:22.000 | split evenly between a typical assets under management wealth advisor

00:31:26.000 | and my own self-managed personal accounts.

00:31:29.000 | When looking at annual performance,

00:31:31.000 | the AUM wealth advisor accounts averaged about 13% gains,

00:31:36.000 | mostly in individual stocks and the taxable account,

00:31:39.000 | whereas on my own, largely through low-cost broad market ETFs,

00:31:42.000 | I averaged 23% returns in 2023.

00:31:45.000 | This pattern has held for the last few years.

00:31:48.000 | So my question is--this gets fiery.

00:31:51.000 | So my question is what in the actual expletive is the point of using an AUM advisor?

00:31:58.000 | What would be the actual valid reasons to use an AUM wealth advisor?

00:32:02.000 | I'm not looking for a sales pitch.

00:32:04.000 | I'm looking for the actual point of using one.

00:32:07.000 | I'm leaning towards just moving all into my own personal accounts.

00:32:11.000 | Our first not to brag of the day

00:32:13.000 | and our first four-letter word that we had to bleep out--

00:32:17.000 | listen, if they're simply investing your money for you

00:32:20.000 | and they're just picking stocks,

00:32:22.000 | they are not a financial advisor; they're an investment advisor.

00:32:25.000 | Now, I'm not saying that there's anything wrong

00:32:27.000 | with outsourcing your investments for some people.

00:32:29.000 | Some people need that.

00:32:30.000 | But if you're just paying them to allocate or pick stocks,

00:32:32.000 | that's a different thing than a financial advisor.

00:32:34.000 | So I would--and this is obviously the thing you want to do up front,

00:32:38.000 | so maybe they're realizing this after the fact.

00:32:41.000 | Performance is not the only reason that you have this kind of change of heart,

00:32:46.000 | but it's certainly something to think about.

00:32:50.000 | So if they're doing something for you besides asset allocation,

00:32:53.000 | security selection, or fund selection,

00:32:55.000 | I would have that conversation to help understand that.

00:32:58.000 | So Kevin, when you're talking to prospects or clients,

00:33:00.000 | how do you try to tell them the things that you're doing for them

00:33:04.000 | beyond just investing?

00:33:06.000 | Because we've had plenty of clients come to us who assume,

00:33:09.000 | "Listen, you're managing my portfolio, you're managing my investments,"

00:33:11.000 | and that's a big part of what we do, but it's not the only thing.

00:33:14.000 | I actually had a conversation with a client this week

00:33:16.000 | who, after the meeting, emailed us and said,

00:33:19.000 | "Listen, I thought the investments were the important thing,

00:33:21.000 | but now I realize it's so much more than that.

00:33:23.000 | It's taxes and insurance and estate planning and financial planning

00:33:26.000 | and all these other things you do that I didn't even realize before."

00:33:29.000 | So I think that--so how do you communicate that to people?

00:33:33.000 | Yeah, so I tell potential clients all the time,

00:33:36.000 | "Do not hire somebody for performance,"

00:33:39.000 | because as many times as you hear it on the TV ads or see it in print,

00:33:45.000 | it does not mean you're going to have success in the future.

00:33:49.000 | And also just think about--yeah, to your point,

00:33:52.000 | what does this person think that they're doing for you?

00:33:56.000 | If you hire them purely to manage their money and invest it for you

00:34:01.000 | and try to get an outsized return, I could see why you have a gripe.

00:34:05.000 | But please note that beating the index is really, really, really difficult,

00:34:11.000 | which is why index investing has become so popular.

00:34:14.000 | Because over time, I think it's something like 90% of professionals

00:34:18.000 | don't beat their benchmark.

00:34:20.000 | So if they don't have a shot, why--if you can't beat them, join them.

00:34:25.000 | And it's worth understanding what your allocation with them--

00:34:28.000 | if they have more cash or bonds or national stocks or alternatives,

00:34:31.000 | whatever it is, that's fine.

00:34:33.000 | But if they're investing your money in a way that you don't agree with,

00:34:36.000 | that's not going to work, right?

00:34:39.000 | Exactly, exactly.

00:34:40.000 | And for your personal accounts to return 23% last year,

00:34:45.000 | I'm guessing you're mostly large-cap U.S.

00:34:47.000 | The advisor or the AUM person might have been investing in small caps

00:34:54.000 | and international and emerging markets.

00:34:56.000 | And maybe against their benchmark, they did perfectly fine.

00:34:59.000 | I'd also say, well, okay, that's last year.

00:35:02.000 | What happened in 2022?

00:35:04.000 | It's easy to think it's simple when the markets are up.

00:35:09.000 | Yes, exactly.

00:35:10.000 | And so to your point, Ben, you mentioned all those things earlier.

00:35:13.000 | If you are looking for somebody purely to grow your portfolio

00:35:17.000 | as fast as possible, risk management be damned,

00:35:23.000 | then, yeah, maybe you want somebody who's going to just try to shoot the lights

00:35:27.000 | out on returns.

00:35:28.000 | But what we talk about a lot is that we're wealth managers.

00:35:33.000 | We are here to literally manage your money.

00:35:35.000 | You've become wealthy in some way, shape, or form.

00:35:38.000 | Our job is to keep you that way.

00:35:40.000 | And so focusing on the emotional components, right?

00:35:43.000 | What did you do in March of 2020?

00:35:45.000 | Did you sell everything?

00:35:47.000 | What did you do in the taper tantrum?

00:35:50.000 | What did you do in '08?

00:35:51.000 | So getting a sense of that behavioral management,

00:35:54.000 | getting a sense of what their goals are,

00:35:55.000 | understanding how to invest which dollars for what event in life.

00:36:00.000 | And if this guy doesn't have a very complex situation,

00:36:03.000 | maybe he doesn't need it.

00:36:04.000 | We have plenty of people who, in our audience,

00:36:06.000 | who are DIY investors and they do it all themselves.

00:36:08.000 | And that's fine.

00:36:09.000 | Not everyone needs an advisor.

00:36:10.000 | But if he has a complicated enough financial life where he's dealing with

00:36:14.000 | estate planning and insurance and taxes and needs someone to stand between him

00:36:18.000 | and making a mistake, that's a financial advisor you're looking for.

00:36:21.000 | So maybe you just have the wrong one or maybe you realize,

00:36:23.000 | "I don't need one."

00:36:24.000 | Yeah.

00:36:25.000 | Yeah, I would actually bet that the vast majority of our clients were former

00:36:29.000 | do-it-yourselfers and they found us by watching this show or listening to Josh

00:36:34.000 | or Animal Spirits or whatever it is and said,

00:36:36.000 | "Hey, I was fine doing this on the way up,

00:36:38.000 | but now I'm getting ready to retire and there's so much about the

00:36:41.000 | distribution aspect that I don't understand and taxes and all the other things."

00:36:46.000 | And that's where it might make sense to say,

00:36:47.000 | "I want to enjoy my retirement.

00:36:49.000 | I don't want to sit at a computer all day and watch my stock portfolio."

00:36:52.000 | I agree.

00:36:53.000 | So I think peace of mind is a big thing.

00:36:55.000 | But if you're happy doing it yourself and you've got a good process and,

00:36:59.000 | you know, Ben, you've written on this before,

00:37:01.000 | like write down your investment policy statement and make sure that you stick

00:37:04.000 | to it.

00:37:05.000 | And there's a lot you can do in that area and save yourself the fee.

00:37:09.000 | So, yeah.

00:37:10.000 | And the point of AUM is there's an incentive to grow the pot, right,

00:37:16.000 | to grow the wealth, right?

00:37:17.000 | That's the idea there.

00:37:18.000 | That'd be the hope.

00:37:19.000 | Yeah.

00:37:20.000 | Yeah.

00:37:21.000 | Yep.

00:37:22.000 | Great questions this week.

00:37:24.000 | Thanks to Kevin for coming in and helping us.

00:37:26.000 | We always appreciate it.

00:37:27.000 | If a guy wears a quarter zip like that,

00:37:29.000 | you know that he knows what he's doing, okay?

00:37:31.000 | That's the truth, right?

00:37:33.000 | Email us your questions, askthecompoundshow@gmail.com.

00:37:37.000 | Leave us a comment.

00:37:38.000 | Leave us a review.

00:37:39.000 | Hit that Like button.

00:37:40.000 | Leave us a comment on YouTube if you're watching there.

00:37:42.000 | And we'll see you next time.

00:37:43.000 | See you, everyone.

00:37:44.000 | Thanks, guys.

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What’s the Historical Return on Housing?

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