What’s a Better Buy Right Now - Stocks or Bonds?

00:00:00.000 | Welcome back to Portfolio Rescue! Coming back to you a little later today, because I was

00:00:18.620 | traveling this morning. You could think Duncan is very accommodating. Remember, our email

00:00:23.160 | here is AskTheCompoundShow@gmail.com. Today's show is sponsored by Liftoff, our automated

00:00:30.080 | investing platform powered by Betterment. Duncan, you know the greatest thing about

00:00:33.100 | Liftoff is, especially for this year?

00:00:35.040 | What's that?

00:00:36.420 | It's all asset allocation-based. You're not picking stocks. You don't have to see any

00:00:40.000 | individual names down 80%, 90%, because you hold index funds in these portfolios. Automated,

00:00:46.080 | rules-based. That's a good thing, because we're going to get into it here. One of my

00:00:50.880 | most strongly held financial beliefs is that investing is simple, but not easy. In fact,

00:00:55.200 | I think successful investing can be very difficult, especially when we're talking about stock

00:00:59.000 | picking. So, take Facebook as a perfect example today. Coming into today, Facebook -- and

00:01:03.080 | I'm sorry, I'm never going to call it meta. It's not going to happen.

00:01:05.760 | Yeah, same. I can't.

00:01:07.280 | So, coming into today, the stock was down 66% from all-time highs. Those all-time highs

00:01:11.200 | happened a little more than 13 months ago, September 2021. So, this is pretty recent.

00:01:16.040 | Today, the stock alone at one point was down 22%. Hadn't looked at it in a couple hours.

00:01:20.960 | That's good enough for a peak-to-trough drawdown of 75%. Three-quarters of the value of the

00:01:24.960 | stock, gone. So, John, do a chart out of the market cap loss of Facebook. This thing peaked

00:01:28.440 | at $1.1 trillion. It's now down to $273 trillion. So, we've lost more than $800 billion in this

00:01:37.320 | in 13 months. This is by far the greatest dollar loss in a company ever, and I don't

00:01:41.820 | think there's even a close second. To put this into perspective, $800 billion, that

00:01:46.860 | number of lost market cap value, is greater than every single company in the S&P 500 right

00:01:52.080 | now, save for Apple, Microsoft, Google, and Amazon. This is just a massive amount of wealth

00:01:57.960 | that's just gone.

00:01:59.520 | The last time the stock was at this level was in late 2015. The total revenue for Facebook

00:02:03.840 | was $18 billion. Last year, Facebook brought in almost $120 billion. So, Facebook went

00:02:10.200 | public in the spring of 2012. From that point through the highs of September of 2021, it

00:02:15.040 | was outperforming the S&P by 800%. It was easily one of the best-performing big stocks

00:02:19.520 | of the decade, up that, not even close. John, do a chart out of the performance of the stock

00:02:24.080 | through today, since inception. Facebook is now underperforming from its IPO price, the

00:02:29.800 | S&P 500, on a total return basis. So, that's 800% of outperformance gone. The S&P is now

00:02:35.200 | outperforming by more than 25%. So, this is just a very not-so-gentle reminder that stock

00:02:41.660 | picking is extremely difficult, even over the long run, even for one of the best-performing

00:02:45.240 | stocks of the past 10 years. And the hard part is, from here, you think, well, okay,

00:02:50.280 | the hard stuff is over, because the stock has already fallen 75%, but there's like two

00:02:54.240 | paths, I think, from here. One is, Facebook is just a broken company. They made a pivot

00:02:58.800 | to the metaverse at the worst time, and it could be a declining social network, and maybe

00:03:04.380 | it's just never going to regain those highs. The other thing is, you could say, well, this

00:03:07.560 | is a stock that is still just bringing in cash flow, the metaverse thing is going to

00:03:11.640 | work. They just added legs to the metaverse. I mean, that's got to be worth something.

00:03:15.840 | What if this is a generational buying opportunity? And honestly, neither outcome would surprise

00:03:19.480 | me at this point. And I give it up for people who want to make that call right now. I don't

00:03:26.120 | know if I could, but this just shows the perils of stock picking. And trust me, I still pick

00:03:32.040 | some stocks. I have a fund portfolio, but I still do this. It's really, really difficult.

00:03:36.520 | Yeah, I mean, you just have to sell it at that peak, though. That's all you have to

00:03:41.400 | do.

00:03:42.400 | Of course, yes. Just sell in September 2021. It was easy to see that it was going to happen.

00:03:45.680 | 13 months ago, it was going to peak. And, ooh, boy.

00:03:49.800 | Mine that looks like that is Oatly. It looks about the same.

00:03:53.080 | Okay, what is this? I've never heard of this company before.

00:03:55.920 | It's Oatmilk. So, I was Peter Wenching, buying what I know, kind of thing.

00:04:00.760 | Oh, Oatmilk.

00:04:01.760 | Yeah, it's not gone well.

00:04:02.760 | Is it supposed to be healthier for you? What's the story there?

00:04:05.680 | I mean, it's supposed to be pretty healthy. It's good for the environment, blah, blah,

00:04:09.280 | blah, all that kind of stuff.

00:04:10.280 | It's like almond milk.

00:04:11.280 | Yeah, it's non-dairy.

00:04:12.280 | Okay, gotcha.

00:04:13.280 | Yeah.

00:04:14.280 | Okay. Can't believe that stock is not holding up better.

00:04:16.640 | Yeah, yeah. Easy to say now.

00:04:19.080 | Okay, all right. Let's do our first question of the day.

00:04:22.080 | Okay. Actually, first up, I want to say happy birthday to Chris Vinh, our colleague here

00:04:28.800 | at the firm at Rihls, and also my mom. They share a birthday. So, happy birthday, mom

00:04:33.360 | and Chris.

00:04:34.360 | I don't know your mother, but I'm sure she's great. She produced a fine gentleman as a

00:04:37.480 | son, and Chris is one of the best people I know in wealth management. Happy birthday,

00:04:40.400 | Chris.

00:04:41.400 | Yeah, yep.

00:04:42.400 | Okay.

00:04:43.400 | All right.

00:04:44.400 | So, up first today, we have a question from Bob.

00:04:47.160 | Wow. Unusual year with both stocks and bonds both down at the same time. I'm in my early

00:04:52.560 | 60s and still five to seven years from retirement. The current market environment has me wondering

00:04:57.120 | which is the better position to be in when interest rates inevitably peak and begin to

00:05:00.620 | fall and stocks rebound. Down 18% and sitting in bonds, or down 25% and sitting in stocks?

00:05:07.360 | What do you think?

00:05:08.520 | I like Bob's line of thinking here, because a lot of investors in today's environment

00:05:12.440 | are viewing losses through the prism of, "This is a nasty risk, and this is awful," instead

00:05:16.840 | of through, "Hey, this is actually an opportunity. Those losses are sunk costs. They happened

00:05:21.240 | already. There's nothing you can do about them." So, let's look at the relative attractiveness

00:05:25.080 | of both. So, let's start with bonds. Interest rates for bonds are now better than they've

00:05:28.700 | been in years, maybe decades. So, John, do the table on here. This is just different

00:05:33.360 | types of bonds, short-term government bonds. The aggregate bond index is like a total bond

00:05:37.560 | index, corporate bonds, and then high-yield bonds. So, we're talking anywhere from, call

00:05:41.960 | it 5% to 9% for yields in bonds, average yield to maturity. That's not bad, right? And I

00:05:47.000 | actually think these yield levels are more important right now to the stock market than

00:05:51.280 | inflation of the Fed, potentially, because for the first time in a long time, stocks

00:05:54.800 | have some competition in terms of, they're providing a decent yield in bonds that give

00:06:00.160 | stocks some competition for allocation. So, the stock market has done just fine with rates

00:06:06.440 | at these levels in the past, but we've never seen the relative attractiveness of bonds

00:06:10.480 | change so fast. So, I think investors finally see, even in short-term bonds and cash-like

00:06:15.800 | securities, that you can earn 4% to 5%. That has to change the equation in terms of allocation

00:06:21.600 | for people. So, the question is, from bond investors, what happens here? So, Bob asks,

00:06:24.680 | "What happens if rates fall?" But I think, if we're doing a scenario analysis here, there's

00:06:28.800 | really only three options for bonds, from what can happen in terms of a variability,

00:06:33.120 | volatility standpoint. So, one, rates fall. Two, rates stay put, or just stay range-bound.

00:06:38.120 | And three, rates rise. Inflation is obviously the wild card here for real returns, but let's

00:06:42.680 | look for the possibilities. So, rates fall. That's what Bob is thinking is going to happen.

00:06:46.400 | If you have any duration in your bonds, they're going to do better than any sort of long-term

00:06:50.760 | duration, or are going to do better than short-term duration, because if yields fall, prices rise.

00:06:55.200 | And the more duration you have, all else equal, the better your bonds are going to do in terms

00:06:58.280 | of prices. So, rates could fall because the Fed decides to pivot in lower rates, or inflation

00:07:03.600 | could peak, or we go into a recession, or maybe all three of those things. And even

00:07:06.620 | during the '70s, John put a little chart on here, even in the '70s, rates typically fall

00:07:11.960 | during a recession, even if they pick up their upward climb after that. So, I actually think

00:07:17.040 | rates falling a substantial amount would be the worst-case thing for fixed income investors,

00:07:21.520 | especially over the long term, because that means returns are going to be lower. They'll

00:07:25.200 | be better in the short term, but over the long term, you're going to lose that yield.

00:07:28.760 | So, what happens if, let's say Bob is wrong and rates continue to rise? Prices would certainly

00:07:34.160 | fall again, for all bonds. They'd fall a little less for short-term bonds, and more for long-term

00:07:39.400 | bonds. And I think if rates do continue to go up, you're going to get a little more short-term

00:07:44.880 | pain. The thing is, this time around, there's a much bigger margin of safety for bonds,

00:07:48.920 | because you actually have that 4-5% yielder sitting on, whereas before, the rate-hiking

00:07:52.320 | cycle happened when yields and bonds were like 0-1%. So, that's why bonds got killed

00:07:56.120 | so bad. There was no yield to cushion the fall. So, I actually think if rates rose a

00:08:00.840 | little bit more from here, that's not the worst thing for bond investors, because again,

00:08:04.720 | those higher yields eventually turn into higher returns in the future. It's just a little

00:08:07.720 | short-term pain to get there. And then, the other scenario is, let's say rates just stay

00:08:11.780 | range-bound, like 4-5% for a while. I actually think this is probably the most welcome thing

00:08:17.480 | for bond investors, even if you don't get that price kicker. You can kind of just clip

00:08:21.660 | your coupon. I mean, that's not always the case in corporates and high yield, because

00:08:26.520 | you have to talk about defaults and credit risk. But if we're talking about just government

00:08:30.600 | bonds, if you just clip that 4-5% for a while, rates stay where they are, in a range, maybe.

00:08:35.480 | That's not the worst case, because bonds are supposed to be the boring part of the portfolio,

00:08:39.400 | right? Now, so, that's bonds. I think, say, two out of those three scenarios are pretty

00:08:44.780 | good for bonds, in the short-to-intermediate term. One of them is better in the long-term,

00:08:48.200 | if rates rise. So, let's look at stocks now. So, interest rates roll over. Bob's right.

00:08:52.520 | You would assume the stock market would be doing better. So, John, let's do a chart on

00:08:56.400 | here. This is just, I've looked at this before, how the stock market performs when inflation

00:09:01.120 | is rising, falling, and then interest rates are rising or falling, using the 10-year yield.

00:09:05.200 | You can see when rates are rising or falling from year to year, the returns for stocks

00:09:08.760 | are pretty much the same. It's like 9-10% average for both rising and falling rate environments.

00:09:13.360 | But if inflation is falling, the stock market has above-average returns, talking like 15%

00:09:18.680 | per year. If inflation is rising, we're talking more like 5-6% per year. So, stocks definitely

00:09:24.320 | do better when inflation is falling or rising, and there's not as much of a relationship

00:09:28.100 | if interest rates are falling or rising. However, I think you would assume if inflation is falling,

00:09:32.480 | at some point, rates are probably going to come down a little, too. But the thing is,

00:09:37.200 | what if inflation and rates are falling because we go into a recession? Does that mean stocks

00:09:41.240 | are going to rise? I don't know. Maybe. Maybe people think that bad news in the economy

00:09:46.160 | is good news for the stock market, but I can't guarantee that. So, it's possible, but I have

00:09:49.600 | no idea. So, either way, whatever the reason is, we know that buying stocks when they're

00:09:54.840 | down 20-30%, historically, over the long term, has worked out pretty good for you. So, John,

00:09:58.720 | do another chart on here. I've showed this before on other shows, and people are probably

00:10:03.120 | getting sick of hearing it from me, but hey, if you buy when the S&P 500 is down 25% from

00:10:07.280 | all-time highs, looking out 1, 3, 5, 10 years, the results are pretty darn good. The average

00:10:13.040 | returns are pretty good. The batting average is pretty good. The past is no guarantee of

00:10:17.600 | future performance and all that, the usual disclaimers here. But it makes sense if you're

00:10:22.600 | buying stocks when they're down 1/3 or 1/4. Over the long term, you're probably going

00:10:27.600 | to do okay, as long as the world doesn't completely fall apart. So, now what do we think? If I

00:10:31.720 | had to bet my life on it, gun to my head, all that stuff, bonds are probably a higher

00:10:36.640 | probability bet over the short-to-intermediate term for giving investors better returns.

00:10:41.160 | That seems to make sense, especially with yields so high. And then stocks are probably

00:10:44.160 | the better bet over the long term, which is not exactly going out on a limb here. But

00:10:49.040 | the good thing is that you don't have to bet your life savings with a gun to your head.

00:10:53.960 | That's not an actual thing. So, you can diversify, especially if you're 5-7 years from retirement.

00:10:59.000 | I go to the extremes and pick one or the other. Right? The great thing about diversification

00:11:04.320 | is you don't have to pick a winner in advance. Your portfolio is going to have it either

00:11:07.120 | way. And I think especially with yields higher, if you're approaching retirement, yeah, it

00:11:11.440 | stinks you're sitting on losses. But from here, from this point, the way things are

00:11:15.160 | setting up with higher yields for bonds and lower valuations for stocks, I think there's

00:11:20.400 | a high probability of pretty decent outcomes for both from here, even though things have

00:11:23.560 | been really terrible this year.

00:11:27.000 | I really like something you just said I wanted to mention on Animal Spirits yesterday. You

00:11:31.360 | guys were talking and you were talking about wanting to see someone do the research on

00:11:35.120 | stocks that have come back from being down 90% and have hit new highs. I would like to

00:11:41.040 | see that, because I think that'd be really interesting.

00:11:44.120 | Yes. How about when a stock loses $800 billion of market cap? That too? But I do think, again,

00:11:52.760 | people have been saying this, 60/40 portfolios, that if you've been in a traditional portfolio

00:11:56.200 | of stocks and bonds this year, you've had a rough year. There has been nowhere to hide

00:12:00.080 | this year. Even if you were in cash, you're losing to inflation. So it's been a tough

00:12:04.340 | year for investors. I think you do have to turn it around and try to change the mindset

00:12:08.560 | to thinking like, okay, this is also an opportunity. It's hard to think that way. Things could

00:12:13.400 | always get worse. That's a caveat here. But I think we're in a pretty good position.

00:12:17.840 | Yes. Makes sense.

00:12:19.560 | All right. One more. Let's do it.

00:12:22.520 | Up next we have a question from Ramachandran. I'm a 28-year-old single male from the Greater

00:12:27.840 | Detroit area, Michigan. I'm maxing out my 401(k) and IRA, and today have almost $47,000.

00:12:34.400 | My goal is to save $1.8 million in index funds before retiring around 65. Once my contributions

00:12:40.280 | reach $175,000, 30 more years of compounding at 8% annually will get me to my goal. Should

00:12:45.720 | I reduce my contributions at that time to save for other financial goals, such as a

00:12:49.360 | house and education expenses for kids? I like this. They're looking so far ahead. 28 and

00:12:54.160 | single looking for that.

00:12:55.160 | Yes. I love the forward thinking here. Shout out to my guy here from the Detroit area.

00:12:58.880 | I lived in Detroit area for a couple of years. That's where I actually learned how to drive.

00:13:02.520 | People over there are nuts on the highway. I think I increased my speed by 10 to 15 miles

00:13:07.480 | per hour on average.

00:13:08.480 | It's Motor City, right?

00:13:09.480 | Yes. Yes. And if you drive a car that's not from Detroit, you get shunned over there.

00:13:15.560 | Definitely. I was glad I had my Ford Taurus when I was there. All right. So I love the

00:13:19.560 | forward thinking. I feel like thinking this way leads me to believe this person has read

00:13:23.960 | a personal finance blog post or three, maybe even one of mine, because you've heard me

00:13:28.300 | give this example before.

00:13:29.300 | Like if you start saving at 25, you save for 10 years, you get 8% returns, blah, blah,

00:13:33.360 | blah. You're going to do better than someone who starts saving at 35 and goes till 65 because

00:13:37.680 | you get so many more years ahead of the compounding, right? So it appears that's what the thinking

00:13:42.800 | is here. So I get to $175,000 by the time I'm 30 or 35, and in 30 years from there,

00:13:48.480 | I can count on almost $1.8 million. And it's true. I ran the numbers here. He's spot on.

00:13:54.040 | $175,000 over 30 years at an 8% annual return year in and year out is going to be like $1.75

00:14:00.560 | million.

00:14:01.560 | It's hard to believe, because our brains don't think exponentially. So, John, do a chart

00:14:05.760 | on here. This is just the charts. This is just average returns, annual returns, and

00:14:10.640 | what they lead to over 30 years. So you can see an 8% return is like 900% in total. 9%

00:14:15.860 | return is over 1,200%. 10% return is 1,600% over 30 years. Even 6% is close to 500% total

00:14:22.840 | returns. So this is the power of exponential thinking and compounding, and it's pretty

00:14:28.740 | darn good.

00:14:29.740 | And the other thing is, if you look at the history of the stock market, your worst case

00:14:34.100 | scenario historically, so John, put the next chart up. This is the rolling 30-year annual

00:14:39.320 | average return. I only did this for 2020 because this is an old chart, but it is what it is.

00:14:43.640 | The worst you've ever gotten is right around 8% investing at the peak in 1929. September

00:14:49.000 | 1929, you invest, you lose 85% of your money in the Great Depression. Over 30 years, you

00:14:53.280 | still get close to 900% in total return and 8% annually. Something like that. I think

00:14:58.160 | it's like 8.50, a little less than 8. So that's the worst case you've ever gotten.

00:15:01.400 | Now, can we promise this is going to happen going forward? Of course not, right? Again,

00:15:05.720 | the past performance is no predictive future performance. That's a pretty good track record

00:15:09.560 | over three decades. The problem is, what if you're wrong? That's the thing. There's no

00:15:17.280 | margin of safety here if you don't get 8%. So if you get 7%, you go from 1.75 million

00:15:23.560 | to 1.3 million. So you're almost 400 grand short. 6%, we're now looking at right around

00:15:28.200 | a million dollars. 5%, we're talking 750K. So you're a million dollars short of your

00:15:32.360 | goal. Right? That's kind of tough. If your entire financial plan is based on hitting

00:15:36.880 | a specific return target and a specific dollar amount, you could be disappointed if the market

00:15:41.280 | doesn't cooperate. That's a big risk. The other thing is, what if the sequence of timing

00:15:46.620 | returns doesn't come in right? So you could say, "You're still going to get your 8% return,

00:15:50.440 | but what if all those really high returns come early on in your career, and you get

00:15:55.200 | crappy returns towards the end of your career?" The sequence of returns, you could still get

00:15:58.720 | 8%, but do much worse, because you retire right when the market crashes or something.

00:16:03.760 | So the stock market returns are lumpy. You don't get 8% year in and year out. Inflation

00:16:07.220 | is the other big one. What if you hit your 1.75 million dollar goal in 30 years, but

00:16:11.360 | your standard of living is different, or that money doesn't go as far? So no one really

00:16:15.760 | knows what their life is going to be like in 30 years. I like the idea here. And obviously,

00:16:19.360 | there's a finite amount of savings for each person in terms of the goals they have. So

00:16:23.800 | if you want to cut back a little bit to buy a home and save for kids and whatever else

00:16:27.240 | you need to do, of course that's fine. Your money can't go everywhere if you don't make

00:16:31.840 | a ton of money. But I like the idea of at least continuing to get that company match

00:16:36.280 | in the 401(k) and save for those goals. Once you hit those goals, I'd be a little nervous

00:16:42.020 | if I'm completely giving up on retirement saving just because I'm going to have compounding

00:16:47.200 | do it all for me. I like the idea. I still think you should probably throw in a little

00:16:52.120 | margin of safety and just keep saving. Maybe you could decrease your savings rate once

00:16:55.920 | you hit that goal, but I'd keep saving. At least get your free match and go from there.

00:17:01.200 | Right. Yeah. The match is free money, right?

00:17:04.520 | It is. But yeah, this person has obviously done a lot of personal finance research. And

00:17:08.360 | this is like, I always say a lot of these spreadsheet answers, like no one actually

00:17:12.240 | does this. This person is trying to do like a personal finance book. And I would say,

00:17:17.360 | it's really intelligent, but also you want to leave some room for any mistakes or errors

00:17:22.080 | or the potential for your life to be different in three decades. No one knows what their

00:17:25.320 | life is going to look like in three decades. I don't know what my life is going to look

00:17:27.960 | like in three weeks sometimes. Right. Yeah. Or three days, right?

00:17:33.120 | True. Okay, cool. So up next, we have a question

00:17:37.160 | from Scott. I hope you don't think I cheated on you with another podcast, but I heard a

00:17:41.480 | tax expert on stacking Benjamins. Excuse me, sir.

00:17:45.000 | Yeah. Ed Slott on October 10th episode said everyone should go all in on Roth instead

00:17:51.560 | of traditional across the board, including their 401k contributions. One of his arguments

00:17:56.440 | was that tax rates will be higher in the future, which I agree makes sense if you're in a low

00:18:00.280 | tax bracket. However, not to brag, but I'm in the 24% marginal federal tax bracket. I

00:18:06.080 | have a hard time believing that my cumulative tax rate in the future will be higher than

00:18:09.960 | my current marginal rate. Do you think I'm wrong? Well, hold on. We have a second part

00:18:15.280 | to this question. Yeah, there we go. Another argument was that you won't have to pay taxes

00:18:23.960 | on your investment gains with a Roth while all withdrawals from a traditional account

00:18:28.360 | are taxed as ordinary income. Anecdotally, his arguments make sense. However, I feel

00:18:32.760 | he's neglecting the time value of money, i.e., the upfront benefit of the deduction now versus

00:18:37.840 | the tax savings in the future. I'd love to see Ben put what he has learned from the CFA

00:18:42.360 | to work and crunch some numbers. I realize that you might need to break out a crystal

00:18:46.080 | ball to predict investment returns in future tax brackets, but I'm wondering if there's

00:18:50.060 | a break-even marginal rate, tax rate, where traditional 401k contributions make more sense

00:18:55.320 | than Roth. I've often wondered this, so I like this question.

00:18:58.840 | There's a lot going on here. This is our first not to brag about a tax rate before, and I

00:19:03.240 | feel like that's a niche joke for 5% of the audience that will get that. I think Scott

00:19:08.080 | is smarter than I am here. He asked me to take my CFA hat out and fix this. Here's what

00:19:12.200 | they don't teach you in the CFA. Instead of crunching the numbers yourself for tax questions,

00:19:16.920 | bring on an expert who knows how to do it better than you. I didn't learn tax in the

00:19:20.680 | CFA, so let's bring on a fan favorite here, Bill Sweet.

00:19:23.240 | Gentlemen.

00:19:24.240 | Bill, tax man.

00:19:25.240 | You're my tax expert.

00:19:26.240 | Good to be back.

00:19:27.240 | Bill, through the magic of airplanes, I was in New York with you yesterday, hung out all

00:19:32.400 | day. We went out to a nice, fancy dinner together, and now I'm back here in Michigan, and here

00:19:35.520 | we are over the Zoom.

00:19:37.360 | Yeah.

00:19:38.360 | So Scott has, I think in our Google Doc here that we share with each other, you said this

00:19:43.080 | is a fantastic question. It's an intelligent question. Scott obviously has thought long

00:19:46.520 | and hard about this. Okay, what are we doing here? He wants to know, okay, I get the generalized

00:19:53.840 | thoughts about Roth, but what about my personal situation? So how does this factor in, since

00:19:58.060 | we know you're a big Roth guy?

00:19:59.320 | Yeah, first off, Ed Slott is a walking legend. The man walks on water in the tax world. You

00:20:04.240 | can cheat on me with Ed Slott any day of the week. Ed Zollers is my other main Ed in the

00:20:09.340 | tax land. He's a CPA. Ed Zollers, can you beat that name? There's only one name, I think,

00:20:13.960 | Bill Sweet. That's better than that. Tony Dindi and Jeff Levine, they surround out my

00:20:19.200 | Mount Rushmore. But Ben, did you know that the high marginal tax rate in 1945 was 94%?

00:20:27.040 | Okay.

00:20:28.240 | So if you're bragging about your 24% tax bracket to your grandpa who landed on Omaha Beach,

00:20:34.680 | you might want to hold that in because he cackles at your 24% tax rate.

00:20:39.760 | If I had a 94% tax rate, I'm pretty sure I would be doing some illegal stuff and not

00:20:44.220 | paying my taxes.

00:20:45.220 | Well, hopefully, no illegal stuff. We're an NSEC registered firm. But that was for somebody

00:20:50.840 | earning more than $200,000, right? And if you adjust that for inflation, it's about

00:20:54.560 | $1,000,000 in today. But still, thinking about earning an extra $100 and only getting to

00:20:59.000 | keep six, again, we have 2020 problems over here. We might have recessions in inflation,

00:21:05.680 | but it was nothing like that.

00:21:07.260 | So another stat I want to share with you guys is for the fiscal year ending August 30th

00:21:12.680 | for the US federal government. The US federal government received $4.8 trillion of receipts.

00:21:17.960 | That's pretty solid in the grand scheme of things. We might be in a recession, but $5

00:21:23.600 | trillion of tax revenue. The problem is we spent $5.8 trillion in the trailing 12 months

00:21:28.760 | for that extra trillion dollar gap, right?

00:21:31.040 | So my point here is I enjoy this question. I think it's a good one. But Scott, you are

00:21:35.160 | living in low tax nirvana right now, and we just don't know it. John, can you pull up

00:21:38.880 | that chart, the chart I slapped together two minutes before broadcast, by the way. Here's

00:21:42.840 | a quick look at historical US high and low marginal tax rates. And so right now we're

00:21:48.520 | at 10 and 37. And again, that's no fun. But like compared to history, we're in a pretty

00:21:53.240 | low tax rate. Really, like it was Ronald Reagan who came along in 1986 and said, enough of

00:21:57.680 | this 50 plus percent tax rate. And we really never looked back. Of course, budget deficits

00:22:02.080 | and everything like come with that. But I really want to turn this question around,

00:22:05.440 | Ben, because ultimately, I think sometimes in this show, we spend a little bit too much

00:22:10.000 | time trying to game things, right? I mean, you try to be a winner with your investments,

00:22:13.840 | right? You've successfully timed Michelin star restaurants, ordering chicken fingers

00:22:18.800 | and asking for ketchup there.

00:22:20.240 | I timed when to get out of the Michelin star restaurant.

00:22:22.880 | It was a good move, but you missed the celebrity chef who came a couple minutes later. But

00:22:25.920 | leaving that aside, with perfect knowledge, knowing how the next 30 years of investment

00:22:30.720 | returns are going to pan out, future tax rates, and your life expectancy, yes, we can perfectly

00:22:34.800 | game this. But the future is not just unknown, Ben. It is unknowable. And I think it makes

00:22:39.920 | sense to optimize, but only up to a certain extent. And so, Ben, let me magically retire

00:22:44.240 | you in 2050 or so. If you're looking back, I think the goal is we want tax diversification,

00:22:48.760 | right? We don't necessarily want to win, but we want to have a bucket of Roth, a bucket

00:22:53.680 | of pre-tax, a bucket of non-qualified assets. So, when we go out and spend money, we can

00:22:58.840 | pick and choose where that comes from to maximize our future tax rates. So, Scott, that's the

00:23:02.800 | frame I'd like you to think of. And Ben, when is the time when you might want to contribute

00:23:07.160 | to a Roth IRA compared to a traditional? Like, when in your life cycle?

00:23:11.220 | When you're young, right?

00:23:12.280 | When you're young, right? And so, Scott didn't give us his age, but ultimately, if he's in

00:23:15.600 | the 24% federal tax bracket, assuming that that doesn't jump up substantially, my guess

00:23:20.560 | is still probably pretty early in life. Now's the time to max fund a Roth. And I think somewhere

00:23:24.960 | around mid-career, you flip that switch and then you try to game it that way.

00:23:28.640 | Yes. And the point is, too, optimization only works for the benefit of hindsight. You can't

00:23:33.400 | optimize for the future because we don't know about it. So, that's the point of diversification.

00:23:36.640 | So, diversification in asset classes and how you save and when you save, and also your

00:23:42.800 | tax rates, right?

00:23:43.800 | Yes. And I would listen to the legend, the man, the myth, Ed Slott. He knows what he's

00:23:47.400 | talking about.

00:23:48.400 | What would you say to someone who's young and who's like, "I'm at a relatively low salary

00:23:54.880 | compared to what I'll be making down the road. And so, this extra money in my pocket right

00:23:59.560 | now could be really beneficial."

00:24:01.080 | Yes. Again, that makes sense to me, Duncan. But I think you really have to balance that

00:24:06.000 | out between the power of compounding, right? And so, $1,000 today, you leave that alone

00:24:09.840 | for 30 years at 8%, like the questioner, the second questioner. That becomes worth $8,000

00:24:15.160 | to $20,000, right? Depending on how long your time horizon is. So, yes, you could use that

00:24:19.560 | money today, but you probably really want that tax-free compounding asset in the Roth.

00:24:24.680 | So, it's a balancing act, but I don't know.

00:24:26.440 | Bill is going to shame every young person into investing in a Roth.

00:24:28.880 | Yes.

00:24:29.880 | That's my goal here.

00:24:30.880 | Well, now I'm thinking, what about that $8 coffee from Blue Bottle?

00:24:33.480 | No, I don't do that. I don't do avocado toast.

00:24:37.280 | Yeah.

00:24:38.280 | All right, let's do another one.

00:24:39.280 | That's like 2015 bullshit. We don't need to play that game.

00:24:41.000 | Okay. Up next, we have a question from Willie, who I like to think is going to be Willie

00:24:45.760 | Nelson.

00:24:46.760 | Yeah.

00:24:47.760 | "I sold my rental property this year, like Ben, and had about $125,000 of long-term capital

00:24:52.960 | gains. I invested the proceeds in a few ETFs and now have some short-term losses. I'm a

00:24:57.960 | bit confused about how to deal with the wash/sell rule. If I take the loss to lower the hit

00:25:02.640 | of my capital gain, in theory, I can't invest in a similar ETF for 30 days. I don't want

00:25:07.840 | to be out of the market, and I really don't want to substantially change what I'm invested

00:25:11.280 | in for 30 days if I'm just going to switch back 30 days later and potentially have short-term

00:25:15.960 | capital gains. Am I looking at this the wrong way? Is the tax-loss harvesting even worth

00:25:21.260 | the trouble? Can I go from VTI to SPY, or is that too similar?"

00:25:26.120 | These are questions you ask during a bear market. No one talks about tax-loss harvesting

00:25:30.280 | during a bull market. Bill, let's start with an explanation. Also, good job, Willie, selling

00:25:35.360 | your rental property when you did.

00:25:36.960 | Pulled a Ben Carlson up in here.

00:25:38.520 | It would be a little harder to do right now. Let's start with a short explanation of tax-loss

00:25:42.680 | harvesting and then the wash/sell rule and how this works and why this is a rule.

00:25:45.880 | Yeah, so just very quickly, Willie sold a property. He realized a gain of $125,000,

00:25:50.560 | a taxable gain. At the end of the year, if he does nothing, let's say he's at 20% tax

00:25:55.480 | bracket, 15% federal, he's going to own about $25,000 right to the IRS. So that clock's

00:26:00.160 | ticking. The gain's been realized. So Willie's question is, "OK, cool. I now have capital

00:26:05.160 | losses in the assets that I reinvested in." Let's say he has a $60,000 loss. He has the

00:26:10.000 | opportunity then to cut his loss in half, right? Because he realized a gain earlier.

00:26:15.160 | Now he has a loss. At the end of the year, 12/31, at midnight, magically, the IRS ferry

00:26:19.560 | declares capital gain season over, and everything gets netted out throughout the year. So Willie's

00:26:23.760 | got an interesting opportunity here, and I would suggest that he acts.

00:26:27.480 | Right, so use those losses to your advantage here, right?

00:26:30.040 | Yep, precisely.

00:26:31.040 | And the whole wash sale thing is basically just so you can't sell a stock at a loss and

00:26:35.360 | buy it back immediately because the IRS is-- you're just kind of locking in those losses,

00:26:39.840 | and they don't want you to be able to easily do that.

00:26:41.560 | Unproductive economic activity. Yeah, I think that's the rationale. And these rules date

00:26:45.160 | back to the Securities and Exchange Commission Act of this year.

00:26:47.800 | Although you can technically do that in crypto right now, right?

00:26:50.120 | That's what I was about to ask, if you could still do that.

00:26:52.360 | Because cryptocurrency is not a security, right? So all these SEC rules that were written

00:26:56.560 | in 1925, they apply to securities. But for reasons that are a little confusing and not

00:27:00.760 | the subject of this question, cryptocurrency is not considered a security, but an ETF,

00:27:04.760 | a stock is.

00:27:06.040 | So what is a wash sale rule? The 30-day wash sale rule is exactly like you described, Ben.

00:27:10.040 | You're not allowed to book a loss for security that you sell and you rebuy it instantly or

00:27:13.880 | within 30 days. And it's actually a 60-day window. Because if you buy a security, let's

00:27:18.600 | say he just goes out and buys another ETF a day before, and then books the loss and

00:27:22.720 | just has that extra capital lying around. He's done that within 30 days prior to the

00:27:27.560 | sale. And so that loss would be disallowed as well if it's a substantially identical

00:27:32.160 | security.

00:27:33.160 | And so that language is really important. The tax code says it cannot be substantially

00:27:37.320 | identical. But nowhere in the tax code can you find out what substantially identical

00:27:41.240 | actually means. But luckily, throughout the last 100 years or so, some morons decided

00:27:45.760 | to push the issue all the way to the tax court. And some judge ruled a couple of rules and

00:27:49.880 | a couple of basic rules that follow. So substantially identical security is obviously the same security.

00:27:55.100 | Another thing, if you have a different share class-- so Google trades two different share

00:27:58.540 | classes right now. Berkshire A, Berkshire B, that's substantially identical. It's the

00:28:02.640 | same company. It's the same underlying asset.

00:28:05.040 | The other thing, options, calls, puts, those are considered to be substantially identical.

00:28:08.840 | So you cannot buy a call option, sell the stock, and then a day later exercise that

00:28:13.280 | call option, just rebuy it whatever price. That is substantially identical.

00:28:17.240 | Another thing to keep in mind, thou shalt not buy this stuff in IRAs too. So if you

00:28:21.960 | have an automatic purchase of your company stock, Exxon Mobil, whatever else, in your

00:28:25.720 | 401(k) or in your retirement plan, that is also considered a wash sale. And what happens

00:28:30.980 | is if you trigger these wash sale rules, like the universe doesn't end, you don't divide

00:28:35.100 | by zero, and your piece of paper, your computer melts down, what happens is your basis just

00:28:38.920 | carries forward.

00:28:39.920 | And so you basically paid that trading commission, or you exercise that bid-ask spread. And ultimately,

00:28:44.800 | it just carries forward.

00:28:46.240 | So what's the solution here? Any ideas, Ben?

00:28:49.480 | So riddle me this. If he sells his S&P 500 ETF and buys a total stock market ETF, it's

00:28:56.600 | kind of different, right?

00:28:57.800 | Right. So that's the key, substantially identical. And there's been no case law on this, but

00:29:01.980 | generally practitioners, Ed Slott among them, say that if you buy a security that is tracking

00:29:07.500 | a different index, and so like the S&P 500 is a large cap US index, the crisp US total

00:29:13.440 | stock index, which happens to be one of the indices that the ticker that he mentioned

00:29:17.200 | follows, that is, in my opinion, substantially not identical. And it's a facts and circumstances

00:29:23.000 | test. But ultimately, if you're buying something that is the total US stock market versus the

00:29:26.880 | top 500 companies by market cap, that's substantially different.

00:29:30.400 | And he got mid-cap and small caps in there.

00:29:32.720 | What if Duncan sells oat milk, and he buys almond milk? Does that count?

00:29:37.600 | I would say both are disgusting, and I would disqualify them from the wash sale rule.

00:29:42.720 | Come on. We already did a poll. People love almond milk.

00:29:44.960 | I think that would work out. It was actually split, and there was no cow. There was no

00:29:49.160 | organic cow listed there. So I throw that poll out. I thought this was an anti-poll

00:29:54.040 | show.

00:29:55.040 | One thing worth mentioning is that DRIP can mess this up too, right? If you're auto-reinvesting

00:29:59.680 | dividends.

00:30:00.680 | Yeah, that's what I was getting at before, Duncan. Precisely. So if that's happening

00:30:02.640 | in a different account, or even let's say you have a Liftoff account, because I'm a

00:30:06.320 | company man, and that is doing loss harvesting for you, you might have a buy in a certain

00:30:10.920 | security, and then you're trying to do this in your account. So you do. You have to take

00:30:13.880 | a holistic look. And again, it's actually a 60-day rule. 30 days before, 30 days after.

00:30:18.240 | But I would do it, because ultimately, if you can cut your tax loss in half, that's

00:30:21.120 | money in your pocket. You realize that economic loss, and all you have to do is just buy a

00:30:25.720 | substantially not-identical security, and then you don't miss out on any of the market

00:30:29.240 | appreciation that may be coming in the future.

00:30:31.520 | All right. Duncan, one more question.

00:30:33.040 | OK. Last but not least, we have a question from Kyle, who writes, "I hit my 401(k) pre-tax

00:30:40.880 | limit for the first time in my life last month as a result of a bit more aggressive saving

00:30:44.480 | this year."

00:30:45.480 | Congratulations, Kyle.

00:30:46.480 | Not to brag, Kyle. Nice.

00:30:47.480 | Yeah, not to brag.

00:30:48.480 | Good work, Kyle.

00:30:49.480 | Close to 15%. "My company matches 7%. Backdoor Roth already maxed at $6,000, and my HSA contribution

00:30:57.000 | is maxed. I aim to go mega backdoor the rest of the year, but it sounds like the provider

00:31:01.680 | won't let me with my after-tax contributions. Now I'm stuck in a pickle. Keep after-tax

00:31:07.080 | 401(k) contributions up to keep getting the company matched for the rest of the year,

00:31:11.840 | or cut back on the after-tax 401(k) contributions and maybe allocate to something else, like

00:31:16.960 | my after-tax brokerage bucket. Thoughts?"

00:31:19.520 | OK. So a good problem to have here. So Bill, I don't know why they wouldn't let him do

00:31:25.080 | the mega backdoor, but what are the options here?

00:31:27.400 | So ultimately, option one is I speed dial our company. I'm going to call the CFO or

00:31:32.360 | whoever's in charge of the money and get that 7% match. That's tasty. We don't have that,

00:31:37.000 | but the solution here, I would like to think about it this way. What is the order of operations

00:31:41.840 | of savings, right? And so where do you get the best bang for the buck or the most preferential

00:31:46.160 | tax treatment? I would start then, and you've advocated this in the past, for that company

00:31:49.760 | match, right? So whatever you need to contribute, I don't think you can necessarily call it

00:31:53.120 | free money, but if you're getting a 7% match, it makes sense just to contribute that 7%.

00:31:57.480 | It's a 7% rate.

00:31:58.480 | Yeah, I'll get the match.

00:31:59.480 | That's it. So that's the ground floor, and now we're on the ground floor. Let's go to

00:32:02.160 | floor two. Big fan of HSAs. The listener maxed out his HSA. That's awesome, but ultimately,

00:32:07.600 | HSA is the potential to be triple tax exempt, but that's not the question here. Next level,

00:32:12.080 | Roth IRA. Why? IRA. You can get your basis back from an IRA tax-free at any point, right?

00:32:17.920 | You're not going to deal with penalties, and ultimately very flexible. I think that's the

00:32:20.960 | place to go for the next level. That's been maxed out. Now we're going Roth 401(k). $20,500

00:32:26.640 | is the limit that you can do with your own savings. So ultimately, we hit this this year.

00:32:31.440 | Great. Now we're moving to the next level, after-tax 401(k). And what that is, that's

00:32:35.320 | that mega, super, whatever it is, backdoor Roth. Ed Slott's talked about this in the

00:32:38.880 | past, the namesake of this show, apparently. And ultimately, I think that's a cool thing

00:32:42.600 | to do, but that option is closed. Not every employer offers this thing.

00:32:46.400 | I think Bill drafted Ed Slott in his tax fantasy week this year.

00:32:49.600 | He is the number one draft pick, right? Year after year. But yeah, the mega backdoor is

00:32:54.040 | not available to everybody because it's super complex, right? And ultimately, the plan sponsors,

00:32:58.560 | they don't want to get into waging war with the IRS over this stuff. There's stringent

00:33:03.400 | testing requirements. We had to go to our plan provider, and it took us about two years

00:33:06.680 | in order to get them to play ball with us there, and many threats of leaving. So ultimately,

00:33:11.360 | if that's not an option, cross it out. I would say six is IBONZ. We've talked about them

00:33:14.960 | in the past, but that's a really interesting opportunity. You have until tomorrow.

00:33:17.880 | Yeah, you have one more day to get that 9% rate, or 9.6, and then it goes down to 6-something.

00:33:21.840 | The clock's ticking. If you're listening to the show on Friday, it might be too late.

00:33:25.360 | But seventh would be a brokerage or tax-managed account. And so I think, ultimately, the listener

00:33:30.720 | here has filled up every bucket. Who is this? Kyle? Yeah, this is Kyle. Ultimately, Kyle

00:33:35.880 | has filled up every bucket. And so yeah, I think the next place to go is a tax-managed

00:33:39.760 | brokerage account. I use Lyft Off. I'm a Lyft Off subscriber, a company man. That's where

00:33:44.560 | I would go. But something that can tax-manage assets, get maybe some tax losses in a year

00:33:48.760 | like this. So I think Kyle's got the right answer.

00:33:51.400 | After all this wonderful tax talk, Kyle in the chat said, "A woman is marrying me, even

00:33:56.680 | though all I talk about is what you guys talk about." Easily our best backhanded compliment

00:34:00.280 | of the day.

00:34:01.280 | Hey, hiring at ritholdswealth.com. Come on, Kyle. But speaking of backhanded compliments,

00:34:06.200 | we did eat at a Michelin star restaurant last night, Ben, as you know. And the specialty

00:34:09.880 | of the restaurant was seafood. You and Michael said no, no to fish.

00:34:13.360 | Michael and I are not huge seafood guys. And I think they were a little taken aback about

00:34:18.720 | what to do.

00:34:19.720 | It was a power move. I will say that. But I think they handled it. They handled it very

00:34:23.680 | well. It was a French restaurant. But when the dinner came and Ben asked for ketchup,

00:34:27.080 | they asked us to leave politely.

00:34:28.080 | I'm pretty sure that was Michael, but they didn't.

00:34:32.600 | Yeah, the crazy thing was they gave me the Michelin star. They were like, "We can't have

00:34:36.440 | this anymore."

00:34:37.440 | Not to totally derail this conversation, but whoever decided that a tire manufacturer gets

00:34:42.680 | to decide the best restaurants?

00:34:43.920 | Oh, it's a great history. I think it's like there was a travel guide, right? Back when

00:34:47.720 | these were things.

00:34:48.720 | The Michelin guys.

00:34:49.720 | Yeah, exactly. And so that was it. And it's just still here today with us.

00:34:52.960 | I'm happy to take all the hate from not liking fancy restaurants in the chat room. I think

00:34:56.560 | you have to be selectively cheap in your life, and life is about trade-offs. And for me,

00:35:00.880 | that means I prefer a burger and a beer to caviar and champagne. Sorry. I'm in a flyover

00:35:06.560 | state. I'm not one of these East Cody elitists. I'm sorry. We don't have any French--

00:35:11.080 | It was in honor of Mr. Venn's birthday, and a good time was had by all, except for Michael

00:35:15.120 | and Ben, who went to a Knicks game. But God bless them, that they have this option.

00:35:19.560 | So thank you again to everyone watching live, everyone in the chat. Thanks, Bill, for coming

00:35:24.000 | on again.

00:35:25.000 | I got to answer a question that didn't have a Roth area conversion in it.

00:35:28.040 | That's true.

00:35:29.040 | Get this tattoo removed.

00:35:30.040 | We got some good ones.

00:35:31.040 | Do you want to mention this email from Will before we get out of here?

00:35:35.560 | It's kind of nice. We get a follow-up from someone who actually asked a question before.

00:35:39.360 | And I think they asked us a few weeks ago. Basically, I'm in a great financial position.

00:35:43.760 | I feel like quitting my job to help take care of my new newborn or new daughter or son,

00:35:48.600 | I think.

00:35:49.600 | Yeah.

00:35:50.600 | What was the follow-up?

00:35:51.600 | Yeah. So Will wrote us. And this was from episode 42. Today's episode 50. So wow. We're

00:35:57.800 | trucking along.

00:35:58.800 | Very cool.

00:35:59.800 | So Will said, "Hey, Duncan. You might remember this thread. Well, I can now say that Ben

00:36:02.880 | Carlson made me quit my job. A big step into the void of no income, right? Well, shortly

00:36:07.680 | after giving my two weeks, an old employer called me up begging for help. They want me

00:36:11.640 | to set my own consulting rate to do part-time work. I now have a super flexible schedule

00:36:16.480 | and make more per hour than I did before. My immediate worries over income were unfounded.

00:36:21.080 | I feel blessed, but it is also a testament to how hard I've worked in my career. I've

00:36:25.400 | worked in compliance, and it's more valuable than ever because everything gets more complicated.

00:36:30.080 | Most importantly, my daughter is, in her own way, grateful for the extra attention. Many

00:36:33.800 | thanks to what you guys are doing." And yeah. So that was kind of nice to see.

00:36:38.280 | Very cool. Kudos to you. I was trying to help Jerome Powell by putting some out of work,

00:36:41.960 | then they just go back and get another job.

00:36:43.480 | Right.

00:36:44.480 | But it's awesome.

00:36:45.480 | Yeah.

00:36:46.480 | This could have been a lot more awkward, right, depending on circumstances.

00:36:48.560 | The flexibility is definitely the key here. And I think what we said was if you're in

00:36:52.320 | a good position to do this financially and you can handle it, then yeah, do what makes

00:36:56.000 | you happy. And that was spending more time with the daughter, and now another job came

00:36:59.880 | about it. So that's awesome.

00:37:00.880 | It's the stuff of life.

00:37:01.880 | It's more flexibility. Yes. Anyone else who's asked questions in the past, feel free to

00:37:04.520 | give us follow-ups. We'll shout you out on a future episode.

00:37:07.140 | One other thing. We were number one investing podcast in Latvia in the last two weeks. So

00:37:13.120 | shout out to everyone watching in Latvia. We appreciate you.

00:37:16.400 | Okay. How many Mission Star restaurants do they have?

00:37:19.200 | A lot.

00:37:20.200 | All right. Remember, email us, askthecompoundshow@gmail.com, and we will see you next week.

00:37:24.800 | See you, everyone.

00:37:25.680 | Thanks.

00:37:26.680 | Bye.

00:37:27.680 | Bye.

00:37:28.680 | Bye.

00:37:29.680 | Bye.

00:37:30.680 | Bye.

00:37:31.680 | Bye.

00:37:32.680 | Bye.

00:37:33.680 | Bye.

00:37:34.680 | Bye.

00:37:35.680 | Bye.

00:37:36.680 | Bye.

00:37:37.680 | Bye.

00:37:38.680 | Bye.

00:37:39.680 | Bye.

00:37:40.680 | Bye.

00:37:41.680 | Bye.

00:37:42.680 | Bye.

00:37:42.680 | (upbeat music)

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What’s a Better Buy Right Now - Stocks or Bonds? | Portfolio Rescue 50

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