(beeping) (upbeat music) - Welcome back to Future Proof. What? Welcome back to Portfolio Rescue. Duncan, I don't know what I'm talking about here. - You're jumping into the ad. - Yeah, good segue. We're this week responsible by Future Proof. I'm just so excited about it still. Biggest wealth festival there is, September 10th through 13th, Huntington Beach, California.

We're gonna have thousands of people there. It's gonna be fun. Last year we did a, Duncan and John filmed us doing a, recreating a rocky scene on the beach. That's how nice the beach is. That was fun. Can't believe I actually ever did that. - I'm glad you mentioned that.

I was gonna ask what we're gonna do to one up that this year. - I don't know. I don't think it's possible to top it. If you want to check it out, if you want to register, I think if you register early now, you can get a decent deal.

Futureproof.advisorcircle.com. All right, so we're back into the good part of the stock market. John, throw up my chart here. I looked at the monthly returns for the S&P and I realized I did January 2022 twice on here, but the last one's supposed to be January 2023. So this year to date, as of this morning, we're up like five something percent in the S&P.

And if you look at the monthly returns over the last, this is 13 months or so. Call it a year and change. We have down five, down three, up four, down nine, down eight, up nine, down four, down nine, up eight, up six, down six, up five, and who knows where we're gonna finish.

It's all over the place. And I just thinking about all of this back and forth and volatility and it's, even though there's been a downtrend in the market, there's been a lot of snapback rallies and it's very confusing to people. And it just reminds me of the John Bogle quote that the stock market is a giant distraction to the business of investing.

In the last year, really last three years or so, we've had so much volatility and booms and busts and things going in different directions. I think it's easy to lose sight of the fact that like over the longterm, these huge moves on a daily, weekly, monthly basis kind of get smoothed out.

And I think even when it's going really well, is it going a little bit better lately? You still have to kind of zoom out and realize like, this is not the way things are gonna be over the longterm. So I do think it makes sense for most people to just kind of ignore the stuff that's happening on a daily, weekly, monthly basis in terms of performance, especially.

- Yeah, no, I mean, I think that the takeaway for me is that I've learned now why people are obsessed with year-to-date, because year-to-date is feeling great right now, you know? So-- - All we need to do is turn over the calendar and look what happens. - Right, right.

Also, there is a firearm test going on in the background, so hopefully it's not too loud. - Okay, good timing. Thanks, guys. - Great, yeah. - All right, let's do the first question. - Okay, up first we have a question from Mike. I've been considering shifting 20 to 30% of my all-stock ETF portfolio to bonds, but I haven't yet because the market is still well below the highs of 2022.

My thought is that I have a long enough time horizon to wait until the stock market reaches new highs before making this shift. I recognize that this is a type of market timing, which generally doesn't work and should be avoided, but I don't see any gaps in this rationale, so I'd like to hear your thoughts.

I find it interesting they admit that it usually doesn't work, but they think that this might work for them. - I guess any sort of market timing, there has to be some sort of gap in rationale. Now, I'm not sure the exact reason here, but since Mike is a viewer of the show, I'm guessing he analyzed his risk profile and time horizon and his plan, and he said, "You know, I need a more balanced portfolio.

"I'm going from all-stock to bonds. "I realize I need more balance," for whatever reason. So he wants to go from 100% in stocks to more of an 80/20, 70/30 portfolio. Now, some people prefer the glide path, which is just slowly moving from all-equity to something more balanced. So that could mean, I don't know, 5% or 10% per year you move.

So you go 100% to 95% to 90%, whatever, in a slow... That's how the target date funds do it, right? They do it in a slow manner. They slowly... Other people would rather just rip off the Band-Aid and, like, "If this is the allocation I want, "I'm just gonna go to it now." It sounds like Mike wants to rip off the Band-Aid, but he's not quite there yet because he thinks stocks can snap back.

Now, the rationale here that stocks are more attractive than bonds, it makes more sense, 'cause even if stocks just go back to all-time highs, they'd probably have more upside. The problem here, as always, that even if you're right directionally, that stocks do have more upside, you might not nail the timing.

So, John, throw up the table I made here. So these are the drawdowns as of yesterday. It might be a little better after a little bit of rally today, but the S&P from all-time highs is down 16%. The Russell 2000 index of small caps was down 22. NASDAQ 100 is still down 28%.

Just to break even, we gotta see gains of 19, 28, and 38, respectively, right? Now, if that happens in less than a year, you're talking great annualized returns. It's gonna be awesome. Of course that's gonna beat the bond market. But I'd say it takes a little longer. I looked at what the annualized returns would be here over two, three, four, or five years.

If we're talking four years, it could be more of a 4% return for the S&P to get back to that break even. And now we're looking pretty similar to bond yields. Now, I'm not saying it's going to take that long, but if you look at the history of bear markets, some of them have taken that long to break even.

I hope it doesn't take that long, but you never know. So I think the whole point of setting an asset allocation in the first place is not necessarily to optimize for the highest returns possible. If you're gonna optimize for the highest returns possible, you invest in the stock market and maybe add some leverage on there, right?

That's like a textbook. That's how you'd wanna optimize. But I think the asset allocation really is about trying to earn the highest return for a given level of risk. And if you've figured out that a given level of risk for me is 80/20 or 70/30, the longer you stay in an all-stock portfolio, the longer there's a risk mismatch.

So I think you might be fine since you've already dealt with an all-stock portfolio for this long, but I think that there's a few options. So you could wait it out and sell some of your stocks after a big rebound. The only caveat here is that you might just need to be a little more patient.

If the market is doing great now, it could fall again next month, who knows? We could be back here next month and say, "Hey, we're back to a down 6% month." Wouldn't surprise me. You could rip the bandaid off and just move to that stated asset allocation. The bad news is you're selling some stocks at a loss, probably in the midst of a drawdown.

The good news is you're buying bonds at a much higher yield here. So maybe bonds provide a little bit of a boost 'cause you have higher yields. The third option, if you want to split the difference, is just my glide path, dollar cost average, right? Do 5% every three months, every six months, every nine, 12 months, whatever it is.

Pick a time, do it at a predetermined intervals, and then just ease into it. And because if the stock market falls, then you're gonna think, "Well, what am I waiting for?" And then you could just have to double down and do it at a different time. So it's possible we could slingshot back to new all-time highs.

It wouldn't surprise me. It's also possible that we could just kind of drift sideways for a while and who knows what happens. So I would just have a contingency plan if you're gonna stick in all stocks that you want to get to this other allocation, just in case stocks roll over again or they go sideways for a while and then you're kind of stuck and go, "Now what do I do?" - But to be clear, what's your market prediction for the year overall?

- I give my S&P 500 levels in December. - Okay, okay. - I wait. - I'm trying to get you on CNBC, you know? - I put all my predictions through Michael. He's like my puppet. Let's do another one. - Okay, up next we have a question from Joe.

"If I have a pension and an annuity, "is that a substitute for bonds?" - Good question. I've received some variation of this question for years. This was actually another follow-up to our discussion last week on the pros and cons of having 100% all-stock portfolio. And what did you say?

70% of the people in the chat last week said that they actually have all their money in stocks? Something like that? - Something like that, yeah. - Okay, pretty good. Another one people ask is if Social Security should count as a bond. 'Cause Social Security really is a form of annuity.

I've seen estimates in the range of, 'cause you take those payments and the present value of any investment is take the future cash flows, discount them back at some reasonable discount rate. If you did that for Social Security, depending on how much you made and how long you live and all these things that they change from person to person, the present value of even Social Security as an annuity could be something like 300 to $500,000.

Like that would be the present value of trying to buy an annuity stream like that. Obviously, it's impossible to come up with a precise value for these things 'cause rates are always changing and no one knows how long they're gonna live. But let's say you made some reasonable assumptions and you discount your periodic payments from your annuity or your pension back to give yourself a range of the current value of those payments.

Let's say you have like a $600,000 portfolio and you realize that these annuity payments and this pension payment is worth something like 400 to 600,000. So does that mean that you now have a 60/40 portfolio or a 50/50 portfolio and then you can go all in on stocks 'cause that other piece is your bonds?

I don't necessarily like to look at it that way. I prefer to approach this from more of a financial planning perspective than a portfolio management perspective because think about it, if you had no, let's pretend you have no pension income and no annuity and you retire, would you rely strictly, and you're relying strictly on your portfolio for your spending purposes.

You decide, all right, I can spend maybe 4% to 5% per year from this portfolio for withdrawals and that's gonna get me through things. Now, let's say you run the numbers and you realize you do have this pension, you do have the annuity, and it takes your spending from your portfolio down from 4% to 5% to 2% to 3%.

So that gives you the ability to potentially take more risk in your portfolio, but the question then becomes, do you want to take more risk? Like you can take more risk, but do you really need to? And you might not need to anymore, but you could want to. So I think that's what it really comes down to.

Like a lower spending rate gives you the ability to take more risk. It doesn't necessarily force you to take more risk. It doesn't require you to. So I think you still, if you have a hard time dealing with volatility, having an all stock portfolio, even if you have that other income coming in, it's probably not gonna help much.

'Cause think about it, if you're still working and you're getting a paycheck and income coming in, does that make it easier to sit through the volatility in the stock market? For some people it might, 'cause they know they have future savings. Other people say, no, I can't do this.

I need an emotional hedge. I need cash or bonds. So I just think you have to decide whether you're comfortable taking more risk. If you have that annuity and the pension coming in, obviously you're in a much better spot. It makes your life more predictable and easier in terms of spending needs.

But I think it really depends on how you handle volatility. - Well now, maybe I'm wrong here, but I feel like I've read before about pensions not actually coming to fruition, right? Isn't that a thing that happens? So are they 100% given? - You mean if a company goes under?

- Yeah, yeah. I feel like I've heard of them getting cut in half or being like, yeah. - Well, there's some insurance there and it'd be hard to cut it in half immediately for some people. But your future benefits could be taken down if you're a young person right now.

Say you might not get the same benefits as if you're a teacher and your benefits are a little, you have to put more money in or you don't get as much as the other teachers. But yeah, for some people, I guess it would be, can I really bank on this?

But yeah, if you're in the position of getting a pension income, you're in a better spot than a lot of people 'cause a lot of people don't have those anymore. - Right. - By the way, I heard the fire alarm. Nicely done. It's getting louder and louder, it feels like.

- All right, let's do another one. - Okay, up next we have a question from Casey. I've heard you guys say quite a few times that trees don't grow to the sky and you're usually talking about a particular company or Bitcoin or maybe ARK, et cetera. But could the same be true for the stock market in general?

Does it hit a point where it simply can't grow anymore? After all, money is scarce and limited. If everyone invests in the stock market, we can't all become millionaires, right? - So I've only read one Jonathan Franzen book in my life. Are you a Franzen fan at all? - I actually have a book or two, but I haven't read them.

- Okay, I think the one was called "Freedom," I think. I read it, I don't know, probably eight or nine years ago. The only thing I remember about the book, it was a really long book, was that the whole basic premise was why do we need to have so much economic and personal growth?

Why can't we just chill and be happy where we are for a while? And that sounds great until you realize that this machine that we're in, it kind of rests on the fact that growth. Listen, if we all woke up one day and decided we're not gonna prove ourselves anymore, no more innovation, we're happy where we are, sure, the stock market will stop growing, corporations will stop throwing off profits, and we'll probably descend into Mad Max territory or something, and people will be very angry.

- So you're that optimistic? - No, I just don't think, I think as a species, the one thing that sets us apart is that we like to move forward and improve and have progress. It's kind of just in our DNA, right? So Buffett, in 2008, wrote his "Buy American IM" thing in October, 2008.

He was like 30% too early, but so be it. He said, "Over the long term, "the stock market will be good news. "In the 20th century, "the United States has endured two world wars, "other traumatic and expensive military conflicts, "the depression, a dozen or so recessions, "financial panics, oil shocks, a flu epidemic," which was one of two now, "and the resignation of a disgraced president.

"Yet the Dow rose from 66 to 11,497." That was in the fall of 2008. The Dow is now over 33,000. "Since then, we've had wars, a pandemic, "skyrocketing inflation and insurrection of the capital. "Things are still moving forward. "People are still innovating. "Despite all the bad stuff, people just keep moving forward.

"So I do, however, think it makes sense "to temporary expectations of future returns." So John Thrope, this is one of my favorite charts, courtesy of the Credit Suisse yearbook. This shows the relative size of equities markets around the globe in 1899 and 2022. The US made up 15% of the equity markets in 1900.

They now make up 60%. It's eating it like Pac-Man, basically, eating the rest of the world. (crowd cheering) Nice sound effect. Way to go. And we still can't beat the rest of the world in soccer. - True. - So we're up like 10% per year for the last 100 years.

So they say the winner writes history books. We're definitely the winner here. I just don't think that's sustainable. So if you look at valuations over time, they've been trending higher. Dividend yields have been trending lower. It would make sense that returns are lower going forward. Now, is that because trees don't go to the sky?

I think not necessarily. The reason that valuations used to be so much lower and returns used to be so much higher is because the stock market used to be way riskier. During World War I, the stock market closed for six months 'cause liquidity all but dried up 'cause people went away to war.

The Federal Reserve was created a year before that happened. During the Great Depression, they basically made the depression worse. They were raising rates. The stock market fell something like 85%. Do you think that the government or the Fed would allow the stock market to fall 85% today? No way.

There's no way they would ever let that happen. So I think if you take the Great Depression left-tail risk off the table, risk premiums should compress. Now-- - What if a bunch of Congress people were shorting the market, though? I could see that happening. - Don't they do that anyway?

So I think if you don't have to worry about this Great Depression 'cause there's now a good lender of last resort, you probably don't have to ask for as high returns on the stocks. So obviously, I'm not saying that the risk of a market crashes off the table. It's obvious volatility in the stock market is still here to stay.

Just look at the last three years. It's not like it's gotten a ton easier. I think we've taken the Armageddon situation off the table, unless we get an actual Armageddon. In that scenario, though, we have Bruce Willis and Ben Affleck, just in case. However, even if I'm right that future returns will be lower, the only thing that matters to actual investors is net returns, not gross returns, right?

So I think gross returns will probably be lower in the future. Why? Because costs were so much higher in the past. In the past, it could cost anywhere from 1% to 3% in commissions to buy a stock, right? Then May Day came along in 1975. They made it so that they didn't have a set prices for brokerages, cheap brokerages, discount brokerages, like Charles Schwab came along.

Costs have been completely wiped out. Obviously, now it's free to trade a stock. From 1900 to 1975, the average CAPE ratio for the U.S. stock market was less than 15 times. Since 1976, it's 22 times on average, right? So valuations have gone up. I think lowering costs helped that.

Bid-ask spreads have collapsed. You said these wide bid-ask spreads. Back in the day, people used to trade stocks using fractions instead of decimal points. You used to have guys in funny jackets on a trading floor yelling at each other. Now, we trade using computers, right? - Those were the days.

- Index funds didn't exist until the 1970s, right? You used to have to pay an upfront fee called a load to buy a mutual fund. It could cost anywhere from 5% to 10%. The very first index fund in 1976 from Vanguard had an 8% load. You had to pay 8% of your purchase price to buy an index fund.

401(k)s have only been around since 1978. Roth IRAs were created in 1997. First ETF was also in the 1990s. So it's never been easier to invest in the stock market at a low cost using tax-deferred accounts. So I think even if gross returns are lower going forward, it's not 10% anymore.

Let's say it's 6, 7, 8. On a net basis, they might actually be higher because it's so much easier to invest now. So that's my positive spin on it. Gross returns had to be higher in the past to incentivize people to invest in stocks 'cause they were so much scarier.

That's not the case anymore. - What's the highest fee you remember for placing a trade for stocks, calling up a broker or something? - I mean, I don't know, Duncan. The first trade I ever made was a target date fund. So it's always been pretty free for me. - I feel like I've heard people talk about the 40s, like $40 or something, which is pretty hard to imagine.

- Yeah, it was pretty high back in the day. And I mean, the thing is, though, people back in the day were more buy and hold investors. They didn't trade as much. So maybe that was a barrier from an emotional, behavioral perspective. But it used to be really, really expensive.

And the other thing is the trees don't grow to the sky thing is more about outperformance. So the reason that a strategy can't outperform at all times is because if such a strategy existed, so much money would just plow into it that eventually sizes the enemy of outperformance and it wouldn't work anymore.

That's what happens. That's the trees don't grow to the sky thing. It's not just that things can stop growing. Obviously, again, if we stop having progress and innovation and that stuff, all bets are off. But I tend to believe that people are still gonna wake up in the morning hoping to get better.

- I see Oliver in the chat says they remember $80 to buy and sell. - Jeez. - It's pretty crazy. - Yeah, it used to be really, really high. The funny thing is you used to not have any sort of scale. So if you were buying 100 shares of stock, it would cost the same as buying 100,000 shares, which seems ridiculous, right?

But that's what it used to be. - I think I just thought of a way to fix Robinhood. They just charge $80 a trade. - Sold. - Okay. - Let's do another one. - Up next, we have a question from Joe. At what point does whole life insurance make sense?

Many advisors seem to have a pretty negative opinion about it, but when does it actually make sense? My wife and I are in our mid 30s. We have $135,000 in brokerage account and about $200,000 between our 401ks. Our house is halfway paid off and we have no other debt.

Our combined annual salary is roughly $210,000 gross. We also do not have any, we do not plan on having children. Our financial advisor is suggesting a whole life policy, but we're having a hard time determining if our situation would warrant it. My wife's big thing is that because we won't have children, she wants to be able to pay for top nursing facilities, et cetera, down the road.

Wow, they are planning like way out, thinking about nursing facilities in your 30s. Yeah, it's a good thought. It's expensive. This one is beyond my pay grade. So let's bring an insurance expert in. This is Jonathan Noby, he's gonna join us. He helps run our insurance business at Ritholtz.

Hey, Jonathan. What's up, fellas? All right, before we get into the specifics here, which these people have, as Duncan said, really thought hard about this, just give me the main differences between whole life and term insurance. 'Cause I was always told when I got my first insurance, when my daughter was born, I got life insurance.

Everyone said due term, it's easier, it's cheaper. I think I pay $23 a month or something for it. Really cheap, it was easy. Didn't have to think too much about it. Tell us, explain the differences there. Sure, I'll explain those in one second. It's just that this question reminded me of my favorite New Yorker cartoon of all time.

John, if you could bring that up. So what's the best time to buy whole life? Never, how's never? All right, bring that down. I'm only partially kidding. Okay, so first let's talk about whole life in the spectrum of what insurance is. There's generally two different kinds of life insurance.

There's term insurance and there's permanent insurance. Term insurance, the kind that you own and I own and most people own and the kind that we generally recommend. It's there for a term of time, whether that be 10 years or 15 years or 20 years or sometimes 30, but I don't love that.

You pay a level premium and it's there for that entire term. And when the term is up, it's gone and that's it. And it's generally, if you're young and healthy, not very expensive. Permanent insurance on the other hand, is the kind of insurance that is there until, at best case scenario, till the end of your life.

Whole life insurance was the first kind of permanent insurance. And it's one of a few different kinds. Now, most people don't know any more about insurance than like term versus whole and they mistake whole life for all kinds of permanent life insurance. Whole life is a kind of permanent life insurance.

It's not the only one. And there's things like universal life and variable universal life and indexed universal life and stuff like that. Now, we're not necessarily gonna get into what all of those are here. So for our purposes, we're just going to assume term insurance versus permanent insurance. One thing I wanna say about this here, I'm gonna use quotes around the advisor who's recommending this to you, Joe.

He's very likely an insurance salesman, doubling as an advisor sometimes, 'cause the only people who generally recommend whole life are people who are insurance salesmen and worked for captive insurance companies who get paid to sell it. - Right, the way that I've, I guess the way that I've heard about it is, you can make a lot of promises and it sounds great in a pitch, but most advisors, especially who are fiduciaries and they're not earning commissions, they're not huge fans of this because there's a huge difference between an insurance product and something that works in an investment portfolio.

- I generally agree with you. So let's talk a little bit specifically about the problem that Joe's trying to solve and let's understand insurance. 'Cause I think this is gonna be helpful for everybody. People buy insurance generally for one reason and one reason only. It's 'cause there will be a financial impact on their family were they to die.

Now there's disability that comes into it in long-term care and we'll get to the long-term care thing in a second because that's what they're asking about here. But our job as advisors is to actually help somebody figure out what the financial impact on their family will be were they to die or their spouse to die or something like that.

That's the job. The job is not to say, "Boy, do I have a product that's in search of a problem." The job is to say, "What problem are you trying to solve?" But I think a lot of times the way these are sold, at least that I've seen is you buy this kind of product and you don't have to worry about the stock market's ups and downs and you're gonna be guaranteed a return.

And that's the kind of thing where people go, "Oh, that sounds pretty good." - Right, so in a vacuum, permanent insurance generally does the things that advisors will say that it's gonna do. But one, nobody lives in a vacuum. And two, like especially with Whole Life, I say it's a series of things, like it's a product in search of a problem and no one really ever has that problem.

So I simply never, I should say rarely recommend it. Now for an individual, not this person, not for you, Joe, but for someone who has a permanent insurance need, meaning throughout the course of somebody's lifetime, if their death would cause financial challenges for their family, then that person has an insurance need late in their life.

We'll use an example. Take someone who has a defined benefit pension from their job and they can't take something like a joint life payout on that pension. And that pension goes away when that person dies. If that person's spouse is gonna rely on that pension, well, then they need to own insurance or something like that, just to make sure that you could recreate the income that you lose.

That is a permanent need. But for Joe, it sure doesn't look like they have a permanent need. To have a mortgage they'd like to pay off. What they should figure out is what the impact is if either of them were to die on their family. And then they should own some term insurance to manage that impact.

It's much less expensive. It solves the problem over what seems to be a fairly short period of time. It's probably only a 15 year risk for them or a 20 year risk. So term insurance seems like a much better idea. - And it sounds like they care more too.

Their long-term worry is long-term care insurance, right? - Right, right. So it's an interesting way to think about long-term care. And we could spend a lot of time talking about how that industry got it wrong really badly in any number of ways. The original kind of long-term care contracts that were issued by insurance carriers, there were these standalone long-term care contracts and they were dramatically underpriced because insurance companies didn't realize that no one would lapse their long-term care.

They assume, 'cause there's, you know, insurance is based on the law of large numbers. So what insurance carriers can come up to terms with is everybody basically dies at the same time and everybody lapses the same, like insurance lapses at a certain rate. So a certain percentage of people will just stop paying for their policies.

They assumed the same lapse rates on life insurance as they did for long-term care. Turns out nobody lapses their long-term care because everyone has an anecdote about how awful it is when a family member needs care and how expensive it is. - So that's something that people wanna keep having.

- Right. So long-term care is now delivered a little bit differently than it used to be. It is possible to wrap long-term care into a life insurance chassis. That's generally speaking how we do it for people who are looking at long-term care contracts. And there's different kinds of contracts, whether there's asset-based or there's like universal life with a long-term care rider or things like that.

There's only very few standalone long-term care policies left in the market. And the ones that have been around for a while have seen dramatic increases in premium. I mean, I'll simply use my parents' policy as an example. Their premiums on the long-term care contract they bought like 15 years ago or 20 years ago or something like that have doubled since they bought it.

So, and that's different than other kinds of insurance where insurance carriers always reserve the right to raise long-term care premiums. And they have, and people are suffering. I imagine there's even-- - For something like this case, it doesn't sound like they have too many extenuating circumstances. The simple advice is just keep it simple.

Don't go into anything too complex unless there's a really good reason for it. - Exactly. That seems like term insurance is the right thing here. And if they're really wanna plan for a long-term care risk, then what they would consider might be one of the standalone long-term care contracts.

Because what that'll have is it will add an inflation factor to the benefit that they buy right now. And if they have 30 years, I mean, they're in their mid thirties. You're literally talking potentially 50 years before they would make a claim on that. You have to have a reasonable inflation factor to that in order for it to make sense 50 years from now.

So I'm not even convinced that's-- - They can probably worry about this later. My long-term care plan is I'm gonna eat healthy and work out all the time, and I'm just gonna live forever. - Good luck with that. - Yeah, I mean-- - It's like the guy in Bloomberg.

- Sounds like-- - Let's do another one. Let's do another one, Duncan. - One thing I was gonna say about that, the positive about the high commissions on Whole Life is that I've seen some really good commercials. So they're putting that money to good use, the companies that are bringing in big commissions on this.

- That's right. - They're employing a lot of film industry people. So I mean, that's the, you know, your money's-- - You're Mr. Culling, Duncan. - Yeah, yeah. - You know, the person who generally wins from the sale of a Whole Life contract is the person who sold it.

So keep that in mind. - Right. Okay, last but not least, we have a question from Johnny. - We're gonna get a lot of hate mail from insurance people on this one. - Well, yeah, it always happens. That's what I said in the chat. Every time a Whole Life comes up, there's like a little, a war breaks out, but yeah.

- That's all right. - Okay. - Last question. - Yeah, so this question is from Johnny. I have a soon-to-be two-year-old daughter and would like some opinions on options for savings. There seem to be many paths, 529, Roth, normal investment account, trust. I feel like a 529 is limiting for the unknown future and ties funds to education only.

I hear people setting up Roths for their child, but tying income to a two-year-old sounds a bit sketchy. I would tend to agree. I also hear the compound team mentioned lift-off accounts for children. I assume these are just normal taxable accounts. My wife and I both have lift-off accounts, so I feel like this would be an easy option, but is there a tax benefit that might make others a better option?

Is there a reason to contribute to a separate account for our daughter versus just adding that savings to the accounts we already have? If it matters, we live in Michigan, and in 2022 made about $230,000 of income. And my quick follow-up to that is, I think this is something I've wondered before is, yeah, what is the exact advantage of putting the money into an account for a child as opposed to just having that money in your own account for your child?

- Right, I guess I'll answer the lift-off stuff first. Yeah, I have an account at lift-off. I just chose the easy option. I have a 529 for my kids, too. I didn't wanna go down the route of creating some sort of income for them, and then I think the taxes is probably the biggest deal if you wanna jump through the hoops.

My whole thinking was keep it easy, but Jonathan, I guess if people wanna jump through some hoops what kind of accounts make sense if they wanna save some taxes? - So if taxes are the driving consideration, the first thing I would say is don't let taxes be the driving consideration.

But with accounts like this, like everything in financial planning, everything's a trade-off. I know that those pesky child labor laws get in the way of funding a Roth for your kids, so that's kind of off the table, but you can start something like that. - I've been pounding the table for years saying that you should be able to open a Roth as a baby.

For every child in America. - That'd be great. Or we should just be able to put 'em back to work again, like I should go to a farm and employ my kids. So the one thing I'm not gonna include in this is given that we probably have insurance people watching this, they're gonna be screaming you should buy insurance on kids because the cash values that grow inside insurance contracts are tax-preferred.

I'm not even going to dignify that with a discussion. I'm going to say we're not considering it. - Jonathan, you're compounding the insurance hate mail here. - Trying to. - Okay, so here's generally the trade-offs you make with putting money in accounts for kids. So there's the traditional brokerage option where you basically just earmark the money for your children, whether it be a lift-off account or your own taxable account or something like that.

- That's basically what I've done. - I think that's probably the best idea. But we're also gonna leave out the big estate planning questions here and trust account for kids and all that, 'cause that's a different conversation. What they're also maybe asking about are custodial accounts. Things like, now, does UTMAs or UTMAs?

Here's the problem with custodial accounts, and I don't love them. And I consulted our resident tax ninjas as well on this one, and they tend to agree with me, or should I say I agree with them? Problem with custodial accounts is that that money, the money that's transferred into there is irrevocable.

It is now your children's money. You just happen to be the custodian of it. When that kid turns 18, whether they know it or not, or whether they're prepared, that money is theirs. Now, I don't know anyone who's funded custodial accounts with tons of money where they're saying to themselves, oh my God, my 18-year-old has hundreds of thousands of dollars in this, and now they're not going to college.

But that's the challenge, is that they're not flexible at all. - Right, you wanted to have some control over the money. - Right, you're giving up control. In addition to that, if ever you're gonna be applying for financial aid, the expected family contribution, you fill out the FAFSA form.

Expected family contribution counts custodial money like that at a higher percentage than they do things like parents' money. So that would reduce the chance of getting financial aid. That comes straight from the bills, the tax team. It's another reason not to use custodial accounts. Regarding 529s, it's actually become a bit of a better option, was already a very good one.

I understand they're not perfect because you say you need, but someone says they don't want to lock them and to have to use them for education, but they're great anyway. And they just became better with the recent omnibus spending bill. Says that in 2024, people now have the ability to convert 529 money to Roth money.

Now it's subject to the same funding options every year. So you can only convert up to 6,500 bucks a year to a total of $35,000 over a person's lifetime. But Ben, as an example, let's say your kids get scholarships and you have money in their 529s. If the money's been in there for more than 15 years, they can convert that to Roth money eventually.

So that's a fan. Yeah, it's a fantastic kind of little extra kicker that's rewarding savers along the way. So I love 529 money. And in the end, if 529 money is tax preferred as it grows, even if you can't use it, your kid gets a scholarship, doesn't go to college, whatever, you can't end up using it.

So you pay a penalty and you get the money out or you give it to somebody else. You still have the money. Right, it's a fantastic way. And what I really like about a 529 is my experience is that it's something that people know they have to fund, so they do it.

We talk about how the great thing about financial goals is that it creates good behavior. It's that it gives you the habits you need. And Ben, you talk a lot all the time about automating everything. 529 contributions are almost always automated for people. It's for savings. Yeah, and if you don't use it, you can help your kids out down the line.

That way, you can pay a penalty. So it's still a decent amount of money. All right, I wanna thank Jonathan for coming on the show. If you have any hate mail for insurance people, send it to Duncan. He's gonna sort through all of those. If you have any other insurance questions, anything else financially related, askthecompoundshow@gmail.com, leave us a review, go to idontshop.com for all of your merchant needs.

Duncan, we got anything new in there yet? - Actually, just right before the show, Josh had me drop a new sticker. So there's a new TCAP sticker on there, inspired by TGI Fridays. So yeah, go check that out. Also, one thing I should mention on this note. Yeah, TGIF instead of TG, you know, yeah.

But yeah, one thing that I wanted to mention is if you have a coupon code from us, it might not work on some things in our shop. It's because we aren't marking up stuff much at all. And our platform that we use won't let you undercut base price of items.

So that's something a couple people have encountered. I just wanted to let everyone know what's going on there. It's not a bad code. It just means there's not enough of a markup for you to actually take that without going into the base cost. - Duncan is doing this as slave labor.

Zero margins, just like Amazon. Keep those questions and comments coming. Thanks to everyone who showed up in the live chat. Remember to leave us a question in YouTube comments as well. And we'll see you next week. - See you, everyone. - Cheers, guys. (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music)