How Should You Invest for Your Kids? | Portfolio Rescue 53
00:00:00.000 | Welcome back to Portfolio Rescue. We always appreciate your comments, questions, feedback.
00:00:21.860 | Email us, askthecompoundshow@gmail.com. Duncan, yesterday you and I were talking offline.
00:00:26.760 | We both have some farming in our lineage. I think you said you have a beard, so that's
00:00:31.000 | close enough. But my great uncle owned a farm. He passed that down to my Uncle Patrick, who's
00:00:35.960 | actually the namesake of my middle name. That's my middle name, Patrick. He still owns and
00:00:39.580 | runs this farm. He used to have a bunch of animals, cows, pigs, chickens, that sort of
00:00:42.920 | stuff. Now it's all fruits and vegetables. One thing I learned, he has 58 different varieties
00:00:47.920 | of apple trees on his farm, which I didn't even realize that there was that many.
00:00:51.360 | Did not know that.
00:00:52.360 | I actually worked on the farm a little bit growing up. Tried to earn my keep. One of
00:00:55.120 | the oldest professions on the planet. Our sponsor today, AcreTrader, allows you to invest
00:00:59.200 | in farmland across the country. Michael and I like to call them the Zillow of farmland,
00:01:03.160 | because they're trying to take all these different factors and figure out water and soil and
00:01:07.600 | allow it to be better analyzed. They say one of the benefits of investing in farmland is
00:01:12.520 | that it has little correlation with stocks and bonds, but it has very positive correlation
00:01:15.820 | to inflation. So, it's something of an inflation hedge. If you think about it, this makes sense.
00:01:19.040 | There's direct correlation between farmland, commodities, food prices, all that stuff.
00:01:22.640 | When prices are going up, it would make sense that farmland would do well. AcreTrader makes
00:01:26.600 | it simple to invest in professionally-reviewed farmland and timberland. Visit AcreTrader.com
00:01:30.440 | to learn more and to understand the risks involved in investing in farmland. Please
00:01:34.680 | go to AcreTrader.com/company/terms. Duncan, welcome back. You were out last week.
00:01:39.480 | Can I just say a quick thing about the sponsorship thing?
00:01:42.120 | Let's do it.
00:01:43.240 | You don't have to go do anything. Just sending traffic to these sites, it makes us look good.
00:01:49.920 | That's all you have to do. Click the link. You don't even have to do anything. Just want
00:01:53.400 | to throw it out there.
00:01:54.840 | Okay. Nice plug. You don't have to do anything. Just click on it. We missed you last week,
00:01:59.920 | Duncan. You were under the weather. Last week's show, we talked about a reader of my blog
00:02:04.180 | that I'd become friends with who recently passed away. He had this strategy for asset
00:02:08.160 | allocation and portfolio withdrawals, and he called it the four-year rule. We had dozens
00:02:13.120 | and dozens of people email in and say, "Hey, I'd like to get more information on this four-year
00:02:18.100 | plan." If anyone wants it, they can feel free to email us. I'd send it to a bunch of people.
00:02:22.360 | But I think this is just a good reminder, especially during a bear market, that everyone
00:02:26.280 | needs a plan. And I think even a bad plan or a suboptimal plan is better than no plan
00:02:31.200 | at all, because this is the time you realize how important it is to understand what it
00:02:35.640 | is you're doing.
00:02:37.640 | We get all these questions all the time, like, "Should I buy this? Should I sell this? Should
00:02:40.560 | I get rid of these losses?" And I think the biggest problem for most people is that they
00:02:45.080 | go into a lot of their investments without having a plan in place. Obviously, there's
00:02:48.440 | going to always be unforeseen circumstances in your life, in the markets, whatever, in
00:02:52.840 | the economy. But just having a plan, I think, can just make this a little bit easier to
00:02:57.640 | deal with in the stomach, even when we have these bad times.
00:03:01.480 | Yeah. I think that was a really good post. I was looking at it, and I saw that the person
00:03:08.920 | -- I can't think of her name right now, but they had actually responded really, really
00:03:12.760 | substantially in a comment on your site back when you posted it. That was back when people
00:03:19.760 | actually interacted in the comments and stuff?
00:03:21.440 | Yeah. I don't have comments anymore. I turned them off. It was too much. But, yeah. Feel
00:03:25.800 | free to leave one in the YouTube. So, all right. Let's get to our first question.
00:03:30.000 | Okay. Actually, I'm going to have you stall for one second, because I just noticed an
00:03:34.920 | issue.
00:03:35.920 | See, Duncan needs a plan for the show, because John, our behind-the-scenes producer, is not
00:03:40.960 | here today. So, Duncan's flying solo. And we've had some technical difficulties today,
00:03:44.920 | but we're going to get through it. And if we can't show the first question, we'll just
00:03:47.800 | read it.
00:03:48.800 | Yeah. Believe it or not, it's actually a lot to do by yourself. Yeah. Okay. No, we got
00:03:54.280 | it now. So, here we go. We are ready to go. Question one. "I'm 24 years old and have been
00:04:01.000 | putting money into stocks every two weeks for about 18 months now. I know it's always
00:04:05.060 | a good idea to diversify between stocks and bonds, but right now, I'm all in stocks. As
00:04:08.840 | I'm young, I know that in the long run, the bear market is a good thing for young people
00:04:12.040 | like me. With the uncertainty of the market right now, do you think I should buy a couple
00:04:16.240 | of bonds, even if it's only $1,500 worth? Or would it be better to buy some of these
00:04:20.520 | stocks that are down significantly, and may list a couple of tickers, and seem almost
00:04:24.920 | certain to bounce back at some point, even if not for a while?"
00:04:27.640 | All right. Good on you. Yeah, good on you. 24 years old, dollar-cost averaging, invests
00:04:33.760 | every two weeks. That's a great plan for someone that age. Here's the thing. A lot of investors,
00:04:38.800 | investors approach the markets from the standpoint of, "What can I put my money in that can earn
00:04:42.680 | the highest rate of return?" Obviously, there's nothing wrong with trying to earn a high rate
00:04:45.840 | of return. That's the whole point of investing in the first place. But there are tons of
00:04:48.960 | other factors involved in trying to allocate what that next dollar is going to do for you.
00:04:52.640 | There's this old saying in personal finance that when it comes to budgeting, you should
00:04:56.680 | give every dollar in your budget a job. Meaning, when you get your paycheck, everything should
00:05:01.040 | be allocated to something. Whether it's rent, car payments, student loan, utilities, phone,
00:05:06.000 | Netflix, gym, savings, whatever. Everything should have a job and go to its rightful place.
00:05:11.040 | I think investing should have a similar rule of thumb. And the main determinants are usually
00:05:14.520 | your time horizon and your goals. So, what's the point of this money in the first place?
00:05:18.320 | Are you saving for retirement? Is this going to be for a down payment for a house, a wedding,
00:05:21.840 | emergency fund? Is it going to go in a tax-deferred retirement account? Are you putting this in
00:05:25.760 | a brokerage account? When do you need to spend the money? So, it's not just what's the best
00:05:30.280 | use of this capital. It's what's the best use of this capital, given my circumstances,
00:05:34.160 | constraints, and goals, and then time horizon. So, I think once you begin looking at your
00:05:37.240 | investments through this personal lens, rather than a market lens, your job as an allocator
00:05:41.440 | becomes a lot easier. It's not just, "Well, what's the best risk-adjusted return between
00:05:44.980 | stocks and bonds right now over the next six to nine months?" You don't have to be a person
00:05:48.800 | on CNBC or a hedge fund manager that manages money this way in terms of, "What's the best
00:05:54.120 | risk-adjusted return right now?" It's, "What do you want to do with your money? How long
00:05:57.840 | do you want to invest it for? And what's the purpose of the investment in the first place?"
00:06:01.240 | And only once you have that figured out, then you can figure out where to invest it. And
00:06:03.960 | the great thing is, as an individual, you don't have these constraints of being marked
00:06:08.600 | against some benchmark, or risk-adjusted returns, or alpha, or whatever it is. That's a constraint
00:06:14.160 | individuals don't have. So, I would not try to make it so difficult in terms of, "What's
00:06:17.920 | the best thing right now over the next three to six to 12 months?" It's, "What's my time
00:06:22.280 | horizon? What's my risk profile? And then, what do I do with those dollars once I have
00:06:26.200 | that stuff figured out?"
00:06:27.840 | O'Reilly: Yeah, that sounds like good advice. I mean, they name some massive companies as
00:06:33.680 | potential stocks that they could invest in. I guess that's better than it being a bunch
00:06:36.920 | of former SPACs or something. Because, some of those might not come back, right? Whereas,
00:06:43.280 | you think the big ones, the blue chips, are going to come back at some point.
00:06:45.880 | Lewis: And they could, but I wouldn't say they're certain to bounce back. There are
00:06:49.280 | stocks like, GE was the biggest stock on the planet for decades.
00:06:52.160 | O'Reilly: With that dividend.
00:06:54.000 | Lewis: Yeah. And that stock, since the turn of the century, has just gotten crushed. I
00:06:58.200 | think it's down 70-80%. And yeah, the dividend gets cut. And so, yeah, you'd assume those
00:07:02.400 | stocks are pretty safe. But, we don't know for sure. It's not certain.
00:07:06.000 | O'Reilly: Right.
00:07:07.000 | Lewis: Alright, let's do another one.
00:07:08.840 | O'Reilly: Up next, we have a question from Tanya. "I've been minimally invested in bonds
00:07:15.360 | as a long-term investor, but if I can get 5% or more interest, I'd love to allocate
00:07:19.520 | funds and lock that in for as long as possible. I'm looking at corporate investment grade
00:07:23.960 | and new issues, and they largely seem to be callable in a year. While I would be happy
00:07:28.480 | if rates came down and I got my principal back in a year, I'd also be happy holding
00:07:32.040 | them if they're not called and I keep earning the less competitive but acceptable coupon.
00:07:37.000 | I'm anticipating bond index ETFs won't compete on yield over the next year with their current
00:07:41.300 | basket full of low coupon bonds until they mature and are replaced over time. Can you
00:07:46.040 | speak to the intelligence of buying individual bonds in today's market if an investor feels
00:07:50.440 | investment grade has acceptable credit risk and wants competitive yield short, or more
00:07:56.440 | ideally long-term, versus dividend or bond ETFs?"
00:07:59.920 | Lewis: Okay. As someone who has been writing about finance for a long time, I know there
00:08:03.840 | are always certain topics that people have very strong opinions about. Paying down the
00:08:08.480 | mortgage versus investing the money, the CAPE ratio, the Federal Reserve, of course, passive
00:08:12.560 | versus active, crypto, all these things. You write or talk about these things, and people
00:08:16.120 | have very strong views. I'm of the opinion that most financial decisions exist in a state
00:08:20.360 | of gray. There are very few black and white decisions. Most of it is gray, but a lot of
00:08:25.040 | people have very strong opinions. One of the ones that surprise me the most is that people
00:08:29.280 | have very, very strong opinions about buying individual bonds versus buying bond funds.
00:08:34.440 | I wrote a piece about this in 2014, and my inbox was full of people saying, "You're an
00:08:39.600 | idiot," or, "You're right," or, "You're wrong," and people have very strong opinions.
00:08:43.720 | Let me lay out the case for and against owning individual bonds. Here's the thing right now.
00:08:49.560 | People think, "I buy an individual bond, and I hold it to maturity, so I get the regular
00:08:53.620 | payments of income every six months or a year, however, depending on the bond, determined
00:08:59.040 | by that initial yield, and then at maturity, I receive my principal back," which makes
00:09:02.100 | sense because a bond is a debt instrument, right? You're being paid back your original,
00:09:06.680 | so let's say you put $10,000 into a five-year U.S. Treasury bond. The yield's 4%. Every
00:09:12.660 | six months, you're going to receive $200, and then in five years' time, you're going
00:09:17.240 | to receive that $10,000 back, right? Now, the reason many people like holding individual
00:09:22.120 | bonds right now is because interest rates are up, and a lot of people say, "Well, my
00:09:26.080 | bond funds are getting crushed. I'm down 10% or 15% on bonds. If I just held individual
00:09:30.240 | bonds, I could just hold to maturity and get my principal back, and I wouldn't have to
00:09:33.560 | worry about any of these losses, and so even if rates move up and down in the meantime
00:09:37.840 | and my bonds are fluctuating every day when they're getting market-to-market, I still
00:09:41.760 | receive that par value at maturity." Now, here's the other side of that. Now, that makes
00:09:46.440 | some people feel really good and warm and fuzzy. Here's the thing. Bond funds literally
00:09:51.400 | hold individual bond securities that are market-to-market every day. How can a bond, how can a fund
00:09:56.580 | of individual bonds securities be any different than you personally holding individual bonds,
00:10:02.600 | right? This whole getting your money back at maturity might be a wonderful emotional
00:10:07.040 | hedge, but are you really any better off? When rates go up, the value of all bonds goes
00:10:11.120 | down, whether you're holding an individual bond or a bond fund, and while holding to
00:10:14.800 | maturity does allow you to get your money back at par, if the environment is higher
00:10:18.880 | rates and higher inflation, like it is now, you're going to still be getting back nominal
00:10:22.440 | dollars that are worth less at the time of maturity. So, let's say, for example, you
00:10:25.400 | own a bond fund that yields 2%, and then the yields go to 4%, which is basically what happened
00:10:29.800 | in a lot of bonds. If the duration of those bonds is five years, you would expect that
00:10:33.320 | fund to fall somewhere in the range of like 10% in value. That's happened to a lot of
00:10:36.480 | them. It's not any fun. Now, let's say, okay, I'm going to sell this bond fund, but I'm
00:10:41.800 | going to buy all the individual bonds in that fund, all the single issues, and those collectively
00:10:47.920 | now yield 4%. Are you really in a better position? Of course not. You're in the same exact place,
00:10:52.560 | right? Now, let's look at the other side. Let's say you own one 2% five-year bond. Rates
00:10:57.320 | go to 4% in that one bond. Sure, if you hold it, you get your money back at par, but now
00:11:02.520 | you're just earning 2% less than the market return. So, either way, you're going to be
00:11:06.440 | losing money. So, you could sell that bond at a loss and now buy the higher yielding
00:11:10.120 | 4% bond, or you could hold it, yielding 2%, get your par back, but then you're earning
00:11:14.680 | 2% less than. So, you're losing money either way. This is just how bond pricing works.
00:11:20.180 | There are no free lunches here. So, it's kind of the same thing. And it's a little bit of
00:11:24.880 | a pet peeve of mine that people think that holding them is like this holy grail of you
00:11:29.520 | don't have any losses, but it's the same thing. Having said all that, there are pros and cons
00:11:33.360 | to each approach. So, if you do hold individual bonds, you can potentially have higher trading
00:11:38.960 | fees, because on the bid-ask spread, it's harder. You're not PIMCO. You don't have trillions
00:11:42.360 | of dollars of bonds that you're trading. It typically requires more money in terms of
00:11:46.280 | minimums, depending on where you're trading. It's much harder to diversify, obviously.
00:11:50.500 | In a bond fund, you can own hundreds or thousands of bonds. If you're buying them on your own,
00:11:54.400 | you might need a lot of money to do that. It's much harder to rebalance with single-issue
00:11:58.680 | bonds. But there is that peace of mind, if rates do change. Now, it's mostly in your
00:12:02.280 | own head, as I explained, but some people need that emotional hedge. The other thing
00:12:07.360 | is, if you own individual bonds, your duration and your maturity is constantly changing.
00:12:12.440 | If you own a five-year bond, in a year, that's a four-year bond. In another year, that's
00:12:16.120 | a three-year bond. So, your duration and your maturity could be changing. A lot of people
00:12:19.960 | might get around this by owning a ladder of bonds to keep that constant, but that's kind
00:12:24.720 | of the same thing. There is much more complexity. Although, the one big positive, I think, besides
00:12:29.760 | the hedge of holding to par, is that it's much easier to match your assets with liabilities.
00:12:34.480 | If you have something that you know you have to pay in five years, and you buy a five-year
00:12:37.360 | bond, you know at par you're going to get that money back. That's something that you
00:12:40.400 | can use to then invest when you need to spend that cash.
00:12:44.240 | So, how about holding a bond fund? Bond funds are easier to diversify and rebalance. They're
00:12:48.680 | low in minimums. You do have to pay an expense ratio, which you don't have to for individual
00:12:51.640 | bonds. You have professional management trading them, and hopefully getting lower trading
00:12:55.580 | fees because of scale. You have that constant maturity and duration, because a lot of bonds
00:13:00.040 | are benchmarked, and they'll keep some sort of constant 1-3 year duration, or 3-5 years,
00:13:05.640 | or whatever it is. But it does make it harder to match assets with liabilities, unless you
00:13:10.600 | own different bond funds that have different types of maturity. So, obviously, each strategy
00:13:14.240 | has its pros and cons. And I didn't even get to the part about callable bonds here, which
00:13:18.720 | seems like that 5% yield might not be worth it, because that's just another added level
00:13:24.400 | of complexity if they do call the bond and bring it back to you. But the way I see it,
00:13:28.680 | you can get 5% to 6% in most corporate bond ETFs right now. So, I don't know if going
00:13:33.840 | to a 5% individual corporate bond really makes sense. I guess that depends on if you really
00:13:40.920 | need that emotional hedge. But, again, it probably depends on your tolerance for complexity
00:13:44.860 | and then how dependent you are on giving yourself that emotional hedge of holding bonds to maturity.
00:13:49.360 | But again, maybe I'm going to get some more hate mail, but owning individual bonds is
00:13:53.480 | not different from owning a basket of individual bonds. It's just like owning a stock ETF is
00:13:58.580 | similar to owning individual stocks. Either way, your performance is going to be similar.
00:14:03.840 | It could just depend how you can make it through those strategies.
00:14:07.920 | So I have a question as a civilian non-financial professional. How do you even go about buying
00:14:14.420 | an individual bond? I don't even know where to begin, other than like high bonds.
00:14:17.560 | You can do it at a brokerage. If you have TD Ameritrade or E*TRADE or whatever, you
00:14:21.380 | can buy bonds there, but the minimum might be $10,000 or $25,000, depending on the...
00:14:26.520 | So you have to buy it in some... $10,000 is probably the minimum for most places. But
00:14:31.800 | you can also go to Treasury Direct, which we've talked about, if you want to buy treasuries
00:14:34.760 | straight from the US government. I'm pretty sure there's no fees there. So you can do
00:14:38.960 | that. It's just your minimums might be a little higher than it would be for bond ETFs. But
00:14:42.120 | yeah, you can do it. And again, some people really like that peace of mind they get from
00:14:46.080 | buying individual bonds. I'm just here to tell you that it's mathematically... You still
00:14:51.360 | own bonds either way, whether it's a fund or an individual bond.
00:14:54.520 | Right. Yeah, that makes sense.
00:14:57.000 | That was kind of nerdy, but I think it's, I don't know, just a little pet peeve of mine.
00:15:00.500 | We've had people write in before asking about being able to buy their own mortgage or stuff
00:15:04.960 | like that. People make this super complicated. Again, I think it's funny how people think
00:15:11.360 | that it's different. And again, bonds are driven more by math than the stock market
00:15:15.200 | is. But that's also why the movements in interest rates affect the prices of bonds you're going
00:15:20.840 | to buy in the future and the ones you hold now. It's not like you can all of a sudden
00:15:23.520 | find this bond that's paying more money and you get money back at par at maturity that's
00:15:28.240 | going to make you better off. It's not going to make you better off unless you can actually
00:15:31.240 | hold on to the strategy, I guess.
00:15:34.160 | Cool. So that sounds pretty definitive. So I like that.
00:15:39.120 | I'm putting this one to bed. That's what everyone... If you read a blog post, you say, "This is
00:15:43.520 | the definitive post about individual bonds versus bond funds."
00:15:46.720 | The only post you ever need to read.
00:15:48.720 | And then people will still be arguing about it in a month. All right, let's move on.
00:15:53.240 | Question three is from Aaron. "I adopted my son recently. Being in foster care before
00:15:59.840 | adoption means he'll get $400 a month until he turns 18. He's currently two. Plus he gets
00:16:05.080 | free college. What can I do with that money to turn it into a big chunk he'll get when
00:16:08.960 | he turns 18?"
00:16:09.960 | I honestly didn't know this either. I had to look it up a little bit. I think that it
00:16:16.840 | varies by state in terms of... But it sounds like that $400 per month is at a lot of states
00:16:21.360 | and also the scholarship piece for free college is a thing for foster care in a lot of states.
00:16:26.880 | So I don't know where Aaron's from. But kudos to you, Aaron. I've talked about this before.
00:16:30.960 | My wife and I went...
00:16:31.960 | Yeah, congratulations. First and foremost, right?
00:16:32.960 | Yeah, congrats. That's awesome. My wife and I went through IVF and it took a long time
00:16:36.760 | for that to work. And in the meantime, we went down the adoption path. And I will say
00:16:41.840 | our personal experience, it's not an easy experience. So I give Aaron a lot of credit
00:16:45.800 | for going through this and pulling it off because eventually the IVF worked for us.
00:16:49.560 | But we went down that path pretty far and it's not easy. So here's the thing. Your son
00:16:54.880 | is two and he gets $400 per month until age 18. So we're talking 16 years of compounding.
00:16:59.840 | My first rule here is just do no harm. If we're talking $400 a month, that's $4,800
00:17:05.480 | a year. And that's also what? $77,000 over 16 years, if my math is right there? That's
00:17:12.920 | almost $77,000. That's pretty good. So back of the envelope, if you've got a 5% return
00:17:17.960 | on that, we're talking, I don't know, $113,000. If you've got 7%, we're talking over $130k.
00:17:23.360 | So that's real money. So unless the system completely falls apart, if you invest this
00:17:28.360 | in any sort of diversified portfolio of financial assets that aren't completely insane and some
00:17:35.000 | really smart 30-year-old billionaire walks away with them, I think you're gonna be okay.
00:17:39.080 | So my one piece of advice would be just don't try to shoot the moon with this. Don't go
00:17:43.320 | like, "You're gonna be offering six figures to your son at age 18?" And that's an amazing
00:17:47.800 | gift. So I've talked about this before, but what I do with my three kids is a couple years
00:17:52.720 | ago, I opened up just a Lyft off account at Betterment, and I just make monthly contributions
00:17:56.160 | to diversified portfolio. And the account is technically in my name. I didn't want to
00:17:59.640 | get fancy because doing a Roth IRA for your child, unfortunately, is not very easy. They
00:18:04.040 | have to have some earned income. I think there's some back doorways around it, but I didn't
00:18:07.240 | want to go through that. So I just opened an account for myself in Betterment.
00:18:09.600 | Does allowance count as income?
00:18:11.200 | Yeah, maybe the two's vary. So I just have a bucket for each of my three kids. I don't
00:18:16.360 | know why I'm gonna turn it over whether it's 18 or 21, but there's two reasons for this.
00:18:20.720 | One is I save a little bit now, and I can give them a head start when they're adults,
00:18:24.620 | and then maybe for their first down payment or their wedding or buying a car or whatever
00:18:27.920 | it is when they need money when they first start out. But I also want to use these accounts
00:18:31.520 | to teach them about the power of compounding and dollar cost averaging. So I'm using these
00:18:35.000 | as a teaching tool to help them understand the importance of saving and investing. And
00:18:38.720 | I'm also trying to incentivize them to save. So I told my daughter when she starts getting
00:18:41.960 | money for birthdays and holidays or whatever, she gets $20, and I say, "Hey, if you put
00:18:46.840 | that $20 into your investment account, I'm gonna match it dollar for dollar." So you
00:18:50.480 | put $20 in, you get $40. So I've worked on her a little bit. She's putting like 50% of
00:18:55.200 | all her cash in there now, which is kind of great.
00:18:58.320 | No two and 20.
00:18:59.320 | Yeah, I'm not charging fees on that. So I think you could also do like a custodial brokerage
00:19:04.200 | account, but I think the best thing you can do is just dollar cost average this into
00:19:07.680 | some sort of diversified basket. Use that money as a learning tool. I was gonna bring
00:19:12.040 | him in for the next question, but let's bring our guest on for today, Kevin Young, who is
00:19:15.880 | an advisor with us at Ritholtz. Kevin, any other financial planning aspects I'm missing
00:19:20.880 | here in terms of taxes or accounts that you could use? Anything else I'm missing here
00:19:25.160 | besides the big building blocks?
00:19:26.560 | Yeah, Dave in the comments said, "Don't forget the taxes."
00:19:30.360 | Okay.
00:19:31.360 | Yeah, that's a good point. I think broadly though, Ben, I'm in total agreement with you.
00:19:35.240 | I think do no harm is a great way to put this. Low cost, dollar cost averaging every month,
00:19:44.480 | it's gonna be a home run. Couple of things to think about from a planning perspective.
00:19:50.680 | I had never heard of this either. So upon some Googling, it seems like the rules vary
00:19:57.640 | state to state. And just make sure that while you might think, "Okay, college is taken care
00:20:02.720 | of. I'm all set." Just read the fine print and make sure you know exactly what that means.
00:20:08.880 | Because if it means that it's free as long as they go to a state university and you live
00:20:16.040 | in Ohio and your child says, "I don't want to go to Ohio State. I want to go to Michigan,"
00:20:22.160 | let's say.
00:20:23.840 | Nothing wrong with that.
00:20:24.960 | Nothing wrong with that. Then you're now in a bind because maybe that tuition is not covered.
00:20:32.600 | So I think the UTMA accounts are a really good way to do it. The taxes piece of it,
00:20:39.960 | you do get a little bit of an advantage in that the first $1,100, I believe it is, there
00:20:46.680 | is no tax on it, the first $1,100 of gain. So whether that be capital gains or income
00:20:53.000 | or distributions from a fund you might invest in, the next $1,100 is taxed at your child's
00:20:58.840 | rate, which probably is going to be effectively zero. I think it's technically 10%, but effectively
00:21:04.200 | it's zero. And then over and above that would be at your rate.
00:21:07.600 | So there is some tax advantage to that. The other piece is when they do reach age of majority,
00:21:14.400 | which it depends the state, it could be as low as 18, as high as 25, there's nothing
00:21:20.160 | stopping your child from getting access to that money outside of you basically hiding
00:21:24.320 | the account. But once that child does reach the age of majority, they call whatever custodian
00:21:31.560 | you have it at and say, "Cash me out. Send it to my bank account or send me a check."
00:21:35.640 | There's nothing stopping them.
00:21:36.760 | Yeah. Which is probably why it makes sense to use it as a learning tool as well. So they
00:21:40.760 | understand this is a big responsibility when you get that much money at that age.
00:21:44.600 | Exactly. But what it does at that point that just opening a brokerage account in your name
00:21:51.000 | and kind of just mentally putting that to the side for your child is if Ben's assumptions
00:21:57.280 | are correct, and let's say there's $130,000 in there at 18 or 20, whenever it is, and
00:22:03.200 | you want to give that money to your child, you've got gift tax considerations. Right?
00:22:08.200 | So we don't want to eat away at your exemption or as little as possible anyway. So by having
00:22:13.960 | the assets in your child's name, that avoids having to technically transfer those assets
00:22:19.340 | from you to the child.
00:22:21.360 | So a custodial brokerage account might be the best option then?
00:22:24.040 | Yeah. I think that's a good way to go. And the only other consideration, again, with
00:22:29.680 | the college piece is if the child doesn't end up going to a school that would qualify
00:22:34.200 | for these tuition waivers or grants or however they're worked out, is that would be your
00:22:41.560 | student's asset. That would be your child's asset on student aid applications and things
00:22:45.760 | of that nature.
00:22:46.760 | So things to keep in mind from a planning perspective, but I think you're in a great
00:22:50.260 | position to set your child up for a really great future.
00:22:53.820 | Yeah. This was a cool one. I've never heard this before, so this was a neat question.
00:22:57.540 | It also made me feel old because I was just thinking like 18. I feel like maybe they should
00:23:01.740 | get it at like 21 or maybe 25. I don't know.
00:23:05.620 | You could just hide it. We get a lot of our clients come to us and they'll be 35 years
00:23:11.060 | old and say, "My parents just told me about this." So if you can beat the kid to the mailbox
00:23:16.620 | every day for the next couple of decades, that's one way to do it, I guess.
00:23:20.460 | That's funny.
00:23:21.460 | Let's do another one, Duncan.
00:23:23.460 | Okay. Up next, we have a question from Charles. I have ulcerative colitis and know that I
00:23:29.380 | may not live as long as most other healthy people, but an online search shows most people
00:23:33.940 | of my condition have a normal lifespan of around 75 years. With new medical breakthroughs
00:23:38.660 | coming out every year, how should someone living with an autoimmune disease like me
00:23:42.280 | be thinking about life expectancy and how that relates to when we should retire? Is
00:23:46.820 | that even a consideration?
00:23:47.820 | This is a good one.
00:23:48.820 | Okay. Heavy question here. Yeah, heavy question, but a good question. I mean, death and taxes,
00:23:52.340 | right? Something we all have to live with eventually.
00:23:54.580 | Duncan, throw out my charts here. This is from Our World in Data. In 1800, the average
00:23:59.780 | life expectancy globally was 29 years old. Go ahead to 1950, we're talking global average
00:24:06.580 | of about 46 years old. By 2015, now we're talking 71 years old.
00:24:12.100 | That is still a relatively new concept. In the past, most people simply just worked until
00:24:16.820 | they died. So, this longevity piece is something that a lot of people have to deal with. Kevin,
00:24:22.340 | you've built a lot of financial plans in your career. Most of the time, you're making an
00:24:25.260 | educated guess. You're going to retire at age 65. Based on your health data and family
00:24:30.540 | history, you could live to age 87, whatever it is. It sounds like Charles is going to
00:24:34.900 | be fine, but if he wants to plan for the potential for health problems and autoimmune disease,
00:24:39.100 | how do you even begin to take that into account when building a financial plan in terms of
00:24:41.980 | setting your time horizon, how much money you should spend, and how do you go about
00:24:47.140 | updating that as you get closer to old age?
00:24:51.260 | Yeah. This is a really good question, one I certainly haven't seen before, but one that
00:24:56.460 | we address constantly in financial planning. There's a couple of things that when we're
00:25:01.400 | building plans and we're talking to clients about this process, there's a few things we
00:25:05.260 | cannot control. One is what the markets are going to do, and two is how long you're going
00:25:11.820 | to live. Whether you have an autoimmune disease or disorder or you think you're going to live
00:25:19.780 | to 110 or anywhere in between, that is a piece that we just can't control. My default is
00:25:27.420 | I always run plans to age 95. Unless somebody is pounding the table saying, "No, no, no.
00:25:33.980 | All four of my grandparents lived to 102. It's going to be longer," or, "None of my
00:25:38.940 | grandparents."
00:25:39.940 | Duncan doesn't eat meat and he drinks oat milk, so he's going to live to 115.
00:25:44.680 | Yeah. Duncan's going to have a very different portfolio than I will because I very much
00:25:51.140 | enjoy meat. Steak is a staple. But regardless of that, we want to be conservative in those
00:26:01.860 | assumptions in the sense that we want to assume you're going to live past some given date.
00:26:07.420 | Because the last thing we want to do is plan for you to live to 82 years old and say, "Okay.
00:26:12.420 | Well, based on 82 and your withdrawal rate, you only need 5.2% rate of return. Great.
00:26:18.280 | Let's build your portfolio that historically should average around 5.2%."
00:26:22.380 | Well, what happens if you live an extra decade? And if you run those projections, the rate
00:26:27.780 | of return that we might need might be 6.2%. So ultimately, I think being conservative
00:26:33.020 | with the projections on how long your retirement is going to last is a good way to do it.
00:26:38.020 | Are you also a little quicker for someone in Charles' situation to say, "But if you're
00:26:43.700 | on the fence about a vacation home or a trip or whatever early on in your retirement, go
00:26:48.500 | ahead and do it and we'll build that into the plan because who knows what's going to
00:26:52.000 | happen."
00:26:53.000 | Right. Right. Yeah. You also, as it's been said, you can't take it with you. So I think
00:27:02.180 | there's a book out now that's becoming more and more popular in our circles called, I
00:27:05.820 | think it's, forgive me if the title's wrong, but it's basically Dying With Zero. The idea
00:27:10.220 | that you can't enjoy this money once you're gone. And I think for a little bit of an older
00:27:14.340 | generation, it was always, "I want to leave my kids and grandkids money after I'm gone."
00:27:19.460 | Well, wouldn't you want to enjoy that money or see them enjoy that money instead? And
00:27:23.860 | so I think this kind of ties with that and that if you do have things you want to do,
00:27:29.020 | to bend your point, build it into a plan and see how it affects things in the long run.
00:27:33.420 | And that's ultimately, I think, going to tell you, "Okay, this is how I should invest."
00:27:38.180 | I mean, generally speaking, we know that academically that equities should do better over the long
00:27:45.740 | term than almost any other asset class, at least any other common asset class. And so
00:27:49.860 | it makes sense that if you're going to have a really long retirement, that you're going
00:27:53.020 | to need to be maybe a little bit more equity-based than fixed income-based.
00:28:00.460 | Good. All right, Duncan, last question.
00:28:02.460 | Okay. I was just looking at that map again, that map that we shared. If you go back, you
00:28:07.820 | can pause and look at each of them a little longer, but it's pretty cool how much that's
00:28:12.700 | changed over the years.
00:28:13.700 | Yeah. And someone in the comments mentioned a lot of that was infant mortality, but we
00:28:17.660 | have now more people over the age of 65, I think, than under the age of 15 or something
00:28:22.580 | ridiculous like that. We've never had a demographic this big live this long before, and just getting
00:28:28.860 | longer every year. Okay, go ahead.
00:28:31.660 | Okay. So, last but not least, we have a question from Micah. "Looking for some help on how
00:28:42.020 | best to structure finances over the next few years. I'm currently working as an analyst
00:28:46.540 | at a bank with a relatively average salary. My wife is a third of the way through a three-year
00:28:51.620 | CRNA program. Once she finishes school, our household income will increase by roughly
00:28:56.100 | three to four times. At that point, we will both be in our late 20s." Wow, young. "I've
00:29:02.620 | been funding our Roths for the last few years, and I recently bumped up my workplace IRA
00:29:06.860 | to 10% to take advantage of current market conditions, but we are still taking on a decent
00:29:11.100 | amount of loans for her DNAP program. Obviously, the calculus would include comparing the loan
00:29:17.420 | rate to the expected rate of return if I were to prioritize the market, but I was hoping
00:29:21.620 | to get your guidance on what to truly prioritize over the next few years. What are some considerations
00:29:26.460 | for those expecting an income jump to keep in mind to best set themselves up for the
00:29:30.460 | long term?" They're really thinking about everything here.
00:29:33.620 | Yeah, wife is in a nursing program, going to be making more money when she comes out,
00:29:38.100 | but she also has the debt to deal with. So, Kevin, with the caveat that there are no right
00:29:42.620 | or wrong answers to something like this, how do you help clients think through this type
00:29:44.940 | of decision where, "I'm going to be making more money, but I also have more financial
00:29:49.460 | responsibilities to deal with as well?" Yeah, I mean, ultimately, this is kind of
00:29:55.140 | what you hope for, right? You're making an investment in education that is going to bump
00:30:00.580 | your income up. And so, that's excellent. And clearly, we've got some forward-thinking
00:30:07.460 | folks here as far as what to be focusing on. And yeah, there is no right answer. Ultimately,
00:30:13.620 | I think personal finances, as you guys have said, as we've said a lot, it is personal.
00:30:18.180 | And so, what exists on a spreadsheet doesn't necessarily, and what makes sense on the spreadsheet
00:30:24.120 | may not make sense in your head or your stomach or your heart, right?
00:30:28.860 | And so, I have clients that have a 3% mortgage, and they are making extra payments to their
00:30:37.980 | mortgage to pay down the principal. And they've got 20 years left on the mortgage. Well, if
00:30:42.860 | we assume that over the next 20 years, the market is going to return more than that 3%,
00:30:48.140 | the spreadsheet, the math would suggest, you absolutely don't put more money into that
00:30:51.980 | mortgage. You put it in the market. But I also, those same clients say, "I feel better
00:30:59.140 | knowing that my debt is being paid down faster. I don't like debt. It makes me uncomfortable.
00:31:04.700 | I want to get out of it as soon as possible." And so, yeah, the math says don't do that.
00:31:08.900 | But ultimately, I think the plan that you can live with and the plan that makes you
00:31:14.540 | happy, as long as it doesn't derail the goal, is going to be the right answer.
00:31:19.740 | So, if you're somebody who, if you and your wife are people that really are uncomfortable
00:31:25.820 | with debt, you can tilt a little bit more of that income towards paying that debt down
00:31:30.140 | faster. If it's going to gnaw at you that this money should be invested and getting
00:31:36.220 | a higher rate of return, then that's the way to go.
00:31:39.580 | I also give them credit for, they've already been investing in their Roths while she's
00:31:43.380 | going to school. He's already, he's still contributing to his plan. My main thing about
00:31:47.960 | getting an income bump, if it's a bonus or a jump in income, I like the idea of doing
00:31:52.980 | some sort of allocation on it where you say, "I'm going to save 50% of this bonus or
00:31:58.580 | this jump in income, and the other 50% I'm going to use for debt repayments or increased
00:32:02.980 | savings." And so, some ways you give yourself a bump in standard of living, so it's not
00:32:07.760 | all for nothing. But then you figure out, "Okay, with 20% of this I'm going to repay
00:32:11.940 | debt, and the other 30% I'm going to save more." And sort of figure out some sort of
00:32:15.400 | set allocation there. And then you can kind of adjust going forward, depending on what
00:32:19.700 | happens. And as you guys get bumps in income going ahead in the future, since you're still
00:32:23.380 | pretty young, you can figure out which one of these made us happier. Is it growing our
00:32:28.660 | retirement accounts or paying off this debt and seeing it go down? So, I think splitting
00:32:32.940 | the difference in some ways can be a good way to test it out, doing an A/B test to figure
00:32:36.260 | out which one is going to make you happier anyway, because some people just don't know
00:32:39.140 | either.
00:32:40.140 | Yeah, that's true. And I also think another thing to consider here is that it's always
00:32:45.140 | nice to have a little bit of extra liquidity, right? So, even if you are really hyper-focused
00:32:50.860 | on paying debt down, you don't want to get into a situation where you've paid your
00:32:54.860 | debt down and that's great, but you have very little liquid assets. And then something
00:32:59.060 | happens, something changes, a career change, God forbid, a disability, anything of that
00:33:04.020 | nature that while everything looks good on paper right now, and the trajectory is solid,
00:33:09.500 | you really want to make sure that you do have funds set aside for if things do change.
00:33:13.900 | Yeah, give yourself a margin of safety.
00:33:16.340 | Yeah, absolutely. And whether that's having six months to a year's worth of living expenses
00:33:22.900 | in cash or just knowing that, "Hey, I want to have some extra liquidity in a brokerage
00:33:28.180 | account if something changes." That's always a good thing to consider as well.
00:33:33.820 | Perfect. Okay. No show next week because of Thanksgiving, obviously. It's too bad we're
00:33:39.740 | going to argue about what our favorite Thanksgiving sides are like they do on social media.
00:33:42.580 | I was hoping we'd have a political debate.
00:33:44.860 | All right. Thanks to Kevin for joining us again. We always appreciate those insights.
00:33:49.660 | Yeah, thanks, Kevin.
00:33:50.660 | Thanks for having me, guys.
00:33:51.660 | Thank you for watching this on YouTube. Remember, hit the subscribe and like button. Leave us
00:33:55.180 | a comment, leave us a question in the comment section. If you want some Compound merch.
00:33:59.020 | Do we still have the Fed shirts, Duncan?
00:34:00.860 | We do. We do. I don't know how much longer Josh is going to have them up there, but yeah.
00:34:04.260 | The Fed Godfather shirts. They're not going to be up much longer. Those are pretty sweet.
00:34:07.500 | Keep the questions and comments coming. Remember, if you have an email for us, askthecompoundshow@gmail.com
00:34:11.460 | and we will see you in a couple of weeks.
00:34:13.540 | Take care, everyone.
00:34:31.740 | Bye.
00:34:35.380 | (upbeat music)