On this Ask Tim & Tim episode of the Your Financial Pharmacist Podcast, we take three YFP community member questions about investing. We discuss investment terminology, considerations for choosing investments, where non-retirement accounts come into play and the pros/cons of target date funds.
If you have a question you would like to have featured on the show, shoot us an e-mail at [email protected]
Mentioned on the Show
- Interested in becoming a beta tester for the YFP Student Loan Online Course? Sign up using coupon code LOANRX at https://courses.yourfinancialpharmacist.com/
- YFP Episode 002 – Why Every Pharmacist Should Be A Millionaire (Part 1)
- YFP Episode 003 – Why Every Pharmacist Should Be A Millionaire (Part 2)
- YFP Episode 015 – West Point to CFP: Tim Baker’s Journey to Becoming a Fee-Only Financial Planner for Pharmacists
- YFP Episode 016 – 3 Reasons Why Pharmacist’s Should Consider Hiring a Financial Planner
- YFP Episode 017 – Essential Questions to Ask Before Hiring a Financial Planner
- YFP Episode 026 – Baby Stepping Your Financial Plan – 2 Things to Focus On First
- Vanguard Investor Questionnaire
- Script Financial Risk Profile Questionnaire
Episode Transcript
Tim Ulbrich: Hey, what’s up, everybody? Welcome to Episode 043 of the Your Financial Pharmacist podcast. We’re excited to be here with you doing another “Ask Tim & Tim” episode this week. So if you missed last week’s episode, make sure to go back and check it out as we feature two listener questions on student loans. As a reminder, if you have a question you’d like to have featured on the show, shoot us an email at [email protected]. Before we jump into today’s listener’s questions, I want to mention that just this past weekend, we announced that we are looking for 50 beta testers to jump into our YFP online student loan course that we’re getting ready to launch here in a couple months. Now, for the first 50 that sign up, we’re going to be offering the course at half price, so it’s going to be $179 instead of $349 when it will be fully launched early this summer. And you can head on over to courses.yourfinancialpharmacist.com, again that’s courses.yourfinancialpharmacist.com. And if you use the coupon code LOANRX, that will get you 50% off for the first 50 that sign up to be a beta tester. So again, make sure you head on over there quick. We’re going to take the first 50 that come, then we’re going to close it. We’re going to get feedback from that group, make final adjustments, and then we’re going to be launching that course later in June. So again, courses.yourfinancialpharmacist.com, coupon code LOANRX. So Tim Baker, investing. I think we maybe is this the first time we’re actually digging in to talk about investing? I know we get a lot of people that say, ‘Hey, you guys need to be talking about investing a little bit more.’
Tim Baker: Yeah, I think so. We’re very heavy on the loan, or the student loan side. And it’s funny, you talk about us launching the course or at least the beta test group, and those spots are going fast so it’s kind of interesting to see that there’s obviously an interest there, but I think equally in the investment side of things, there’s a lot of interest and I think there’s a lot of people that are confused about how to start and where to begin, and that’s encouraging too because I think we’re looking outside of the world of student loans, and I think it’s something that we need to do. And I think we’re going to be more focused on the investment stuff going forward too.
Tim Ulbrich: Yeah, I think we’ve been hesitant on some level, not because of course we know people are interested in it, but I think one of our concerns especially knowing lots of people are with student loans and trying to build a solid foundation is that is there a concern, are people looking at this topic of investing in a silo. And so I think that’s a good preface to just our conversation as we talk about the investing questions that came in to remind our listeners, hey, to take a step back, that investing is one part of the financial plan and to figure out exactly where it fits in for your own plan. Alright, well let’s jump in with our first listener question on investing, which comes from Latonia from sunny Los Angeles.
Latonia: Hi, Tim and Tim. This is Latonia Lou (?) from sunny Los Angeles, California. I have a couple questions for you today. The first being what strategies do you have for investments in stocks, bonds and real estate? And secondly, what do you recommend for choosing different types of investment options? And what funds do you recommend for retirement and the 401k?
Tim Ulbrich: Thank you, Latonia for submitting your question. We really appreciate it. And I love your question because I think while it’s rather broad, I think it gives us a good launching point to just talk broadly about investments almost an Investing 101, talk over some terminology. And I think here what’s interesting is I hear Latonia’s question is to me, there’s almost a question behind the question. So Tim Baker, before we jump into answering her question and talking more specifically about the terminology and 401ks and Roth IRAs and asset allocation and all that stuff, what are some of the other factors that you want somebody to be thinking about when it comes to their financial situation before they talk goals related to investing?
Tim Baker: Yeah, I think to get back to your point, Tim, of looking at investing in a silo, I think ultimately, before you really dip your toe into the investment waters, you’re going to want really to focus on a few things. One is what does your debt situation look like, particularly the consumer debt. And we talk about this in Episode 026 of baby stepping into your financial plan, the two things to focus on first. What does your consumer debt look like? And also, what’s your emergency fund look like? And I think that’s why we’re a little bit hesitant is we don’t want people to wade down to the waters of investing without really having that sound foundation in place. If you start building a house without the foundation, it’s going to crumble. So ultimately, you want a good emergency fund to have funds available if something hits the fan. And then you want to make sure that your debt situation is in check. And I think like we mentioned last time, a lot of people draw the line of when to invest differently. So some people want to get through their student loans as quickly as possible before they really take a serious step toward investing. Other people have a little bit of a different mentality, so I think having an inventory of that, in a sense, is smart too. With that said, you know, there’s a few types of investing that is worth taking note of is, you know, if you have a retirement plan that offers a match, more often than not, you want to take advantage of that because that’s essentially free money or 100% return on your investment. Anything you put in, you’ll get 100% return. So that’s one thing to consider. But I think also just kind of an overarching, you know, question to ask is what is your appetite for risk? And for a lot of people, that’s really difficult to quantify. And for a lot of people, especially young people that have kind of come to the market maybe in a time of, you know, recession or market volatility, that we as kind of a generation are scared to wade into the waters of investment. And that really shouldn’t be that way, so what I see with a lot of clients is a little bit of a hesitancy to take intelligent risk and put your money into the market. So I know that’s kind of a very big picture look at things, but I think those would be some questions to ask yourself and like I said, easier said than done, right?
Tim Ulbrich: Absolutely. And I think before we jump into Latonia’s question specifically about choosing different types of investment options, to me this is a good place to just provide that reminder of we have to ultimately know what goal we’re shooting for and why we’re shooting for that goal. And I think that’s going to become evident as we begin this discussion because as we get into terminology and we talk matches and asset allocation and tax advantage, vehicles, 401ks, 403bs, Roths, etc. is that I think it can easily become somewhat overwhelming, especially when you consider with all the other priorities that somebody’s working on. And you’ve heard us talk before on this podcast about having a why behind what you’re doing, whether that’s saving for the future or whether that’s paying off debt, and I think that’s critical here because ultimately, we have to know why are we even doing this in the first place? Why are we putting away 10, 15, 20% potentially of our income towards retirement? Why are we choosing asset allocation models and trying to figure out how we can best invest for the future and keep fees down? So I think that purpose and vision of what we’re trying to do, and I would also reference listeners back to the very beginning of the podcast, Episodes 002 and 003, “Why Every Pharmacist Should be a Millionaire,” where you interviewed me, Tim, and we kind of walked through the what is a nest egg calculation. How do you get to that number? And ultimately again, before we talk about what you’re doing this month or next month, ultimately trying to figure out exactly what are we trying to achieve in the future?
Tim Baker: Yeah, definitely.
Tim Ulbrich: Alright, so let me ask the somewhat naive and I guess beginner question about why do we even need to invest in the first place? You know, we’re going to talk about risk and fees and potential for losing money and all of these things, why do we even need to go there to begin with?
Tim Baker: Yeah. I think it’s important to understand that you face major roadblocks when you’re trying to accumulate wealth and build that nest egg that you mentioned. And the two big ones are taxes and the inflation. So if you, what I often tell clients, if you take a dollar and put that under your mattress, so kind of like a savings account that doesn’t offer any type of interest rate, if you put that under your mattress with average inflation, if you wait 25 years and take that dollar out from underneath your mattress, it’s going to be worth about $.46. So that inflation essentially chops your purchasing power in half. So what investing does is allows you to really kind of get ahead of that curve and allow things like capital appreciation and dividends and that whole thing that we talk about on the ugly side of debt, the interest on top of interest, we kind of turn the tables, and we allow that to work in our advantage. And that’s basically what investing is. The other thing I mentioned is taxes. Obviously, no such thing as a free lunch, so the government wants their piece of the pie. So really, your investments are in that arena. So we have to do some tax planning to basically be able to grow your net worth in a way that is most efficient and where you’re paying Uncle Sam the least amount of money as possible. So again, investment is a major player in that space. So for people that say, ‘Hey, I’d rather just sit money in a savings account and let it go and not really have to worry about the investment piece’ — and I don’t see that a whole lot, but I do see some very, very conservative approach to investing — you’re really going to damage your ability to build that nest egg of $2.5 or $3 or $4 million or whatever the amount is, which for many pharmacists out there, that’s where they’re going to need to be in terms of their retirement savings. So the investment piece is hypercritical to make sure that you’re taking advantage of the compounding interest, the capital appreciations, the dividends and all that.
Tim Ulbrich: So once we establish that investing is in part essential to us achieving our financial goals, then the question becomes how do we invest? Where do we put that money to start to achieve those returns that ultimately are going to combat against the issues you mentioned around inflation and taxes? So I think that gets to the basics of the different investment vehicles, which obviously, there’s more than these four. But I think the four that are our audience should really be thinking about at this point: cash, cash equivalent, bonds, stocks and real estate, as Latonia mentioned in her question. So cash and cash equivalents, Tim, how would you broadly define — obviously, we all know what cash is, but I think it’s that term “cash equivalents” that often gets people hung up.
Tim Baker: Yeah, that could be things like different, not mutual funds, money market funds, that type of thing. You’ll want something that is highly that you can get to, in some cases it could be things like commercial paper, these are things that aren’t necessarily near and dear to what a typical individual investor would have. But typically when I explain cash and cash equivalents, it’s cash what everybody and then kind of like a money market fund, which is not necessarily cash. It’s a little bit less liquid, but that’s kind of what I want clients to understand in that regard.
Tim Ulbrich: Yeah, so I think cash and cash equivalents as low-risk, it’s liquid, it’s accessible, obviously at varying degrees. But also with that low risk, you’re probably not going to see much, if any, upside. And I think all of us are probably feeling that right now in some of our savings account with typical banks, which then takes us up one level, so I think of a bond. So bonds, you know, is I think about a bond, I think about a bond as a debt investment. So I have fond memories actually of my great-great-grandmother buying me EE bonds every Christmas, they’d be hanging on the tree. But it’s a debt investment, so whether it’s the federal government, whether it’s a local government, whether it’s a corporation that ultimately is trying to raise money, it’s a debt investment that you take on. And in return for investing in that, you’re guaranteed a certain interest rate or return on your money. And obviously, there’s different time periods, five, 10, 15, 20, 25 years, and historically, what have you seen, Tim, in terms of rates of return and risk levels when you think of bonds?
Tim Baker: Yeah, I mean, they’re kind of all over the place. So I guess it depends on the type of bonds. Most people when they think of bonds, they think of like government bonds. So on the federal side of things, you have things like bills, which are more shorter term, notes, which are T-notes, which are a little bit longer term, and then treasury bonds, which are the longer term bonds. So again, typically with interest rates, interest rates pay a pivotal part. Typically, when interest rates go up, the values of bonds go down and vice versa. So the bonds and the fixed income market, which is another way to say bonds, have struggled of late just because interest rates have been down. But just like stocks, you can have different types of bonds out there. So if YFP was a publicly traded company, and we had stocks, we could also issue a bond offering. So we could say, ‘Hey, listeners, we’re trying to raise money. Here’s a YFP bond, and with a principal of $1,000, but we agree to pay you 4% semi-annually, twice a year on that particular bond.’ So bonds can be very diverse. And you see companies issue bonds, municipalities issue bonds, and everyone has kind of different application that goes along with it. But bonds in a portfolio are typically, they’re cousins to stocks or equities, but they’re typically viewed as a safer approach to investing. So to give you an example, for young people, a typical split in terms of a bond-to-stock ratio might be 80% stocks, 20% bonds. When I’m helping manage my parents’ money, it’s kind of inverted. It’s 20% stocks, 80% bonds, and really the idea behind that is the capital preservation. So bonds are viewed as less risky and less chance for that basically your investment to go to 0. Stocks are more of a wild card where you enjoy more of capital appreciation and dividends, but the dividends aren’t necessarily fixed like an interest payment. So it’s kind of all over the board. I know I’m jumping a little bit into stocks, but I think they’re easier to explain them in tandem. So you know, in the bond market, it kind of depends on terms of return, what you’re looking for, but you’ll get an interest rate that’ll basically provide you income to the portfolio — or when I say income, it’s cash — whereas stocks are more a dividend and capital appreciation play.
Tim Ulbrich: And actually, this is great timing. So last week, you’re sitting down with Jess and I and looking at our overall asset allocation, which is what you were just referring to in terms of distribution between stocks and bonds, and obviously even within those, you get into different funds and so forth. But talk us through, and this in part answers Latonia’s question, talk us through how somebody determines that or in working with a planner determines that. You kind of identify that Jess and I were on full throttle, I think 97% or something equities and really not much at all in the bond market. And we were leaning more towards 90-10ish type of mix. What were some of the factors that were driving you towards that evaluation and getting us to think of different things?
Tim Baker: So typically, what I will do is I will give clients kind of a risk tolerance questionnaire that asks them, I don’t know, eight questions or so. And what that basically does is it spins off this is where your balance should be. So I think for you, Tim, you were 90% in stocks or equities and 10% in bonds or fixed income or cash or cash equivalents. So a 90-10 split. So then my job is to kind of look at it and say, ‘OK, if you were’ — and again, this is talking a very general sense, but if you were a 65-year-old person approaching retirement, and you were a 90-10 split, I would probably would say, that’s a little bit aggressive because what we don’t want to happen is something that happened, what happened in 2008, 2009 where your investments are all tied to the stock market, and then you wake up and you lose 40% of your portfolio. So what I’m basically surveying is your kind of where you’re at in your career, your appetite for risk, and I generally will suggest either staying or sliding a little bit to the left in terms of being more conservative or a little bit to the right in terms of being more aggressive. So there’s a little bit of a science, but a little bit of a kind of an art to it as well. And essentially, what I do is in your guys’ situation, you guys have both your own investments that I’m helping you manage at TD Ameritrade, which is where I custodian, but then you also have, Tim, you have your 401a at the university and a 403b, which have different investments that go into it. So basically, my job is to basically give you a model of that 90-10 split in your Roth IRA that you have at TD Ameritrade and then give you a 90-10 model with the 403b and the 401a. And as you know, when we were kind of going back and forth in the 403b, the little bit of — I don’t want to say sketchy situation — but I kind of went through your prospectuses and things like that, and it was even confusing to me about how the funds are charging and all that kind of stuff, which is a little bit of a different question. But it’s a little bit of art and science together.
Tim Ulbrich: Yeah, and for the listeners to know, he’s being gentle. And it’s humbling for me to admit this, but basically, what we concluded was the 403b that I have is trash. I mean, what did we find on the fee standpoint? That’s insane. Not only was it the number, but then it was even the language within the prospectus. We couldn’t even fully identify where those were coming from and the total amount, right?
Tim Baker: Yeah, it was one of those things where in the disclosures, they say fee about 40 times. And they’re just compounding fees. But the problem is the fees for the funds didn’t match the fees in the prospectus. So, which means basically that there might be other fees that they’re putting into the — yeah, I don’t know. And I think ultimately, we concluded that there’s a number for the 403b that you can call an advisor, so you might call them up and give them the business because — and the problem is like I do this for a living. So if it confuses me, it certainly is going to confuse a pharmacist that basically looks at this maybe an hour a year or two hours a year or once in their life to set it up. So that’s my frustration, that’s kind of like when I approach clients or when I approach any type of like paperwork or agreement, I want brevity and I want basically in plain English because a lot of this stuff is not, and to me, it does nothing but confuses the consumer, and that’s a problem. So getting back to Latonia’s question, ultimately — and I typically will put in cash and cash equivalents and bonds. So like for Tim, if you’re a 90% split, we might have 8% in bonds and 2% in cash, and then 90% in stocks. The real estate item is a different piece. So like I think if you listen to the podcast, we’re all big fans of real estate. You can buy real estate obviously and kind of be your own landlord and do it that way, but you can also buy what’s called a REIT, you can buy a publicly traded REIT, so that’s a Real Estate Investment Trust, which basically pulls together lots of different types of investment property, and then you basically buy shares of that trust. So it’s a way to expose your portfolio to real estate. So typically, my portfolios will have some of that. But again, if you buy an index fund or a S&P 500 index fund, and that’s kind of the next level of investments, a lot of those will have real estate exposure in there. So you know, in terms of the three investment classes, I would say for me, I put bonds and cash equivalents together, and then stocks and those are the two big ones. And then you can slice it as finely as — like I said before we were talking on mic, it could be real estate, it could be merged markets, it could be international. Some people have commodities or a gold allocation. So you can get as complex, but you know, typically you want to keep it simple and go from there.
Tim Ulbrich: Yeah, and they way I look at real estate, and we could talk about this on a lot of other episodes, and I’m not — this is not advice, and I know people will disagree or agree — is that Jess and I are itching to get real estate started, but we’re also looking to other things, saying we need to have these things in place first, and then we’re going to jump into real estate. So I think the timing is key, and for me, obviously we talked about the importance of an employer match and probably getting towards even beyond that and maybe evaluating real estate. So just to go back through those quickly, we talked about cash, cash equivalents, bonds, stocks or what are also known as equities, which essentially is ownership in a company. If you buy stocks in Apple or in Uber or whatever, you actually own a piece of that company. And then you mentioned real estate as well. So we’ve established that investing is important to outpace inflation and to beat taxes. We talked about vehicles by which you can begin to think about how to do that, and we briefly dabbled into asset allocation. Now the question is, where do you begin? Where do you get these things? So obviously you can buy bonds and stocks, etc. in an open market, but most pharmacists are probably going to be thinking, OK, I’m going to start within a 401k or a 403b or Roth IRA or Roth 401k but essentially those being the taxed advantage savings account in which you are then choosing the investments in bonds or stocks or other mutual funds, etc. So Tim Baker, just give us the 30-second kind of high level 401k, 403b, Roth IRA, what they are and how they’re different.
Tim Baker: Right. So I always like to do visuals. And you know this, Tim, because I use like the cat gif every time I explain, you know, investments because basically the inception that goes on here, to kind of reiterate what you’re saying, is you have a vessel, if you will, so that basically is the 401k, the 403b, the Roth or whatever, and inside that cup, we’ll call it a cup, you basically have — and for most people, it’s mutual funds. So it could be a stock mutual fund or a bond mutual fund. And inside of that mutual fund are all the different stocks that you hear about, so Apple and Google and Tesla. And then inside the bond mutual fund, you have all of the bonds like a Detroit bond or a Facebook bond or whatever.
Tim Ulbrich: Hopefully not Facebook.
Tim Baker: Yeah, yeah, exactly. So just think about that in terms of the different layers. So to kind of go all the way back to that original cup that we were talking about, the 401k, 403b, those are generally qualified plans that are provided by your employer. Generally, they’re used to incentivize or attract talent. And the 401k, 403b were originally meant to kind of supplement the pension. So a lot of people are saying, ‘What’s a pension?’ My dad worked for the same company for 40 years. He had basically a pension, and that was the golden handcuffs that basically forced him to stay at his job for that long. And it was basically based on his earnings and the amount of years that he worked on. So when the 401k came around, the company said, ‘Well, let’s ditch the pension and move with that.’ So typically, the 401k company will hire a Fidelity, a Vanguard, a Transmerica or whatever, and they’ll say, ‘Hey, we want you to custody our 401k.’ And then employees basically get individual accounts, so they have their own statements, pick their own investments, generally there’s a match, so the employer will say, ‘Hey, if you put in 5%, we’ll put in 5% matched,’ or whatever the case is. But the offer inside of that 401k or that 403b is typically limited. So you might have 10 or 12 or 15 investments inside of that tax advantage account. So anytime you see Roth in front of any of these types of accounts, an IRA, a 401k, a 403b, anytime you see Roth, you want to think after tax, after-tax money. If it doesn’t have Roth in front of it, it’s typically pre-tax money. So what that means is if you put — typically, now, you can put up to $18,500 of your own dollars into a 401k every year. So say you make $100,000 and say for that year, you put in $10,000. What the government basically taxes you all things else being equal is not $100,000, it’s $90,000. So that money basically flows into your account pre-tax. Now what happens when you distribute that in retirement, when it comes out, it basically is taxed upon distribution. So it either has to be taxed going in or taxed going out. So if you have a Roth 401k, it’s taxed going in, so you make $100,000, you put $10,000 into your Roth 401k, so what the government taxes you on is $100,000 of your income, so you don’t get any type of deduction, but when you go to retire, that Roth 401k, when you distribute that, basically it comes out tax-free. So it’s already been taxed going in, so it doesn’t get taxed going out. And that’s the case with the Roth IRA versus the traditional IRA and all that kind of stuff. So again, sp the big difference is between the 401k and the 403b versus the IRAs, the 401k, 403b are employer-provided or employer-managed. The IRAs, the Individual Retirement Accounts, they’re individually managed by you, and that’s basically the main difference.
Tim Ulbrich: That’s good stuff, and I’m glad we broke that down because a lot of times, I’ll talk with pharmacists, and they’ll say, ‘Hey, I’m putting away whatever, 5% of my income, and my employer’s matching the same into say a 401k or a 403b or a Roth 401k or a Roth 403b.’ But then often that conversation stops there. So I think your point of the vessel, the cup, however you want to look at it, is critical that that’s the vehicle, but then within there, you’re then digging into the asset allocation and actually choosing the investments. And while I think you and I are both certainly in the camp of keeping things simple, there’s some basic things you have to know about strategies of asset allocation and how to keep those fees down, etc. that’s going to have a big impact over 30 or 40 years worth of saving. So Latonia, great question. Thank you for submitting it that we can start this conversation. Obviously, we’re going to have lots more content coming in the future around investing. And I think for me, Tim, this really highlights one of the benefits of a financial planner. And I think back to Episodes 015, 016 and 017 where we broke down exactly what those benefits could be, what you should look for. But investing is only one part of a financial plan, but even within that plan, here we’re talking about looking at how do you minimize your fees and how do you determine the asset allocation models? How do you think about strategy of Roth versus 401k, 403b and the timing of that? And what about the distribution side of things, when you finally get there? And again, investing only one piece of it. But I think a really good financial planner can help you unwind some of that and hopefully take some of the confusion off of your mind there. So let’s take a minute to break to hear from today’s sponsor, and then we’re going to jump in with two more listener questions related to investing.
Sponsor: Hello, Tim Baker here. You know me as team member of Your Financial Pharmacist, co-host of the podcast and one-third of the Tim trifecta. But I am also the founder and owner of Script Financial, a fee-only — that means I’m a fiduciary — financial planning firm dedicated to helping pharmacists achieve financial freedom. We work with pharmacists all over the country every day who look at their financial situation and just don’t know where to start. Why is that? They say, ‘Tim, should I focus on this mountain of student loans? Or should I invest? I think I want to buy a home, but I’m not sure how to prioritize that goal or what that process looks like. I know I need insurance, but I’m confused how much or what kind and paralysis. Blue screen of death.’ There’s a better way. So let’s imagine — actually, first let’s queue the motivational piano music. OK good. Let’s imagine — and you can close your eyes as long as you’re not driving or running on the treadmill, and kudos to those that are doing the ladder — but let’s imagine you have clarity over your goals and how you should prioritize them, you know that this Tim has your back when it comes to your exact student loan strategy or how and where to invest, how much and what kinds of insurance that you need, maybe you’re confused about how much tax to withhold — we file taxes now too — and all the things financial. If you like that script that we’re writing for you — that’s a terrible pun, but let’s go with it — if yes, go to yourfinancialpharmacist.com/scriptfinancial and book a free consult to take that first step towards financial freedom.
Tim Ulbrich: And now back to today’s episode of the Your Financial Pharmacist podcast.
Tim Ulbrich: Alright, let’s jump into our second listener question, which comes from Laura from Pennsylvania.
Laura: Hi, Tim and Tim. It’s Laura from Pennsylvania. Can you talk to us a little bit about non-retirement investments? About six years ago, my husband and I started putting money aside in a Scottrade account. Every few months, we pick and choose a few stocks to buy. But I’m wondering, are there other things we can be doing with this money?
Tim Ulbrich: Thank you, Laura, for taking time to submit your question. We appreciate it. And we’re excited. I think it’s a great follow-up from the one that Latonia submitted where we talked a lot about some of the tax advantage savings accounts, 401k, 403b’s, Roth IRAs, etc. Here, we’re really talking about non-retirement accounts. So you mentioned you and your husband putting money aside in a Scottrade account and trying to then determine where you want to invest that money. So Tim Baker, talk us through — what Laura here is referring to is a non-tax advantage retirement account, so essentially putting money into an account in what I often refer to as the open market. So what are some of the places where somebody might do that? And then even some of the implications tax-wise that people need to be in tune with.
Tim Baker: Yeah, so typically, you know, what we usually call this is an individual, or if it’s with her husband, a joint account. You can also call it a brokerage account. So these are typically names for accounts that are the non-retirement, the IRA type of accounts. So typically, these types of accounts, you really want to drill down to what the why is of this account. So when you set up a brokerage account like this, you know, it’s typically because you’ve either maxed out your $18,500 into your Roth, and you’re maxing out into your 401k, your 403b, or you’re maxing out your IRAs, and basically, this is kind of the spillover into the next investment arena. That’s typically where you see it. Another place that you’ll see individuals do this is when I sit down and go through kind of the find-your-why and essentially, what I’m trying to extract is what are the goals or what are the buckets that we need to basically set up and fill over the next 10, 20 or 30 years? And basically have a plan in place for that. So typically, there’s a lot of short-term goals out there like an emergency fund or I need a sinking fund for travel because I want to go see the orca whales, Tim. Or maybe I need a cat fund or a puppy fund, so you should have a cat fund, Tim. I’m going to have a puppy fund, right?
Tim Ulbrich: Yeah.
Tim Baker: Or a gift fund, we talked about that at the end of last year, where people see spikes in spending, and it’s not necessarily accounted for, so maybe there’s a gift/holiday fund. So typically, I see that, which are kind of more of a near-term, I’m going to spend that within the next 12 months, to the other opposite side of the spectrum, which is retirement. Another place that a brokerage account might fall is, hey, Tim, I know that I want to buy a house in five years, four years, whatever the timeline is. So how do I go about properly saving for that? So typically, what I advise clients is if it gets over a certain amount of time, and we don’t just want to put it in a high-yield savings account, maybe it makes sense to then build out a conservative allocation or a moderate allocation to basically use the market to get a little bit more returns. That’s kind of the in-between, kind of the middle ground of saving for or investing for a goal. There is no tax advantage here at all. So you’re basically funding it with after-tax money, and when it comes out, you basically are taxed on your gain. So there’s long-term capital gains, which are basically any gains that you’ve realized after a year. And those have more preferred tax treatment. And then you have short-term capital gains, and this is basically where you’re buying Facebook one day and then selling it the next day, and it all kind of happens under that year time frame. And typically, those are taxed more aggressively than the long term. What the government wants you to do is basically invest, so invest in a company, invest for the long term, so they penalize people that are kind of moving in and out of investments, by the way, the tax it. So that’s one thing to be considered aware of, and there’s different strategies that you can use in terms of your fixed income or wash sales or tax loss harvesting, which is a little bit kind of probably out of the scope of answering this on the podcast, but those are kind of some of the things to be aware of when you’re investing outside of the retirement-type accounts.
Tim Ulbrich: So Tim, the other thing as I hear Laura’s question just quickly, that as somebody myself who just loves the passive investing approach, and I hear the notion of single stock picking, that makes me a little bit nervous. So just talk for a minute about some of the behavioral biases and some of the things to look out for when people might be getting into the area of single stock picking.
Tim Baker: Yeah, so you know, in terms of behavioral bias, the big thing is confidence buys. So if you’re one of those people that said, ‘Hey, I invested in GM way back in the day or when Ford hit the bottom,’ and then basically you bought it at $4 or whatever it was, and now it’s trading where it is now, you basically create this false sense that you’re the next Warren Buffett. And you know, people that do this for a living, professional money managers, mutual funds, myself included, can’t pick stocks. You can’t pick stocks on a consistent basis in a way that is where you’re not spending a ton of money on information or trading or whatever. So I think that’s the big thing is confidence buys. But I often say that your portfolio should be mostly, if not 100% of it, low-cost index funds. For some people — and I work with some clients that they have an itch to scratch, so they’re like, what do you think about Tesla? Or what do you think about this company? I’m like, I don’t pick stocks. But I can give you my opinion in terms of where it’s trading and where I think it might go. But to me, that should be limited — if you do it at all, it should be limited to 5%, maybe 10% of your portfolio because it is, you’re basically gambling. Most people, all people, they don’t know if the stock’s going up or down, left or right of any particular stock. And the problem with picking individual stocks is you’re basically putting your eggs all in one basket. If you pick an index fund, so people are like, well, what the heck’s an index fund? If you pick an index fund, you’re basically buying the market. So it’s — and an S&P 500 index fund is basically all of them, you own stock in all of the companies on the S&P 500. You can buy an index fund for, a bond index fund, you can buy an index fund for different sectors or things like that. So I would say, be cautious when you’re doing individual stocks. You can look like a genius, but over the course of investing career, it’s very spotty at best, even for people that do it for a living.
Tim Ulbrich: Yeah, and I think a good point there, looking like a genius, remember is you hear stories from other people, usually you’re hearing the good ones and not necessarily the bad ones, right? So I tell people all the time I bought Ford at less than $2 a share. I don’t tell them about buying Circuit City penny stock, which who would go to a Circuit City anymore? Right? What a joke.
Tim Baker: Right, exactly.
Tim Ulbrich: Alright, let’s jump into our third and final listener question of the episode, which is focused on investing, and that comes from Wes in North Carolina.
Wes: Hey, Tim and Tim. This is Wes Hartman from Durham, North Carolina. I had a question for you guys regarding investing. There seems to be a lot of different options out there to invest in, but is it even worth me trying to beat the target date funds?
Tim Ulbrich: Thank you, Wes, for submitting your question. Great one as we follow up on the first two related to investing. So here, we’re talking target date funds. And essentially, I think the way I interpret Wes’ question is it worth messing with trying to pick all these different asset allocations so much in stocks and bonds, etc., or should I just pick a target date fund? Would it be easier? So Tim Baker, why don’t we first just break down exactly what a target date fund is.
Tim Baker: So typically, a target date fund, and usually if you have auto-enrollment in your 401k or 403b, which I am a proponent of — so basically, what auto-enroll is you start with your employer, and they automatically put you at deferring 3 or 4 or 5% of your income into your 401k without you having to do anything. So typically, in that case, they’ll put you into a target date fund, basically probably would be based on your age. So you might have a target date fund for 2050 or 2055 or 2045, depending on your age. And what the target date fund essentially just takes a mix of other funds and it builds out an allocation for you that says, OK, if we’re going to retire in 2055, it might be a 90-10 split that we talked about with Tim early on. So it might be aggressive allocation that says, retirement’s a far way off, let’s basically build the allocation out in mostly stocks, equities, and a little bit of bonds. And as the portfolio, so as we passed through 2018 and now it’s 2025, maybe it’s 80-20. 2035, maybe it’s 70-30, and so on and so forth. So it becomes over time, more and more conservative. So for the individual investor, man, you’re looking at it like, man that’s great. That’s exactly what I would want — basically, someone else to do all the work for me. There’s some pros and cons to that. Typically, the advantage is if you have no idea what you’re doing, that’s probably the best thing to do is basically, get started, get the money into the retirement account. And if they don’t pick it for you, it’s your choice, just pick the target fund and call it a day. Probably the big disadvantage are of target funds is they typically are more conservative than I guess what I would normally advise. And it’s also hard to really determine if you’re going to retire at the time you said you’re going to retire. So for me, if I were to say I was going to retire in 2050, it might be 2060 or 2065 by the time that actually happens. I’ve said I’m going to live to at least age 100, so in that case, like that decade or whatever, I’ve lost out a lot of my portfolio’s earning potential because I went conservative too fast. The other thing is that in some cases, the target date funds can be more expensive and not perform as well as maybe some of the other funds that are provided for you. So there’s obviously a cost to basically that kind of turnkey strategy that depends on the actual investment plan that you’re in. And not all of these are created equal. I work with some clients that have amazing 401k’s and amazing 403b’s, and then I work with some others that are really bad and really — maybe the follow-up question is, how do you know if it’s good or bad? And typically, the first thing that I look at is expense ratio. So in my opinion, a 401k or a 403b, along with target date funds, which many of them have now, should also offer an index fund and a total market index fund, an S&P 500 index fund, that basically says, hey, I can buy the entire market and basically you buy the entire bond market and then call it a day. So if you compare, if you have one of those 401k’s that has that available to you, typically, that’s a little bit of a cheaper option. And you know, with a little bit of tweaking or a once-a-year checkin, you could probably do as good or better compared to the target date funds. So those are typically, that’s typically my advice on target date — they’re not bad. They’re not bad, but they’re probably — dependent on the plan — there’s probably some meat left on the bone in terms of what you can do with your funds.
Tim Ulbrich: Yeah, and I’m thinking even just Wes, I know you’ve been engaged in the YFP Facebook group and kind of following your questions, I can tell you like to nerd out on this stuff, which is awesome. And so my gut says probably for you, you’re going to probably look at some of those fees and performance and etc. and say, ‘You know what, I think I can do better. I can get the fees lower, I can get the performance better. I don’t mind rebalancing and checking my portfolio, etc.’ But I think to your point, Tim, that for many people, and I’m even thinking of the conversation that was flying around this weekend on the Facebook group, there seem to be a lot of feelings of, I just don’t know where to get started. And I think for many people, this could be a great place to start, especially if you know, you know what, I’m putting money in my 401k, but from there, I’m overwhelmed, and I’m not ready at this point in time to take action. I think it’s a great place potentially for somebody to get going but probably not ideal, in my opinion. I mean, I think for some people, it could be an option that they’re pursuing. I am thinking, though, of a handful of pharmacists I’ve talked to that open up their portfolio and they don’t realize that they’ve had a bunch of their money in their 401k just sitting in cash and cash equivalents because they haven’t allocated money. And obviously, there’s an opportunity cost of doing that. So I think for some, a great place to start, but for others when you consider, you know, is it too conservative? Does it match your goals? Does it match your risk profile? What’s the fees? What’s the performance? It may or may not be the best option to move forward. The other thing I think worth highlighting here, Tim, is that what I understand of target funds, the philosophy behind them is that they’re designed to be selected in a way that they’re potentially the only savings vehicle. It’s determining that different breakdown of stocks and bonds and etc. And so if somebody has other investments, in a Roth, in CDs, in real estate, etc., it may be throwing off, obviously, that intended asset allocation. And I think, again, working with somebody or taking a step back to say, ‘What’s the overall goal? And across all of my investments, where am I at? What am I trying to achieve?’
Tim Baker: Yeah, and it becomes more difficult when you’re trying to manage it at a global level, you know, between your own individual investments and then what’s in your employer investments and then by the way, let’s take into account your spouse’s investments. So it can get a little bit complex. But I think ultimately, the one word that I would describe for investing that kind of plays into all these questions is just simplicity. If you can keep it simple, that’s typically the best route to go. In my industry, typically, the more complex it is, generally the more laden it is with fees and the worth it is to the consumer. So there’s some people that look at index funds that are boring — and investing should be boring. The sexier it is, and the more bells and whistles it is, it’s smart beta and alpha and all this other stuff that we try to dress up investing, typically, the worse off the consumer is. So keep it simple, try to come up with an allocation, and I think one of the questions we had here on the notes that we probably didn’t answer, I think I answered it kind of in passing is you know, what tools do you use to kind of figure out how to do risk profiles. So I basically give a risk questionnaire, but it’s based on Vanguard’s risk questionnaire. So if you Google, and maybe we’ll put a link to it on the website, but if you basically Google Vanguard and risk tolerance or risk questionnaire, it outlines basically what your equity to fixed income number should be. So get that number and look at your 401k and if there is an index fund or a bond fund, basically you could slot it into those two things and call it a day or go the target route. Again, this is not investment advice because obviously I don’t know the individual listeners and all the things that are kind of going into effect with you know, goals and debt and all that kind of stuff, but for simplicity’s sakes, that’s basically how I would approach it.
Tim Ulbrich: Well, good stuff, as always. And I know this was one of our longer episodes, but I think long overdue that we dove into some of this information related to investing. So thank you again to Latonia, to Laura, to Wes, we appreciate you taking the time to submit your question to be featured on this Ask Tim & Tim episode of the podcast. And as a small thank you, we’re going to be sending them a personal favorite, a super comfy YFP T-shirt in the mail this week. And as a reminder, if you have a question that you’d like to have featured on the show, just shoot us an email over at [email protected].
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