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Afford Anything Podcast Episode Summary: Ask Paula | 10-Year-Old Asks: How Do I Save for My First Car? (Episode #459)
Podcast Overview Host: Paula Pant Co-Host: Joe Saul-Sehy Theme: Critical thinking in financial decision-making, focusing on the psychology of money and metacognition.
The episode revolves around four listener questions that target various financial concerns, primarily focusing on saving and investing strategies for young individuals and those facing unique financial situations.
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Episode Highlights
- Introduction and Context
- Paula introduces the podcast's theme: the trade-offs in spending money, time, and energy.
- The episode features questions from young listeners and examines their financial queries.
- Announcement of an upcoming live recording at the Podcast Movement conference in Denver.
- Question 1: Andrey's Car Savings
- Andrey, a 10-year-old, asks how to best save $1,000 for his first car.
Key Discussion Points:
- Crypto vs. Savings Accounts:
- Crypto: Viewed as speculation rather than an investment that produces income.
- Emphasizes the need for investments that yield income (e.g., dividends from stocks) rather than those purely dependent on price appreciation.
- Savings Account: Safe but likely won’t keep pace with car inflation and thus might not be suitable for the 6-year timeframe until he needs the money.
Recommendations:
- Andrey should consider investing in income-generating assets, like index funds or stocks.
- Discussed the balance between learning to invest through individual stocks vs. the long-term stability of index funds.
- Suggested a possible allocation of $900 in index funds and $100 in individual stocks.
- Question 2: Ingrid's Parental Guidance
- Ingrid queries about the efficacy of the 4% rule versus retiring on dividends.
Key Discussion Points:
- 4% Rule: Typically suggests a safe withdrawal rate for retirement savings.
- Dividends: While dividends can provide income, focusing solely on high-yield dividend stocks can be risky during market downturns.
Conclusion:
- Both strategies can coexist, encouraging diversification in a retirement portfolio.
- Question 3: Erica's Income Opportunity
- Erica, a new nurse, is considering a Roth conversion but also has student loans.
Key Recommendations:
- Convert Traditional IRA to Roth IRA this year due to a temporarily low income bracket.
- Prioritize the conversion over aggressive student loan repayment, as the interest rates on her loans are relatively low.
- Question 4: Chloe's Loan Management
- Chloe, a teacher, seeks advice on managing her student loans amidst retirement contributions.
Discussion Points:
- Chloe has options regarding her federal loans that allow her to defer payments while enrolled in a master’s program.
- Recommendation: Prioritize maxing out her Roth IRA contribution before focusing on paying off student loans.
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Key Takeaways
- Invest Wisely: For young investors like Andrey, prioritize income-generating investments rather than speculative ones.
- Diversification: A balanced approach to investing in both high-yield dividends and growth stocks can provide stability and income.
- Maximizing Tax Opportunities: In a transient low-income period, take advantage of Roth conversions.
- Psychological Factors: Paying off debt can provide psychological relief, but making contributions toward retirement should be prioritized when feasible.
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Additional Resources
- Listeners are encouraged to leave questions for future episodes on the Afford Anything voicemail page.
- For a deeper understanding, listeners are suggested to refer to episode 377, featuring insights from the creator of the 4% rule.
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Conclusion This episode emphasizes the importance of making informed financial decisions, recognizing opportunities, and balancing growth with caution, particularly for younger individuals navigating their financial futures.
Written by AI. May contain mistakes. Listen to the episode to check what was said.
Transcript
Automatic transcript. May contain errors.0:00Hey, Joe, when you were 10, did you ever think about money? No, I thought about stuff, but I never thought about money. Ah, well, you're about to be shown up. Not the first time.
0:14Welcome to the Afford Anything podcast. This is a show that understands you can afford anything, but not everything. Every choice that you make is a trade-off against something else. And that doesn't just apply to your money. It applies to your time, your focus, your energy, your attention, any limited resource that you need to manage. So that leads to two questions. What matters most? And how do you make decisions accordingly? Answering those two questions is what this podcast is here for. I'm Paula Pant. I am the host of the show. And every other week, my buddy, former financial planner, Joe Saul-Seihai, and I tackle questions that come from you.
0:48What's up, Joe? We just booked you tickets so we can be in the same room in Denver. Yes, we are going to go to a conference called Podcast Movement. We'll be there. Joe, you and I, we're going to record in person, face-to-face. We'll record live. Right. We don't care what the restraining orders say. We have no care at all. We're going to do it. It'll be several days of podcast nerddom. It'll be great. Just some time to get seeped into that world. Fabulous. In the meantime, today, we are going to answer several questions, kicking off with this one from Andre. Hello, I'm Andre, and I'm 10 years old.
1:30I was wondering what I should do with my$1 ,000 since I want to save up for my first car. Should I maybe invest in cryptocurrency or put it into a bank for safekeeping? What do you think I should do? Before we answer Andre's awesome question, I've got two points. I think it would have been funnier if Andre had said his third car. That's the first thing. Wait, did Andre clarify my first car? He did. He said first car. I'm like, really? You're 10 and it's only your first car? The fact that he's thinking about this at all. And then whatever human being helped him with this, the fact, Paula, that they bait us with these goalposts of emotions, crypto or a savings account?
2:17Why don't you just say lottery tickets or put it in the backyard? So anyway. Well, we should explain to Andre. So Andre, let's talk about those two options. Let's talk crypto. Let's talk savings account. And let's talk about why neither of them are really quite right. Joe, which one do you want to tackle first, crypto or savings? I'll let you tackle the crypto piece. I'll take the savings. Cool. Go for it. So I should go. Okay. Well, you know what? Actually, let's start with crypto because that's a little bit - More exciting? More exciting. Yeah, exactly. I haven't talked to a 10-year-old about money ever.
2:55So Andre, first, thanks for calling it. And this is so much fun. Andre, you have probably heard a lot about crypto from just people chattering about it. And sometimes the more we hear other people talk about a certain type of investment, the more likely we are to think it's a good idea. It's like following the crowd, following the herd. When you stop to think about how does an investment make money, there are some investments that draw an income, right? So if you own a share of Coca-Cola, Coca-Cola is a company and it sells Coke, it sells products, and those products make money. And so if you own shares in Coca-Cola, for example, that will earn some type of an income.
3:44And hopefully over time that will also go up in value too. But even if those shares never go up in value, you still get some kind of income payment, which is called a dividend, from those shares, right? And that's because you're investing in a company that makes money and that has an income. Same thing if you one day, like when you own a car, if you were to rent that car out through an app like Turo, T-U-R-O, then by virtue of renting that car out, your car would create income. And so anytime you're investing in something that creates income, that's a real investment. When you're investing in something because you think it'll go up in value, but the thing that you're investing in doesn't actually draw in any type of income, that's what we call speculation.
4:34Examples of speculation, one is cryptocurrency, one is art. Sometimes you've got like art dealers who will buy very expensive pieces, Picassos and things like that, hoping that it'll go up in value. Sometimes people invest in foreign currencies. so they'll trade their US dollars for British pounds or for Indian rupees or Thai baht. And they hope that over time, they'll be able to make more money on the spread. Those are all examples of speculation. And so when you're investing, the first thing you want to ask yourself is, is this the type of investment that creates an income or is it something where I'm just speculating?
5:17And as a general rule, you want to save speculation. Only do that at the very end after you have already built a whole bunch of income producing investments and only speculate with a very, very, very small amount of money, a tiny portion of what you overall have. And so for you right now, you know, you're 10, you have your first thousand dollars. You want to start with some type of investment that's going to make money, that's going to actually produce an income. And later when you have like a million dollars, that's when you're, once you have a million dollars, then you can take 5 ,000 of it and put it into something speculative.
5:57Yeah. I don't like any speculative investments, especially when I have a set timeframe and a set goal. And assuming that Andre wants his car six years from now, I don't want to bet that Bitcoin's going to be higher, lower than it is today. Yeah. That's the other piece about the goal, Andre, is there are some goals that you have, where you can wait an extra year or two. So for example, one day when you buy a house, you might have like a window of time, maybe a five-year window of time where you're like, I want to buy a house sometime within this five-year window. But if it's something like a car, you're going to need that car to go to work and to go to school and to go out.
6:33There's a big difference between buying a car at 16 versus at 17. You don't want to lose that year. So you're going to want some type of investment where you can hit that timeline because you don't have timeline flexibility. Joe, you want to talk about savings accounts? Absolutely. A savings account is a nice, safe place to put money. But the problem is, is that with a six-year goal, the price of cars is probably going to go up. And so we look at this nice, safe savings account rate versus the rate that cars have gone up historically. And you get a lower interest rate in the savings account than the price of the car is going up, which means you're really losing value on that money by not investing it, which is why I think that a savings account is a great place for money that you might need tomorrow, you might need next week, might need even next year.
7:32But if you know that you've got six years until you need this money or longer, then certainly there are other spots that historically have done better. And I look at it like you're planting a seed. You want to plant the seed that has the right growing season for your goal. So right now we're looking for a seed that's good in a six to eight year time frame to make sure that you're able to get the car that you really want to get instead of having to speculate. Right. So, Joe, where do you think Andre should invest this money? Well, I can hear, you know, the, what's, I thought about this a lot. Yeah.
8:09You know, the, the, the Uber finance nerds are like, duh, you choose an, an index fund.
8:19Oh, wow. That was, that was the Uber nerds right there telling me that the, yes, of course we do. Perfect. But you know, I thought about this. So there's two things in my head going on. And the first one is, is that an index fund is probably going to be the right answer, but they're also Paula is an emotional piece to investing. And the quicker you learn about the emotions that happen when you invest real money. And also certainly there are ways to learn why indexing is a great way to invest without having to learn some hard lessons. Right. Right. However, I do think that it's really helpful if I kind of know the underpinnings and I get the feelings that come with investing.
9:07And I'm thinking that Andre may have had a parent that helped him call in. And if the parent wants to help him, I actually think buying a good, solid, really boring six to eight year large value oriented stock or two or three is a great thing. Do you know Adam Carroll? I think you do know Adam Carroll. Adam Carroll had a documentary he sold to CNBC called Broke, Busted, and Disgusted about the student loan crisis. And so Adam's a great guy. Adam actually has a TEDx video that has been seen by, I think, four and a half million people. And what he did, Paula, was he played Monopoly with his kids with real money.
9:53And what he found was that when you have real money invested, when there is real money on the line that you can take home, you make decisions differently. And that game of Monopoly went way different than games of Monopoly go when you're not playing with real money. And so I like this idea of investing the first thousand dollars in a few safe stocks where we can make money. But I think then you totally get, oh, yeah, I could just index. You know, so I like both of that. I like knowing the underpinnings of the index. I like knowing how the basics work, how the fundamentals work, which kind of lead you, I think, in a more not just cerebral, but a more primal way to the value of diversification.
10:44Right. This surprises me, Joe, if I'm understanding you correctly, you're advocating for buying a few individual stocks. I am. Wow. No, no, that's what I'm saying. And as I opened, as I opened, Paula, I said, indexing is probably the right answer. But if it's my first thousand dollars I'm investing, I really like the lessons that you can get by buying a few stocks. Cause I think there's some great stuff there. I think the distinction is, is the goal to learn about investing and to get excited about investing, or is the goal to buy this car in six years? Andre, only you can answer that. Andre, if what you want to do is get really excited about investing, remember the analogy that I made earlier, like the Coca-Cola stock?
11:38There are platforms out there where you can experience owning a handful of your favorite companies, right? You own some Nike, you own some Apple, you own some whatever, your favorite companies. Those platforms are designed to get beginners who have never invested before really excited about investing by saying like, hey, I know how much you love Disney. Hey, look, now you're a part owner of Disney. And that's cool. Like those particular platforms allow you to buy fractional shares. So you can buy$10 worth of Disney. You can buy$10 worth of Apple. You don't have to put a lot of money into it. That's why I'm talking about these very specific platforms that are designed for that.
12:20The benefit to it is you kind of get the fun and the excitement of like, hey, look, I'm a part owner of Disney. I own$10 worth of Disney. The benefit is that it's fun. The drawback is that it's not a good long-term plan to get you to your goals. Joe's making a face at me. I didn't know that I wanted to be fun. Like I want to be educational. I can think of some very educational courses I was in in school that were not fun, but I definitely needed that lesson. So I don't know that if I buy$10 worth of Coca-Cola that I feel the feels that come with the emotional roller coaster that happens when you own a stock.
13:08But you get the emotional roller coaster when you own an index fund, too, because you watch it go up, you watch it go down. You do, but it's the educational piece as well, Paula, which is, and once again, you don't have to own individual stocks to understand the fact there are a collection of individual stocks inside of an index. But when you own individual stocks and have owned individual stocks, you understand even better the power of indexing. You're like, oh, and you also understand the downsides of indexing. And of course there are downsides of indexing, which is you will never get any, to put it very nerdily.
13:44you're never gonna get any alpha you're gonna be a middle-of-the-road investor you're not gonna pop any huge you know wild numbers that you could do an individual stock i mean that is the downside now seasoned investors now are yelling at their device going but you don't want to play that game and i right i get that but i think you get it a lot when you go and you buy some stocks and you witness the nice upsides, the wild upsides? As a learning, as a teaching tool, as a thing to keep, I wouldn't be opposed, you know, Andre's got a thousand dollars. I wouldn't be opposed to him putting, let's say, 900 into a combination of equity and bond indexes.
14:27And we can talk about that in a second. Putting 900 into that and then taking the last$100, 10 % of what he's investing, Take that$100, break it up into five stocks, 20 bucks on each stock, and pick a handful of your favorites. So remember where I started. I started with the phrase, indexes are the right answer. And a sound effect. Yeah, I wouldn't be opposed to that. all of this talk of individual stocks is, you know, focusing on the 10 % and the 90 % really needs to go that$900 out of this thousand should go towards index funds. But I also think given that he has a fixed timeline, it can't be all in equities.
15:20It's too soon. Yeah. I mean, if he wants it at 16, he didn't tell us the date, but let's just assume 16 years old. then you're right, it's too soon. So Andre, you really want 10 years if you want to make a very little chance of downside decision with stocks. You want to have at least 10. And maybe not in some instances over 10 years, you haven't had a lot of upside in some scenarios. But your risk of downside goes through the floor if you give it 10 years. So I think, yeah, you have to have a stock bond mix. What percentage do you think Andre should aim for? And how should it shift over time? I don't think you can go more than 50-50.
16:07I don't think you can. With a six-year time frame, you truly can't. Because we are so close to that five-year number that I think having more than 50 % in stocks is just asking for it. Interesting. So your recommendation then would be like of this$1 ,000,$450 into a stock index fund,$450 into a bond index fund, and then$100 into an assortment of your favorite individual stocks. No, no, not your favorite. No, no, no, no, no. We still want to match the stocks to the goal. So we want to look at stocks that over a six-year period should be stocks that accomplish that goal. So you've got to think utility companies.
16:52You have to think railroads. You have to think about some of these companies that are pretty boring, boring companies. This is not for fun, Paula. This is education. All right, Joe, this is where you and I disagree. This is where you and I disagree. Why? You wouldn't invest in a railroad? I'm not saying I wouldn't, but for someone like Andre, we've got two goals here. We want to learn how to invest and we want to get excited about investing and get set up for life. We also want to make sure that we can buy this car in six years, right? We don't want to lose money on the path to that car. So I'd say for 10 % of the money,$100, we put it towards the goal of learn how to invest, get excited about investing because that's - But if you're learning how to invest, job one at learning how to invest is invest with the end in mind.
17:46period. Why am I going to buy stocks that that do not meet the goal? Well, a large cap, I'm not saying you should buy small cap or micro, but like stable, large cap stocks that get you excited about checking your portfolio. That has the best chance of motivating you to increase your contributions. And ultimately, Andre's contributions are going to be the single biggest determinant of how much he has in his account when he turns 16. But I think if he's investing in stuff, even if it's with that 10 % that isn't toward that six-year goal, then he might as well go buy some lottery tickets. Okay. We disagree here, but we're also talking about the 10%.
18:36We're talking about the exciting 10 % rather than the core 90%. Because where you and I agree is that that core 90 % needs to be an indexes. Although I would do something different. I would not go 50-50 right away. If it were me, I would go 70-30, 70 % stock index, a 30 % bond index. I would do that today. And then over time, as he gets closer to the age of 16, he then rebalances and gets closer to 50-50. But right now he's six years out. I say go 70-30 today and then work towards 50-50 over a six-year time frame. I think he starts at 50-50 and then every year as he gets closer, because that would mean over six years, he'd go 50-40, 30-20-10 and it would back down to when he gets his car, it's all in bonds.
19:31Wow. Wow. You want to put him in bonds and railroads, dude. Grandpa Andre. this is a funny point though, because I'm, you know, I mean, the joke here is that we're talking to Andre who's 10 years old and we're talking about grandma, grandpa stuff. Right. But it isn't about the age. I was got frustrated when I would meet people and they go, she's 80 years old. She's got no business being in growth stocks. Like this is money. She's never going to use this money. She's investing for her grandkids that don't need the money for 20 years. Right. So even though she's 80 years old, she should be holding on to these growth-oriented stocks.
20:13And for Andre, even though Andre's 10, he's got a six-year goal. Kid wants some wheels. If you want some serious wheels and you don't want to have to discount those because the price of my Coca-Cola went through the floor at the wrong moment, I don't want to take that chance. I want the wheels. If I want the wheels and I'm serious about that goal. And by the way, this is why, and I'm sure there's people yelling at their device going, you're the guy that said individual stocks. Why are you now advocating for being more conservative? Because individual stocks can meet the goal too. Individual stocks can get you there.
20:48It's just a hell of a lot easier to do it with indexes and more reliable with indexes. But to teach him that, hey, we can do some work on PE ratios, what value means, looking at the guts of this company so that we learn a little bit about fundamentals, like stuff that I think is super fun. Like, let's dig into the company. How much debt do they have? How much revenue do they have? How does that compare with other companies in the same sector? Like having some fun picking those stocks. I think whether it's a railroad utility, your favorite beverage company or shoe company, I think that can be a ton of fun.
21:24but I just don't think we go by 20 year stocks. I don't think we go by Microsoft with a six year goal. I mean, I think if you're putting 20 bucks on Microsoft, why not pick five companies, put 20 bucks on each of them. That keeps you excited about checking your portfolio. That keeps you excited about buying more. And at the end of the day, the goal here is twofold. It is, well, it's threefold, really. It's growth of principle, protecting against loss of principle, and encouraging future contributions. I think you can do that just by learning about an industry. And so if we start with a goal and we learn about the industry, then we get, I mean, it's easy to get excited about what's going on with utilities right now.
22:12There is actually some pretty interesting stuff going on with utilities. I mean, all the renewable energy stuff going on right now, all the non-boring renewable energy initiatives happening is pretty exciting. There's exciting stuff going on in railroads, you know, huge cost overruns in California. We've got this, you know, high-speed rail initiatives all over the place. We've got the cost of transporting goods across the country. We've got all kinds of safety things happening in that. So just diving into these industries, I think can be fun. I think there's a lot of ways to have fun than just going, oh, oh, so you like Nike shoes?
22:49Let's put money in Nike. I think we end up there. I think we end up there. So there's two ways to invest, by the way, for everybody listening. When you're buying individual stocks, there's a top-down approach and there's a bottom-up approach, right? Bottom-up is I focus on Nike and I go, okay, Nike. Nike, how do they compare to their sector, other shoe companies, Adidas and everybody else? then how are shoes going to sell overall so will this company do well in this sector will the sector do well in this economy that's a bottom-up approach where i start off with the company i want to invest in then i look at everything there's also a top bottom approach which is what i'm talking about start off with the type of sector that does well in this economy railroads or does with this time frame railroads let's say and then go down from there okay railroads what's going on with railroads.
23:44What's happening? Do we expect this sector to do based on all the interest rates being where they're at, what the Fed's doing, what's going on with legislation going on with safety concerns, with consolidation, with shipping, all this stuff. And then we nail it down to, I want to invest in that railroad. So top down or bottom up. I think learning about it from a top down approach is every bit as fun is saying, I want to invest in Coca-Cola. hmm okay i won't fight you on that that makes sense but it seems a bit more labor intensive oh it certainly is no which is why when you said fun i'm like i didn't say anything about this being fun right right that that sounds a lot more labor intensive and my question with andre's you know he's juggling school you know maybe some after school clubs or sports or whatever he's doing like andre's like let's just i i said i want to throw it in bitcoin my man does andre have the the time the interest the inclination to take that top-down approach think about this paula what is the lesson andre's going to get really really quickly by index funds by index funds put 90 of this in index funds and put it into a mix of one total stock market index fund one total bond market index fund.
25:03He does a few of those and goes, this is valuable. This is important. This is the right way to pick a stock. I think I'm just going to index. And then I think you get there. I think you get there from a much better approach than just let's throw all the index funds. And then we see the market go up and down. I'm like, I don't know why it's going up and down. I think once you walk through buying a few stocks the right way, I think you end up with an index portfolio because you go, yeah, I could do it this way. And by the way, you actually could, and you could make money, and you might eke out a little bit more money than the index does as a small investor.
25:41Because historically, when people do beat the S &P 500, which I know people say is a bad thing and you cannot – when people do, it's people with smaller amounts of money who do. these huge money managers, it's not that they don't know what they're doing. It's that they're managing so much money and it's so difficult to deploy that money to gain any edge that they can't do it. And even for a small investor that can potentially maybe do it, they find out very quickly that the, what's that phrase that people use? The juice isn't worth the squeeze. I'll just go to the grocery store and buy it. So even if you can eke out some, which I think you actually can, I think indexing still is the right answer.
26:26But to get that lesson at 10 and to walk through that, I think it's pretty cool. Yeah, absolutely. But at the end of the day, Andre, take$900 of the thousand that you have, take$900 and put it into index funds. the other hundred you can play with but 900 goes into index funds and then uh six years from now send us a picture of your car yeah or just come and let us ride in it yeah take us for a spin road trip thank you andre for asking that question good luck with buying that car in six years
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31:45Joe, do you feel like you're a dividend guy? Like, are you super into dividend strategies? You mean like more money in my pocket? Yes. I'm listening. That's like asking if I'm a hot dog guy. Yes. Correct. I would not have necessarily assumed that you love hot dogs. You look at this body type and you don't think, that guy eats a lot of hot dogs. That's the way I feel. Well, our next question is not about hot dogs, but it is about dividends. Oh. And it comes from Ingrid. Hi, Paula and Joe. My question is regarding the 4 % rule. My parents recently came across something called retiring on dividends, I think it is.
32:32And I found a whole bunch of articles on the 4 % rule versus dividend income. And I just wondered what your thoughts were on that. I probably don't know exactly what I'm talking about, but basically the dividends, they were buying high yield dividend stocks and just living off the dividends rather than withdrawing 4 % each year. And they had all these reasons why that was better. They also said that these certain high yield dividends tended to pay out more dividends when the market was down or lower. And they had some reasons for that. So I just wanted to get your take on that. It sounds kind of sketchy.
33:19I've always been a fan of the 4 % rule, and that's kind of what I was helping teach my parents. but now they've found this and they think that the 4 % rule is not something that they should be following, according to these articles. Hope you can just give us some insight and explain it a lot better than I did. Thank you so much for all that you do. You know what, Paula? Know what? Ingrid talks about the 4 % rule versus a dividend strategy. They're not polar opposites. I feel like parents, yeah, parents are talking about how these are opposites. We're still talking about money that's being produced by the portfolio.
33:59So they don't have to be two different ends of this football field of investing. They can be much closer than you think. And in fact, a strategy which includes taking gains from a portfolio and having some dividend production actually historically has been shown to be a safer way to take money because you're dipping from these different baskets instead of just focusing on one. So as everybody out there may or may not know, there's basically two ways to produce income. I can either take money off the top of the mountain and spend it, right? My big old mountain of money, or that mountain of money has trees on it and I get dividends off of the trees.
34:44I get the fruit from the trees. So either from real estate yields being tenants in my real estate, or I have the stocks that pay a dividend, I have bonds that pay interest, whatever it might be, I get this yield from the fruit of my investments. Those are only two ways that you can get money, money off the top or the yield. You're talking capital appreciation and the income stream. That's it. So it's very, very simple. Now, a dividend income stream only focuses on one of these. So let's talk about this. When we talk about companies that produce a high yield, now high yield stocks, we can talk about high yield bonds too, if you want, high yield stocks, why would a company offer a high yield?
35:31Ding, ding, ding. Ooh, ooh, call on me, call on me. I know. Yes. So a company typically would offer a high yield because they are not reinvesting back in themselves, which means they are not growing very fast. Right. Which means that in a capital appreciation type environment, you will see these companies get smoked. When the stock market goes up, they ain't going up because that's not how they pay money. So what's going to happen is even though your mountain of money will stay there, the mountain of money that you need for the future, because prices double roughly every 18 years, if we use the rule of 72 and 3%.
36:12So I think if we use 4 % as a good conservative number for inflation over the long term, we certainly have seen higher inflation than that the last couple of years. But over long periods of time, 4 % is a good number. We find that prices double about every 18 years. I should note the Fed's target inflation rate is 2%. And historically, it's been around 3%. Calling 4 % a conservative inflation projection. is great. It is then, right? Are you stating that you believe that we will have a future inflation rate of 4 % long-term? I'm stating that if you bank on inflation being 4%, that is a conservative number that will give you an optimistic outcome.
37:01Meaning you are conservatively saying that things can get worse and I will still be okay. If I can make my portfolio work at a 4 % inflationary rate. Understood. Okay. So you're stating that I'm going to plan for inflation being 4%, knowing that historically inflation has been 3%, knowing that the Fed's target rate is 2 % for the sake of being conservative. I'm just going to assume that things will be worse. Things will be worse in the future than they were in the past, basically, is what you're assuming. Yeah. Dave Ramsey saying that funds, you know, 12%, right, in the stock market. And then he points at funds and yes, they've done it, but financial planners will say, let's focus on eight.
37:42For future planning, I don't want to use 12. I want to use eight. Doesn't mean that they haven't done 12. It means we're going to use these conservative numbers. So what happens though, is that when things get better in the market, the market flies, these companies just stay the same. Their stock stays the same or they decrease. But even when the price goes down, they keep the dividend the same, which means the dividend as a reflection of a lower stock price is a higher percentage. Yeah. Yeah. Which is actually the same yield. So what has to happen in a dividend strategy, if you're betting on high yield companies is you're going to find your budget's going to get tighter and tighter and tighter and tighter and tighter because there's no room.
38:27There's no room. There's no growth driver to keep up with inflation. So you have to do one of two things. You have to spend either less money off of those initial dividends and reinvest it. And if it's in a portfolio that's outside of an IRA shelter, you're paying unnecessary taxes. You're spinning off taxes by reinvesting all this stuff versus going with more of a growth strategy. Either that has to happen or at some point you have to start chopping down the dividend trees to live on. Which is exactly, you know, the whole purpose of designing a dividend strategy is to not have to sell off those stocks, right?
39:03do that. Right. Right. Now, a dividend strategy that's much safer is if you can live off the much smaller dividends that some of these growth oriented, more growth oriented large cap companies have, that is a much, much safer strategy because then you get growth with dividend and then your mountain of money has a much better chance of growing and you get that. So whenever I hear high yield anything, Paula, that is a strategy that's great today that's going to break down 15 years from now. Right, right. And you know, it strikes me, Ingrid's question fundamentally, it's about high yield dividends and about the safe withdrawal rate.
39:48And what's interesting to me about the framework, the construction of that question is that high yield dividends refers to the composition of the portfolio, the way that she's asked the question, she's asked the question not so much about the composition of the portfolio, but rather about the withdrawal strategy, right? Do we take a dividend-oriented withdrawal strategy, or do we take the 4 % safe withdrawal rate strategy, right? The withdrawal strategy, it's a separate conversation. It's separate from the composition of the portfolio itself. Obviously, they're related, but they are separate conversations.
40:30Conversation number one is how do we want to compose this portfolio, which is a fancy way of saying what do we invest in, right? What should be inside the portfolio? That's conversation number one. And then conversation number two is how do we draw down from this? So it's perfectly fine for some percentage of the portfolio to be dedicated to dividend-oriented stocks because it's good to have the diversification where some of your stocks are growth stocks, right? They're the ones that will probably see that capital appreciation over time. Tech stocks or even just broad market, there's a lot that's growth-oriented.
41:13you could go into a growth index fund. Some composition of the portfolio will be around that. Some composition of the portfolio will be around dividend. Now you've got some good diversification inside of that. Well, if we put the 4 % rule just into practice, let's say it's a$100 ,000 portfolio, that means that you can safely take out$4 ,000. That doesn't mean you're going to sell$4 ,000 worth of stuff. It means$4 ,000 is going to come off the portfolio. That might be dividends. Yeah, it could be. Exactly. The thing is, the growth of a portfolio is reinvested dividends plus capital appreciation.
41:49So if you simply stop reinvesting the dividends and start harnessing that, depending on how much you have in dividends, that might be the entire 4 % right there. And what's Bergen's model portfolio for that anyway? It's a pretty balanced portfolio, which means that there's an assumption built in that part of that is going to be income producing investments anyway. Right. Ingrid, the episode that I want you to play for your parents is episode 377. You can find it at affordanything.com slash episode 377. It is with the creator of the 4 % rule. His name is Bill Bengen. He's an MIT graduate who looked at the performance of investment portfolios across 30-year time horizons beginning in 1926, under the assumption that the portfolio is invested 50 % in an S &P 500 index and 50 % in intermediate term bonds, and that all of that is in a tax-deferred account.
42:45Under that set of assumptions, he found retirees could withdraw 4.2 % in the first year of retirement, and then that amount adjusted for inflation every subsequent year. So 50-50, Joe, is the answer. He's assuming a very conservative 50-50 allocation. I said Bergen. I almost got it right. Bill Bangin. Bangin. Bill Bangin. I always goes, my bad, Bill. My bad. So yeah, assuming a 50-50 allocation, that was how he modeled out the 4 % rule. Which means if 50 % of that portfolio is an intermediate term bonds, bonds create an income stream. Dividends are an income stream, right? So he's modeling the entire 4 % rule based on assumptions around at least half of the portfolio being dedicated to assets that are income-oriented.
43:37An income stream from a bond is not conceptually different from a dividend from a stock. Either way, they are income streams. And so an income orientation is what you gain from the fact that it's income-oriented. You lose in growth. I think dividends are a good part of a strategy. But whenever I hear go all in on one, that's when I start to hesitate a little. Absolutely. But yeah, dividends for as part of the portfolio composition, I have no opposition to that. So as long as it's properly asset allocated, right? If they want to tilt a little bit more towards dividend oriented holdings, that's fine.
44:20Well, and I do like that. I mean, I've always liked leading with, if you have multiple, multiple investment choices that meet a goal, go with the one that you're strongest at, that you feel the most strongly about. You've got a lot of people listening to this show that love real estate, real estate and the stock market. That's an income play also, right? That's an income oriented play. But also real estate and the stock market, you know, the North American re-index and the S &P 500 over long periods of time get to almost exactly the same place. So if you're a big fan of real estate and you love investing in real estate, invest more strongly in there.
44:58But when somebody goes, yeah, I'm going to invest all in real estate, nothing in the stock market. That is horrible. I should keep a red flag by my desk so that the people watching on YouTube could see me just wave one from time to time. Personal foul. Too much money in one asset class. Lose your first down, go back five yards. You know, and that's what turns me off from some of these, quote, gurus online when they're like, well, you should invest in the stock market. You should invest in real estate. I'm like, it's not an either or zero sum game. Exactly. When I hear that, I immediately turn off.
45:31I'm like, OK, pass. Exactly. So thank you for the question, Ingrid. And I hope that we have helped shed some light on the role of dividend stocks or the role of more broadly speaking, the role of income oriented assets. in your portfolio.
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49:05Joe, have you ever tripled your income? Yes. Yes. What was the first thing that you did when that happened? Spent it all, which was absolutely the dumbest thing to do. That was before I had any financial controls and yeah, made a bunch of bad choices, Paula. Thanks for bringing that up. Way to open a formerly closed wound. Well, the next question that we're about to answer comes from a caller named Erica. She has just tripled her income. Oh. You know what she wants to do with that money? Make bad choices? Convert from a trad to a Roth.
49:48So let's hear her question. Hi, Paula. My name is Erica. I want to start by thanking you so much for your contribution to humanity and society with your content. I've learned so much and come so far. Thanks to you. Really appreciate you. My question is about converting a traditional IRA account to a Roth account and paying the tax hit that that creates when I also have student loans to pay and which should I prioritize. So the details, I just graduated nursing school and accepted my first position. My salary is going to start at$131 ,680 per year. This is almost three times what I made in my previous career as a public school teacher, so I'm thrilled about that.
50:33I have a traditional IRA account with$77 ,758 as of today, and I do have a Roth IRA with about$4 ,000 in it. My job starts on August 1st, so I will only have five months of income this year. Thus, I think it'll be a good opportunity to convert my traditional IRA to a Roth because I'll have less income. However, I also have student loans to pay off. I have about$36 ,000 in private student loans. The interest rate is variable and it's at 6.2 right now. I do plan to refinance those and get a fixed lower rate. And I'm getting quotes for about 4.8%. And then I also have about$24 ,000 in federal student loans, which are at 5%.
51:26I have done the calculations to how much I would pay in taxes if I convert my entire traditional IRA to the Roth, my calculations came out to$19 ,738 in taxes. I'm in a position with my expenses that almost$20 ,000, it's one or the other. I can't afford to do the conversion and pay extra towards my student loans. So my question is, should I just make the minimum payments on my student loans and put off really tackling that so that I can do this conversion this year? Or is it more important that I just start slamming on that debt and get rid of the student loans and not worry about the conversion this year and do it at a later year or do it in smaller chunks?
52:16I'm going back and forth. Some days I really want to tackle the debt. Other days I really think it's important to jump on this opportunity to convert my traditional IRA. I would love your feedback on this. Thank you so much for your help. These are my favorite questions because, Erica, I know because I get to sit here and look at her that Paula has a definite opinion and I have a definite opinion. And we don't know if they're the same opinion or not. We don't know. You could see it in my face. Oh, yeah. Which means the next three minutes are going to be a lot of truth coming out here. Wow. I can't wait to watch the YouTube video and see my own face to see what was registering on my face as she was asking her question.
53:07Because I didn't realize my face is that easy to read. You had, I got it, girlfriend. I got you. I got you. I did not realize. Okay. I note to self, do not play poker. I did not realize that I was that facially expressive. But maybe mine gave it away too. I don't know. But I saw yours and I'm like, oh, she's got it and I've got it. So let's see where this goes. Yeah. I mean, you know, anyone who's listened to this podcast for a while knows that typically I don't come right out and give an answer. Typically I'm like, here are the pros and cons of A, here are the pros and cons of B. Here's how you frame this question and think about it.
53:46And, you know, here's how to think about this. Now you make the decision for yourself. This question, I have a definite answer. Yes, you do. I feel very strongly about it. Convert the trad into a Roth. Do it now. Do it, do it, do it. Is that also your answer, Joe? Yes. We're in agreement, which is great news for Erica, but actually, but less entertaining radio. That's right. Nothing more fun than disagreeing with Paula. Yeah, yeah. The more entertaining radio would be if we disagreed. But the better news for Erica is that both of us agree and both of us feel strongly about it. Because this opportunity goes away next year, Paula.
54:25Exactly. So to explain the rationale, this is the one and only opportunity, foreseeable opportunity, in which you will be able to convert this money at this very, very low tax bracket because you're going to be making, you're only earning money for five months out of 12 months this year, right? There's no time in the future that you plan on not working for seven months out of the year. So this is take it or leave it. This is your one shot. Do it. Do it. Strike while the iron is hot. Whatever that expression is. Yeah. Something like that. Yeah. Take advantage. Bird in the hand. Take advantage of the opportunity while you have it because this is your only chance to do that at this rate.
55:09And the way to understand this is that tax rates are like stair steps. They go up depending on how much money you make. So the first X amount of money that you make, whether you're single or you're married, is going to be at 10 % and then the next amount of 15 % and it's going to go up and up and up. So when you do this Roth conversion, it's always going to be converted at that top stair step because the money that she's making from her new job is going to fill all those lower stair steps. So she is a lower stair that she's on now. The right time to do this was last year when she had none of the income, but we can't go back and get last year, but we can do it this year when she's only partway up the stairs.
55:53So yeah, absolutely. Yeah. And do not for exactly the same reason, Erica, you asked, should you do it piecemeal? Like do a conversion in smaller chunks? Nope. Nope. Do it all right now, immediately. Like pause this recording and just go do it now. Do not brush your teeth before you do this. Do not eat a meal before you do this. Just drop. Maybe she should. If she's going into the post office or something, she needs to brush her teeth. Just do this before you do literally anything else. Do this before you shower. Do this before you. I'd shower.
56:30Make this the first thing you do and do the whole thing right now. Because the thing is, your student loans, number one, the interest rate doesn't terrify me. That's actually quite good, particularly if you get the private loan lowered to 4.8%. sweet. That's awesome. So I'm not taken aback by your student loans. The interest rate's reasonable. And, and, and, and, come January 1st, 2024, you'll be in a position from that point forward to really just crush those student loans with future money that you make. So what's the advantage of paying them off in August of 2023 versus January of 2020? I mean, and granted, you won't have enough money to pay it off on January 1st.
57:16But the difference between being hyper-dedicated to your student loans in the last five months of 2023 versus the difference between being hyper-dedicated to your student loans starting January 1st, 2024 forward, I mean, interest rate-wise, it's a who cares situation, right? It's not going to be significant. but in terms of the tax advantages of doing this conversion in 2023 are just, they're spectacular. And this is your only shot. I'm so disappointed. Yeah, I know. Right. Right. Alternatively, you could just like take seven months off in some future year, and then that would give you the opportunity again.
57:59Let's talk sabbatical. She's like, I want to do more. But yeah, I mean, unless there's some future year where you just decide to take seven months off of work. This is not going to come around again. Congrats on the big win, by the way. Yeah, exactly. Well, that was a quick question. Should we do another? Yeah, boom. Knocked that out. Okay, fine. We'll do another one. All right, let's do it. We should answer a question from Chloe.
58:29Chloe, you know what? Erica was a teacher. She was a public school teacher. Chloe is a teacher, also. Perfect. Yes, perfect. Perfect. We're flowing right from Erica into Chloe. Let's hear what's on Chloe's mind. Hi, Paula and Joe. My name is Chloe and I'm a 27-year-old teacher in Pennsylvania. I'm calling to get some advice about the end of the student loan interest pause and also about tax advantage and taxable accounts. So here's a rundown of my situation. This school year, I'll make about$61 ,000 before taxes and I teach at a private school, so I have a 403B and not a pension. My school requires a 4 % contribution to the 403B, and they match that 4 % with 6%, so I don't have to put in 6 % to get 6%.
59:19I just put in 4 % and get 6 % from them. I currently contribute an additional$500 a month to my 403B, so with that plus my 4 % and my employer's 6%, around$1 ,000 a month goes into that account. I also have an HSA and a little over$300 a month is automatically deducted from my pay to fund that. I started putting in the extra$500 a month because for the past few years, I've been able to max out my Roth IRA on the 1st of January every year, and I wanted to know what my paycheck would look like if I were putting in that$500 a month that I would take to max it out if I were contributing monthly. I lived at home after graduating from college in 2019, and that plus the pandemic meant that I was able to save a lot of money to put towards my Roth IRA and other savings goals.
1:00:04My 2023 Roth IRA was maxed out on January 1st, but I do not have money set aside for my 2024 Roth IRA. I currently have around$29 ,000 in my 403B,$28 ,000 in a taxable brokerage account,$3 ,000 in my HSA, and$21 ,000 in my Roth IRA. All of this money is earmarked for retirement currently and not other savings goals. I also have a$10 ,000 emergency fund and contribute monthly to other sinking funds. I'm wondering if I should use money from my taxable brokerage to max out my Roth IRA on January 1st, 2024, or if I just should stop making the extra contributions of$500 a month to my 403B and instead contribute that amount to my Roth IRA, leaving my brokerage account as is.
1:00:50I also have a total of$16 ,000 in federal student loans. I paid down my loans from the$30 ,000 I had when I graduated in 2019 while I was living at home, and I originally had the$16 ,000 waiting in my high-yield savings account to pay off whenever the pause ended, but I invested$10 ,000 of that into my brokerage account when the forgiveness plan was announced. So I guess I'm wondering if I should pay the$6 ,000 as a lump sum and then pay monthly to the remaining 10K, pay off the loans completely with money for my brokerage, or make the payments monthly from the 6K and then cash flow the payments after that.
1:01:23And I can also defer my payments because I'm enrolled in a master's program. The highest interest rate I have on my student loan groups is 4.45%. Thank you so much for your help. Chloe, thank you so much for your question. Congratulations on kickstarting your career. Congrats on saving so much during the pandemic that you have been able to fund your Roth IRA on January 1st. That's amazing. So let's talk through your questions. So fundamentally, you're wondering if you should prioritize paying off your student loans or prioritize investing for retirement. You have$16 ,000 in federal student loans, and you could potentially put a lump sum of $6 ,000 towards that and then pay monthly to pay off the remaining$10 ,000.
1:02:18Or you could put that $6 ,000 towards your Roth IRA on January 1st of 2024 and just do that in one big chunk. Similar to the previous question, I have a definitive answer for this one, which I typically don't. I like to usually, here's the pros and cons of each. For this one, And I'm a big fan of you taking that$6 ,000 and making a big lump sum payment to your Roth IRA on January 1st, 2024. And deprioritizing repaying those student loans. That doesn't mean, I mean, pay them off, obviously. But I would prioritize contributing to your Roth IRA and contributing to your other retirement accounts. the$500 monthly contribution that you're making to your 403B, that extra contribution, I would keep doing that.
1:03:11So make the lump sum to your Roth IRA on January 1st. Continue making the extra contributions of$500 a month to your 403B. Continue funding that 403B and the Roth IRA. Do not deprioritize that. And then make those retirement contributions your top priority and make the payoff of that$16 ,000 student loan debt your second priority rather than your first. Prioritize retirement first. This is annoying because I have to say a big me too. I totally agree with that. The place where I would have differed. You're annoyed because you like to disagree with me? Because I agree and I want to disagree. Yes.
1:03:49I'm being disagreeable today and I can't be. Wait, we're not agreeing to disagree. We're disagreeing. Disagreeing on our agreement. You're feeling disagreeable about the fact that we agree. fact that we agree. Yes. Joe likes to fight with me. He doesn't get the chance. I'm not giving him the chance. But you know what, Paula? My advice would have been different if it was, do I put this money toward retirement or I can completely pay off the student loans now? If she could completely have paid off the student loans today, I would have said, this is not an interest rate decision. This is a get it behind you.
1:04:23This is a make the cash flow better. Psychologically close it out kind of a thing? Absolutely. I would have then said, let's go ahead and go against the math and let's pay off the debt because behaviorally that works a thousand percent better. But because she can't completely do that, I totally agree that this one, you know, with the market going up 70 % of the time, making that Roth IRA payment to herself on January 1st should yield most years, seven out of 10 years, a bigger number than she's paying on interest in an aggregate over 10 years, that'll definitely increase her chances of substantially beating that 4.4 interest rate.
1:05:05Yeah, yeah, exactly. The interest rate on her student loans is 4.4%, quite reasonable. And so it's not an interest rate problem. And it's also not really a cash flow problem, because she has the ability, if she wants to, to defer the payments on her student loan because she's enrolled in a master's program. But I don't think we want to do that either. She's got the cash flow. Don't do it. Yeah, yeah. She doesn't. But she has the option to do that. So let's say that there's some type of a financial emergency, an unforeseen financial emergency. She knows that the ability to defer the payments is in her back pocket.
1:05:42She can shut off that spigot. Yeah, exactly. And so anytime that you're considering paying off a debt, there are two advantages to doing that. One is the interest rate. The other is cash flow. And when I say cash flow, what I mean is in the event of an emergency, you want your mandatory minimum bills to be as low as possible, right? What's nice, Chloe, about the fact that you have the option to defer the student loans if you want to, is that in the event of an emergency, if you needed to, you could just say, hey, you know what? I'm going to hit pause on this. I can't pay off the student loans right now.
1:06:20So knowing that that option is there puts you in a better spot. Knowing that your interest rate is 4.4%, that's a really low interest rate. That's great. That's the reason I say prioritize retirement. And I agree, Jo, she should not defer the payments on her student loan, but it's nice to have the option. It's nice to have the choice. Yeah. Because if she didn't have that choice, what did most people end up doing? They slow down the Roth IRA contribution and then they're mortgaging their own future by not making that payment. Right. It's great. Yeah. Amazing. Both Erica and Chloe are or were teachers.
1:06:58And for both of them, we had very definitive answers. and for both of them, the answer is prioritize retirement. Yeah. Fabulous. Well, Joe, we've done it again. Amazingly. We have done it again. That's the end of another amazing episode. Joe, where can people find you? You look like you're mocking me. I'm not. I'm just sitting here. I'm just like, I'm not sure where this sentence is going to go. I see that gleam in your eyes. I just didn't know where the sentence was going to go. I had no idea. You can find me Monday, Wednesday, Friday at the Stacking Benjamin show. A big thing that has happened there is that we have, you know, we have writers for our show, Paula.
1:07:46And we have a new writer, a professional comedian named Lisa Curry. Lisa, you can look up on YouTube and see her hilarious comedy. She's a touring comic. And apparently for people that don't think the show is that funny. we will get funnier. No, she's great. She's fantastic. And I can't wait for people to see what we've got because we've started performing some of Lisa's material and adding her to our team. So big new team member at Stacking Benjamins, Lisa Curry. Oh, nice. Well, welcome Lisa to the Stacking Benjamins podcast. And you can download that anywhere where finer podcasts are downloaded.
1:08:24anywhere anywhere only the finest the finest in podcasts oh joe i'm on tiktok now oh hello are you dancing no not yet although tiktok is like very addictive oh it's so addictive oh my goodness i i've resisted until now because i know myself well enough to know that once i'm on tiktok it's it's down the rabbit hole i've had to teach myself to put it down because i will literally just go watch TikTok videos all day. That program is scary addictive. I thought I was addicted to Instagram and then TikTok came along and I don't even remember how to get into my Instagram account. I have no idea because it is TikTok.
1:09:08Wow. Yeah. Not good. I am at Paula Pant on both Instagram and TikTok. You can find me on both. And you'll find Stacking Benjamins podcast for me on Instagram and I think just stacking Benjamins on TikTok. Well, thank you so much for tuning in. This is the Afford Anything podcast. If you enjoyed it, please share it with a friend, a family member, an enemy. Share it with someone. A former colleague. Yeah, yeah. A former neighbor. Yes. Former sibling. Yes. The server at the restaurant you're going to go to. Yeah, yeah. Share it with your dog walker, your cat walker. Yes. Share it with everyone you know and people also that you don't know.
1:09:53Share it with strangers. Walk up to a stranger. Go meet somebody. Exactly. Have you listened to Afford Anything? Excuse me. Well, thank you again for tuning in. I'm Paula Pant. I'm Joe Salcihai. And we will catch you in the next episode.
1:10:12Here is an important disclaimer. There's a distinction between financial media and financial advice. Financial media includes everything that you read on the internet, hear on a podcast, see on social media that relates to finance. All of this is financial media. That includes the Afford Anything podcast, this podcast, as well as everything Afford Anything produces. And financial media is not a regulated industry. There are no licensure requirements. There are no mandatory credentials. There's no oversight board or review board. The financial media, including this show, is fundamentally part of the media.
1:10:50And the media is never a substitute for professional advice. That means anytime you make a financial decision or a tax decision or a business decision, anytime you make any type of decision, you should be consulting with licensed credential experts, including but not limited to attorneys, tax professionals, certified financial planners or certified financial advisors. Always, always, always consult with them before you make any decision. Never use anything in the financial media, and that includes this show, and that includes everything that I say and do. Never use the financial media as a substitute for actual professional advice.
1:11:33All right. There's your disclaimer. Have a great day.
From the publisher
#459: Andrey is a savvy 10-year-old wondering what’s the best way to save up for his first car.
Ingrid wants to know if her parents’ preference for Retiring on Dividends is a better approach compared to the 4 Percent Rule.
Erica’s part-time work schedule will place her in an unusually low tax bracket this year. Should she take this rare chance to execute a Roth conversion? Or is it better to prioritize debt payoff?
Chloe is worried about the end of student loan forbearance. Should she pull back from making retirement contributions to focus on debt payoff?
Former financial planner Joe Saul-Sehy and I tackle these four questions in today’s episode.
Enjoy!
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