Mailbag! Maximizing Dividends, Spending in Retirement, Managing a 529

0:02Merry weekend, fools, and welcome to the first mailbag episode of the Personal Finance Edition of the Motley Fool Hidden Gems Investing Podcast.

0:16I'm Robert Brokamp, though my nickname around the fool is bro, which you'll hear about today. And my colleagues who host the weekday shows have been soliciting questions from our audience for the past few months. And it turns out y 'all have plenty of financial planning questions. So I thought I'd devote an entire episode to answering some of them and to help me as my longtime partner in crime, Dan Kaplinger. Dan is a former financial planner and trust attorney. And for more than six years, Dan and I have been answering questions for Motley Fool Premium members during two live shows each and every week.

0:46So I asked Dan to join me for this inaugural mailbag episode. Welcome to the show, Dan. Glad to be here, bro. It's always fun to talk financial planning with you. Outstanding. So this is how this is going to work. So we chose six questions from those that we received, which touch on personal finance as well as a little bit of investing. I will read each question and Dan and I will take turns taking a first crack at it. And then the other will add his thoughts if he has any. With all that said, here's the first question. It comes from brother Zach, who wrote in that the fool recommends holding at least 25 individual stocks.

1:19How do ETFs play into that? Do they count as one stock, one and a half stocks, or do you count them as completely outside of the 25 individual holdings. Dan, what do you think? So, Zach, I need to update you quickly on the Fool philosophy because Fool CEO co-founder Tom Gardner recently updated that 25 individual stock number to 50. That really reflects the importance of you have so many individual stocks that kind of overlap in terms of industry, in terms of business model. You don't want to assume that just having 25 stocks is going to give you perfect diversification. That's part of the justification for Tom pushing that number up to 50.

2:03So I wanted to get that out of the way first. But to answer the question you ask, how do you deal with exchange traded funds? For me, an ETF counts as however many stocks that fund has a significant position in. So let's take a couple of examples. A lot of people invest in ETFs that track the S &P 500 index. And to me, if you have that one ETF as a position, then you have satisfied the 50 stock requirement. You have a diversified portfolio. I am comfortable with people. If you don't like investing in individual stocks, just picking a broad market ETF like that can get the job done. But not all ETFs are like that.

2:48Some ETFs are more concentrated. I know one popular ETF that concentrates on South Korean stocks, it really has two positions. Two positions make up half of the entire portfolio. So to me, that's not a diversified portfolio. That ETF counts really closer to just like two stocks for me. And so you kind of have to look at the holdings and make a judgment call. Yeah. And I think it's important to keep in mind the spirit of this rule, right? The guidance is so that you don't have too much riding on one stock or one type of stock, but also that you have enough exposure to other types of stocks, industries, and sectors.

3:25So when I look at my portfolio, which is a mix of individual stocks and ETFs and mutual funds, I use Morningstar's x-ray tool to look at how my portfolio is actually allocated because that tool can look into the mutual funds at ETS and see which stocks or investments it holds. And so I know, you know, when you add my individual holding in Berkshire to my S &P 500 index fund to whatever actively managed funds I have that have Berkshire, this is the total amount I have in that stock. And you could have all kinds of ETFs, but you're not really diversified because there's so much overlap. So I think that's also important to keep in mind.

4:00That's a really smart thing to do because these days, even big market ETFs are more concentrated than they were in the past. And so getting some kind of tool that gives you that x-ray, gives you that look through, can be really valuable. All right, let's get to our second question from Matt. So I've been reading The Fool and investing foolishly for about 30 years. My wife and I have lived a good, though not extravagant life. While I have never made more than$50 ,000 per year, we have grown our portfolio to a few million dollars, as well as owning a home that is worth more than a million dollars.

4:31And we have gold and other assets, all debt-free. Wow, that's outstanding, Matt. Now I am 70 and retired. Our social security dividends and other income beat all of our expenses. I'm having a hard time switching mindsets from saving mode to spending mode. I can't seem to bring myself to sell shares and withdraw the funds from the portfolios. What advice do you have for new retirees who need to switch from saving mode to drawdown mode? And which accounts from among the IRA, Roth, SEP, joint and personal should we draw down first? Thanks to the Fool for a lifetime of sound investment advice. Well, congratulations.

5:02You have done a fantastic job, you know, not knowing everything about your situation, but it sounds like you're in fantastic shape. So congratulations to you. And you probably could feel more comfortable spending a little bit of your money. Just a couple of thoughts. You might want to choose just a really conservative guideline, such as the old 4 % rule. I've talked on the show before about how 4 % is actually probably too low, should be closer to 5%. And that's for someone who's 65. So if you, a 70-year-old withdrew 4%, that's pretty safe. And very soon, you're going to be required to take some money out anyhow, at least from your traditional accounts, because at age 73, you're going to have to start taking required minimum distributions from your traditional accounts.

5:43So you could at least feel comfortable spending that money. Which brings us to the question of the order of withdrawals. So the basic rule that you often hear is that you draw down your taxable accounts first, then traditional accounts, and then the Roth accounts. but since you're near your rmd age you actually might start with the traditional accounts first and one other thing i'll just add that if you work with or have considered working with a financial planner this is a great question for her or him you might value having that objective second opinion where someone looks at everything and says listen you can feel very very very comfortable spending this amount each and every year and you're not going to run out of money dan what do you think the other thing i'll just point out is you talk about having had a modest lifestyle throughout your career.

6:29And if you are comfortable, if you don't have aspirations to spend a whole bunch of extra money, then you might be in a position you're totally comfortable maintaining that lifestyle. You're not necessarily looking to spend a whole bunch more money. But here's the thing that you might consider. Try out some upgrades. If you stay at a certain type of hotel, consider moving to the next upgrade up. If you routinely fly coach, then consider trying to business class flight. Just try looking at some of those ways to spend your money and see if they have value. Some of them won't, but some of them will.

7:05That might put you in a position you're more comfortable spending that money. You've worked so hard to accumulate and that you've done such a good job investing. You deserve those little luxuries as you enter your golden year. Very well said.

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8:02So you would have to hope for share price appreciation to come out ahead, correct? Retirees love dividend stocks because it gives them income. Technically, a non-dividend stock could give them income as well by selling the exact same amount of stock each time to create a dividend yourself, minus the different tax treatments. And with a bond ETF like the iShare zero to three month treasury bond ETF, ticker SGOV, that doesn't get much share price appreciation. Isn't the dividend payment every month kind of a nothing burger? Because you aren't getting share price appreciation with that. So you're just breaking even.

8:34Dan, what do you say? Yeah, so Casey, you're right. You can't just get rich by buying the stock the day before the ex-dividend date and then selling it right after collecting the dividend and then selling the stock. You're not going to get money that way because you're absolutely right. The share price usually will adjust downward to reflect the dividend that's going to get paid out. However, that's just looking at one day in time. Over a longer period of time, ideally the company is being financially successful the stock price is rising over time and in part some of that is because of the income producing power that that business has that business is generating income that cash flow is coming in the assets of the business are going up the share price is going up in line with that it's exactly some of those assets that are going to pay your dividend So it's not just that there's share price appreciation just from, I don't know, multiple expansion or investor demand or things like that.

9:40It's because the business is operating that way. now also your point it is true shifting to dividend stocks in retirement just for the cash flow purpose it's not necessary you can just sell shares periodically as you point out it's just a comfort thing a lot of people are more comfortable leaving their shares intact not selling in retirement they feel like they are selling off their principal if they sell shares whereas a dividend payment it's just income it's not selling principal off it's maintaining the income producing potential of the portfolio one last thing you'll notice with that etf that you're talking about if you look at the share price trends often the etf will pick up like a penny a day and it'll keep doing that penny a day at the end of the month it takes all those pennies it pays them all out in a dividend.

10:36And so you can kind of see it, that makes the dividend payment. It's not a nothing burger. It's really the whole burger. It's the entire point because that's the income that those assets are generating throughout the month. Yeah. I was thinking about this as you could think of like a dividend paying stock or a bond fund as sort of a temporary cash holder, right? Cash comes into it with the dividend paying stock. It's basically the earnings from the company, it holds that cash for a while, and then it gives it to you as the holder of the stock. And same with the bond fund, except that cash is coming from the interest paid from the bonds, and then eventually it gets distributed to you.

11:14One of the differences, though, with the dividend-paying stock, ideally the dividend is growing year after year, if not quarter after quarter. Historically, dividends have outpaced inflation by about one to two percentage of points. So that's part of why the stock price rises, because investors are anticipating bigger dividends. But in the end, you're still ending up getting that cash. It's definitely not a nothing burger. All right, let's go on to question number four from Bonnie. Over 10 years ago, I started contributing to a 529 for both of my sons. My oldest son is now a senior in high school and looking to decide on a university in the next week or so.

11:51So it's a very exciting time for us. As I look at his two options, one school is in-state and we would be able to cover the four years of tuition and board with what is currently in his 529. However, the other school is out of state and it'll take a bit more than what is in the 529. In all the years I've been listening to the Motley Fool podcast, and it's been many, I've never heard anyone cover the best ways to draw down a 529. I'm sure that there are a few strategies and I'm curious to know the pros and cons associated with each. Any chance Robert Brokamp could opine on the topic in the near future?

12:21Well, Bonnie, I think there's a very good chance because we're going to look at it now. And Dan and I were both recently in this situation to an extent we still are. So I think we'll talk a little bit about our own experience. So I'll say what I did with my four kids. So first of all, I would say that once my kids were in high school, I played it very safe at the 529. So I put them all in cash. That's pretty conservative. Some folks are comfortable having still a little bit more stocks in the 529s once the kids are close to her in college, but I didn't. I wanted to make sure the money was there and that it was very protected.

12:53I didn't want a bear market to cut the 529s in half while they were in college. So that's one thing. What you'll find, too, is in terms of the payments, for the tuition and room and board and other fees paid directly to the school, you can actually have that money transferred directly to the school. So that's very handy. For other items like textbooks or maybe off-campus housing, you can take the withdrawals up to the qualified amounts yourself, but then keep the receipts in case the IRS wants proof of that at some point. And I'll just highlight anecdotally, by the way, that when your kid leaves college, you might notice a slight drop in your household expenses, you know, such as food or maybe extracurriculars, right?

13:33High school sports cost a lot of money. So some of those expenses will actually go away, which may somewhat slightly offset the cost of going to college. Dan, do you have any tips from your own experience being a dad with a kid in college? for sure yeah i the one thing that i will say is make sure that the 529 expenses line up with the year that you take the money out as a withdrawal you don't have leeway there's some other types of accounts like flexible spending accounts for health expenses where you have a little leeway you do not have the leeway here make sure you take that out in the same year a lot of people in 529 plans, there are now age-based portfolios that kind of do this for you.

14:16They make your portfolio, you're investing more cautious as you get closer to the age where your child is in college to prevent the exact same scenario that bro was talking about where you're over-invested and the kid's in college and suddenly you have a bear market and you're losing a whole bunch of money. So if you have one of those portfolios, that's done for you. If you don't, then it's up to you and you need to figure out what to do. Only other thing I'll say is if you have multiple kids and you anticipate having money left over from a 529 for your first child for use in the second child, sometimes that might change the way that you want to invest because it affects the time horizon.

14:58But again, that's a more individualized situation that will vary from family to family. Yeah, and I think what Dan was kind of touching on there is, you know, you may have a 1-5-29 with one kid and that kid's going to need more money. But the money in the other 5-29 for the other kid, maybe they don't need all of that money. So that money can be transferred to the other kid. So you could almost think of these as really one big account to some degree. Exactly.

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16:35It's a rare look inside a firm that's been helping people pursue their financial goals for more than 90 years. Listen to the Capital Ideas podcast from Capital Group, published by Capital Client Group, Inc. All right, let's move on to question number five from Zach. A question for you all about what to do with dividends. Do you let them get automatically reinvested? Do you prefer to have more control where they go and the timing when you purchase stocks? Discussion on dividends and all types of investment accounts would be awesome. So Zach, I'll just say generally, it kind of depends. There are some stocks that I'm totally fine when they pay a dividend reinvesting in more shares of that same stock.

17:15There are other stocks where I'd kind of prefer to take the cash, let it accumulate, and then potentially redeploy it somewhere else. Maybe I'll buy additional shares of that stock, but maybe I'll buy shares of a different stock. It just kind of depends on my level of conviction in that individual stock and also kind of my time frame for that stock and my investing thesis for it. There are some stocks that you want to consistently add to. There are other stocks that I'm comfortable taking an initial position, kind of leaving it alone, adding to stocks I have more conviction in. One thing I'll point out when it comes to different types of accounts.

17:52I tend to avoid reinvesting dividends in taxable accounts. Here's why. It's because it makes my tax accounting harder whenever I close out that position. If you reinvest your dividends, you have all these little bitty tax lots every quarter or several times a year that you have to account for when you're calculating your capital gains. Now, admittedly, brokers are supposed to do this for you. Tax software is supposed to make this easier. But nevertheless, I like it when those purchases in taxable accounts are cleaner. In retirement accounts, not nearly as big of a deal. There's no tax impact. There I'm more likely to allow things to accumulate, to reinvest those dividends.

18:34Also in part because I'm not touching that money. That money is for retirement way down the road. I'll just point out that how you manage your dividends can be a good way to rebalance your portfolio. So if you've become overweight in a certain stock or maybe a certain group of stocks, you might want to stop reinvesting those dividends and then use that cash to buy underweighted assets. And once you're getting closer to retirement, it can be a good way to gradually de-risk your portfolio. I know once I'm within five years of retirement, I'll probably stop reinvesting all my dividends, let them accumulate as cash, maybe invest them in bonds so I can gradually get more conservative as I get closer to my retirement date.

19:13All right, it's time to move on to our sixth and final question and it comes from Bill who writes, I'm 44 and finally started learning about the market. I made lots of mistakes in life but finally got to a place where I can start saving for retirement and investing. My job now doesn't offer a retirement plan. I have about$50 ,000 in a money market savings account and about$20 ,000 as my emergency fund in the same money market account. My question is, how will you guys start a retirement plan and investing in the market? I feel like I'm way behind and might need to take some risks. I believe my risk tolerance is strong.

19:43The goal is to retire with enough money to live comfortably and only make$50 ,000 gross a year. I know the most important step is to try to find a higher paying job. Any help or advice would be very much appreciated. Well, Bill, so the good news is you do have an emergency fund and some savings. So that is a great start. You are likely a bit behind. Various financial services firms provide guidelines based on your age and as a multiple of your household income. I'll just take a look at T. Rowe Price's guidelines. they suggest that someone at age 45, so a year from now, should have about three times their household income saved for retirement at that point.

20:21So you're not quite there, but you're also not horribly behind either. I'll point out, if you're a W-2 employee, you say you have a job, and so if you're actually being employed by that job, your only choice for a retirement plan in terms of a tax-advantaged account is an IRA. So you could sock away$7 ,500 this year in that. if you're actually not an employee of that company, if you're a self-employed contractor or a 1099, as they often say, you actually could open up a solo 401k and save more. Of course, you do have that$50 ,000 in that money market account, and that's pretty safe, but also low returning.

20:58So if you don't need that money in the next five years, it could be invested in the stock market. And given that you likely have more than a decade until you retire, you could be very aggressive with the rest of your portfolio that you save for retirement. Assuming, of course, that you're comfortable with the ups and downs that come with the stock market. Yeah, I would just say that if you're relatively new to investing, I would start with a diversified collection of ETFs, maybe large caps, small caps, some international, and then you can move into individual stocks as you gain more knowledge and you get comfortable with the unique risks of owning individual stocks.

21:29I'll just close here by saying that, you know, for those who are getting a later start on saving for retirement, one of the most powerful things you could do is just work a bit longer, right? That allows you to save more, to delay withdrawing on your savings, and to delay claiming Social Security. And for every month you delay Social Security, you get a bigger benefit. So as you consider a higher paying career, which I do think is something to strongly investigate, aim to find something that you'll be happy to do well into the second half of your 60s. I know it's easier said than done, but if you find a new career, a higher paying career that you really enjoy, you may be perfectly happy working well into your 60s.

22:06We had the question earlier from someone earned about$50 ,000 a year and is doing very well, but he retired at age 70. And that can be very, very powerful. Dan, you have any thoughts? Only thing I'll add quickly is don't be afraid to invest for retirement in a regular taxable brokerage account. You indicate that you have a high risk tolerance. investing in growth stocks that don't pay dividends for the most part you can do even in a taxable account without paying a whole bunch of tax until you decide to sell and if you're a long-term investor like we espouse at the motley fool then that can be a tax efficient way to get your money working don't be afraid to invest for retirement in that regular taxable brokerage account you don't have to get it all into an ira and that's the show thank you dan for joining us and thanks to Bart Shannon, the engineer for this episode.

23:00Thank you all for listening. As always, people on the program may have interest in the investments they talk about and the Motley Fool may have formal recommendations for or against. So don't buy or sell investments based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. See our full advertising disclosure. Please check out our show notes. I'm Robert Prokamp. Fool on everybody. Thank you.