Personal Finance Wednesday
The title is a nod to Tadas Viskanta who runs the Abnormal Returns blog which every Wednesday posts personal finance links.
Suze Orman had some comments get a lot of attention saying that it makes more sense to save in a Roth vehicle (IRA or 401k) than a traditional vehicle because she believes with all the debt the country is taking on, taxes will have to go up. The difference between the two is that with a traditional IRA/401k you get the tax deduction on the way in, up front and pay taxes on the way out, presumably when you're retired. With Roths, there is no tax break on the way in but no tax owed when you take withdrawals. Part of the conversation about traditional or Roth is attempting to guess what your tax rate might be when you're retired. A higher tax rate now while you are working than what you expect in retirement argues for a traditional IRA/401k. Orman is saying that tax rates will be higher in ten years or 20 or years or whatever which if correct, would argue for a Roth. I don't know if she'll be correct but the logic is reasonable.
Nick Maggiuli weighed in, pointing out there is some potential optionality operating from a traditional account by using low income years to convert to a Roth (meaning you'd be likely to pay less tax). I would add that in a year where you are retired and at least 59 1/2, have no earned income and letting your Social Security payout grow that you'd be able to take a tax free withdrawal out of a traditional account, tax free up to the standard deduction which this year is $24,400 (don't think that was changed in the CARES act but you get the idea). Run your particulars by your accountant on this if this might end up pertaining to you.
My take on this is to have both types. Our personal account breakdown is 15% in Roth accounts, 10% in an HSA, 25% in taxable accounts and the rest in traditional (aka qualified) accounts. We put some into Roth accounts every year but more into traditional accounts because I do want some tax break now.
The building block of understanding for the order of accounts to withdraw from is taxable, then traditional with Roth being last. HSAs are kind of wildcard because you can deduct on the way in and avoid tax on the way out for qualified medical expenses. There is no time limit on when you can withdraw for a qualified medical expense. So if you pay $1000 for a broken wrist when you're 45, you can hold onto the receipt and take that $1000 out tax free when your 65 or any other time.
Above I gave an example where you might want to access a traditional account out of sequence. Another example might be with a large purchase. If you want to spend $40,000 on a car it would make sense to consider pulling that from your Roth account (assumes taxable assets are depleted). The reason is that if you take the money from your traditional IRA you'd need to actually gross it up by $10,000 assuming a 20% tax bracket and ignoring state tax so your $40,000 car actually costs $50,000. More if you're in a higher tax bracket. Taken from a Roth, you just need the $40,000. Yes you could take a loan, my biases are to avoid car loans other than 0% interest which do come along every now and then. Paying tax on required minimum distributions is more palatable, RMDs are like income and you've always paid tax on income.
This year is another, perhaps one-off example, to take from a Roth early because required minimums have been waived as part of the CARES act. If you have both types of accounts, you have optionality of just taking from a Roth and paying no taxes in 2020.
Burt Malkiel was interviewed by Marketwatch and made a couple of interesting points. On 60/40 portfolios he said "I don’t think there ought to be a 60/40 portfolio. I think there ought to be a broad diversification." He says the low yields from bonds are less attractive because there is no income to be had. He is a fan of preferred stocks. Preferred stocks got crushed, absolutely destroyed during the Great Financial Crisis and yes, future events will be different than past events but preferreds are capable of going down a lot and that needs to be understood before making a meaningful allocation. I've got dozens of posts you can look at regarding alternatives that offer bond-like volatility with returns typically associated with "normal bond market" performance.
He also said "I don’t think there is anybody who devotes a life to studying and working on the stock market who doesn’t have something of a gambling instinct." I thought this was interesting, I have no interest in gambling at all.
Mr.Money Mustache was interviewed by Motley Fool. The most interesting part was a direct quote early in the article;
The pandemic has definitely been a painful thing for most of the world, but if I had to pick the ideal life arrangement to ride it out, it would be as a person with a lot of flexibility -- a big cushion in areas of both money and schedule. And this is really all that we're talking about when we use the terms "financially independent" or "retired early."
I feel a lot of overlap with FIRE (financially independent/retire early) because I kind of did it in 2003 when I was 37. Where FIRE is about benefiting from living below your means, setting your own schedule and I will throw in not having a commute which is a big one for me, then yes I'm a FIRE guy. Where I am not a FIRE guy is that I have always worked, more often than not I've had multiple, albeit related, jobs and I can't see ever wanting to stop working in capital markets. The cliche about find a job you love and you'll never work a day in your life is a pretty good fit for me, I am acutely aware how lucky I am. We are also lucky that the life we want (my wife and I) costs less than what we make. This creates resiliency and optionality which I think are huge cornerstones of FIRE.
The picture from the header of this post was taken the other day. It's my wildland fire pack, helmet and hand tool. We got called out for smoke. It turned out to be nothing thankfully but having the freedom schedule-wise to respond to the occasional call we get is a huge priority for me and have been able to incorporate that optionality into my life.
Obviously market panics are tough (and I try to help clients avoid anguish) but they are also fascinating. I can take that stance because I know exactly what will happen. The market will stop going down eventually, then it will go back up and eventually make a new high, the only variable is how long that takes. Once you fully embrace that this is how it works, it makes enduring panics much easier. All the better with the right asset allocation and enough set aside for cash needs.
Two paragraphs up I mentioned optionality that I want in my life, what optionality do you want in your life? Not only do I believe that having that optionality will make you happier, even getting on the road to creating that optionality for yourself can make you happier. The above ideas contribute to our optionality, whatever that word means to each of us.