← Afford Anything | Get Smarter With Money
Afford Anything | Get Smarter With Money
Everyone Says Don’t Hold Bonds in Taxable Accounts. They’re Wrong
01:24:46
Loading summary
Transcript187 lines
- [00:00]
A
Joe, you know how sometimes we have episodes where we really keep to a particular theme?
- [00:05]
B
Sometimes.
- [00:06]
A
Today we've got three incredibly different areas of personal finance that we're covering. So we're going to be talking to somebody who's reached coastfi and has some questions about asset allocation and asset location. Okay, that's a fancy way of saying where do you put various things in your portfolio and how much of it do you have? We are going to be answering a question from someone whose mother in law needs some money for retirement and he has a very generous but somewhat creative idea as to how to help his mother in law.
- [00:41]
B
Sounds good.
- [00:42]
A
And we're going to talk about covered calls.
- [00:46]
B
I love covered calls.
- [00:47]
A
I know you do.
- [00:48]
B
I don't do them often and I'll explain why, but I just love explaining how they work.
- [00:53]
A
Amazing. Well, all of that is coming up right now. Welcome to the Afford Anything podcast, the show that knows you can afford anything. Not everything. This show covers five pillars. Financial psychology, increasing your income, investing, real estate and entrepreneurship. It's double I fire. I'm your host Paula Pant. I trained in economic reporting at Columbia. Every other episode ish I answer questions that come from you and I do so with my buddy, the former financial planner Joe Salsihai. What's up Joe?
- [01:19]
B
Paula, what's going on?
- [01:20]
A
Oh, you know what? I am excited to dive into today. So let's get started. This first question comes from Brandon.
- [01:29]
C
Hi Paula.
- [01:30]
D
Question about bonds and coast fi. I've never owned any bonds. I'm 100% equities. I've always been aggressive but I do wish to become more conservative soon as in today in my brokerage account. My wife and I ages 41 and 45. We plan to begin Coast Fi within the next year. We will supplement a new part time income by beginning drawdowns from only our brokerage account which is currently 100% equities. We will need a 4% withdrawal rate for the next 20 years to achieve our goal. I've always heard the advice to never place bonds in a brokerage account. In our situation, should I not allocate bonds in the brokerage account while we begin drawdowns Put I feel it's way too risky as it sits now. So in a hypothetical example, 70% stocks, 20% bonds, 10% cash for the next 20 years. What we draw down something in those regards also potential to explore risk parity method. But again concerns that this would all be within our brokerage account. Of course we don't want the tax tail to wag the dog. But I'm very curious to hear your thoughts. We believe our retirement accounts don't need touched. They have more than enough to grow without further contributions to reach our full retirement needs at ages 61 and 65. With that said, I want to keep Those retirement accounts 100% equities for at least another 10 to 15 years as I have no intention on using those accounts until full retirement age. And again, that's more like 20 years from now. Very curious and grateful to hear your thoughts on where to put bonds if this makes sense, if our plan makes sense, and then how we reallocate the brokerage account because it's certainly going to trigger taxes if we sell today to get that, that cash cushion. Love the show. Appreciate all you do. Keep up the great work.
- [03:28]
A
Brandon, thank you for the question. And first of all, congratulations on reaching Coast Phi. That's incredible. I am so excited for the adventure that lays ahead as you and your wife embark on part time income with a 4% drawdown from the taxable brokerage portion of your portfolio. That sounds awesome and I am very excited for all of the, the life and the adventures that you're going to have. So to address your question first for the sake of everybody listening, the reason that people often say don't put bonds in a taxable brokerage account is because people are assuming that. The premise under that is that people are assuming a framework in which you have three different types of accounts, tax deferred, tax exempt and taxable under the traditional retirement framework that you are planning to use and to therefore later tap at an equal timeline. So under the traditional retirement model, if a person waits until full retirement age before they start making drawdowns, then yeah, you treat all three of those accounts as a collective and you locate your assets across those accounts in a collective manner. But Brandon, what you're doing is something totally different. What you're doing is you're saying, you know what, my tax advantaged accounts, I'm going to wait until I am at the appropriate retirement age before I start tapping them. Until then, I'm purely going to tap my taxable brokerage account. So you're in a totally different situation in which those three accounts don't get regarded as a collective. So for you, it totally makes sense to have bonds in the taxable brokerage account because that taxable brokerage account stands alone as the sole account that you are going to tap between now and when you reach full retirement age.
- [05:22]
B
Or Paula, they're not drawing down at all because for many People that are conservative enough that they want bonds in their portfolio, then you certainly don't want these bonds throwing off taxation for no reason. If you're not going to use the income stream. I think that if you're looking at what the important, most important thing here is its stability of the income stream.
- [05:47]
A
Right.
- [05:48]
B
And if that's the case, we really have three choices. Something that throws off a high income stream and we can get into that. A bond which throws off a high dividend or, or income number or something like a high yield savings account, which is going to be the most stable but isn't going to give you much.
- [06:10]
A
Right. But regardless. So I think his root question was, in a world where everyone says don't put bonds in your taxable brokerage account, how should he think about it?
- [06:21]
B
Yeah, I think that's one of those deals where we hear half of what Quote they say. I mean, which happens a lot. Right. We hear, we hear the sexy part. Like as an example, back in the early 2000s, a wonderful money manager. A lot of people still know this guy. I've heard of him, Peter Lynch. Peter lynch said, buy what you know. And Peter lynch also then said, that's the top of your filter. Don't just go buy the ketchup manufacturer because you use ketchup. Don't go buy Nike just because you wear Nike clothes. He's like, that's the top of your filter. Are things that you know and then work down from there to see if it is a good buy or not. But the number of people who told me they got burned by Peter lynch because they, quote, bought what they know but didn't stay around long enough to hear the rest of it is a huge number of people. And I think this is, I think this is that case where I have heard a lot of people say, don't have bonds in a brokerage account, but I feel like there almost always is among professionals, the. Unless.
- [07:26]
A
Unless.
- [07:27]
B
Yeah, you're building an income stream.
- [07:29]
A
Right, Exactly. Yeah. Don't buy bonds in a brokerage account if you have a total of three accounts, each of which have different tax treatments and you are managing all three as one singular unit, you know, or.
- [07:47]
B
You'Re managing all three and I don't need income today.
- [07:50]
A
Right, exactly, exactly. And that's the case for the vast majority of people. And I think what this really gets to the heart of his question is how do you discern when the advice that is appropriate for the vast majority of people in the vast majority of cases is not appropriate for you as an individual, based on your own individual circumstances. Right. Because necessarily what you get through mass media is meant for the mass public. And while that works in the aggregate, it doesn't necessarily work for the individual. And particularly when you get to coastfi, which is something that is unusual in our society. Right. There isn't going to be specific advice for that. Not a ton.
- [08:40]
B
This I found frustrating when I was a financial planner because often a client who was the exception to the rule, like Brandon is in a lot of ways in this case, would come into my office and they would say, hey, I know that you told me to do this thing, but I was just listening to Susie Orman who on national TV said, don't do that thing. And I would have to then walk through why they're the exception. And by the way, I got good enough at this that I learned that the best battle is the one that's never fought. Right? Sun Tzu, the Art of War. And so I would bring to people, Paula, when they were the exception to the rule, I would groan. I go, oh, no, no. Oh, I have the exception to the rule. So I would walk into the room, let's say you're my client, and I would say, paula, I want to show you something that Susie Orman says. And I would either show you the video, read you the p, show you the piece, we'd walk through it together and I'd say, and the reason I wanted to show you that is because we're about to do a strategy which is specifically the opposite of, of this thing. And here's the reason why. Susie Orman, number one, is talking to maybe 10 million people on TV and you are a single person. She needs to use the law of large numbers. What is it that is a universal truth? Dave Ramsey. We should get out of debt. So I'm talking to a huge number of people. What do I do? Focus like a laser, not like a flashlight where it's this big dim ball, but like a laser on that debt and get rid of it and then practice a no debt life style. Debt is bad. Now, you and I with our audiences go, is debt bad all the time? No, it's not. But for Dave Ramsey to reach that huge audience, he's got to be adamant. Debt is bad, period. And if he's not that way, then he's not going to be able to talk to as many people as he. As he talks to so succinctly. So I think if you start with Dave Ramsey as an example and you begin with debt is bad, later on when you've swam into deeper waters and you understand more of the nuance, you're, oh, okay, I see why he said that, and I see why I would start there. But I also see why I'm in a different spot now and why leverage might actually work for me.
- [11:03]
A
Right, exactly.
- [11:05]
B
I'm thinking of a specific client, by the way, this couple between the two of them. And by the way, this might have been in 2001 or two. So if inflation, if prices double every 18 years and just wages would then just keep up with inflation. Hypothetically. Right. If that's the case, at the time, these people were making about $700,000 a year. So today, today's dollars making maybe one and a half million dollars a year. Right. So they have a ton of income coming in. We have maxed out every single tax shelter that's available to. Had plenty of money on hand to fund all their goals. They were naturally fairly frugal people. And so we were just looking for places to put their money and not get smoked on taxes. You know what's a great place?
- [11:56]
A
Oh, you're about to say the W word.
- [12:00]
B
A permanent life insurance policy.
- [12:01]
A
Oh, I thought you were going to say whole. That's where it's a W. Whole life.
- [12:05]
B
How do you explain to somebody that as much as I detest 99% of the time, people putting money into these policies and they got ripped off by somebody who was more interested in a commission than anything else.
- [12:19]
A
Right.
- [12:20]
B
Why this is specifically perfect for them.
- [12:24]
A
Well, and remember, we had somebody who called in and her father had purchased a whole life insurance policy for her many, many decades prior. Right. And so that policy was paid up. It had, like, it cost like 50 bucks a month to keep it active. And she said, well, you know, I. I hear that these are bad. Should I. Should I let it go? No, absolutely not. It's like 50 bucks a month to keep it, you know, and she said, what if I don't have any beneficiaries? Give it to charity. For 50 bucks a month, you have the opportunity to make a massive charitable donation.
- [13:03]
B
Huge impact.
- [13:05]
A
Yeah, exactly. And so it was one of those situations where what is good advice in the aggregate? Because when you're speaking in the aggregate, you're talking to people who are thinking about buying a policy now. You're not talking to people who had a policy purchased for them 25 years.
- [13:23]
B
Ago and already have done all the painful hard lifting.
- [13:27]
A
Right.
- [13:27]
B
And did it correctly back then. So that this policy actually has a very low cost of insurance and and is doing what it's actually designed to do.
- [13:36]
A
Exactly. And so that's the problem that you run into when, when mass market advice doesn't fit with the nuances, the specifics of your individual case. So Brandon, where all of this is going is in your individual case, when you think about the bucket of money that you are going to be drawing down from from the age of 45 until you reach full retirement age, you don't have three buckets, you have one bucket. And so because you have only one bucket during this window of time, of course you're going to keep bonds in that bucket. It's your one and only bucket.
- [14:15]
B
It certainly makes the strategy easier. You don't have to overcomplicate it. And this is the cool thing, I think the best piece of this is knowing. And we'll get into this when we talk about options, we'll get into this when we talk to Andrew about his mother in law's situation. You know, you have a good strategy when you know what the Achilles heel is, because every strategy has an Achilles heel. And Brandon, your Achilles heel is you're going to pay a little bit more money in taxes, but it's okay. And once you know that that is the Achilles heel of this strategy, great. Assuming that Achilles heel is acceptable. Do you know what I mean? Like the pain of the taxes is worth what you're going for. Here's what Brandon's going for. Brandon's going for stability. Brandon's going for a paycheck that comes every month. Bonds are a phenomenal way to get that done. The downside is when you take money as income, you're going to pay a tax well.
- [15:19]
A
And Brandon's going for not tapping his tax advantaged accounts, letting those grow and letting those accumulate until he reaches full retirement age. So he continues to get the advantage of having an all equities position in his tax advantaged accounts.
- [15:37]
B
Brandon, there's a couple other ways that you can go. One I moderately like, possibly I don't know how much money you're talking about, I don't know the numbers that you're dealing with. But one I moderately like and one I don't like to minimize the tax game. You could go with low volatility equities like utilities and then sell them off, hoping for small capital gains along the way along with dividends so you won't get taxed as heavily on the capital gain. And you'll also then have a smaller stream of income from the dividend payout which will be also then That'll make a lower tax game. I think the volatility doing that one, Paula, makes that unacceptable for me and not something I would, I would do. You don't want to begin your Coast VI journey and have something happen to the equities market and have that blow up. So I would not do that one. But it's, it's one that I considered. The second one is you could have a piece of that income stream come from REITs because REITs have a little tax advantage in the income stream that bonds don't have. Because generally the way a REIT pays out income, Paula, part of that is a continual return of some of the principal that you put in it initially. Sometimes only a piece of that income stream is going to be taxable while a piece of it is along the way a return of the money that you initially invested. I would talk to a tax advisor about that before I did it. REITs also, while they move like equities and much of the same economic data impacts the real estate market, that that also affects equity markets, it tends to move slower. Right? It's going to go down, but slower and up, but slower and down but slower. And so having a portion of it in a REIT portfolio where you're holding on to the base and not selling it off, but taking some of that income stream out of a REIT versus a bond might also help defeat the tax devil a little bit.
- [17:47]
A
For anyone who's listening who wants a guide on asset location, we have a free guide called the Asset location cheat sheet and it gives you the fundamentals at a broad level. Fundamentals of asset location. And remember, it's just general advice for everyone. So it's not specific to any unique situations. But if you want to learn the backbone of that framework, you can download it for free@affordanything.com asset location. That's afford anything.com asset location. It's the free four page cheat sheet of the fundamentals of which assets to put in which types of accounts. Afford anything.com asset location, totally free. Thank you so much Brandon for the question and congratulations again on reaching Coast Phi. We're going to take a moment to hear from the sponsors who make the show possible. When we return, we're going to hear from someone whose mother in law does not have adequate money for retirement and he has an idea that is very generous but also unusual. It's unlike any question that we have ever answered on this show. The holidays are approaching and if you are hosting, there's a lot that goes into getting ready to host. Maybe you need more serveware. Maybe your guest room needs a new comforter. Whatever you need, Wayfair's got it. They've got Christmas trees, wreaths, all kinds of holiday decor. You can refresh your guest room with bedding, linens, throw pillows and accent chairs. You can make holiday hosting easier with quality cookware. You can upgrade your living room with seating rugs, lamps, get holiday linens and towels. Decorate the kids rooms. They have a massive selection for every style and every budget. I have lots of shelving from Wayfair which helps me keep my apartment more organized. So I've got shelving right at the entry door. I've got it in the bathroom. I've got it all over the apartment because I live in Manhattan where square footage is really small. Where which means organization is important no matter what your space or budget. Wayfair makes it easy to tackle your home goals this holiday season. And there's free and easy delivery even on the big stuff. Get organized, refreshed and ready for the holidays. For way less, head to Wayfair.com right now to shop all things home. That's W A Y-F A I R.com Wayfair Every style, every home so imagine it's midnight, you're on the couch, you're scrolling through this new website, hitting the add to cart button and you decide to check out. But you remember that your wallet or your credit card is in the other room and you don't want to get off the couch. That's okay, you don't need to because there's that big iconic purple shop button. You know the one with that shop button? That's Shopify. And there's a reason that so many businesses sell with it. Because it makes everything easier from checkout to creating your own storefront. Shopify is the commerce platform behind 10% of all e commerce in the US from household names like Mattel and Gymshark to brands that are just getting started. Shopify will give you a leg up from the beginning with beautiful ready to go templates to express your brand. And you don't need to know how to code. You can handle everything in one place, from inventory to payments to analytics and they've got built in marketing and email tools and that icon iconic purple shop pay button used by millions of businesses around the world. If you want to see less carts being abandoned, it's time for you to head over to Shopify. Sign up for your 1 month $1 per month trial period and start selling today at shopify.com Paula go to shopify.com Paula shopify.com Paula.
- [21:33]
B
This episode is brought to you by Progressive Insurance. Fiscally responsible financial geniuses, Monetary magicians. These are things people say about drivers who switch their car insurance to Progressive and save hundreds because Progressive offers discounts for paying in full, owning a home and more. Plus, you can count on their great customer service to help you when you need it. So your dollar goes a long way. Visit progressive.com to see if you could save on car insurance insurance, Progressive Casualty Insurance Company and affiliates. Potential savings will vary. Not available in all states or situations.
- [22:20]
A
Welcome back. Our next question comes from Andrew.
- [22:26]
C
Hello Paula and Joe. This is Andrew from Oakland, California. Got a fun one for you. In 2018, following my in law's amicable divorce, my wife and I moved into her childhood home in Oakland, California to help her mother with the mortgage and upkeep. At the time the home was valued at around a million dollars with a $460,000 mortgage. The arrangement was presented to us by divorce lawyers that it would be a way for us to, quote, buy our way into the home while providing financial stability for my mother in law. Now over the past eight years, my wife and I have made a lot of contributions to the home's value and maintenance. We've paid at least two thirds of the mortgage and utilities in the time since we've moved in, which is about $160,000. We've also invested about $100,000 in home improvements like foundation and earthquake retrofitting, new roof and solar panel, and also electrical work removing old knob and tube. About a year after we moved in, we all decided to build a detached ADU in the backyard. This was seen as a solution for our need for more space as we now have three children, my wife and I, and my mother in law's desire to age in place near her grandchildren. We used a cash out refinance to fund the project, pulled about $220,000 in cash out to fund the ADU development and that brought the mortgage to just under $700,000. The home at that time was appraised at 1.4 million. That was in 2020. That was before the ADU was completed, but it's settled back to about $1 million now. Again not included in the ADU. With my mother in law nearing retirement at age 71, there's concern about her financial readiness. The main home and the detached ADU seem to be her primary investment and her retirement savings appear to be limited. I would like to have a conversation with her soon about her financial plans and explore ways to compensate her for a portion or all of the home's remaining value to help secure her retirement. Caseless Helps My wife and I are both 40. We make about $150,000 pre tax. We've saved about $550,000 to retirement, various IRAs and 401ks. We don't have much liquid cash, but we are determined to build that up in the coming years. We're on the deed for the home for 50% while my mother in law has the other 50, but that's not the same as really being true owners. Any advice or creative or simple ways to increase our financial stake in the home and supplement my mother in law with some type of retirement funds during her pending retirement? Appreciate your thoughts as always. Take care.
- [25:15]
B
Paula Andrews question went a different route than I thought it was going to go when I first heard it.
- [25:21]
A
Where did you think he was going?
- [25:23]
B
I thought he and his spouse were helping out mom and I thought that they had kind of done things on handshake deals and now even though he'd done all these improvements to the property that he wasn't a true owner of the place. Like they, you know what I mean, they had helped out, quote, helped out.
- [25:44]
A
Right?
- [25:44]
B
I've seen that happen a ton of times.
- [25:46]
A
So Andrew, far too many times.
- [25:47]
B
I was so happy to hear it didn't go that way. Yeah, so happy.
- [25:52]
A
My favorite part of that question was when he said that he and his wife are on the deed for 50% and his mom's on the mother in law is on the deed for 50%. When I heard that, both of us, that was our favorite part and I want to explain why. And it's because often when family is involved or loved ones, I should say more broadly when loved ones are involved so much, especially in real estate, is done on handshake deals because you love and trust the person and that goes horrendously bad.
- [26:22]
D
So often.
- [26:24]
A
Omg. Making sure that the paperwork reflects reality. Making sure that the paperwork reflects the handshake deal. I cannot overemphasize how critically important that is to anybody who's listening. And Andrew, I'm so glad that you have already taken care of this. But to anybody who's listening who currently has a handshake deal with a loved one around real estate, around small business, around any monetary but particularly the two areas where we see this are real estate and business, right? If you have a handshake deal, run, do not walk run to a lawyer. To heck, even if you have to print out some legal forms from the Internet. Even that is better than nothing.
- [27:12]
B
Although we'd prefer you didn't do that.
- [27:13]
A
We'd prefer you didn't do that. But that is way better than nothing. I mean, if you have to write something on a napkin, you know, please do that is better than nothing. Because the worst, worst, worst thing you can do is to have documentation that is different from the handshake agreement.
- [27:35]
B
Misunderstandings, hurt feelings, people forget.
- [27:39]
A
People often have selective memories.
- [27:41]
B
They can.
- [27:42]
A
Yeah. And memories get revised in history.
- [27:45]
B
But even if there aren't, Paula, there is even then the accusation of selective memory. So if somebody does not have a selective memory, they just plain forgot, it's easy to see why somebody would go, oh, yeah, yeah, right. You were just trying to get away with something. So even if that's not the case, the accusations are justified. Yeah, don't do that.
- [28:08]
A
And Andrew, we'll get to your question in just a moment. I realize we've gone a little bit on a tangent on this, but I'm doing this for the sake of the tens of thousands of people who are listening to this.
- [28:17]
B
The broader good.
- [28:18]
A
The broader good. For the sake of the greater good. And Andrew, we'll get to your question in just a second. But for the sake of the greater good, I really, really want to hammer this point home. Oftentimes people are so reluctant to think the worst of a loved one. Oh, they would never do that. Oh, they're such a good person. Oh, I know that. They'd be. They'd be good. They'd be fine. They're never going to do anything bad. And so if that's you, and if you're getting caught up in that, then here's what I would say. Let's assume that you're right. They're a great person. They would never do anything terrible. But imagine that they get impacted by cognitive decline. Maybe they get impacted by early cognitive decline. Some. For some people, cognitive decline shows up shockingly early in life. Right. That's not their fault. It's not their fault at all. It's. It's just their brain nature. Right. It's nature that can really, really F up everything. Or imagine, let's say that everybody in question, maybe you're doing a business deal with a bunch of people who are all in their 20s. So you're sitting here thinking, well, the cognitive decline is not going to start in your 20s. Okay, let's imagine somebody's in a car accident and they have a traumatic brain injury. Then what? Again, it's not their fault. It's the brain injury. What do you do if somebody has a traumatic brain injury? You want to protect yourself in the event of that happening? What do you do if somebody gets addicted to substances? Addiction is a disease. It's not your fault. Addiction is a disease. And if somebody has a disease, what do you do? So you want to protect yourself in the event of traumatic brain injuries, cognitive decline, addiction, you want to protect yourself because those things happen. Those things have happened to millions and millions and millions of great people. And there but for the grace of God go I. So, all right, I'll get off my soapbox now. But I, I feel very strongly about this.
- [30:26]
B
I couldn't tell number one, but number two is I think it needed to be said. And frankly, Paula, that's why I brought it up at the beginning because I, I thought, oh, thank God we don't, because that is a rabbit hole. Can I just say two things to Andrew? And then I'm going to get out of the way because this feels like your definitely much more your area of expertise than mine. Andrew, I have one thing that I considered that maybe I would ask if we were in a room together and that actually comes back, Paula, to health because of this. The one thing that happens when a person passes away is that their assets get a step up in basis to the beneficiary. So that other half of the house that she owns, you would end up avoiding a lot of tax if she still owns it. So if in her family, Paula, they're going to live 25 years, you know, the average person lives to 90, 95 years old. Fantastic. If mother in law is not in great health, it may make sense to explore other options as well. In fact, I always like exploring two or three different options and see which way to go. Almost like we did earlier with Brandon. I said I thought about low risk equities and I thought about real estate. I'm always exploring a couple other things. So I want to just put that out there. I don't think that's going to matter here. The thing I think that is going to matter though, the thing I'm much more excited about, I believe this involves a concept called seller financing, which, the cool thing here, Andrew, is that you can devise a strategy that will work really well for your mother in law and for you. Because when the banks are out of the way, when the banks are off the table like they are here, you're going to be able to structure this thing in a way that really is great for everybody. Like like you can get very imaginative. So the thing that I would say is often people go and they look in this situation, you know, they go down to a banker and say what could I do? I don't know that you need to do that here. I think there's a lot of creative things you could do that work with the amount of cash flow that you have available with the amount that your mother in law needs. So if we start off with what's the amount that she needs, how do we structure a deal then where she gets what she needs and you're able to afford it on a monthly basis like this could be a really win win situation. And frankly it's going to take. Again, you want all this in writing, but it might cost a couple thousand bucks, Paula, to have some good lawyers draw it up. So I get really excited about where this could head.
- [33:13]
A
Well, let's back up a little bit because I have a couple of questions. I'm going to question the premise here a little bit. I hear an assumed problem followed by a proposed solution. So the first thing that I want to do is clarify what is the problem that we're trying to solve. Andrew, I noticed two things. There are two words that you said in your question that made my ears perk up. You said that it themes. You use the word themes when you talked about your mother in law's savings and you also used the word appear. Both of those words it seems and it appears her savings appear limited. Both of those indicate that you do not have a lot of clarity around what your mother in law's financial situation is.
- [34:04]
B
That's funny, Paula, and I'm glad you said that because I took that a whole different way. Oh, I took that as Andrew being kind and having a little velvet on his hammer of the fact that she doesn't have much. So I thought he was being polite, but I think that needs clarification.
- [34:21]
A
Yeah, I interpreted that as him not knowing. Interesting. This is why there's two of us. So that's the first thing I would want to clarify. The second thing I would want to know is how much help, if any, does she want want and what role does she see you playing in that? Right. So what is her plan? And plan is maybe a fancy word, but what are her thoughts? What are her assumptions from where she sits? How does she view her financial situation and what role, if any, does she want you and your spouse to play in in solving whatever problem she has? That's the second set of questions and I start with that because that's kind of the premise that we're building from. The third question is, does she want to relinquish ownership in this home? Or if she did that, would that make her feel less secure about having a place to live? I mean, there is that psychological element of, if this is not my home, do I know that I'm going to have a place to live when I turn 80? And again, you can have a handshake deal that says, yes, of course you will.
- [35:44]
B
Right.
- [35:44]
A
But there's. There is a certain reassurance that you get when that home is 50% yours.
- [35:51]
B
It's a human emotion that's a, as they say, tale as old as time. I mean, I think the way back to Shakespeare and King Lear. Right? No, we'll take care of you, dad. And then King Lear does not get taken care of.
- [36:04]
A
Spoiler alert.
- [36:05]
D
Sorry.
- [36:09]
B
I just, I just blew the. Blew the whole thing. And then you find out the butler did it.
- [36:18]
A
I actually watched a video where somebody was like, do you have to spoiler alert, Shakespeare? You had 400 years to read it.
- [36:25]
B
I don't think that's my problem anymore.
- [36:29]
A
But yes, I mean, from your mother in law's point of view, it might be the case that she doesn't want to relinquish her share of the home because there is a certain psychological comfort and there's a certain level of certainty, both at the emotional level, really at three levels. At the emotional level, at the psychological level, and at the legal level.
- [36:51]
E
The.
- [36:51]
A
The actual administrative legal level. There's a certain level of certainty and comfort that she gets from knowing that she has a stake in this property and she may or may not want to lose that. And again, we just went on the. Our tangent about handshake deals. There's a certain risk that she would be taking on if there's a handshake deal that she can continue to live in a place that isn't hers, which is to say there's a certain certainty that she has now because that place is partially hers.
- [37:24]
B
Well, this is another reason, Paula, that I brought up the step up in basis issue. Because if this is an asset that ultimately Andrew and his spouse are going to end up with in the far future, is there another way to help mom?
- [37:44]
A
Right, right. And that goes to my. My fourth question. So question number four is, what are your mom's actual cash needs? What are her cash outlays and how is she paying for it? How is she paying for it now and how much is she going to need to pay for various cash outlays in the future. I mean you think about the expenses that a person in their 70s might have. There are your basic expenses, groceries, your share of utilities, some clothing, Medicare premiums, prescription co pays, car insurance, gas, wait.
- [38:19]
B
We'Re going to try to go through.
- [38:20]
A
All the expenses, right. Evening add up to nail polish, floss, steaks, but only on occasion, eye drops.
- [38:31]
B
Garbage bags, you know, various things, those.
- [38:34]
A
Things that you buy. So what does all of that add up to?
- [38:39]
B
I think we understood where you were going, Paula.
- [38:41]
A
Maybe she has a dog. What do those expenses add up to for her and how much money does she need moving forward? When we answer question number four, the follow up question is if this 50% of the house was bought out, would it be enough? And again, I just keep going back to what certainty would she have that, that she has a place to live? If you were to take over full ownership, could she sign a 30 year lease for $1 a year and would it be valid? Would it uphold? Because if you were to take all of the expenses that she has and then if you had to add rent to it or something like that, you know that, that would certainly defeat the purpose. But if you could draw up an agreement for where she could lease the place from you for a dollar a year guaranteed for the next 50 years and if you knew that, if you ran it by some lawyers and you knew that it would hold up, you had it notarized, I'd feel better about that.
- [39:45]
B
I'm also wondering, Paula, you know, maybe the reason Andrew has this solution in mind because his spouse has siblings and maybe instead of asking the siblings to take care of mom, maybe it's an exchange. Right. Equity of the house in exchange for money that mom can get. That makes it a more, I don't know if fair is the right word, but a more, you know what I mean, Makes it so that there's an exchange there versus they're taking charge of mom and the other siblings are not helping mom at all. I don't know.
- [40:21]
A
Right.
- [40:22]
B
Like you, I was also wondering why this specific conclusion, besides the fact that they already live there, I mean that, that makes sense.
- [40:29]
A
Right.
- [40:30]
B
But that could complicate things as well.
- [40:33]
A
Right.
- [40:34]
B
Andrew, I'm very happy that you didn't fall in the, in the well of, of dealing with friends and family on a handshake basis.
- [40:43]
A
Yeah.
- [40:43]
B
And this is, this is all drawn up.
- [40:45]
A
Yeah. Kudos to you for doing it. Right.
- [40:48]
B
Yeah. And I think these are all the areas really to examine. Number one, does this involve siblings? And if it does how do you make that equitable? Number two for mom, how is she going to feel about not owning a piece of her house? Number three is, is there then a different way to handle this? And if so, there's many different ways to support mom versus buying the house. If you do, if this does end up being the best way, I think designing it based around mom's needs and your ability to pay and you got to really remember mom's needs here, not just your ability to pay. This is I think an excellent opportunity to look at a non conventional seller financing deal if it comes to that at the end that you are going to buy the house.
- [41:40]
A
Well, can I float one other possibility? And again it depends on how much mom spends. But you know, part of the reason that I brought up groceries and utilities as the first two points before we got to toothpicks, they live together. These are probably shared expenses. Could an alternative be that mom retains her stake in the home but they pay for a portion of mom's cost of living? Maybe they pay for all of mom's cost of living. Andrew, I know you mentioned you don't have a lot of cash but it might be the case that your mom doesn't have a lot of spending. I don't know, I don't know what her spending is. But if her spending needs are predominantly groceries, utilities, Medicare and clothes, I mean that's other than health related expenses, that's probably not going to be a whole lot. And it might be the case that rather than buy out her portion of the property, you make an arrangement in which you cover some of her expenses and through inheritance or through. You mentioned you have three kids through child care services that she provides. You know that's where the reciprocity in value comes in. So that might be another way of making this deal fair. Maybe you cover, you and your wife cover the mother in law's expenses and via inheritance your spouse and but not the siblings receive this asset. And that agreement is just made in advance so that everybody knows it. That way your mother in law still retains her share of the home, but she has the, the assurance of knowing that her bills are covered and you have the assurance of knowing that the house will be totally yours when she passes.
- [43:37]
B
I like directionally where this heads though. What does mom need? Begin with what mom needs and I think that'll light the way to a creative solution.
- [43:46]
A
Eye drops. She needs eye drops and floss and nail clippers.
- [43:50]
B
Nail polish. Garbage bags.
- [43:53]
A
Garbage bags. See, probably shared expenses.
- [44:00]
B
We could team up on those.
- [44:01]
A
I'll Venmo you for my half of the garbage bags.
- [44:05]
B
Everybody wins.
- [44:07]
D
All right.
- [44:08]
A
Well, thank you Andrew, for the question and best of luck. Please call us back after you've decided what to do and let us know how things pan out. We're going to take one more break and when we come back, we're going to discuss covered calls. That's up next. There's nothing like gaining fresh perspective from experts who've seen it all and who have the wisdom to prove it. I learned about how to connect with audiences about storytelling from R.L. stein's class on masterclass. You remember R.L. stein. He wrote the Goosebumps series as well as the Fear street series. When I was a kid, he was one of my favorite authors and so I got to learn from him about how he keeps kids engaged and keeps them reading and interested in books, even now. So with Masterclass, you can learn from the best to become your best. With plans starting at $10 a month billed annually, you get unlimited access to over 200 classes taught by the world's best business leaders, writers, chefs and more. And you get thousands of bite sized lessons across 13 categories. For example, you can learn about investing fundamentals straight from Wall Street Titans. You can learn about leadership skills with CEO Bob Iger or Howard Schultz. You can learn from CIA hostage negotiator Chris Voss. And three in four surveyed members say they feel inspired every time they watch Masterclass. And every new membership has a 30 day money back guarantee. Right now our listeners get an additional 15% off any annual membership@masterclass.com afford that's 15% off@masterclass.com afford masterclass.com afford when did making plans get this complicated? It's time to streamline with WhatsApp, the secure messaging app that brings the whole group together. Use polls to settle dinner plans, send event invites and pin messages so no one forgets mom's 60th and never miss a meme or milestone. All protected with end to end encryption. It's time for WhatsApp message privately with everyone. Learn more@WhatsApp.com.
- [46:22]
B
The holidays have arrived at the Home Depot and we're here to help bring the excitement with decor for every part of your home. Check out our wide assortment of easy to assemble pre lit trees so you can spend less time setting up and more time celebrating. And bring your holiday spirit outdoors with unique decor like one of our Santa inflatables. Whatever your style, find the right pieces at the right prices this holiday season at the Home Depot.
- [47:00]
A
Welcome back. Our final question Today comes from Chandan.
- [47:06]
E
Hey Pola. Greetings. Huge fan. Thank you for everything you do. You're awesome. I'm 42 years old and I have been living in the US now for close to 10 years. I work for an extremely large IT company, one of the FAANG companies and over the past 10 years I have managed to build about $2 million across. My brokerage and retirement accounts are not including my home. To be honest, I never thought that this kind of wealth was ever possible. You might connect with this, but I grew up pretty poor in India and no one in my family can guide me on what to do with this kind of wealth because it's literally unheard of. I feel both incredibly grateful and I'm also extremely skilled. Hate that I might screw this up from here. I would love your help on two questions please, if you don't mind. The first one is how do I make sure that I don't screw this up? Roughly 30% of my portfolio is in my company stock, mainly from RSUs and the rest of it is in market ETFs like Voo and QQQ broad market ETFs. I like to keep it as simple as possible. The second question is how do I turn some of this portfolio into passive income? I can already imagine Paula thinking this has to be something around real estate for passive income. But I don't like real estate. I don't think I will enjoy dealing with tenants, property issues, so on and so forth. As much hands off as possible is the approach I like to take. Recently I came across something called as covered call ETFs for passive income and I don't think I've ever heard you discuss that in your podcast before. Q. Q. Q. I. For example, seems like an extremely good covered call ETFs which give you monthly income. I was wondering what's your guidance on this? Should I invest some part of my net worth into QQQI so that I can make passive income if I want to stay within equity? If not, what are the other alternatives I need to look at? Once again, thank you for everything you do. Really appreciate it. Thank you.
- [49:16]
A
Chandan. First of all, congratulations to you on everything that you've built on, how hard you've worked and how far you've come, how much you've done. You've created incredible success and so you deserve all the congratulations in the world for what you've been able to build. I like that you said that you're scared of screwing it up because it reminds me of something. Morgan Housel wrote about, and I'm paraphrasing him, he wrote about how you have to be optimistic to make money and paranoid to keep it. And what he means by that is that, and I think your life is really an example of this, you have to be an optimist to be able to achieve what you've achieved. To start from a poor family in India and come to the United States and work at a FAANG company and build a portfolio of $2 million, not including your primary residence. That requires an enormous amount of optimism because if you were pessimistic about the future, then you would never even begin. Optimism is at the root and you might not have even thought of it like that. You might not have even thought of it as optimism. But optimism has to be necessarily at the root of your set of assumptions in order to be able to do that. Fundamentally, investing, all investing is an optimistic act because investing inherently is the act of assuming that the future is going to be better than the present. So you must be optimistic in order to make money and you also have to be paranoid in order to keep it. Because once you have money, it is so easy to lose it. To scams, to thieves, to swindlers, to bad advice, to handshake deals. It is so easy to lose it.
- [51:21]
B
The way I've seen people screw it up fast is when they begin to think that beyond the wealth they've built so far, there is a different strategy that applies and they think they have to get fancy. I guess to put it the way my mom would put it, don't. You don't need to get fancy, Joe. People don't lose generational wealth by continuing to invest in exchange traded bonds, broadly based exchange trade funds like he is largely now they mess it up by thinking, now I have to go into venture capital, now I have to go into private equity, now I have to go into startups. Now I loan it to my well meaning friends who are, quote, really trustworthy and they have a new restaurant idea and I can help them out. I think that's how people mess it up. I would say just fundamentally from the beginning, continuing to do what you've done. A, you know it and B, it's a diversified approach. Besides the RSUs, which we can get to in a second, that's not diversified and I'm glad that you recognize that. But by staying with the diversified ETF based approach, you're not going to mess it up because you are investing in the biggest companies in the world. You're investing in the bedrock that employs people that builds things, that is the economic engine that fuels the world. So by investing in that, it will fluctuate, but you will still be there as long as we have a civilization, because you're investing in the bedrock of that civilization. What I like about the exchange traded fund piece as well is that it's self cleaning about the fact that you don't have to pick which what's going to continue to lead civilization. I don't know, Paul. You don't know, China doesn't know. So what do you do? Well, you go with the proof. And these exchange traded funds only put companies in the exchange traded fund if they meet the criteria. And when they no longer meet the criteria, they take them out. You don't have to do anything, so you don't have to bet which companies are going to win.
- [53:34]
A
And just to clarify for everyone specifically Joe, you're talking about broad market ETFs, not some of the. Because there, there are some ETFs out there that are like very niche and too fancy. So you're talking about extremely broad market ETFs.
- [53:50]
B
And that's a great point, Paula, because even in the ETF market, marketers are starting to get into that market because they know it's a exchange traded fund. That's a buzzword, it's a hot word. So I'm going to create these niche weird, could lose money very quickly exchange rate.
- [54:07]
A
But there are now they're inverse ETFs. Yeah.
- [54:11]
B
Jason Zweigen, the Wall Street Journal was talking about there are now ETFs that are doubling and tripling and 10 Xing single stocks. So you're buying an exchange traded fund which we all think is, oh, diversified, broad based. No, it is 10xing the risk in a single stock. So it will go up faster and down faster. And Jason wrote in the Wall Street Journal just a couple weeks ago that you know, largely these were made for professionals, but even the professionals that made them know the vast majority of people buying these things are amateurs who are looking at it more like a roulette wheel than as an investment.
- [54:53]
A
Right. There's a meme stock ETF now. It's called Meme ETF. Its expense ratio is 69 basis points.
- [55:01]
B
Of course is the ticker symbol M.
- [55:04]
A
E. M E. Yes, it is. It's M e. M E. That's so awesome.
- [55:07]
B
See, I love that. Everything, I hate everything about that except the ticker symbol.
- [55:11]
A
Right? Yeah.
- [55:13]
B
Such a good time.
- [55:13]
A
Yeah. So I just want to clarify for the whole audience, not all ETFs are good. In fact, I would say the vast majority of what's there on the ETF market right now is actually pretty terrible.
- [55:24]
B
But the vast majority of where the money is. So if you go by names, most of it's junk. If you go by the assets under management, the vast, vast majority is in what we're talking about broad based.
- [55:38]
A
Broad based, yeah, exactly.
- [55:42]
B
So that would be the S P500. That would be the total stock market index. That would be S P large cap, mid cap, small cap. That would be the qqq, that which is the NASDAQ exchange that you're buying. So those broad based exchanges. All right, we want to talk about RSUs first.
- [56:01]
A
Yeah, let's talk RSUs.
- [56:03]
B
Because, John, you already recognize that having so much money in your company could be a problem. The answer is a hundred percent. Now it's a problem and it's also a solution. So the reason your wealth grew as quickly as it did, you recognize in your call that, that being concentrated in that stock got you where you want to go. So whenever a financial person tells you to diversify, it's not going to make you more wealthy. This, this goes back to Brandon. Paula. People always say, well, I heard I should diversify and I'm not getting rich. Diversification doesn't make you rich. Diversification makes sure you don't get poor. And those are two different things. If you want to get wealthy, reduce your diversification, get just a few positions, increase the standard deviation in your portfolio and don't be wrong. And if you do, if you do those things well, so what am I saying? Bet more on a few good bets and win. And there you go. So buying an individual company is going to get there. So I think the first thing is to recognize that right now you're feeling, I don't want to mess this up. And if that is a bigger goal than growing quickly, which it sounds like it, 100% is then taking some of the money out of the RSUs and diversifying. It makes a ton of sense to me.
- [57:30]
A
Joe, to quickly summarize what you just said. Concentration is playing offense. Diversification is playing defense.
- [57:38]
B
Absolutely. And that's why, by the way, certified financial planners will stress diversification. There's actually two reasons. What about you and what about them? The first one is, is for you. It makes a lot of sense, John. Unsaid. I, I don't want to screw this up. You know a great way to not screw it up. Broad based ETFs versus single stock. You will not, you will not Screw it up. And then the second thing that has to do with them, you're less likely to fire them if that stock goes down and they told you to keep it. Which if the broad based economy goes down and the exchange traded fund goes down, the advisor just points the economy and goes, hey, everybody's doing it. It wasn't me.
- [58:17]
A
Right?
- [58:18]
B
It's both. I do feel like there's a little bit of COVID your butt there though, Paula, where advisors are very reticent to tell you, no, go ahead and keep a concentrated position because you want to win. But here's what the downside's going to be. So with the RSUs, I think you set up a strategy that's dollar cost averaging, but you're dollar cost averaging out versus dollar cost averaging in. And what do I mean by that? If you take a look at insider trading reports, you can find these@cnbc.com as an example. If you look at any stock, a lot of people out there going, joe, you said insider trading, isn't that illegal? No, it's not. Insider traders are allowed to sell their stock and buy their stock, but they have to flag it. They have to tell people and there are times when they're not allowed to trade their stock. As an example, when there's material information coming out about the company like a quarterly earnings report, there's a timeframe before and after when they're not allowed to do anything. You will see though when you look at insider trades, when a good financial plan is in place because Paula, you will see they sell 100,000 shares at the beginning of every quarter on the same day. And this is an executive, an insider who is divesting themselves of a position. And you can usually tell there's a financial planner behind that because they're not betting, they're just saying this stock might go up, this stock might go down. I want to make sure I'm around if it goes up. We have plenty of money that's already diversified, but let's get safer but over time. So I'm going to just sell a hundred thousand shares or you know, whatever the number is over X amount of time. And then you're not betting on a specific date and you're getting where you need to go. And the other thing too is you're spreading that tax bill out a little bit. We're near the end of the year, we're in the fourth quarter. You're going to take some tax it today for selling some RSUs and you're going to take some of it next year. So I like that as a diversification strategy, we don't do it all right now, but set up a plan. The hardest part of that, by the way, sticking with that plan. So many times we would be in the middle of this. I would be with an executive where we set one of these plans up, Paula, and the executive would go, oh man, we got this new line coming out. You know, I was in Detroit. We got this new car coming. It's going to be. Well, we have to forego all that. We had a plan, we have it in place. Let's not overthink it. If the line goes great, you still have X amount of your car company stock. You're still in it to some degree. Most financial planners, John Don will say between 5 and 10% of your overall portfolio can be in a single concentrated stock like your employer. I think you said you have a third right now, so you may want to get that down to 5 or 10% along those guidelines. It's up to you though, how concentrated do you want to be?
- [61:15]
A
What I have done with my own portfolio, because I have one individual stock that's done very well and so it has turned into a significant portion of my investable assets. And the way that I have thought through what to do next is my mental framing is what is the purpose of this money? Is this money earmarked for retirement? Or is this money essentially play money that I'm just investing for the sake of seeing how far it grows? The mental framework that I have come up with is a goals based approach in which I know which buckets of money are for which goals. And then I also have a bucket that's sort of just for fun. And inside of this just for fun bucket, if something becomes a runaway winner and I believe in it, and I believe in its future, I'll continue to let it ride. And so what that means is that that runaway winner becomes overall an overwhelming portion of my portfolio. But because the goal of that particular bucket is just for fun, that's okay.
- [62:26]
B
Well, that's why I like starting with the financial plan. Right. If my goals don't include any of this money, then why not? Right Then why wouldn't I? Now you could choose to change the goal now that it's become a runaway winner, make the goals bigger. And the second you do that, then there's your diversification strategy for some of that money.
- [62:44]
A
Right?
- [62:45]
B
Because if your goals depend on it, then certainly you're not going to let it run. Our mutual friend Grant Sabadier talks about how much he invested in Amazon in the early days. And if he would have taken CFP's advice to diversify, which is what everyone will tell you to do, he would never have built the wealth as quickly as he did by not having just Amazon in his portfolio. And interesting discussion, I think there, because as you get into a different place and the goals change, then certainly you relook at the portfolio and why am I, why am I doing what I'm doing? So coming up with the RSU divestiture, I think SHA is going to be based on all that. Now, the second question you asked is about options. So we should start off with what is an option in the first place? And an option is either an option to buy or an option to sell. So, Paula, let's say that you have this concentrated position of this stock. We'll say it's Amazon, because I just said that about our friend Grant, who has talked about his Amazon openly. Grant wants to divest some of his Amazon. But instead of selling it, what if he sells it today, Paul, and it goes up tomorrow? He could instead place an option to sell, meaning he's going to buy the right to sell it at this price, and if it goes up, he will let the option expire. Now he has to pay for that option. He has to pay some money. So there's, there's, it's like an insurance policy. An option in a lot of ways is insurance policy. If you use it conservatively. If it goes up, he's going to let it expire and he's just going to sell it for the higher price later on if it goes down. Guess what? He has this option to sell it at the price he was at when he bought the option. So now he can sell it there. So options, instead of buying the underlying security, an option is an option over a set specific contractual amount of time to control stock and decide, am I going to use this option later, I can sell it later if I do an option to sell, or if I do an option to buy, I can buy it later. Shonda, what you're talking about is buying something called covered calls. Holy cow. This is going to be a lot of one explanation after another, guys. So hang in there because you're going to get it. Because each of these words is easily explainable, Some of the music call is a tough word, but covered is easy. So we'll do that one. This is a strategy that can work for income. So he said, how do I increase income? I heard about this strategy, buying covered calls, and I Think about qqq. We're going to set QQQ to the side for a second. What he wants to buy covered calls in. Let's just talk about how covered calls work. This is an active strategy, meaning you're going to have to stay on top of it. So it can be a little bit more of a pain than most investors in the afford anything audience may want. Generally, you know, we talk about passive investing and ride a broad based index. I've done this myself before though. Like any strategy, it has a big Achilles heel. We talked about this earlier today. You know, you got a good strategy when you know what the Achilles heel is and you still go, okay, this works for me and I understand the downside. So we'll also talk about the downside options, by the way, some people might go, oh, I heard about options. They're really risky. A hundred percent. They can be risky. You can be a huge gambler using options. Imagine, Paula, I can buy stock in. Let's just stick with Amazon. I could buy stock in Amazon or I could just buy the option to buy it at a price in the future, hoping it gets to that price. Let's say it's trading it. I'm going to use just baloney numbers, guys. Let's say a stock's trading at a hundred dollars now. I think it's going to go to 110 instead of betting it will with all the money it takes to buy those shares. I just buy the option to buy it at 110. Fantastic. And I buy the option. I get it for pennies on the dollar because it's got to go up 10% before I even before this option's even viable. So fantastic. I get to control these shares and for a lot less money than I would have had to spend to buy the stock. I get to control the stock with less money. It is. It can 100 be gambling in this option strategy though, buying covered calls. This is not gambler at all. We are not gambling in options. There are two roles. There's the gambler, the person going, you know what I bet, Paula, I bet Amazon's gonna go up. So I think I'm just gonna buy an option and then there's the person on the other side that I'll call the banker. And I like calling them the banker because bankers, as you know, are not risk takers.
- [67:31]
A
Right, right.
- [67:32]
B
And the cool thing about bankers is bankers don't make a ton of money on the deals they do. The risk taker makes a ton of money on the deal. They do. The banker doesn't make a lot of money on the deal, but the banker makes money on every deal. The banker always makes sure they make some money on the deal. And in this case, buying covered calls. You are the banker in this strategy. As the banker, we are selling covered calls. So we need to know what the hell these words mean. Covered means we own the underlying security that we're selling. So covered means I've got it covered. I'm sitting on these things. So Shonda talked about doing this with qqq. So the first thing is I buy a bunch of Q. Q. Q.
- [68:18]
A
As opposed to a naked option.
- [68:20]
B
And naked option. Naked option means I don't own any of it.
- [68:24]
A
Right.
- [68:25]
B
And I'm giving. Now that is a. Imagine what a super strategy that is.
- [68:29]
A
Yeah, exactly.
- [68:30]
B
I am selling you the option to control shares that I don't own. How the heck does that work? I'm just going to go off on this tangent for just a second on naked. I borrow them from my broker. I then give you the right to control them. And then if it goes sideways, oh, crap, I got to go buy those shares from my broker that you bought away from me. I could lose infinite amounts of money on naked calls.
- [68:56]
A
Right. Well, with naked shorts, you don't even borrow it. You enter into a contract, but without actually borrowing it first. So you don't even have it to give.
- [69:06]
B
You don't even have it to give? No. When that closes, you got to find the shares.
- [69:11]
A
Yeah.
- [69:12]
B
For the contract. So that's why it's infinite risk.
- [69:15]
A
Right.
- [69:15]
B
It's incredibly risky. This one. Number one, I own the shares. So in this case.
- [69:19]
A
So it's covered. Yeah. Covered is the opposite of naked.
- [69:22]
B
Yes. So covered means I own it and I'm going to cover. I'm going to cover this. Think about the options like a blanket. I'm putting it on top of this big body of. Of this position that I own. So it's covered. I'm fine. Again, a banker move. Right. I own these shares. What I'm going to do is I'm going to give you the ability, the option to control them for a while. I'm going to sell the option that you get to control my shares. And guess what happens when I give away that to you? I don't give it. I sell it to you. I'm going to sell you the option to control these shares that I own for a few months. So a call is an option to buy. A put is an option to sell. In this case, I'm selling Covered calls. So I am selling the option for you to control shares that are I own and you have the right to buy those. So the call is an option to buy. I'm selling the right for you to buy them. So I'm saying, hey, Paula, you want to buy these shares for me in the future for X price? The risk taker says, yeah, sure, depending on what the price is and how much that option cost. So if you're with me so far, that's what the strategy is. Now, how does this actually work? So let's put this in play. To put it in play, we have to know two more things. Oh, God. There's more, but they're really easy. There are in the money calls and there are out of the money calls. In the money calls means let's say the stock is trading at a hundred bucks again and you want the option to buy them. 400. So, Paula, what you're saying to me is, hey, I want to sit on this for another three months, but I'd love to control your shares instead of paying for them right now if the price goes up further, heck, I'd love to buy them for a hundred. I mean, how great would that be? I know I could buy it for a hundred, but I instead, I'm going to pay you a little money to make sure the stock might go down. It might go up. So I'm going to pay a fraction of the money to control your shares for a few months and maybe then I'll buy them for a hundred. Now, if it goes down, Paula, you only lost a little bit of money versus you would have lost a bunch more money had you purchased them in full. If it goes up, well, you paid a little extra by the premium for the right to sit on it for maybe three or four months or maybe a year or whatever the amount of time is in the contract. So because you were able to do that, you paid a little more, but you still had the ability to make the decision later. So for the risk taker, there's a lot less money at stake for me for an option trader, I frankly, maybe I wanted to get rid of the shares and for me to lock in the fact that I don't need the money now, but I'm going to get a little extra money on top of the hundred dollars a share for the in the money call, I'm going to get a little extra money from you for controlling the shares. And I'm guaranteed that you're going to buy them for $100 a share. Fantastic.
- [72:21]
D
That's great.
- [72:22]
B
I might do that. What we really like for this strategy though is not that we like what are called out of the money calls. Because out of the money calls means I'm going to sell them for a price that doesn't exist yet. It's trading at a hundred. I'm going to give you the right to buy them for 110, let's say January of next year. So if it goes at or above 110 now, you're going to buy my shares for $110. Now why would a risk taker do that? You know why? Because it cost them a fraction. And if they think it's going to shoot the moon, they think there's something that's going to happen. The stock's going to go up big time in the next few months. They can spend very little money for this huge move to control my shares versus imagine what they'd have to pay for an in the money call, right? And in the money call, you got to pay a lot. Why the hell am I going to give you my shares for a price when I could just wait? Why would I do that? You got to give me a lot of money to do that. But to control my shares for a price that's better than what they're at now. You kidding me? You could do that for a fraction. So I'm going to sell out of the money calls to you. So I'm selling covered calls that are at a price that's not there. And a price tag that I've always liked in the past is 8 to 10% above what the price is now. So let's walk this through. I have a stock that's trading at a hundred bucks. I sell a covered call to you. One call equals 100 shares, by the way. I sell a covered call to you for X amount of money for a little bit of money right now. By the way, I get to keep that money. Whether it works out or not, I get to keep that money. So you pay for the right as the risk taker, me as the banker, I get the Cha Ching money in the bank. I also know that one of three things are going to happen. The price stays the same. This is a beautiful world for a covered call seller. Because if the price stays the same, Paula, then you let the option expire because you don't have the right to buy. Why are you going to buy my shares for 110 when it's still trading at 100? Not going to do that. You'll just go buy them for 100. So you let the option expire. I get to keep that money. The stock goes down in value. I still own all my shares. And guess what? I still got to keep that money, which offsets the amount the stock went down. So now, even though the stock went down, I made a little bit of money where if I would have just held them going down, I would have lost a little bit more money than that. So I lose less money when the stock goes down. When the stock goes up. And this is the Achilles heel, if the stock goes up 15, 20, it goes to 115, goes to 120, goes to whatever. I gotta sell it for 110. And I didn't keep all that. But think about what happened. I got 10% and I said January. Between now and January, I got to look at my crystal ball and go, you know what, Paula, I'll play this game. I'm going to make 10% in the next three months and I get to keep 10%. You get the rest of it, but I still get to keep 10% plus the premium that you paid me. So I'm not keeping it all. I got to split with you. And the other bad thing, by the way, I got to sell the shares. The shares go to you. You're going to exercise that contract in a second. If it goes up to 115, you can buy it for 110. You're going to do that. And by the way, what does Paula usually do in this case is the risk taker. She automatically, then she buys them for me, she sells them right away. She captures the five bucks. Boom. Cost her a fraction of the money to capture the five bucks. Really the sweet spot on this is if it goes up 5% or 6% or 7%. Right. Because now I actually made money and I also got your money as the risk taker. So covered calls, it's an active strategy. You have to look at the prices of calls and they're, they're published everywhere. It's easy to find out what the prices are. You will see the line, by the way, between covered calls that just don't make sense because you're not going to make any money because the risk takers are going to. Yeah, I'm not taking that risk. Forget it. So it ends up being a waste of time for everybody versus where the risk takers are going 8% and they've got an earnings report coming out in six weeks and they're thinking about this new drug. Okay, maybe. All right, maybe you can see that line where People are betting, Paula, where the risk takers are betting. And if you're willing as a banker to go, yeah, okay, I will take that and I'm happy with my shares being sold away, then I'm good. So my first question then, Shonda, hopefully you understood that is do you need the income? Because if you need the income, then maybe the juice is worth the squeeze. I do this only from time to time because 85 of the time I look at the charts and the juice is not worth the squeeze. I'm like, why am I going to waste my time on this? It is so not worth it. But for people that want a consistent income stream and they're willing to sell some of these big positions away, then sure. Now if there were a way to do this with your RSUs where you turn them into just stock that you own and they're now unrestricted stock that you own and you're happy selling those away in the future, but until then, you're going to make crank and make money on them, Right. As a covered call strategy, maybe that's a strategy to sell away the RSUs. So for QQQ, you would have to sell me on that for the nasdaq. Why am I going to buy the NASDAQ and earn income if I don't need income today? I don't, I don't understand why I would do that with the RSUs when they become unrestricted. Maybe that's a part of your strategy of divesting some of these.
- [78:13]
A
That makes sense since he wants to get rid of that stock anyway. He wants to start shedding that stock anyway.
- [78:18]
B
Sure. And then he could even price it where he's going to make more money over the short term.
- [78:22]
E
Right.
- [78:22]
B
I used 8 to 10 because generally I want to keep the stock.
- [78:27]
A
Right.
- [78:27]
B
But if I'm okay getting rid of the stock, what if I placed it at 5 where I eke out another 5% on top of it and I divest, which is what I wanted to do anyway. And I get to keep the premium that you paid to ride those shares, Right. So I get to keep the risk takers money. I get a 5% up and I got rid of the stock. It's all a win. But the Achilles heel becomes the win. While option strategies generally are considered risky, this is known Shandon far and wide. And for everybody else in our community, it's known far and wide as a very not risky strategy. When people say, well, I was going to do this covered call strategy, but then I heard options are risky. Yes, this is not risky. You are the banker here. This is the banker strategy. I'm not going to make a ton of money. I cap my earnings. I mean, the big problem with this strategy, Paula, is you cap your upside, you're going to lose out on some upside at some point. If you keep doing this, you're going to lose some upside. That thing's going to go through the roof and you're going to go, I sold my shares. And then the question has to be, how do I feel about that? If I feel good about that, because that was my strategy along, then great. If I feel horrible about that, then why the hell was I doing it in the first place? Why am I doing this?
- [79:43]
A
I think that sounds like an incredible strategy for the RSUs. Since he's over allocated to RSUs and needs to shed that anyway.
- [79:51]
B
He's got to look at his contract and find out how to make them unrestricted stock. But if he can convert them, and for some employers, there's ways to convert them, if he can convert those to unrestricted stock, then this might work.
- [80:06]
A
That was incredible, Joe. Thank you for that. That was absolutely incredible. I think this episode is going to go down in Afford Anything hall of Fame as one of our best. I really do. All three questions.
- [80:18]
B
We saw the questions ahead of time.
- [80:20]
A
Yeah.
- [80:20]
B
And when we got on, we're like.
- [80:22]
A
Oh my goodness, this is going to be one of the best episodes. Certainly one of the best Q&As. I have really nothing to add to this other than the broader question, Chandan, of the premise of all of this was you asked how to create passive income. My question back to you is do you need to create passive income? And I ask that because what you stated in your voicemail was a desire to protect the network that you have built. What you did not state was any desire to necessarily stop working. You, you have a successful career. You work for one of the faang companies, you're young. It sounds as though. And you didn't directly state this, so maybe I'm misinterpreting it, but my impression is that you're eager to continue working and that you're eager to continue building your career. You just want to make sure that you preserve your net worth along the way. And assuming that you're eager to continue building your career, you don't necessarily need to build passive income. You could certainly focus on your career, keep your money in broad market ETFs or broad market index funds and essentially have a set it and forget it plan with your investments while you Keep your focus on your career. That's a incredibly viable, wonderfully viable path forward. So you know you mentioned that you're not interested in real estate because of the level of work that it would require, which is a great thing to know about yourself. So don't go into real estate, please. And I say this to everyone who's listening, if you do not want to go into real estate, then don't do it. Rule number one is you have to want to do it. If you don't want to do it, don't do it. Don't do it just because you think it seems like everybody else is like FOMO is a terrible reason to do it. Do it only if you want to do it, only if you think that you'll enjoy it. Do it only if, at a minimum, you have a curiosity about it that you would like to explore. Explore or pursue. Those are great reasons to do it. But if you know that you're not going to enjoy it, if it's going to be like pulling teeth, don't do it. Stay out. The same is true when it comes to any other method of developing passive income. Unless you are retiring from a career or semi retiring from a career, you don't necessarily need passive income. If you're focusing on your career, you can just let your assets grow. Which is essentially another way of saying you don't have to take an income oriented strategy with your investing. You can simply stash money away into broad market index funds or ETFs and let those ride while you focus on your core skill set, your core career.
- [83:11]
B
This goes back to Brandon's question too. Around asset placement, not only do bonds throw off more taxes or income strategies throw off more taxes. And if these are all in tech shelters like a 401k Shandon or other places, but of course the RSU aren't. Those are going to be non qualified. Those are going to be out and exposed to taxation. We don't want to create taxation. That just ends up being friction. Capital gains gives you the ability for not just more upside, but also for less friction as well.
- [83:48]
A
But I think that was an epic answer. Joe, thank you for that walkthrough on covered calls.
- [83:52]
B
I love talking covered calls. As I mentioned, I've used them. I use them sometimes, not often. I generally play with covered calls and it's usually with the stock I was considering selling anyway. Yeah, instead of selling it at the current price, I'm like, you know what, let's go out in the covered call market. But I've also Used it. When I was an advisor, we would use it as an income stream sometimes for retired individuals or people looking for income.
- [84:18]
A
I feel like I should get into it. I mean, I've just been sitting here selling my stocks like a chump.
- [84:25]
B
Yeah. Why. Why just sell?
- [84:27]
A
Right?
- [84:28]
B
Why sell? But there is the downside. You know, I have had times when I decided to do a covered call instead of sell because I thought, hey, I'm going to. I'm going to squeeze out a little more money and the stock goes down. And if I would have just sold the damn thing right. So you have to look through the downside and go, am I okay with a. Am I okay with selling it away if it gets called or if it goes down and it doesn't get sold away? And I really wanted to sell it. Am I okay with that? I got to make sure my downside, that I'm fine with that before I enter into this agreement.
- [85:02]
A
All right, well, thank you, Joe, again, for the explainer, and thank you, Shantan, for the question. And congratulations again for everything that you've built. That is our show for today, Joe. We have done it again.
- [85:16]
B
Wow.
- [85:17]
A
That was epic. Cho, where can people find you if they'd like to learn even more about options?
- [85:24]
B
Well, how about the option of instead of fire? Making work more fun and more enjoyable for you, for the people around you, for everybody. And whether you're somebody that works in an HR department or even, heck, for people who aren't working, who just want to make things more joyful for the people around them. We have a great discussion with Richard Fain. And if you don't know that name, Richard was the longtime chairman and CEO of Royal Caribbean Cruise Lines and talks about wow and about bringing wow to everything that you do. And it's a fascinating conversation with a guy who thinks a lot about hospitality. So we're getting close to holiday soiree time, Paula, you know, inviting your friends over, maybe put a little wow on that. Or at work, wowing your customer. So, Richard Fain and thinking about making life a little more fun. And that conversation is at the Stacking Benjamin show, where finer podcasts like this one are found.
- [86:24]
A
Oh, that's excellent. Well, thank you, Joe, and thanks to all of you for being afforders. If you got value out of today's episode, please do four things. First, download one of our freebies. So I mentioned earlier, we have this free asset location cheat sheet, affordanything.com asset location. We also yesterday we put out a fi r e guide. So affordanything.com f I r e Go there and download a guide to F iire. It's a walkthrough of the core concepts, the core fundamentals around Double I fire. So afford anything.comf I I r e Totally free. Share it with your friends. If you want to get people on board with the notion of good financial health, the notion of fire, or the notion of generally like solid personal finance practices, it's a great resource. Affordanything.comfiire. that's number one. Number two, share this with all your friends, family, neighbors, coworkers, fellow options traders.
- [87:36]
B
People you buy garbage bags from, the.
- [87:38]
A
Person who sells you eye drops.
- [87:41]
B
This will go all day. Everybody.
- [87:44]
A
Share it with all of them and more. Because that is the most important way that you spread the message of F I r e Number three Open up your favorite podcast playing app. Please leave us up to a five star review and write some words about what you enjoy about the show. We really appreciate it. Thanks to the person who did that about the Cars episode. Thank you to that person. Karsten is wonderful. We agree. So please, if you haven't done so yet, leave us a review. Or if you have done so, update your review and tell us what you enjoy. Thank you again. Number four hang out with our community affordanything.com community thanks again for tuning in. I'm Paula Pant. I'm Joe Salsihai and we'll meet you in the next episode.