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- [00:00]
A
Welcome to Ask the Compound, the show where you ask and we answer. I am Ben Carlson. Let's say you have a $2 million portfolio in your early 40s. Is that enough money to live off the dividends? Can you retire on the dividends from your stock portfolio and coast fire? We'll answer these questions and more on the show today. Let's do it. Email here@the compoundshowmail.com if you have any questions. Duncan is still on vacation in Japan. Phil Sweet is filling in this week. Phil, I knew we could count on you.
- [00:29]
B
I am Oatley, creative director. It's going to be my job here today, guys.
- [00:35]
A
On today's show, we'll be answering questions straight from the compounders on how box spread loans work, how to think about taxes and asset location and diversified portfolio retirement planning for small business owners, how to coast fire on your dividends. And finally, can you live off your dividends in retirement if you retire early first? The show today is sponsored by Betterment Advisor Solutions. What growth strategy are leading rias using that most firms don't? Some segmentation. Some clients needs are sophisticated and require deep ongoing planning. While some clients needs are simple like wealth accumulation stage. The smartest firm with no planning shouldn't look the same for every client. But the experience should always be exceptional. Now it can be with Betterment Advisor Solutions. It's a platform built for segmenting your book and streamlining those smaller and simpler accounts. The onboarding experience is automated and paperless. The portfolio management is streamlined and tax efficient. Client experience is consistent and modern. The impact isn't just felt by your clients. It's felt across the entire practice. Imagine a back office that's helming, a team that's thriving and a service model ready to scale. Betterment Advisors Solutions. Your biggest regret will be not doing it sooner. Learn more@betterment.com Advisors. Bill, looking good. Let's do it.
- [01:38]
B
Thanks. Ready to rock and roll. You ready for question one, Ben?
- [01:41]
A
Let's do it. You're reading them.
- [01:42]
B
It's true. It's true. So, Bill Sweet, I know that guy mentioned box spread loans on a recent episode and it's something I want to learn more about. I've seen some stories in the financial press, but I don't really understand how these things work. All I know is the rates look too good to be true. What am I missing from Steve and Chipboygan?
- [02:00]
A
All right. We're still kind of new to this process. We're bringing these into our practice, but we wanted to bring on an expert for this One. So let's bring in Joe Decipio. Joe works for Aaron Risk Advisors. Also published an excellent parameter on box spreads for life architect. Joe, are you okay calling these loans or do you call them financing? What do we call them? What's the nomenclature?
- [02:18]
C
I would go with financing because they are based upon the collateral in the account.
- [02:24]
A
Okay, so you have a lot more background with options than we do. I think a lot of people see these and they say, geez, I'm paying 4% for a loan instead of like 6% of the mortgage market or something. How are we doing this? So how do you explain these box spreads in plain English to regular old financial advisors like us?
- [02:42]
C
Very carefully. And the reason for that is because the options industry does a magnificent job of shooting itself in the foot by putting all these fancy terms and mumbo jumbo in the way of what is actually the trade doing for the end client. And in this particular case, a box spread is a four legged option trade. And it's important. In fact it's imperative that you trade all four legs as a single package. Some people have gotten in trouble in the past trying to leg their way into these trades. Please do not do that. The idea is to trade four legs simultaneously in a listed option product that enables you to access the kind of over the financing rate that's embedded within option contracts. In fact, it's embedded in all derivative contracts. That's the implied forward rate that often is recognized in futures and such. So all you're doing here is teasing out that interest rate that's embedded within the options. The options complex.
- [03:48]
A
Right. So the box spread essentially is you're selling two calls and you're buying two. Now you're selling a call, selling a put, buying a call, buying a put. Right. You're kind of covered there in. The difference essentially is, is that the difference is the financing. Right? And what you said is embedded in the options market. So what is that financing rate tied to? Like what is it, what is it tracking? Essentially?
- [04:12]
C
What is it tracking? Essentially is tracking fed funds essentially. Because remember, the reason the box spread market exists in the first place is option market makers are lazy. They could go out and go to the repo market, then it's all this paperwork mumbo jumbo. Or alternatively, if I'm in the options market making game, I can go out and just say I was selling calls all day, so I need to buy some stock. So I'm going to have a big debit balance with my clearing firm. Well, they're going to charge me fed funds plus say 200. Well, you may have been on the other side of that transaction. You may have been selling stock all day and you may have a big credit balance at your clearing firm and they're going to pay you fed funds minus something. So I just magically. Not magically, but practically, we just come together through the box bread market where you would lend your dollars to me through an option transaction. And remember, these are all centrally cleared through the Options Clearing Corporation. So if I wind up being a deadbeat or you wind up being a deadbeat, it really doesn't matter because that's going to be backed up by the options clearing.
- [05:21]
A
I like the fact that you call this a trade because it is a trade. You're still essentially borrowing money and then at the end of it you're paying back. And I went through this because we're doing this at our firm now and I did this one. So I'll be kind of the guinea pig here. Here's what I did. I had a home equity line of credit. Right. Those rates are six and a half, seven percent still. Right? Right. My wife wanted new floors. We borrowed against the house. I'm going to pay it off over the course of two or three years and we're back to square one. Right. I didn't like paying rates that high. So now I can take a box spread loan out and I'm borrowing at 3.8%, I think, for three years. Right. Pretty good. That's way better than what I'm paying on my heloc. I get the money out of the account I have these options positions on. It's funny because the options position, you said it's a trade, it's still showing in my brokerage account. Right. I'm borrowing against a taxable brokerage account. I get the cash, I pay off my HELOC, then in 3 years I either have to pay back that box spread with interest or I can roll it over again into a new box spread loan.
- [06:16]
C
That is correct.
- [06:18]
B
Yeah.
- [06:18]
A
Go ahead.
- [06:19]
C
Well, again, the important caveat here, and I want to make sure everybody understands that when you're using box spreads, the unhidden or unspoken risk in this transaction is the value of your collateral can go down.
- [06:31]
B
Right.
- [06:32]
C
If the value of your collateral goes down, this is a security based loan and the collateral value of the securities and your agency.
- [06:41]
A
Right. If my, if my, if my brokerage account crashes, they could, I could get a margin call essentially. Right. So you have to, you have to be careful how much you and I didn't of Course, I didn't take out as much money as I could have essentially. But you're right, that's, that's, that's a risk. And then the other, I think the other great thing about these, why people like them is you have no monthly payments.
- [07:00]
B
Right?
- [07:00]
A
There's, there's no payment made. It's like a balloon payment at the end, essentially there's no monthly pay. So with my heloc, I'm at least having to do a minimum monthly payment for the interest. With a box spread, there's no payments to be made.
- [07:12]
C
Correct. And you can do. And again, the box spread market can be from, you know, one day to several years. And depending upon what your outlook is on interest rates, some people choose to lock in for a longer period of time and do a single reset. Other people want to just track what they think is going on in the interest rate market. Again, the Fed funds futures curve is going to give you a pretty good indication of where the market thinks interest rates are going. And that's already embedded in the longer term rates. It's just a matter of do you agree or disagree with the way the world is structured currently? You may be a big believer that interest rates are going down to 2% in three years. Well, the market doesn't think that. So you're going to be, if you lock in your longer term rate today, you'd be actually paying a higher rate than what you would want to pay if you had done a shorter or more frequent reset along the way. So again, there's a little bit of nuance to how you set up these trades. But as you point out, if your collateral can support it, there's really no need to make a payment along the way. This is kind of like a negatively amortizing loan to the extent, again, I just want to harp on this because I know at some point someone's collateral is going to go down, they're going to have a margin call, they're going to have a forced liquidation and it's going to be options bad yet again. And it's because you had that asset liability mismatch because the collateral in your account is being repriced daily, the value of your house and your key lock is not being repriced daily. So I just want to make sure that those two asset and liability streams are carefully and conscientiously aligned.
- [08:43]
A
And Bill, what do we need to ask him about taxes here?
- [08:45]
B
Yeah, I guess, Joe. The other just quick question I have is, I mean, what else could go wrong? You mentioned refinancing potentially the loan comes due, you don't know what exactly you could be going into. That's one. And I guess, Joe, if you have any comments on the tax implications, is there any limit to what you can do with this now? Capital loss from the options trade?
- [09:05]
C
I am not a tax expert, but to the extent that I have heard no. And because you can take the money out as a, I think it's called a non purpose loan, you don't have that problem of the deductibility of margin interest if you were taking the money out of your account to buy a car or a yacht or whatever, or doing your floors. You don't have that same limitation with the box spread.
- [09:29]
B
Right.
- [09:29]
A
So people in the, people in the comments are a little confused here. I guess the best way to think about this is like most of the time you do a margin loan against your portfolio, you're borrowing from a bank and the rates are much higher. Right? They're probably closer to like mortgage rates, maybe even higher in some cases. We've seen 6, 7, 8% for these s block loans. This is just a way to do it, utilizing the options in financing market to get a much lower rate. And I guess Joe, my question is why are these things seemingly blowing up in the last 12, 18, 24 months? There's all these stories, people are using them more. Why is it becoming more prevalent now when the options market has been around for so long?
- [10:04]
C
First person I love to thank for that is Roaring Kitty because of that whole GameStop and AMC activity that happened several years ago. It forced kind of the entire industry to get aware of the, what's going on in the options market. And the options industry to their credit, like the Chicago Board Options Exchange jumped on that and said, hey look people, if you wanna get invited, if you wanna get involved in the option game, there's no simpler, safer way to do it than with the box spread. Because you're stripping out a lot of market risk or no volatility risk embedded in these things. All you're doing is saying, I wanna disintermediate from, from my broker, my clearing firm and go directly to the options market in order to access this rate. So that I think is why finally people are starting to pay attention to the box spread market. It's been around since the early 1980s and now as I understand it, we're in 2026. So it's taken a while, but sooner or later the options industry gets their act together and does tend to market these things to an audience that is able to utilize them.
- [11:14]
A
So I can thank Roaring Kitty for refinancing my debt.
- [11:18]
C
Exactly. Yes. Because again, he really stripped the COVID off of utilizing options because it made advisors answer the phone call, hey, I hear about these options. What's going on? And then it just becomes kind of that Steven Pinker moment when everybody knows. Everybody knows now. It just starts to catch on like a snowball going down that hill.
- [11:42]
A
Okay, Anything else? We didn't ask you that we should on this stuff. Bill, what do you got?
- [11:46]
B
No, that's a big one, Ben. I think it's really interesting. And Joe, I think the key takeaway for me and listeners is it's not a loan, functionally. Right. It acts like a loan, it smells like a loan, it looks like a loan, but at the end of the day, it's not a loan. And that's why you get probably superior interest rate treatment and its ability to deduct the capital loss, because again, it's not a loan,
- [12:06]
C
but it is based upon the collateral in your account. And again, I just want to keep harping on that because I know sooner or later someone's going to have a box spread and the collateral value in their account is going to go down, the account's going to get liquidated, and it's going to be options bad again. And we're going to walk ourselves right back to 1992 as opposed to staying in 2026. When it comes to, you definitely have
- [12:28]
A
to be careful about this. You don't want to borrow against an individual stock that's going to crash 50 or 60%. There should be some common sense guidelines around this. I totally agree. You shouldn't necessarily borrow everything they like. It's kind of like a home. The bank will give you a certain amount of money to buy a home. You don't have to spend it all just like this. You don't have to use all the collateral that you can or the margin that you can. Yeah, but I think these things are fat. It's a fascinating way to utilize the market, but you better go in with your eyes wide open.
- [12:53]
B
And yeah, Ben, to your point, it's still leverage. Right? So to quote Jeff Goldblum, just because you should spend so much time thinking about whether you could, you didn't stop thinking about whether you should.
- [13:03]
A
All right, Joe, this was great. Appreciate it. We're going to put a link to the Alpha Architect piece that you wrote on short box spreads. I think if people want to learn more, you go into way more detail on there. So we appreciate it, this was, this was fascinating. Thanks for your time, man.
- [13:15]
C
All right, thank you.
- [13:16]
B
Rock and roll. All right, Ben, you ready for questions?
- [13:19]
A
Everyone's still, still confused in the chat, but I guess it's think about it as a way to borrow against your portfolio in a way that kind of tracks the treasury market, essentially. Yeah, right. Yeah.
- [13:35]
B
Treasury sets the rate of return. I think that's a good way to think about it. And effectively you're borrowing from the options market, but your stock, your securities been that are held in that account, that's the collateral. So if anything goes wrong, if you don't repay the box spread on trade date, guess what you get margin called.
- [13:50]
A
Yeah. And Chris in the, Chris in the comments says, I fear leverage like this. And I would not, I would never tell someone, take a box spread loan out, invest it in the market. That to me, that's not why you do something like this. You do it because you need a bridge loan for a house. You're paying down some of your high rated mortgage. You're doing the HELOC thing like I did. I think Michael did it and he paid down a high his debt on his boat because the rate was so high. You know, it's something like that where you're refinancing debt or you need a bridge loan or something. It's not like you, you borrow money to then invest in the stock market. That to me, you and I are pretty comfortable with leverage. I'd say me and you are more comfortable than most people. I would not be comfortable doing that.
- [14:25]
B
No. Because it cuts both ways. Ben. I think we all have a very long time horizon with this stuff. But yeah, I would agree. Very generally doubling down doesn't make a ton of sense.
- [14:33]
A
Yes. And Seth in the chat said, think of it as the inverse of the box ETF boxx. If we're from ELF Architect that you're on the opposite party there, you're earning the interest there. So it's just the, it is the inverse of that. Nicely put, Seth. All right, let's do another question.
- [14:48]
B
Great. So yeah, question two. Since Ben mentioned Bill, Sweet God, that guy's everywhere. Would be an S the compound.
- [14:53]
A
That's a not to brag being mentioned on the first two questions.
- [14:56]
B
While reading your own question, I thought that it was a good time to ask about asset allocation. How do I adjust dollar values and holding weights for this? I'm comfortable with equity risk, but I want to maintain dry powder for rebalancing to reduce volatility and take advantage of downturns. My goal is a 90:10 portfolio. How should I weigh this? With asset allocation in mind, any simple rules of thumb would be appreciated. And that signed Josh from Intercourse, Pennsylvania.
- [15:20]
A
Bill, your second question. You missed a word. He said asset location, location. Big miss by you as a location. Okay, that's fair. So I guess my question for you is do you have any general rules of thumb about asset location? So people think the one people usually say is, hey, if you have a high income strategy, it goes in a tax deferred account. If it's REITs, bonds, something like that. Alternatively though, well, what if I want to use that fixed income for spending though? Then I don't want to have it in my tax deferred account. So do you have rules of thumb for this stuff or is it like, no, no, no, I need the whole plan first and then I can tell you where your funds are going to go.
- [15:55]
B
Yeah, I think it's the latter, Ben. It's, it's the big picture that matters. This is the work of CFPs. I do prepare a chart though. Not a napkin, but a chart. Can we chart on please? So Ben, what Josh is asking about is income tax arbitrage. So if we take a taxpayer, Ben, let's say hypothetically at the 35% tax bracket, they're, they're going to pay 35% on any ordinary income which Ben, to your point would come from bonds, right? Something that's ordinary income or REITs you mentioned before. And so what that does, the tax rate turns $10,000 pre tax to $6,500 there in bold red post tax. And one way, Ben, to improve on that, if you think about where you could place your, your, your income producing vehicles, you would want to take advantage of non qualified accounts of qualified dividends, capital gains getting taxed at a lower rate. So Ben, just to kind of highlight, like to think about where to put the asset, that's where location comes into place and that's a pretty big arbitrage. Like how much would you work to save 15% on, on taxes.
- [16:50]
A
Right.
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B
It's a big deal.
- [16:51]
A
Right? You'd want like your index funds in your taxable account. If you have a dividend ETF that's going to go in the tax deferred. Right. So that's what they're getting at here.
- [16:58]
B
Exactly.
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A
That's the rule of thumb.
- [17:00]
B
Exactly, Ben. And you mentioned the big picture. So can you Pull on Chart 2? If you look at the big picture and you think, okay, I want 90% of my assets in this and 10% of my assets in this. You would start there and then go to each account and say, all right, where am I going to start? And I think we're. If you only have 10% of your funds that are going to be in income producing vehicles, I would want to allocate as most as I could to those in tax qualified accounts. And then I would fill in everything else in the long term gains, the qualified bucket. And that's been the kind of two layers to think about this. You would let the portfolio drive. You'd want to set your asset allocation first because that's a much more important factor. But then once you've determined that, then it's a question of which account do you hold? Which asset?
- [17:39]
A
Bill, I'm really disappointed in you. Why did you not put that chart back up? Why did you not make it yellow and make it into Mr. Pacman.
- [17:45]
B
Yeah, and turn it around. I mean, I thought about it at the very end. The reality is that train you heard coming by before. Before that. They did my homework. I had a bunch of napkins ready to go.
- [17:52]
A
So that train was you, not Joe?
- [17:53]
B
It was, yeah. That was not in conshohocking. Yeah, exactly.
- [17:57]
A
Are they exactly shoveling coal into that thing still?
- [17:59]
B
They're shoveling snow because we had that blizzard. 25 inches. Yeah. I don't know. I don't know about the lake effect situation up there, but I'm still. I'm still digging my way out up here in New York.
- [18:08]
A
Holy cow. 25 inches. Okay. You have a plow though, right, on your Jeep?
- [18:11]
B
I do, yeah. Unfortunately it's a little baby plow. I get a Jeep wrangler. I wish I had a picture, but yeah, that doesn't do a lot when you got two or more feet overnight. It was a rough one.
- [18:19]
A
Okay. All right, let's do another question.
- [18:22]
B
Cool. Question three. So if you have a home based business, Ben, and no other employment, what do you recommend for a retirement plan? Perhaps in the future, but five years. The business is not anticipated to have any other employees. Except for the principal employee, which I assume is DK. The owner income will be in the 90 or 125,000 range for a while. Is it worth setting up a 401 plan? Should I just contribute to an IRA or is there a way to get Roth money invested? And that's from DK and Truth or Consequences, Arizona.
- [18:50]
A
So I guess my. My first two options that spring to mind is a SEP IRA or Solo 401K, right?
- [18:57]
B
Yeah, it's exactly in order.
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A
Is that It.
- [18:59]
B
Yeah. No, for. For dk, I would. I'd start with the sep. And they're super easy. I think that's like, the key benefit to SEPs that I think is super underrated.
- [19:07]
A
That's what I do. I set a step up with Vanguard. You're right. It's super easy. They even tell you what the contribution limits are each year and how close you are to it.
- [19:15]
B
Yeah, it's pretty awesome. And you can do some really neat time arbitrage, too. So the SEP IRA contribution and establishment deadline is the tax return deadline plus extension. So for most folks, they're sole proprietorships. That's usually all the way out until October 15th. So, Ben, you or DK or anybody who starts a SEP until September. Excuse me, October of this year, 2026, you have the ability to contribute and take a deduction for last year's tax return. That's a pretty big advantage you get with seps.
- [19:43]
A
And then I guess his question about Roth. There's really not an easy way to get a Roth option, though, right? There's no SEP Roth option. There's no solo 401k option for a Roth, is there?
- [19:51]
B
Yeah. Oh, contraire. And so it depends on your custodian. I don't know about Vanguard, but I know the major custodians that we work with at Ritholtz. Yeah, you can do a SEP Roth ira. That's a thing. That's not a problem. And ultimately, you do not get a tax deduction. Right. For somebody earning roughly $100,000 net, they're able to contribute roughly $18,000 to a SEP. And you can select Roth and you can select traditional. So the question there has been, do you want that money to go in post tax? Right. No tax deduction. So you don't get to enjoy a tax break up front. But then it grows tax free. There's no reason not to consider SEP Roth in this. In DK situation.
- [20:25]
A
Yeah. And it sounds like he does want the Roth, but. Yeah. The good thing is these things are not that hard to set up.
- [20:32]
B
No, they're really not.
- [20:33]
A
You can still do a Roth ira, too, but. Okay.
- [20:37]
B
Yeah, it's functionally the same. You know, regulatory structures and ira. It's just the contribution limits are different because they're tied to the business. The only thing DK mentioned, no employees. Right. Now, if you do hire somebody, you do have to contribute to your employees SEP IRA at the same rate that you're contributing to yours. That doesn't mean the same dollar amount. It's all tied to compensation. The other thing that DK might consider is a K plan, but it's a little more complicated. There are a lot of prototype plan spend that are available. TD Fidelity, our main man, Dan LaRosa out in Long island also got buried with almost 30 inches of snow. He's the gentleman to talk to about this. And there you'd be able to add about $24,500 of elective contribution, exactly the same money that you can contribute to traditional 401k plan. You could do that with a K plan. So the contribution limits are a lot higher with, with solar, with solo K plans.
- [21:22]
A
Now, I didn't, I didn't look into the, all the details. Yeah. But it sounds like last night at the State of the Union, Trump mentioned something about maybe opening up the TSP to people who don't have. And this is the platform you and I have been running on for years now.
- [21:34]
B
It does.
- [21:34]
A
What are the odds that that actually happens?
- [21:36]
B
Yeah, I don't know because, you know, Trump says this, Trump says that. Who knows exactly what that means, right. Until we get it. But you're exactly right. I was going to bring that up at the end at the State of the Union. That was exactly what perked up. I was. The conversation, that comment that got back to me was, we're going to open this up. It's going to be similar to what the government thought people can contribute to and blah, blah, blah, blah, blah, whatever that cadence of word is. And yeah, tsp, the, the Carlson Suite platform came to mind.
- [21:58]
A
I hope we see this. That'd be great.
- [22:00]
B
That would be amazing.
- [22:00]
A
It makes no sense. Why? Because. Right. For people who don't have. Or people who are. Because I, I have to imagine. I know there's a lot of worries about AI right now. I think what one of the things that's going to happen is we're going to see an explosion of small businesses from AI. I think there's going to be explosion of 1, 2, 5, 10 people. Businesses that don't have health insurance, don't have their own retirement plan, are going to need something like this and want to still do this. And I think if that's an option, I hope it is. That would be great. Because it's not easy to do on your own, is it?
- [22:27]
B
Yeah, I love that comment. You guys talked about this on Animal Spirits yesterday. But like, what's going back and forth in my mind is like these competing science fiction narratives. Right. About what AI is going to do. The thing that I just kind of Conclude at this day and age, Ben, is anybody who says this is going to happen with all the language model stuff, I just automatically discount it. These are people making up stories based on what they're projecting and who the heck knows. But yeah, I, I take the opposite because Ben, I think the lesson of history is when you get technological disruption like this that creates a lot of opportunity.
- [22:56]
A
Yes. And credit to our, our audience because we are not getting a lot of AI questions, which is nice.
- [23:02]
B
That's interesting.
- [23:02]
A
I'm glad, I'm glad to take it. I surprisingly, we haven't gotten many. Maybe the inbox will be full of next.
- [23:07]
B
That's really interesting. Do, do the listeners know that we're on an AI model right now? That that's you and me going back and forth the joke I made the comments. Have you seen the things where Tom Cruise and Brad Pitt are getting no fights and they're just beating up bad guys in history?
- [23:19]
A
Yeah, I, I watch those and I'm not worried for Hollywood when I see those. I don't know.
- [23:24]
B
Exactly. Exactly.
- [23:25]
A
I was going to the movies. All right, let's do another one.
- [23:28]
B
Exactly. So this comes from Nathan. So Nathan says, my wife and I, 36 years old, are leaving our high paying jobs in California for lower stress job in the Midwest. We've saved about $3 million of investments, 2 million in taxable, not to brag and more or less want to coast fire capital C, capital F and potentially use dividend payouts to support our lifestyle where we take lower paying jobs and some general time off working, leaving the rest to grow. Looking at funds that you can see on the ticker, you can get roughly 3% dividends tax to capital gains rates and still get upside from equities versus bonds at a higher tax rate but more limited growth. Since I wouldn't plan to touch the principal for about 10 years, I'm trying to find the best way to allocate for this extra type of income with upside. That's from Nathan in French Lake, Indiana. Ben, what do you say?
- [24:15]
A
All right, so obviously the big for you is lower taxes by moving to the Midwest from California. Much lower taxes.
- [24:21]
B
Yeah, right. Where would you pick if you didn't go to Michigan? Ben, which state would you pick for income tax purposes?
- [24:27]
A
Oh, what are we talking? Minnesota. Wisconsin. Not Illinois, Right?
- [24:32]
B
No, Illinois actually doesn't tax retirement distributions. A flat 5.75%.
- [24:37]
A
Chicago. Okay, what is your answer?
- [24:39]
B
The state is not Minnesota that has freakishly high tax rates. Believe it or not, you get almost 10% pretty quickly. Yeah, I don't know. That's a really good question.
- [24:46]
A
Michigan's not bad, right?
- [24:48]
B
Yeah. Wisconsin. Yeah, any place, any place in the, in the, in the beautiful Midwest would be great. I think I'd choose Michigan though. I just didn't want to give you that option.
- [24:56]
A
All right, so they're looking at 3% dividends and their $2 million taxable portfolio. And obviously at 36 years old with $3 million they have their flex, they can be flexible here. So they're saying we're taking lower paying jobs and we're going to try to supplement some of the income that we're giving up in California with 60k in dividends. Call it. So it's 3%, that's 60k. I do think that they're probably not taking into account much lower their standard of living is going to be like they might not even need to live on these dividends depending on what the salary difference is and because the cost
- [25:25]
B
of housing and yeah the housing thing is huge.
- [25:27]
A
That's going to be if, especially if they're selling a home in California potentially to move like so a lot of
- [25:32]
B
cows in Wisconsin, price of milk, what they give it away, right? They give, it's 50 cents.
- [25:36]
A
But actually they, their whole coast fire thing could be doable. So I, I just did a back of the envelope thing. I should have done a napkin one. People in the chart, in the comments are really mad. You're not doing napkin charts anymore. Everyone's.
- [25:46]
B
I'll be back.
- [25:48]
A
So let's say you pull your 3% dividends and then let's say conservatively you get 4% growth in on the rest of your portfolio right from that I think 7% total return is conservative and I'd be conservative for a reason. If you're using, doing this at age 36. Right. So in 10 years that 4% growth would still grow your 2 million to 3 million plus whatever your million dollars in tax deferred retirement account is growing to. That's not bad, right? That's not, it's not terrible. So I, I, I don't think that this is with how much money you have at age 36 can you retire on that 3% depending it depends a lot on your spending. Probably not. But can you be more flexible and yeah, take a lower paying job and maybe work part time or something for a few years while you figure. I don't see why that's a problem. They've amassed so much money at such a young rate, young age. I think they can probably do this
- [26:41]
B
yeah, it's a great point for Nathan didn't give us a lot of cost of living information, so that would be super helpful here. The way I kind of thought about this, Ben, I would recommend Nathan consider a total return approach. Right. I think focusing on the dividend yield is useful, but ultimately the income stream that you get from a portfolio, I don't know that I would necessarily segregate it this way. The dividends make sense because they hit your account and you can spend them.
- [27:03]
A
Right.
- [27:04]
B
Ultimately, roughly $30,000 would be their dividend yield if they were invested in, let's say a diversified basket of stocks and bonds. But Ben, I generally think it's a mistake to overalllocate to dividend paying stocks just for the yield. Right. Because not always, but typically those are not the fastest growing companies. You end up underinvested and things like that.
- [27:21]
A
People love living off the dividends. So there's another question about it, that idea that I'm going to live off the income and I'm going to let the principle go for whatever reason, psychologically people love that idea. And you're right because they could, if there's long term capital gains taxes, sell down the portfolio.
- [27:36]
B
Yep.
- [27:37]
A
Right.
- [27:37]
B
Yeah.
- [27:38]
A
If they have a very fair point. Yeah, they could create their own dividends. But people don't want to touch the principle. It's, it's antithetical to some people's just way of living.
- [27:46]
B
Yeah, I've just seen it, I have seen it go wrong though, Ben. I've seen people over allocate to these types of dividend strategies and the dividend traps are everywhere. Right. So ultimately it's in the eye of the beholder or the future is not unknowable, you know, unknown. It's just unknowable. But at the end of the day, I think the issue with overalllocating to dividend paying strategies is that those are still equities. Right. And they can have a 60% drawdown, some of these individual securities. And you're probably going to end up in places like energy, you know, industrials, you know, larger, more established companies who theoretically are more stable. But Ben, you mentioned before the disruption coming in. AI we don't know. I think that's the issue. So I think a total return approach makes a lot of sense. Ben, are you familiar with the work of Asth de Mordrin at nyu? Taking a look at how he breaks down things, that would be to me where I'd spend a deep dive. Because I think he does a really good job, academically breaking up what the components of expected return are.
- [28:38]
A
Right.
- [28:38]
B
And ultimately, dividend yields is one factor, but really the source of all this is earnings yields in the company and then an expectation of future return and an equity risk premium. Right. And so if you set the risk free rate for treasuries at 4%, you have a 3.4% earnings yield. Like the equity risk premium embedded in all those assumptions is about 3.5% right now. So overalllocating that to dividends to me doesn't make a ton of sense unless it's like Nathan's getting at. They want to extract cash from the portfolio in the near term and they're comfortable giving up a little bit of upside on the back end.
- [29:11]
A
Either way, you're pretty good. At 36 years old, this much money, people in the chat keep writing in that. We need more people with less money to be writing in. Henry's. Hey, send us your question. Inbox is open. We do not discriminate in the inbox. And if you're a service member who's also a woman, we're going to read your question immediately.
- [29:26]
B
Top of the list, right?
- [29:27]
A
We're going to do an emergency pod. All right. We got one more question.
- [29:30]
B
Sure. So question five. I have $1,600,000 in a taxable brokerage account, $250,000 in traditional, and another $150,000 in cash. No debt and no house. I'm single, no dependents. I need about $170,000 of annual income in order to retire at a 4% withdrawal rate. I need about 4 1/2 million to meet that goal. In recent years, covered call funds have become very popular. For example, One fund yields 12%. That means $1.4 million would, quote, unquote, yield $170,000 a year. If this is too good to be true, why is this a bad idea? This part stuck with me, Ben. I'm 42 years old and I'm miserable. I own a small business. I've worked nearly every day for a decade. I don't know if I can do it anymore. I'm totally burnt out and I want to be done with it. John.
- [30:16]
A
Now, see, this is the other side of people saying, like the. Not to brag, but this person has 2 million. If you add it all up, it's $2 million. He's 42, $2 million and miserable because to get that money worked his butt off probably. Right?
- [30:28]
B
Right.
- [30:29]
A
So I think that's something to remember on the trade off on this stuff.
- [30:31]
B
Yeah, there's downside.
- [30:33]
A
I really liked how you did yield in quotes. Or was that him? Because yield is okay. I'm glad you did that. Okay, so here's the thing. He's right. We've Talked about the 4% rule a lot here and at talking wealth. If he did 170k out of that 2 million, that's an 8 and a half percent withdrawal rate at 42 years old. There's very little margin of safety there. We're talking razor thin. I would not be comfortable taking an 8 1/2% withdrawal rate at 42 years old. That to me. And the thing is the way he lays it out, the covered call option sounds enticing. I know a lot of investors love these funds for this reason. You go, oh my gosh, the yield is so high I could just take it out. And I'm living off of this same thing. I'm living off of a much higher dividend. Yeah, John, it's too good to be true. It sounds awesome in theory. Let's look at some charts. All right. Pull up my first one. Actually do the next one. Guys, we're going to come back to this one. There we go. All right. So this is this fund SPYI get it SPY Income. Neil's fun. We had Neil's on talking about before talking about this fund. So this is over the last five years call it since this third fund came out. And it lags the S and P in a bull market which shouldn't be a surprise. But the returns are still pretty good, right? For a covered call fund. Because the way covered calls work is you're. It's. It underperforms during a raging bull market because you have a ceiling on it because you're. You're getting that option income. Right? Your stocks are getting called away. Okay, makes sense. Now let's look at the difference between this fund, the price and total return. Next chart please. So again, this is the same fund spyi the total return 60 some percent. The price return is about 7% in total. What this means if you don't get it already, the major. All of that gains is coming to you in option income. And what it's doing, that 12% yield is more or less paying you back essentially some of your principal in the form of future growth. That's what option income is. You're selling your future returns to get them. Now that income, right, you have to be compensated for. So you're. All of your return essentially is being paid back to you. Right. That's what that yield is. So the Risk here with this strategy is inflation could eat you alive or a bad market. These types of covered call funds don't go down as much as the market because of the option income. But you're getting, I'm making up a number, 90% of the loss or something. So a bad environment that's going to make your income volatile and that's also going to potentially with inflation, eat it away. Yeah, you're still getting 170, but you're not growing that 170 very much. So that's the problem with this. This is not a, this is not a fix here, essentially.
- [33:08]
B
And it's negative tax arbitrage too, Ben. What you would enjoy in capital appreciation, tax deferred, that would come in the form of capital gains in the future. You're now paying ordinary income in the present. Effectively, you took exactly my point, Ben, and said it better. You're stealing from your future income and it's pretty tax inefficient to boot. So therefore I wouldn't recommend covered calls as the solution to John's problem. Ben. I just kept that could be, that
- [33:34]
A
could be part of it, you know, that could be a smaller piece of it. But if you're banking on that being your whole thing. But I guess so what are the tax implications for option income too? Is it any different than what you're paying?
- [33:47]
B
It's ordinary income is my understanding. Because ultimately, yeah, you're writing calls, so you're getting that income today. And yeah, it's, it's pretty tax inefficient. And if you're not running a business, you're not doing anything else. Maybe that's not a bad thing. Right. With higher standard deduction and lower taxes today. But still I think it's pretty tax inefficient relative to where John is and furthermore the success that he's had for the last 10 years. Right. He's in a position, Ben, in my opinion, of tremendous financial strength. Oh yeah, yeah. And I just looked, I felt my heart bled for John. Right. Because I was in his shoes back in 2015, before I joined this merry pirate ship and I was on my own. I was running a business and I was having a lot of fun doing it. But ultimately the weight of the business of being that sole individual bread earner, that started to drag me down. And I was working weekends, particularly this time of year during tax season, and it does take a toll. So I just kept thinking, John, the business has some value, right? I mean, you've built something. It sounds like it's been successful. You've been able to save. Yeah.
- [34:45]
A
Sell the business, take on a partner where they get some of the profits. You get some of the profits. Yeah, you're right. He's 42 years old, no debt, no pesky kids on his balance sheet to pay for 2 million dollar portfolio.
- [34:57]
B
He's got.
- [34:57]
A
He's got plenty of options.
- [34:59]
B
Yeah.
- [34:59]
A
It's just. Yeah. Could he do. Is that. How much is that business worth to do something with? And then, you know, could you, could you reassess for like, you know, if he just got 8% in his portfolio for the next 10 years, he's at $4.3 million. Is that his goal? Could you do. Listen, he also could. He could take a year or two off. Right, right. He's got so much money. Well, take a year or two off,
- [35:20]
B
depending on the business return. Yeah. But I just kept thinking, John, to me, feels trapped. And I would just say, hey, I would strongly recommend talking to a CFP at Ritholtz or somewhere else to sit down and come up with a plan. Because ultimately, $170,000 today, Ben, based on John's assets, it's about an 8% withdrawal rate. He's not that far off. Right. Versus where he would want to be. If he's able to average a 6% return, he'd probably chew through about $600,000 of principal over the next 10 years. And then you just need to build a bridge for the next 10 years to get to Social Security at 62. I think John has set himself up very well financially for retirement. He just. I think he needs to sit down and have somebody tell him. That would be my take.
- [35:58]
A
Mark in the chat says 8% is way too high. I think. I feel like in this environment, I'm being conservative here. I'm trying to be conservative.
- [36:04]
B
Oh, wow, the AI has got your. Got your mind, huh? I think it's more responsible, Ben, to plan on somewhere 6 per 7.
- [36:10]
A
Yeah. I think if it's a more diversified portfolio, he takes a year's worth of cash and puts it into a CD or money market or something. And. Yeah, you're right. Fair. Yeah.
- [36:19]
B
I mean, just for planning purposes. Right. And if you get 8%, that's even. That's great. But yeah, I think, Ben, John needs to find a bridge for the next 20 years. And I think somebody who works in financial planning could really make him feel really good about where he's at and ultimately give him some options to consider. Even. Ben, to your point, he sells a business, works Part time. I think that's more than enough to bridge to where he needs to go. Similar to our question from two questions ago. You know that, that east coast fire or Midwest.
- [36:43]
A
I don't think trying to find like some back way around to get in the back and the back door retirement to like use a fund to like, hey, I figured out the solution. Like that's not a solution. That, that's not a financial plan. Right, that's exactly. I agree. He's got to talk to someone. Good point.
- [36:59]
B
Exactly. Yeah. Some of these, some of these questions just go, go beyond, you know, the numbers. And I, I think sitting down, having John, you know, get some counseling and ultimately figure out where he wants to go, build a plan that, that, that bridge I think is there. I, I could paint a couple of different pictures for.
- [37:12]
A
See, this is what makes. Says 8% is too low. I knew it. See?
- [37:16]
B
Exactly. We'll know in 20 years.
- [37:19]
A
It's the old George Carlin bit. Everyone who drives faster than you is a maniac. And everyone drives slower than you is an idiot.
- [37:24]
B
Exactly, exactly. And you're not in traffic. You are traffic is what I tell folks in New York.
- [37:30]
A
Yeah, there you go. Okay. And next week, everyone in the live chat on YouTube and in Twitter, I expect you to tell us what a box spread is. There's going to be a quiz, okay? I don't care if it was confusing. We're going to ask, email us, ask the compound showmail.com. we don't care how much money you have. We don't care. Your financial problem is taxes, personal finance, investing.
- [37:50]
B
You said it a couple shows ago. Just cut off a zero. These problems are universal.
- [37:54]
A
Exactly. Thanks to Bill. Bill will be back next week, so ask many more of your most speak questions.
- [37:58]
B
We miss you, Duncan Hill. Come back soon.
- [38:00]
A
He was saying prayers for Oli in Japan. All right, see you next week, everyone.