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- [00:00]
A
Welcome back to Ask the Compound, the show where you ask and we answer. I'm Ben Carlson. The Fed cut short term interest rates 25 basis points in the latest meeting. They signal they will be likely cutting at least two more times this year alone. What does this mean for your cash? Is it time to move it around? Should be making asset allocation or asset location changes. We're going to answer these questions and more on today's show. Stick around please. All right, if you have a question for us or email, here is ask the compoundshowmail.com on today's show we will be answering answering questions from the Compound inbox about whether or not it makes sense to store your cash in a Roth ira. Does Social Security count as part of your fixed income allocation? Should a level 3 CFA candidate what should he do about his career? Where should you staff profits from a real estate investment? And how should financial advisors think about setting long term return expectations? Today's show is sponsored by exhibit A. Check out exhibit A for advice to transform your client experience with Wealth's premier custom based branded charts. You know Chart Kid Matt, he used to work for Tom Lee, I was about to say. Then he came to us.
- [01:05]
B
Chart Kid Matt. People hear about Chart Kit Matt all the time. That's exhibit A. Yeah.
- [01:09]
A
He said I want to start a business where I take all the charts that we have and we allow people to financial advisors to brand them, put their colors on there, have some dialogue, explain it to their clients. Because financial advisors are busy. They tell us all the time, listen, I don't have time to create content like you guys. I want to be able to explain this stuff to my clients. What's going on, some long term charts. The cool thing about exhibit A is you can take your own logo, put it on there, send these charts out to your clients on a weekly basis, put a newsletter, send out a chart, two or three bullet points. Here's what's going on. Here's some long term context for you. It's great. You can sign up today for a free trial, seven days and then you're going to sign up and you want to stay forever. So it's exhibitafouradvice.com to learn more.
- [01:52]
B
Everyone wants a piece of Chart Kid Matt.
- [01:53]
A
You know that's right. The charts are everywhere. They're going to be all over my blog. It's great. All right, let's do some questions.
- [02:01]
B
Okay. Up first day we got a question coming in from Chris with a K. Like our own Chris Fenn.
- [02:07]
A
That's right.
- [02:08]
B
With the Rates on cash going lower. Is it ever a good idea to store cash in a Roth IRA since the deposits can be taken out whenever. Is this a better plan than lower interest rates on cash?
- [02:19]
A
Very astute questions.
- [02:19]
B
I don't quite understand this one, so I'm looking forward to hearing where you go.
- [02:23]
A
Well, so I think I know what's going on here. So the Fed did cut rates last week. The dot plot, which I still don't get, the dot plot thing, it seems like something that my kids would do in kindergarten. I don't know why they do the dot plot.
- [02:34]
B
I just picture a dot matrix printer. I don't know.
- [02:36]
A
So yeah, yes, it shows that we could do. And then you had to pull the things off the side, remember? So it shows that we'll likely see two more cuts this year at least. So that would take us to sub 4% on cash and cash equivalents in a hurry. So that's lower yields on Money Markets. CDs, T bills, floating rate bond funds, ultra short term bond funds, stable value funds, high yield savings accounts. Sure, I missed something. Just about everything. Those yields that you got like 5% in are going lower, maybe much lower, who knows? So I think the question here is, listen, I don't want to keep my money in a high yield savings account anymore or T bills or whatever. If the yield's going lower, what do I do? And it's funny, I don't know what the magical level is, but do a chart on for me, Daniel. This is the money currently sitting in money markets and it's $7.3 trillion and you can see it's taken off like a rocket ship even as the Fed's been slowly but surely cutting. So I don't know what the line in the sand is, but I think it's going to be very interesting to see like if this bull market and money market funds ever reverses or if this is just baby boomer money that's going to be there and sticky forever. But it is pretty crazy that we've had this bull market for the last couple years and you've also had a bull market in money going into money market funds. So I think it's interesting to see if that money is sticky or not. So back to the original question. Does it ever make sense to park your cash in a Roth ira? I think the thought process here, and Bill Sweet has talked about this, is the fact that you don't pay a penalty, you don't pay taxes on your contributions to your Roth. Right. The investment dollars you can't take those out if you make any money, but you can take out your contributions tax and penalty free. So I think that's the idea. The problem is I don't totally hate this idea, but you still have to invest it in something, right? Your Roth IRA is not.
- [04:12]
B
Well, that's what I was about to ask for our young people watching who are completely new to this. As soon as you make the contribution into your Roth, even if it's still cash, it still counts as a contribution. You can't just pull it out without it counting as withdrawing a contribution, right?
- [04:26]
A
Yeah, but even if the money is in the Roth area, you still have to pick something to invest in. You have to invest it in stocks or cash or bonds or some other type of investment. So this is more of an asset location question, but you also have to answer the asset allocation question part of it. Right. So your Roth can work as a place to pull cash from. But I still think with like if this is an emergency fund type of ordeal, I think it's probably just easier to have it in a high yield savings account type of place. So it's, it's easier to access and more liquid. And so I don't know, I don't want to over. I think a Roth IRA can be a great like backstop break in case of emergency. I don't know that you want to use it interchangeably as that type of cash fund. I think there's a lot of better and easier ways to do this. Just keeping cash in your brokerage account, for instance. Like I think any of that stuff is probably easier. And since we're talking about Fed rate cuts, I wanted to pull a chart we did last year just to show people. Let's do chart on Daniel. I think we did this last year after the first Fed cut. It just shows the four different. Speaking of Char kid, Matt, he created this one Forward returns with over one, three and five year periods after the Fed cuts. And if there's a recession or not, and obviously if there's not a recession, the returns tend to be a little better. It's funny, even if there is a recession, the returns tend to be not bad. So maybe the stock market is going to be just fine coming from here, who knows? But yeah, I would just be careful about taking too much risk with your cash. That's always kind of my personal stance. I don't think it makes a whole lot of sense. And I think adding an extra layer of complexity and another step in getting that cash back is to me not probably not Worth the hassle. That makes sense when a max IRL fire rate do it, but I don't think I would do it with the understanding that it's going to be some sort of emergency thing unless you really need to tap it.
- [06:15]
B
And yeah, there's no, like, magic here. That's what I was trying to figure out, what they're asking. There's no magic to just keeping cash in a Roth IRA versus keeping it in a brokerage account.
- [06:24]
A
Yeah, yeah. Or you could say, well, you're not getting taxed on the, on the income anymore, but, you know, that's the kind of place where if you're trying to defer taxes, you want to do it for long term gains and better return prospects than cash.
- [06:36]
B
There's not the equivalent of a high yield savings account in a, in a rotha. Right. It would have to be a money market fund or something.
- [06:42]
A
Oh, yeah, Money market or. Yeah. Kind of similar yield. But yeah, again, if you're trying to defer taxes and not do the tax thing like you want to have it be something that pays more income or has a higher return profile than cash, that, to me, does make a lot of sense. All right, let's do another one.
- [06:57]
B
Okay. Up next, we got one straight from the YouTube comments. Andy Jacobson asks you reckon your Social Security balance should be considered a portion of the 40% of bonds in the 60:40 portfolio. So the rest of what you directly control might be 65, 35, 70, 30 or whatever. And the bonds would exclude Treasuries.
- [07:21]
A
We've been trying to guess where people are from lately, but Andy's got to be another Southern guy if he's saying reckon, right? Because I don't use the word reckon or y'. All. That's not my lexicon.
- [07:29]
B
Yeah, I was thinking about that. Yeah. Or like Australian, maybe.
- [07:32]
A
Reckon. So we've gotten a lot of questions like this over the years, right? I have a pension, I have Social Security, I have an annuity. Does that count as a fixed income portion of my portfolio? I actually wrote a blog post this week about the importance of Social Security, and it's, it's much more important to a lot of people than you realize. So, Daniel, let's do the chart here real quick. So the CBO estimates that Social Security accounted for 20% of household wealth in the US by the end of 2022, which is the last time they had this data. Other retirement accounts, 401ks, 403s, IRAs, pensions, et cetera, made up 21% of household wealth. So Combined retirement accounts and Social Security are like $80 trillion of the 199 trillion in total household wealth. But you can see this, this chart here shows by different wealth percentiles. The top 10% has most of their money in stocks and other investments. So the Social Security doesn't make a big, big piece. But if you look at the bottom 50th or the bottom 25th percentile, Social Security makes up a huge portion of their wealth. So actually it is a big thing here. And you can do chart off. I may be splitting hairs here, but I personally like to separate regular income from your portfolio in terms of like the allocation. So you take your sources of income and then you take your spending and you figure out like what is the difference my portfolio needs to make up. So maybe you could say Social Security allows me to take a little more risk. So Instead of a 60 40, I can do a 7030 because I don't need to take as much from my portfolio. But it's hard to have Social Security do the same things that a fixed income allocation can do. You can't rebalance with it. It's not liquid. You can't sell, sell it all. So it provides liquid like fixed income or sorry, it provides income like fixed income, duh. But it doesn't really have the same, it doesn't dampen your volatility of your portfolio. So I think it can allow you to take a little more risk. But I don't necessarily look at it like a bond because it doesn't share all the same characteristics. It shares more characteristics of an annuity or a pension stream of income. So I like to invert the question and think how much am I going to have to cover for my portfolio after my income sources and my spending and then figure out what that can look like. So yeah, it can allow you to take more risk, but it doesn't, doesn't give you everything a bond allocation can give you.
- [09:48]
B
Got it.
- [09:49]
A
Are you worried that Social Security is not going to be there for you when you, when you retire or not?
- [09:52]
B
I mean people have been saying it for a long time. So it's one of those things where yeah, I'm kind of numb to, to the idea of that happening.
- [09:59]
A
But yeah, Social Security is going to be there.
- [10:01]
B
Yeah.
- [10:01]
A
Listen, it's a Ben I don't want.
- [10:03]
B
To Ben Carlson guarantee.
- [10:05]
A
Yes. Listen, I don't want to overestimate our politicians density for making dumb decisions if they ever decided to touch Social Security. You can see from that chart it's such an important part for so many people's lives. It would, it would seem to be very reckless. But like, hey, politicians have done other reckless things.
- [10:22]
B
When I saw some people saying that the, the Trump accounts for kids are like a first step in the direction of possibly trying to, you know, either lower or get rid of Social Security, I don't know. I mean, maybe, who knows? But yeah, I don't, I don't, I.
- [10:36]
A
Don'T think Social Security, it's, it's one of the best programs we have ever enacted. And if politicians decided to get rid of it, it would be a very, very bad idea for a lot of people. That's my stance. All right, let's do another one.
- [10:48]
B
Oh, before we move on to question three, I forgot my own follow up to question one I was going to ask you about. So the Fed just cut 25 basis points or, or bips, right. If you want to sound cool. How does that impact mortgage rates? And does it, you know, directly impact mortgage rates? I see a lot of people thinking that immediately mortgage rates are going to drop then. Do they?
- [11:08]
A
Well, it's funny because The Fed cut 50 basis points last year and mortgage rates like immediately from the day the Fed cut, mortgage rates started going up. And so yes, the Fed controls overnight rates. It's short term rates. That's why it impacts cash yields. But it doesn't necessarily impact mortgage rates. Like if you turn on the Today show or CBS Good Morning, that's what they say. How does the Fed rate cut impact you? Well, it could mean lower bar. It doesn't necessarily mean that because the mortgage rate is tied more to the 10 year treasury, it trades at its spread to the 10 year Treasury. So if bond yields fall, then yes, mortgage rates should fall. But just because short term rates fall doesn't mean bond yields have to fall longer term bond yields because the Fed doesn't control. Unless the Fed decides to start buying longer term rates or buying mortgage backed securities, which I don't completely rule out either, then it doesn't have to. But it's, it's, you'd think as long as inflation is falling and the Fed is cutting rates, the signal would be for mortgage rates to fall, but not guaranteed at all.
- [12:06]
B
Okay, so am I understanding it correctly then that let's just pick like a random winter, like SO5 for instance, they just can pick whatever mortgage rates they want to offer people. It's just, there's no, like, it's not tied to anything directly from a regulatory or government standpoint. They can just be like, this is what we're charging. This is what we want.
- [12:25]
A
Well, technically, but they, they have their own balance sheet that they then. Right. Earn income on and they have to have some sort of spread that. That's. Could a bank. But yeah, they'd be, they'd be locking in losses for. For what reason?
- [12:40]
B
Right, right, yeah, I meant on the other end, they can just charge as much as they want for.
- [12:43]
A
Yeah, but as much as. Typically a spread over the ten year treasury, though. That's the thing. A lot of people think it's the 30 year mortgage or 30 year treasury because a mortgages are mostly 30 years. But the average like duration of most mortgages because they get paid back or they get refinanced is like seven to 10 years. So typically that's why mortgages, that's why the mortgage rate follows the 10 year treasury more closely than anything because it's got a similar duration.
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B
Okay. I didn't realize that that many people pay off early.
- [13:11]
A
Well, think about it. People move, people pay off, people refinance. Yeah. Most mortgages don't make it to 30 years. I've, you know, in my. How many years as a homeowner? Almost 20. You know, 15 years as a homeowner. I probably refinanced four times in different homes. Right. So yeah, not as much happening these days. But yeah, that's the, it's the duration of a mortgage. The average duration is something like eight years.
- [13:35]
B
Okay, I didn't realize that.
- [13:37]
A
Yep.
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B
Okay.
- [13:38]
A
Learn something new every day, Duncan. All right.
- [13:39]
B
I do. Okay, up next. We got, we got a good one. It's a hard one, but a good one. I'm a 22 year old CFA level three candidate. I work as a portfolio analyst for a wealth management team in a multinational bank. I've been working here for about a year and haven't found much pleasure in it. My team is composed of good people and I'm grateful that I have a job. But I spend most of my days plugging in Excel formulas. I've always seen myself as an introvert and struggle to talk in large crowded areas. So I don't think becoming a wealth advisor would suit my skill set. Do you have any ideas on what I should do with my life? I've considered risk management, running a fund or PE in a blue collar sector. My net worth is about 250 to $300,000. I started a lawn mowing business in high school and started investing when I was 17. I still mow lawns part time. My parents recently got divorced, so I've been struggling with depression and I'm not sure where my family will live in the future. Since I've been working since age 15 and all through college. Would you recommend that I take one to two months of a break from work after I pass the CFA Level 3 to clear my head and think about next steps?
- [14:49]
A
All right. A cliche podcaster would say there's a lot to unpack here, but I'm not a cliche, so I'm not going to do that. This is a lot for a 22 year old and my mind is like blown that this person has 250 to $300,000 of a net worth at age 22.
- [15:04]
B
I mowed lawns in high school and I did not save up that much money from it.
- [15:07]
A
It's crazy. Obviously you've been carrying a lot of responsibility from a very young age and now you're dealing on top of that with a difficult family situation. So my first piece of advice is just pat yourself on the back like you're. This is an incredible accomplishment at that age. Like I can't even imagine how much hard work has gone into that while studying for the cfa, while going to college, while running a business, while having now an actual job in the real world. So this is an amazing accomplishment. At 22, I did not have any of this stuff locked down at all. Well done. Here's the thing. If you don't save another penny and you grow your, let's call it 275k, take the middle point, right chart on here. If you grow this 275k at 8% from now until you turn 65, so it's 43 years or whatever, it would be worth $7.5 million. So the fact that you saved so much money at a young age, you know, you have more than the median retirement balance right now for any age. In 40 plus years, you're gonna have seven and a half million dollars. So chart off if you need to take a couple months to get your head right and use some of this money for that, like, do it. You're fine, you're fine.
- [16:12]
B
Are you coast by at 22?
- [16:14]
A
He is. He's coastify already. But this is the person that's never gonna be able to do that. Right. Because they're a hard worker and they're saying saver.
- [16:20]
B
And yeah, when I read the still mowing wands part time part, I was like, wow, this, this is a serious guy, right?
- [16:25]
A
Yeah, yeah. So there's a lot on the plate here. He's shown that he can work hard. Like if you have to take a couple, couple months off of work after finishing the CFA and figure out what you want to do with your life and figure out your family situation, like that's not going to be the end of the world. I don't know what you should do with your life, but I have a few ideas for you. All right, so risk management was one of the options. That seems to make sense with what you're looking for. It's very math heavy.
- [16:49]
B
Can you give me a Cliff Notes of what that even means? I don't even know what that means.
- [16:52]
A
Well, it would deep quantity. He'd need a deep quantitative background for that. So that's like risk management is just a lot of formulas and stress tests and what happens. So, so it's.
- [17:03]
B
And you work at bank or a hedge fund or. Or what?
- [17:06]
A
Yes, okay, yes, exactly. Bank or a hedge fund. It's a. But again, a very math heavy. So you need a big, deep quantum background to do that. Maybe he has that, I don't know. Could go for an analyst role at a fund company if you want to run your own fund someday. But those positions are kind of a dying breed at the moment, especially for a 22 year old. I think. I think that one might be kind of tough. I think you could also consider going to work for like a family office or some sort of institutional fund, like an endowment or foundation. That's what I did. And it was a wonderful way to learn about portfolio management and the different fund structures and all that. But here's the biggest piece of career advice I will give you. He says he's an introvert. So this is from one introvert to another. Like you have to learn how to sell and communicate. And I get the idea that like you don't like it, you're not comfortable with it. But when I was younger, I always looked down on the sales profession like it was beneath me or something. Because to me, sales was always the used car salesman. Right? It's someone who's trying to trick you into buying something for a price that's not fair and something you don't need. So that was always my. And like in my head that was what sales was. I interviewed at a bank right out of college for an analyst role. And they said, listen, this is an analyst role, but essentially it's a sales position. I told them, no, thank you, I don't sell, I can't sell. I want to do the Excel stuff like this guy. But I quickly learned in my career that in some way everyone is in sales. None other than Warren Buffett himself said the most important skill in finance is salesmanship. So think about it. Everyone in some ways is in sales and marketing, right? Finding a good job is about selling your self and your strengths. Finding a spouse is about marketing your good qualities, right? If you want people while you're at a job to like your ideas and your opinions, you have to convince them that your opinions matter, right? This is especially true when you're first coming up, right? So you need some sort of like elevator pitch because people aren't going to give you much time. Networking plays a huge role when finding a job these days. Especially when people can just AI their cover letter and resume to everyone in every position. Like so even if, let's say this guy decided I'm going to run my own fund, you know, it's fine, I'll pick the investments. Being a portfolio manager is not just about picking investments. You have to sell your strategy to investors too if you want. Like why do you think all these fund managers are on CNBC all the time? It's a sales role in a lot of ways, right? Yes, they have to pick the right investments, but they're also selling to their. Like, why do you think bond investors are always talking about how the stock market sky is falling? Jeffrey Gundlock is not a perma bear because he really believes it. He's a perma bear cause he's trying to sell his bond fund to people like hey, invest in bonds cause all this other stuff is going to go wrong. But the thing that really clicked for me is that once I found something I was passionate about, it didn't feel like sales anymore. So I think you have to find a company or a group of people or firm that fits your values and belief system. Then it doesn't feel like sales. Someone told me that, I think Michael Kitz has said this, that blogging is selling for introverts or marketing for introverts. And maybe that's why I started one, because, but, but I think like, because at that point you're telling it like it is and you're not coming up with narratives to convince people about something that you don't believe in. But that's, that's like a longer term thing, right? So it might take you some time to find your land as a 22 year old and that's okay. You're still young and have plenty of time to find your thing. And in finance, the great thing is there's so many different career paths you can go on like, you don't have to have it figured out. You can try this, try that, figure out what works for you or figure out what doesn't work for you and then go the opposite way. But I think in the short term, yeah, give yourself a break. If that's going to put you in a better place mentally, I think this guy deserves it. Like, it's okay to take a break and figure stuff out and reassess.
- [20:28]
B
Yeah, that's what I was going to say is I think you owe it to yourself to take some time off. You've worked hard. You've done really well, you know, good job. Like, yeah, now you owe it to yourself to sit and think seriously about your next steps. And you don't want to wake up in five years and be like, oh, I've just been grinding away for five years doing this, you know, job that I don't find fulfilling or interesting. You know, you're going to regret that if you do that.
- [20:50]
A
Maybe he can do. Maybe in the meantime, he creates a landscaping empire. Right. He's already shown he can create a business that way. Like, it doesn't have to be finance. Like, you could. This person has a lot of talents in different areas, so maybe, maybe it ends up being something else completely outside of their own finance.
- [21:04]
B
Yeah, yeah, it's true.
- [21:06]
A
Yeah. But. But again, really well done. It's an incredible accomplishment. What you'll be able to do, to do by age 22 and hang in there.
- [21:13]
B
I have a feeling you're going to be just fine based on your history here. I think you're going to. I think you're going to make it. I think you're going to be fine.
- [21:19]
A
Yeah.
- [21:21]
B
Also, can I point out how hilarious it is to me that two introverts are almost 200 episodes into a podcast, A weekly podcast.
- [21:29]
A
I know. I just pretend like no one is reading my blogs when I put them out there. And no one is listening to you under the podcast. Right. It's just us talking. Next question.
- [21:37]
B
For me, it's just the chat, you know, There you go. Okay, up next, we got. My wife and I are 32 and 34 and we recently sold and bought a new home in Pittsburgh. Over two years, we saved $120,000 for the down payment for the new home, so we wouldn't be in a tough situation trying to sell our old home immediately. The old home recently sold for $107,000 profit. I would like your thoughts on how and where to deploy that cash. We don't have any near term needs and will hopefully be parents in the coming year. We aim to max out our 401ks and IRAs annually and have a good chunk in brokerage assets and dollar cost. Average monthly. We have a healthy emergency fund and $300,000 combined annual income.
- [22:22]
A
I'm constantly amazed, obviously it's like a self selecting thing. The people who listen to our shows are people who are interested in finance and like this stuff. But I'm constantly amazed at how well certain people are doing in their finances because all you ever hear is about how bad people are with their finances. But the people who write us, like a lot of them, it's like you don't need our advice. You're doing just fine.
- [22:38]
B
Right? But and it's a lot of people, it's not like eight people writing the same question. We have tons of questions from different people coming in.
- [22:44]
A
So yeah, first off, nicely done all around. I first, I love the strategy of being prepared when selling your house. So they, so they saved. Instead of saying we're going to take the equity from our home we own and use that as the new down payment, they decided we're going to save for the down payment. Because the thing you don't want when you're buying a new house, you don't want it. You don't want the purchase of your new home to be contingent on selling your old home, right? You want to people, you want to thread the needle, right? I got to sell my old house first and then I can buy this new house. Because if there's more than one offer, guess what? The other seller is going to go, I'm not going to wait for you to sell your house. I'm going to take the offer from someone who's not going to do that. So the fact that they planned ahead and then now they saved and then now they get the profit on the back end, that to me sounds like they know what they're doing, right? Plus they already maxed out their 401ks, their IRAs. They have a healthy income, they have a healthy emergency fund, they have some brokerage assets. They're in a really good place. So. And we get this question too from people being like, okay, what's next? Now what do I do? I'm in a pretty good place. So I'll give you some ideas of what you could do with your housing windfall. Okay, so one of the things you could do, you got a new house you could do. Renovations like that can be expensive. Also do it now before you have a kid. Like they said, maybe A kid's in the next year. That's because it's a pain in the butt, as someone who just went through some renovations can tell you. You know the thing I didn't think about, a dog. What do I do with the dog all day while they're getting renovations done? So we did, like, bring the dog to her, her kennel thing every day where she plays the dogs, which is fine, but it's a pain in the butt. You could also take some of that money, go on a vacation also something you want to do now before you become a parent, right? Get that travel out of the way. Because once you have a kid, traveling becomes way, way harder. You could fund it, start to fund a 529 plan. You don't need to have the kid yet to do that. You can always put it in their name after they're born. You could fund an hsa. You could be, you know, going to the doctor quite a bit with a little one in the coming months ahead, years ahead. You could also give yourself a margin of safety. Like top that, top off that emergency fund, top off the brokerage account. Just have that money there if and when you need it for things in the years ahead. And the other one, I like to. Anytime you get a windfall, I like the idea of like setting some money aside to just blow on yourself, whatever it is, whatever you like to blow money on. Shoes, clothes, going out to eat, whatever it. Like. This is also why I like having some sort of windfall strategy for any bonus money that comes your way. I think of it like an asset allocation, right? I'm going to take 15% is going to go in the vacation fund, 20% is going to go into savings, 25% into the brokerage account, 10% to the 529, 10% to the HSA, 10% for stuff for the new house, and then 10% to go nuts on yourself. I think that's 100. Carry the one. Obviously, it doesn't have to be these exact percentages or categories, but that's the way that I like to think of these things is if you're a numbers person and a spreadsheet person like me have almost like an asset allocation of where this money is going to go. And it doesn't have to be just investments. It can be other areas, too. But I think if you plan it out a little, then it makes the blowing it on yourself part great because you already got all these other things taken care of.
- [25:39]
B
I like that. They could also buy a $25,000 Porsche.
- [25:42]
A
You know, and have plenty of money left over.
- [25:45]
B
Yeah.
- [25:45]
A
People keep emailing me saying, ben, you have to say Porsche, not Porsche. Sorry, never going to happen.
- [25:50]
B
I just, I just did it, you know?
- [25:51]
A
You did it.
- [25:52]
B
It feels good.
- [25:53]
A
Yeah. Kind of like museum. How do you say museum?
- [25:57]
B
Okay, museum.
- [26:02]
A
You can't say the word museum. That's okay. Everyone has their word.
- [26:05]
B
That's right.
- [26:05]
A
To me, statistics is always gets me. All right, one more question.
- [26:08]
B
Okay. And that one was from Alex, by the way. Up next, or last but not least, we have one from cj, Longtime listener, first time emailer. I've been working at a firm. Now I'm, I'm overthinking how I'm pronouncing all of these words. Okay. I've been working at a firm that uses historical returns for financial planning purposes, but we're switching to projected capital market assumptions in the planning software we use. Aside from some questionable returns for asset classes, it seems to me that a 30 or 40 year plan would be better served with a mean return than by relying on what a model expects the next five to 10 years to look like. I understand why we use them in building portfolios, but I do not understand the argument for using them in financial planning. Can you discuss some of the advantages and disadvantages of either side of this?
- [26:55]
A
Okay, so I've written a lot about expected returns in the past and I've done this from a math perspective. So Daniel, show my poster. I think I did this earlier this summer. Like expected returns in the stock market. I went through all these different examples and I looked through some models in the math. So every investor needs to set reasonable expectations at some point. Right. This is even more important for financial advisors than anyone like your client. Just they need that, those reasonable expectations. I think you just have to be realistic about it. So I'm not even going to go into like the pros and cons of each because here's the thing, like your expectations are going to be wrong. No one can predict this stuff. Returns over the past 10 to 15 years have been so much higher than anyone predicted in the early 2000 and tens. I can't even believe like how many people were talking about the new normal. Prepare yourself for a low return environment. Valuations are way too high, interest rates are too low. There's no way stocks can go higher. Everyone was saying that didn't happen. We got high returns. Right. So I don't think the 30 to 40 year return expectations are going to be any better or worse than the five to ten year estimates. Obviously the financial planning software needs some sort of input to give you. They do these Monte Carlo simulations, right? And they say if these millions of paths happen, like here's what happens and then here's your probability for achieving your goals and how well your financial plan is on the way to achieving them. But I like to talk about it with clients in terms of a range of returns. Right. Here's our base case, here's our best case, here's our worst case. Right. Because who knows what's going to happen in the future. I think that's kind of the way you want to think about it. And maybe you build in a little margin of safety by using like a higher than average inflation estimate. But I don't think any sort of return expectation is going to be better or worse because you could take the starting dividend yield and add earnings growth. But then what are people going to be willing to pay for those earnings? I don't know. That's like the one, the biggest unknown. So you could take all the fundamental data you want, but you kind of have to throw it out the window. The thing is you just have to make course collections along the way as expected returns turn into actual returns. But like, the thing is, no one has this process completely figured out. No one. You're making educated guesses and that's okay as long as everyone realizes that ahead of time, like there is no perfect solution to this, it doesn't exist.
- [29:01]
B
I feel like this is something AI has probably had a huge impact on. Right. Being able to run a bunch of scenarios.
- [29:07]
A
Yeah. I mean, but the scenario analysis stuff is great until you realize like, okay, where was the COVID scenario? Where did that come? Right. Like, so I, I, I had you mentioned like the risk management thing. We had this risk management software back in the day that would, that would stress test your portfolio. If this happens, then this will happen to your portfolio. And it's like those things all sound great in a vacuum, but the, you don't invest in a vacuum. There's things that like oil prices went negative and we had a pandemic and interest rates were bought from 0% to 5% in a hurry. And so all these things that have happened, even this decade alone, like no one ever could have planned for. Right. It's kind of like, well, if the Fed cuts rates, this then your portfolio is going to do this. The world doesn't necessarily work like that, especially in the markets. There's very few relationships that like if A happens then you should do B, or if B happens, then C will happen. Unfortunately, it doesn't really work like that. And that's the hard part about investing. And that's why people in finance don't like to say this, but a lot of stuff about the future is just guessing. It really is. You make educated guesses. Again, you can have your baseline assumption and then your best and worst case. But I like to think about it in a range of returns and like a probabilistic framework rather than like, hey, let's just do that. That's going to work. It's because it never works out like that.
- [30:19]
B
Yeah. I mean, you can only plan so much for the future. I guess you have to be good at reacting too, right?
- [30:24]
A
Yes. I would say financial planning is a process and not an event. How's that?
- [30:28]
B
I like that.
- [30:30]
A
All right, we'll be back live next week. We're filming this week because I was away for a conference. Thanks to everyone in the live chat. As always remember, email us, ask the compoundshowmail.com leave us a comment in YouTube, leave us a comment on Twitter for the live stream and we'll see you next time. Thanks, everyone.
- [30:48]
B
See you, everyone.
- [30:50]
A
Thanks for listening to Ask the Compound.
- [30:52]
B
All opinions expressed by Ben Carlson, Duncan Hill, and any of their guests are solely their own opinions and do not.
- [30:58]
A
Reflect the opinion of Ritholtz Wealth Management.
- [31:00]
B
This this podcast is for informational purposes only and should not be relied upon for any investment decisions.
- [31:06]
A
Clients of Ritholtz Wealth Management may maintain.
- [31:08]
B
Positions in the securities discussed in this podcast.