Tax-efficient investing, smart pension decisions, direct indexing strategies, and costly financial mistakes.
On this week’s Money Matters, Scott and Pat discuss how strategic investing, guided by historical lessons, can help you master your financial decisions. Then, they take calls from listeners seeking advice on optimizing savings and investment plans. Scott and Pat share their expertise on managing large sums of money, such as deciding between annuitizing or taking a lump sum from pension plans. Plus, they discuss the potential pitfalls of certain financial products, like fixed index annuities, while highlighting strategies like direct indexing for more tax-efficient investing.
Join Money Matters: Get your most pressing financial questions answered by Allworth's co-founders Scott Hanson and Pat McClain live on-air! Call 833-99-WORTH. Or ask a question by clicking here. You can also be on the air by emailing Scott and Pat at questions@moneymatters.com.
Announcer: Have a financial question? Scott Hanson and Pat McClain of Allworth's "Money Matters" are here to help. This Thursday, February 20th, they're offering you a special opportunity to speak with them directly, whether it's about asset allocation, tax planning strategies, or any other financial concern on your mind. To schedule your call, email questions@moneymatters.com or call now at 833-99-WORTH.
Scott: Welcome to Allworth's "Money Matters", Scott Hanson.
Pat: Pat McClain. Thanks for joining us.
Scott: Yeah, glad you are taking your time to... This program is about financial matters. Both myself and my co-host, we're both long-time financial advisors and we've been doing this radio show podcast for almost...
Pat: Thirty.
Scott: ...30 years talking about all kinds of things that are going on in the markets.
Pat: Yes, and this too, good or bad, shall pass. Wherever we're at in the markets, good or bad, it shall pass because everything reverts to its mean.
Scott: That's right.
Pat: Everything reverts to its mean. And, you know, been doing this in this industry for 35 years and I think of all the jubilant points in time where clients were so happy they were making so much money and I'd say, "Don't get too excited." And all the times when the markets were in turmoil and the world's coming to an end and I said, "Don't get too depressed." And the good investor is the one that walks in with a thesis, an investment thesis, which means typically an allocation. And if their money outside...
Scott: A strategy of how they're going to manage their money.
Pat: Yeah. And then if it's outside an IRA, a tax program that actually sits on top of that to make it as tax efficient as possible. Or if you're high net worth, a gifting program, but whatever it is, a strategy. And the markets come and go and the political environment will change, but you're not reacting.
Scott: Tariffs, no tariffs, all that stuff comes and goes.
Pat: Yeah. You're not reacting to outside forces.
Scott: But Pat, it's so tempting to think, "This is going to happen." Because you turn on CNBC or Fox Business or whatever else is out there. Does "Money Magazine" still exist?
Pat: I actually don't know.
Scott: I don't know. Or MarketWatch or whatever it is. They write articles and have stories and packages on the news for what? What purpose?
Pat: To draw your attention.
Scott: To draw your attention, right? We all understand how it works. So they can sell advertising. That's their product. They've got to deliver eyeballs so they can sell to their advertisers. So they're constantly having stories about, you know, "What's the right thing to invest in now?"
Pat: "What's the next big thing?" And this is...
Scott: All stories like that. "How the wealthy are investing now." "Four things you can do..." All that garbage.
Pat: Seven things. Nine things. It's never 28 things you should do to get your financial...
Scott: That's too many. I'd like one.
Pat: Seven-minute abs. But I go back to the creation of the Dow Jones Industrial Average.
Scott: Late 1800s.
Pat: It was...what was it?
Scott: Eleven stocks.
Pat: Eleven stocks. What were they consisted of?
Scott: Nine of them were railroads.
Pat: Nine were railroads.
Scott: What else could there be?
Pat: Right.
Scott: What was the most important technology of the time?
Pat: What else was...
Scott: You think how railroads transformed our country.
Pat: Incredible. Right? That was the newest technology. What people fail to understand is that many of the railroads went bankrupt. And many of them did very, very well.
Scott: That's right.
Pat: Right? They did very, very well. And many of them went bankrupt. So what does that tell you?
Scott: And the average investor in railroad stocks in the 1860s, 1870s lost money.
Pat: Yes.
Scott: Because of the amount of bankruptcies.
Pat: Because of the amount of bankruptcies. But if you had a diversified portfolio of railroad companies and as new technologies came online you added them to your portfolio while keeping your existing, you did well over time. So the Dow Jones...
Scott: What would come out of it? Was it 100, the index number, the numerical value?
Pat: Yeah, I believe it was 100. I think it was 100.
Scott: I think it was 100.
Pat: Yes, it was 100.
Scott: And what, $44,000, $45,000?
Pat: It's not a weighted average either, unlike the S&P 500.
Scott: Today it's 30 stocks.
Pat: So today it's 30. How many railroads are in there?
Scott: I don't know. I haven't looked at the Dow. I don't pay attention to it. I have no idea. Actually, I have no idea what...I mean, I can make some guesses.
Pat: But the point being is don't get too excited about the latest, greatest thing. Just don't.
Scott: Both on the positive and on the negative.
Pat: That's right. Don't feel like you're missing out on this or missing out on that.
Scott: It's funny, Pat. So we get tempted sometimes to have more commentary on the current market stuff. And then we're like...
Pat: What's the point?
Scott: How is that going to be helpful to people? And there's enough of that out there.
Pat: The closer you get to retirement, the more your interest should be in not being poor than it is in getting rich.
Scott: Maintaining your standard of living.
Pat: Maintaining your standard of living.
Scott: That's what most people are mostly concerned with. You get your retirement, you've got a couple million dollars saved. Like, "Boy, it'd be great if it was $10 million, but it's probably not going to be $10 million. I just want to make sure it doesn't go back to zero."
Pat: So you had clients, I had clients during two market cycles where there was great exuberance. One was in the housing and the other was in tech. And against our advice, we had clients that permanently ruined their financial well-being, their lifestyle, by putting big bets into those. I still remember when one guy said to me, "You don't get it, Pat."
Scott: "It's different this time."
Pat: "Everyone's going to move to Florida." Bought seven houses in...and the only thing that was left when it was done...he bought seven houses in Florida, condos.
Scott: It's the client of yours?
Pat: Yes. The only money that was left after the whole thing was over was the amount of money that his wife left in an IRA with our firm. That was the only money left.
Scott: Because he had debt on them all.
Pat: Because he had debt on them all. Or the tech, same thing.
Scott: I remember, Pat, we had...this was in the year 2000. So 1999, if you're 55 and older, you probably remember, particularly if you had any money saved at that time. The market was on fire the late '90s and everything was dot com. If your company had a dot com part of the name, you had a tremendous valuation. It was just crazy. And in 1999, the NASDAQ returned...I believe it was 85% that year.
Pat: It was crazy.
Scott: NASDAQ goes up 85%. I remember two lessons from this. NASDAQ goes up 85%. The S&P was up about 20% that year. I had a client come in, in January, February, was upset. He said, "Scott, you're obviously not doing a good job in paying attention to this portfolio." And I'm like, "What are you talking about?" And we had about...I think his account was up about 20% or 21%. We had the same return as the S&P 500, even though we had bonds in there. But he says, "Here's what I'm frustrated about, you've got real estate in this portfolio." This was in 2000. "You've got real estate in this portfolio. I don't know why you have real estate in portfolio when the stock market's doing so great." So he fired me. Said, "I'm taking my money elsewhere," he says, "because you don't have enough technology in the portfolio." Well, I think we all know what happened after that. Tech stocks, how far did they fall?
Pat: They were down 80-some percent.
Scott: Disaster. And what happened with real estate?
Pat: It went up.
Scott: It had the best eight-year run as ever.
Pat: A tear. It went on a tear. So before we go to the calls, remember, this too shall pass, good and bad.
Scott: Another story. Someone was bragging about...they had a side account they were investing in tech stocks. And they said, "Scott, my account trading, I made 78% last year, 78%." And I said, "Wow, you did kind of poorly." He looked at me. I said, "The index did 85%. You did all that work for nothing. It cost you money for all that work. You should have just bought the index and went out and golfed every day or whatever."
Pat: You have a bedside manner that's incredible.
Scott: I don't think I quite said it like that.
Pat: It's amazing we have any clients at all.
Scott: We'll go back. It happens on both ends, on the euphoria...
Pat: And on the downside.
Scott: I remember the financial crisis. This one client... And look, we were pretty highly diversified. When downturns come, one of the things that's helpful is looking at your portfolio. All right, what's actually not in stocks? Like, what's protected? What do we have in conservative bonds and cash? What do we have outside?
Pat: And especially if you're taking income now or you believe you're going to be taking income in the next few years.
Scott: So this is a particular client that had been retired for a few years. He had been a client for a number of years before this. Many years, actually. And he was really nervous about the markets declining. And he called like every three weeks. And I'd tell him the same thing. I'll call him Steve. "Steve, like you got to stick with it. We've got 62% in stocks," whatever the number was, "Like, we're going to ride this thing out. They always come back." So he called about every three weeks. And one day he calls and didn't want to speak with me, talked to someone in our trading team and did a trade without...
Pat: Yeah, without your input.
Scott: "I'm going to do what I want to do anyway." And of course, he missed out on the recovery. And the Dow...what did the Dow fall down to, $7,000 or something? It's at $45,000 today.
Pat: Your memory is much better than I. And so they missed a large portion of... They did get back in at some point in time, I'm sure.
Scott: But not to the extent... He ended up needing a reverse mortgage to make his monthly net work.
Pat: But you understand how emotionally hard it is to stay invested.
Scott: I do understand. That's why it's important to be wide-eyed on your portfolio today. Like, what might come in the next...what will come in the next 20 years? If you got 20 years left of life expectancy, have a pretty good idea. Like, what's kind of...we'll have some bear markets. We'll have some nasty downturn. We'll have some recessions again.
Pat: That's right. And we'll have some great times.
Scott: And we'll have some great times.
Pat: This too shall pass. If you'd like to join the show, 833-99-WORTH or 833-999-6784, or you can email us at questions@moneymatters.com and we will get you on the air.
Scott: We're in North Carolina, talking with Brian. Brian, you're with Allworth's "Money Matters".
Brian: Guys, greetings. Thanks for taking the call.
Scott: And thank you.
Brian: As a long-time podcast listener, I really appreciate what you guys do. Thanks for all you do.
Scott: Thank you. How did you find us?
Brian: I listen to another podcast regularly and you were advertised through that podcast. And so I thought that's a topic I should be more...
Scott: I didn't know we advertised.
Brian: Yeah. So I've been listening to you for a couple of three years now. So thank you.
Pat: I did not know we advertised on another podcast.
Scott: Me neither.
Pat: Well, thank you, marketing team.
Scott: Yes.
Brian: So my question relates to some incremental savings that I've built up that I want to deploy better than I've got it deployed right now, I think. And so let me give you sort of some core sort of financial info about me. I'm 44 years old, married, two children, 15 and 12. My wife and I both work. The household income, it's a little bit hard to tell you what that is because it fluctuates a lot, but I'm going to peg it at $300,000 a year. We have currently about $660,000 in pure retirement savings across 401(k)s, IRAs. I also have a brokerage account with a broker. That's got about $140,000 in it. And of course, I pay a fee for him to manage that. And just candidly, I've been pretty underwhelmed with the performance of that account, which has led me to start thinking, okay, as I've built up this incremental cash, which I'll talk about in a minute, how can I deploy it better?
So initially, my goal in saving up cash was to just build a sort of traditional, you know, six-month kind of an emergency fund, which I would say I would be comfortable at, you know, $60,000-ish in that account. Well, over time... And I've been keeping that money in a high-yield savings account, which currently gets a yield of about 3.8%. But over time, I've been fortunate to...I've maxed out 401(k)s, so I've done everything I can on those fronts. So with the extra money I have, I've continued to throw it into this high-yield savings account that currently has a balance of $275,000 in it. I think it's not doing the work it ought to be doing, but I've had great inertia about how to deploy it better. I've thought, okay, maybe I need to open a Vanguard, a Fidelity. Should I get into index funds? But then I wonder, should I do it in one big chunk? Should I do it over time? I'm just not sure how to start navigating towards those options. Yeah.
Pat: Brian, how much term life insurance policy do you have on yourself?
Brian: So I've got about...good question, I've got both the max I can get through my employer and some supplemental, so I've probably got about $1.5 million on me, and probably about a $0.5 million on my wife.
Scott: All right. And what do you owe on your house?
Brian: So I just bought a new house several years ago when the rates were great. So I do owe about...here, I'm going to pull that, I just pulled that before this call. Let's see, I owe, let's call it $390,000.
Scott: And when do you hope to... And I'm sure it's a rate of 3% or a ballpark in that range, right?
Brian: 2.875%, yep.
Scott: And when do you hope to retire? Is that part of your goal? Like, are you saving for retirement? Like, what's the objective here?
Brian: Yeah. So I mean, I sort of think of this extra money...I say extra, the stuff sitting in the high yield as what I would call retirement or retirement adjacent, right? Like, if I needed it, I could reach for it, but it's really for a longer term than a high yield.
Scott: And what about your two kids with...
Pat: Yeah. Is there money in a 529 plan for them?
Brian: Yes. Across both of them, I've got about $150,000 in 529. I'm glad you asked. I was going to say, you know, should I throw more into those? I mean, that's another thought.
Pat: You're a poster child. You're doing a good job. I think you should deploy some of those dollars outside of that cash account into...
Scott: Yeah.
Pat: Absolutely.
Scott: Maybe even use like a direct indexing strategy.
Scott: Actually, it would be perfect for you. Would be perfect.
Brian: Meaning just buy some market index funds?
Scott: No.
Pat: No, no, no, no.
Scott: No, build your own.
Pat: Okay. So let's explain. Well, this is a perfect scenario for direct indexing. And by the way...
Scott: Even two years ago, you might not have been a good candidate because...
Pat: Because the account balances weren't high enough. So they're going down. So let's explain what direct indexing is, Scott. Let's explain why it's relatively new, why most people don't understand how it works, and why it's such a great place for what we call fresh or new cash.
Scott: That are outside of retirement accounts.
Pat: Outside of retirement accounts.
Scott: Because inside a retirement account, the only time we pay taxes is when we take money out. When we have securities that sit outside of a retirement account, the stocks will pay dividends, right? We might have some capital gains we need to incur. So with an index, an index strategy is just simply saying, instead of trying to...let's pick the S&P 500 for a second...instead of trying to figure out which stocks to own or not own, let's just buy the whole index of the 500 largest companies and let's live with the return that's going to have. And historically, it's done about 10% a year over 100 years.
Pat: So that'd be buying...
Scott: And you can do that...you can buy Fidelity or Vanguard or Schwab. Everyone's got an index fund.
Pat: That's what you actually...
Scott: Super low cost.
Pat: Brian, that's what you said. You mean like an index fund. We said like an index fund, but not an index fund. This is called a direct index.
Scott: And so not too many years ago, when we bought or sold a security, we'd have to pay a commission. Right? So it was...
Pat: Whether it was Schwab, Fidelity, wherever.
Scott: So that was a pretty significant cost it would be on a portfolio. Today, there's lots of places you can buy and sell without any sort of commissions at all.
Pat: So there's no friction in the trading of the security.
Scott: And so with a direct index strategy, rather than buying a fund or an ETF that owns those securities, you actually buy all those individual securities yourself. The technology behind it buys this. And they don't buy all 500. They could get a 99% confidence level with maybe 300 securities. And then they're actively managed not just to maintain that index strategy, but they're managed from a tax standpoint.
Pat: So, as an example, let's say you need exposure to the airlines in your index. It may not own Delta, American, United, and Southwest. It might own three out of the four or two out of the four. But let's say United falls, not saying it will or did, but let's say it falls by 20% United. What does the direct index algorithm do, Scott?
Scott: It will sell that and buy something very similar.
Pat: Buy something similar, but not identical.
Scott: Because there's tax loss rules, wash rules.
Pat: It will wait 31 days for the wash rule to play itself out and then decide whether to hold that alternative security or to sell the alternative security and go back to the United shares.
Scott: So the benefit to you and the benefit to people who use this strategy is a couple of things. One is there are some tax loss harvesting that occurs throughout the year. And you can dial it in how much you want or not want. Rather than having capital gains, you can literally generate capital losses. And then second, when it's time to use the money, you can cherry-pick which stocks. You might, matter of fact, maybe the $150,000 is not enough to get your kids all the way through school. And you might say, hey, let's take a few dollars of the most highly appreciated securities as part of my index and let's transfer them to the kids. They can sell it and they're not going to pay any capital gains tax because their tax rates are so much different than yours.
Pat: Or you might say, I need money. And you actually sell something that doesn't have much gain or very little gain. And then you take it one step further. And if you're charitably inclined...
Scott: Even if it's a small amount on an annual basis, you can cherry-pick.
Pat: You take that individual stock, you put it into a donor-advised fund. And then you actually...
Scott: You get a tax deduction on the fair market value and you avoid the capital gains.
Pat: Yeah. And then you get great tax strategy behind it where you actually maybe just fund the donor-advised fund once every three or four years so that you actually really dig in. Right? And so there's so many things around it that...by the way, if we sound excited about it, it's unbelievable. I mean, it is all driven by technology and the fact that there's very little friction in the marketplace to buy and sell these securities. And no one's touching this. It's all algorithmic run. The only time you touch it is...
Scott: What's surprising, Pat, is...I've been pretty bullish on the strategy the last couple of years, but the adoption of it is still relatively nascent.
Pat: So the only people that you're getting involved in is when you actually say, "Okay, I need money," or, "I want a gift." Otherwise, the algorithm runs it. The last thing that to kind of keep in mind here is as this technology has been not as widely as adopted, the account values that you can actually do this with has fallen.
Scott: Dramatically.
Pat: It used to be $500,000...
Scott: Millions.
Pat: ...or $2 million or $3 million. Right?
Scott: Yeah.
Pat: Now, I think you can do it...it's down to 100 grand or...
Scott: The fees are more expensive.
Pat: There's no question, but they're worth it.
Brian: So thank you for that. I mean, conceptually, I follow what you're saying. It makes a lot of sense tactically. Where do you access these things? How does one start?
Pat: Any big brokerage firm.
Scott: Or advisory firm.
Pat: Yeah. And if they say what are you talking about, never talk to them again.
Scott: That's right. So I mean, it's really... And I would use $200,000 of it. I don't know how the rest of the brokerage stuff is.
Pat: Yeah, I don't know how your brokerage looks, but I would... And if I was worried about the market, maybe I'd go $50,000 now, $50,000 in 6 months, $50,000 in 18 months, $50,000 in...
Scott: You're 44, though.
Pat: I'd go all in.
Scott: I mean, you're not going to touch these dollars for 20 years.
Brian: The one last variable I wanted to throw out to ask about is I've I still got lingering...I'm an attorney, so I've got law school debt still. I've paid most of it off. I've got about $10,000 left at 4% interest. My thinking has been my money can do better elsewhere, but should I go and pay that off?
Pat: I would pay it off. I'd get that behind me.
Scott: Just from a psychological standpoint. Yeah, I would've paid it off.
Pat: This administration...
Scott: It's not going to make any difference to your net worth one way or another
Pat: It's behind you. And Brian, this administration is not going to forgive it.
Brian: Oh, no chance. I have no thought about that. No, that has nothing to do with my hesitation.
Pat: I would just pay it off. I mean, economically...
Scott: It's not going to make any difference.
Pat: What's it make? I mean, let's say you could get 5.25% in a high-yield, it's 10 grand, you know?
Scott: I mean, you have a $1 million saved. The 10 grand, whether it's paid off or not, it's not going to make any difference. But I think psychologically, having it paid, for me, I would feel good.
Pat: What type of law do you practice?
Brian: Mostly commercial litigation.
Pat: There we go. Good times.
Brian: Yeah. Yeah.
Pat: Good times.
Brian: Thank you. I really appreciate it.
Pat: One other question. Are you self-employed or are you part of a big law firm?
Brian: Well, the answer is both. I'm part of a big law firm, but I'm an owner. So I'm technically, you know, for tax purposes, I'm self-employed.
Pat: Got it. And you guys don't have a non-qualified deferred compensation plan set up for you guys?
Brian: So we do, but I've done everything I can in my contributions to those as I understand it. Maybe I'm not asking the right questions on that.
Pat: It's called a non-qualified deferred compensation.
Scott: But you say you're self-employed. So you guys just share the expenses and then...
Brian: That's correct.
Pat: Wait, wait. So wait, what do you...for tax purposes...
Scott: So you just share expenses.
Pat: He's a partner.
Brian: That's right. And then we share in the profits. I mean, we're all equal partners.
Pat: Yeah, it's a partnership.
Brian: It's a partnership.
Scott: Okay.
Pat: You're not self-employed.
Scott: Okay. All right.
Pat: Okay. Listen. Yeah. But you're doing a great job. How is the 529s invested?
Brian: So I'm actually in...for reasons that I can't recall, I'm in the South Dakota 529 across several funds in there, but I couldn't tell you off top of my head the exact allocation. I sit down once a year with my broker that I work with and we just look at the allocations relative to the ages of the children. And frankly, I've wondered, you know, my kids...I went to a private university. And if they wanted to go there, I'm nowhere close to well enough for that.
Scott: Yeah, that's right.
Pat: That's right.
Brian: I mean, I'm well enough funded to cover up the average in-state tuition. And I've kind of wondered, should I be throwing more in? Should I be, you know... I've struggled to think about that and know what the "right answer" is.
Pat: Yeah, it wouldn't hurt to fund it some more. And I'd look at the allocations based upon the age to make sure that that was appropriate. So in that, that's why I said I'd leave at least $75,000 in cash.
Scott: Your broker you're working with, is he a financial advisor or just like kind of a traditional?
Brian: He is. He's a certified advisor, CFP. Someone I know well personally and trusted candidly. That's what took me to them. But also when I feel a little underwhelmed by performance, it complicates the relationship.
Scott: Well, then I would ask a quick question, like trying to understand why the performance...why you're disappointed. Maybe he hasn't been aggressively investing for you. Like, is this a misallocation?
Brian: Yeah, we just had that conversation where when I first opened the account, it was with the only incremental kind of extra money I had. And so I was pretty risk averse and he several years ago put me heavy into bonds because he heard that and that was a terrible time to be in bonds. And so we've readjusted and had conversations to clarify risk appetites and such.
Pat: Yep. Yep. I mean, you understand the dance, you're a civil litigator.
Scott: And you know, the younger we are, sometimes it's a bit irrelevant how you feel about things. You just need to suck it up a bit on the risk side of things, to be a successful investor. Right?
Brian: Yeah. I mean, I don't want to pay daily attention to this. I want to have confidence in the long-term plan and set it and forget it.
Pat: That's right. You're a poster child for direct index. And then I'd come back and revisit the 529s and I would look at funding those some more.
Brian: Okay. Well, great, guys. Thank you very much. I really appreciate you.
Pat: Well, thank you. And share this podcast with the rest of your partners.
Brian: I will do my best.
Pat: Well, probably not this one because then you'll get all your personal financial information is going to be out there.
Brian: Three months from now, I'll start praising your name.
Pat: Perfect. Thank you.
Scott: That's funny. I appreciate the call.
Pat: He's never going to share this with anyone now in case they're likely to hear.
Scott: All right. Let's now continue on calls. Let's talk with Roshna in California. Roshna, you're with Allworth's "Money Matters".
Roshna: Hi, Scott and Pat.
Scott: Hi.
Roshna: How are you?
Scott: We're wonderful.
Roshna: Good. I have a bunch of questions, but I'll try to limit myself to one.
Pat: You can ask as many as you'd like.
Roshna: Oh, wow. Okay. Well, you might be sorry you said that. I'll start with the one I was originally calling for and then other things happened in the day and a half. So the first question is, we're getting ready to retire in the next probably year. We're probably a year out from it. I'm 58, my husband's 60. And we will have a pension. We also have a pot of money that we're going to annuitize. And we will get it when we retire.
Pat: I'm sorry. So let's stop for a second here.
Roshna: Okay.
Pat: You have a pot of money you're going to annuitize. Tell me what that means. Like, where did it come from and how and why would you annuitize it?
Roshna: Yes. Good question because if you have a pension, why do you need an annuity? We're both in the CalSTRS system. And I have, in 33 years, never taken a summer off or not worked anything extra I could work. So it's that extra money that's been built up over time. And we can either take it as a lump sum... And it's not an insignificant amount.
Pat: It's your accrued vacation or sick leave that you can either decide to stay on payroll, so you declare a retirement date, and then you use this up over the remaining 18 or 24 months. And it helps accrue...
Roshna: No.
Pat: No?
Roshna: It's something completely different.
Scott: Okay. Is the pot of money in...does CalSTRS control that pot of money? Or is this in a 403(b)?
Roshna: No, they control it until we retire.
Scott: Got it.
Roshna: And then we can then take that pot of money and either just roll it over into an IRA or take it out, which we wouldn't do, or we can annuitize it with them. And we did the numbers and like, I don't know how they can afford to do this, but it's a really good rate of return.
Scott: Yeah, do it. You're going to want to do it with STRS not...
Roshna: No, we're not going outside of STRS.
Scott: So, yeah, yeah, no, it makes total sense what you're doing.
Pat: Pension versus a lump sum. So you choose the annuitization versus the lump sum.
Roshna: Right. And then we have our regular pension that is totally separate in the sense that...that is, you know, the formula that you're all familiar with. So we have that. So this pot of money, the question is, it's going to be about...we do it for a nine-year period and it'd be $93,000 a year in income. And my question is, we can either take it as income or we can have it go directly into an IRA, into a tax-deferred account. My concern is having it go...
Scott: Is that right?
Roshna: Yeah.
Pat: You take it as income or you take the lump sum and put it into an IRA or you take the $93,000 a year and put it into an IRA.
Roshna: Any and all of the above.
Pat: Okay.
Roshna: So I can either just take the whole...it's $625,000. I can either take the whole thing and put it in an IRA or take it, or we can let them annuitize it, keep it for that amount of time and then they would pay us $93,000 a year. And then the money's gone after nine years.
Scott: Got it. Have you calculated what that rate of return is?
Roshna: Yeah. I don't have my spreadsheet up at the moment. And I kept doing it again and again thinking this could not be right. But it seems right.
Pat: It's probably about 6.7%, 6.8%?
Roshna: Well, it's more than that because basically for $93,000... Let me see if I can pull out my spreadsheet. I'm sorry. I knew it would be right here. Too many tabs on the spreadsheet. So basically, the end of those nine years, we would end up with, both my husband and I, separately. So got to see it together. Yeah, we end up with a $212,000 gain. Yeah,
Pat: But that's not the math we're using here.
Scott: I just calculated...
Pat: We just calculated. The return is...
Scott: 6.277%.
Pat: Yeah. So the return is...
Scott: What did you guess? 6.3%?
Pat: I said sub-seven, right?
Scott: Yeah.
Pat: So what that means is you looked at the gain, but it has to do with the time value of money calculation. So what Scott did was he ran a net present value calculation in the stream of income. Essentially said, okay, if I take $625,000 now and put it in an account, and I made payments of that account over nine years at $93,000, what is the rate of return I need to get on that money in order to make sense? And the answer comes out to 6.27%.
Roshna: Okay.
Pat: So that's what we call the hurdle rate.
Scott: That was a rough, by the way. I didn't calculate the time of the year or is it monthly or quarterly?
Pat: It's somewhere around 6.5%. Let's just go with that.
Roshna: Yeah.
Pat: And my guess was somewhere...
Scott: That's where you were right there.
Pat: Yeah, it was close.
Scott: Pat is really sharp with numbers.
Pat: That and you know the interest rate and what the pensions are doing behind it. So the question that I would ask is, okay, well, that's great. It is 6.2%. It depends on what it's invested in. But the question more than that is, do I need that $93,000 a year in income now, or should I roll the $625,000 into an IRA and defer it even longer?
Scott: Well, she can defer... What she's telling us, she could take the 93 grand a year and have...
Pat: That's wrong, Scott.
Scott: Yeah, I question that. I don't know how that could be.
Pat: That's wrong.
Roshna: Okay. I can tell you how I came up with that number. Basically, they have a sheet that I met with them to go over everything. And you can get that period certain annuity.
Scott and Pat: Yeah.
Roshna: It can be 1 year it can be 10 years.
Scott: Yeah, I get that.
Roshna: So for the nine year, $50,000 is $620 dollars a month.
Pat: No, I understand that. We understand that.
Scott: What I question is, how can you take what is technically a qualified pension plan, you receive an annuity on that...
Pat: And you said that you could put it back into an IRA on an annual basis. And I've never seen it before.
Scott: Me neither.
Roshna: I don't know if it's an annual basis or a monthly basis.
Scott: It's neither. I don't know how you get it back into a retirement account. I don't know how you get 90 grand paid from a pension and turn around and get back in a...I don't care what it is.
Pat: I think that there's been some confusion in the description of what this is. So it's either you take an annuity for a series of years and you select those years, or you take a lump sum. But what we do know is that the rate of return on that lump sum on the annuitization is...call it 6.5%.
Roshna: Okay.
Pat: So the question is, how much of the other pension is coming out, and is that enough to live on? And should I take that $625,000 and roll it into an IRA and I'm 58 and my husband is 60 and I defer that until 68, 69, 70, 73, 75, whatever the number is until the required minimum distributions? And maybe I can convert some of it into a Roth and maybe I don't.
Roshna: Okay. So yes, that's the second part. That's part of this question, which is we currently have about $1.6 million in tax-deferred accounts.
Scott: There we go. You're answering all the questions we were going to ask. So you have $1.6 million in 403(b)s and in IRAs and that sort of thing, correct?
Roshna: Yeah. So it's fully tax deferred. And we won't really need those in retirement because the pension is a little over $200,000.
Pat: And what is your income today?
Roshna: More. So it's around three-something, but we put a lot away.
Pat: That's right. And you have no mortgage on the house now, correct?
Roshna: We do. We do.
Pat: How much is it?
Roshna: We have a mortgage of $165,000. We have several houses.
Pat: Okay. So you want to take this as a lump sum, not as annuity over that nine-year period. Of that $1.6 million you have in 403(b)s and IRAs, how's that invested?
Scott: Going back to your point, I think the reason behind why Pat made that recommendation is these aren't dollars that you...you chose a nine-year payout, but you don't need the money in nine years.
Roshna: No.
Scot: So you actually have a much longer investment horizon than suddenly pay these dollars out, give me essentially one-ninth each year for the next nine years.
Pat: And this is based on the premise that you said to us, you could take those on an annual basis and move it back into an IRA.
Scott: We don't believe that.
Pat: I don't believe that's the case.
Roshna: I appreciate that. So the reason it's 9 years, not 10 years, because the 10 year they said you cannot put it into a tax-deferred account, but at 9 years you could have it automatically go into a tax-deferred account.
Pat: If that's the case, if you...
Scott: I learn something new every day.
Pat: If that's the case, then if you want...
Scott: It qualifies as a rollover, that's what it would technically...a direct transfer of a rollover.
Pat: If that's the case and the CalSTRS...if you're happy with a 6.5% return, 6.25%, then do it that way. If you think that you could do better in the open markets, right, then take it as a lump sum and invest it yourself. That's the only question.
Scott: If these were dollars that you were going to spend in the next nine...
Pat: I'm going to go with the fact that you're right in the nine-year thing because your, your description was pretty exact. News to me how CalSTRS would treat it that way. But who knows? Why wouldn't you take this $650,000 and invest it thinking that you're going to get over 6.5%, net of fees, over the next 10 years?
Scott: Twenty years.
Pat: Ten years because remember, Scott, it comes out over nine years.
Scott: Yeah. But she's going to turn around and reinvest it.
Pat: Yes. Part of it, longer periods of time.
Roshna: Yeah. And you know, at 75, we're going to have RMDs.
Scott: Yeah. You know, I know we say this often, but you got a lot of moving parts here. A lot of moving parts. Like, hire yourself a financial planner and do a good plan and do a bunch of what-if scenarios. You got millions of dollars here. These are huge decisions.
Roshna: They are, which is why...the question was really like, can I do better than 6.5%...
Scott: I think so.
Roshna: ...based on the last three years? Yes.
Scott: Well, not the...
Pat: No, no, no, no, no. Based on the last 50 years. Let's take it based upon how disciplined of an investor you are and how aggressive a portfolio it is.
Scott: It may or may not. And maybe after they're doing the analysis, you'll choose to take the 6.25%.
Pat: And maybe you actually say, you know what, we're going to actually increase our...
Scott: Equities in the other pieces of the portfolio...
Pat: ...in the 403(b)s...
Scott: ...and use this as fixed income.
Pat: ...and use this as fixed income, which is...actually, I could make an argument for that. Right?
Scott: Yes.
Pat: So if we opened up your portfolio today at this $1.6 million, how much would be in equities and how much would be in fixed incomes or bonds?
Roshna: I have 5% in bonds and the rest is stocks.
Scott: Five percent?
Roshna: Yeah. It's in a balance...part of it is in a balanced fund that we've had forever. And then I started listening to you guys and I was like, what am I doing? I have a pension. Why do I need bonds?
Pat: Well, that balanced fund is about 40% to 50% fixed income.
Roshna: It's a small amount that's in the balanced fund.
Pat: Okay. So the point being, if that's the case, I could make an argument as that this should be the [crosstalk 00:39:43.316]. And then I'd make the argument to counter that, which is your pension so big. If it were me...
Scott: You'd take the lump sum...
Pat: ...I'd take the lump sum...
Scott: ...and move on.
Pat: ...and move on. If it were me.
Roshna: Okay.
Scott: Yeah.
Pat: Your risk tolerance could be pretty high if you're living off those pensions and you've got time for markets to play themselves out.
Scott: That's right.
Roshna: Yeah. We don't see ourselves needing to touch the 403(b)s.
Pat: That's right.
Roshna: Because we also have rental income.
Pat: You're fine financially.
Scott: Yeah. But then all this is like, what are we trying to accomplish over the rest of our lives? Right? You're at this point, you've worked your entire life. Suddenly you're looking at retirement.
Pat: You're 58 and 60. You've got plenty of money.
Scott: More money than you probably thought you would have.
Pat: You know what I'd say? Where do you want to go on vacation? And by the way, it's hard to go on vacation when you're retired because you're not really vacating anything, you're going on trips.
Scott: You've got rentals. My guess is you guys have always lived a little bit below what you're making and probably the first half of your careers, you weren't making that much anyway. In the last decade, things have gone phenomenally well for you financially. This is just my guess. Tell me if I'm way off base.
Roshna: Yeah, 100%.
Scott: Right. But you've always lived below your means and now you've got all these assets and you're like, "Oh, my gosh, our pensions, can you believe how large our pensions alone are going to be? And now we've got a couple million bucks in retirement accounts and we have these rentals like, holy crap. Like we've got a lot of money." So really all of this comes down to like, what is it you're trying to accomplish? What do you want these dollars to do for you? You have this responsibility now for these dollars. What?
Pat: Do you want them to go to your kids?
Scott: Do you want to increase your standard of living?
Pat: Relatives?
Scott: You want to fund something else?
Pat: Charities.
Pat: You want to go to a really awesome safari in Africa?
Roshna: No.
Scott: But I mean...
Pat: In the Okavango Delta?
Scott: ...it's all those things. And then it's getting clarity on like, what do we want these dollars to do? Then we can build the plan on what's the best way to structure this. And based upon what you guys...and you're not going to come up with the answer overnight either on this, but based upon what you and your spouse decide, what's best, that might dictate taking the $93,000...I mean, the $625,000 over 15 years or over 5 years or whatever. I don't know, but that's where I would start.
Roshna: Okay. Am I ridiculous to worry about RMDs?
Scott: No.
Pat: No, not at all. Not at all, but that's just part of the picture.
Scott: But to your point, you're going to be in a high-tax bracket going forward regardless.
Pat: Yes.
Roshna: Yeah.
Pat: I mean, you're asking all the right questions, but you don't know what direction you're going.
Roshna: I mean, you asked me my goal, I'd like it to grow and I'd like it to...obviously, legacy for the kids. But other than that, I don't have any grand plans because, Scott, you hit it on the head, exactly described my life.
Pat: Yeah. Well, most people with money, that's how they live.
Scott: And most, I mean... Yes, that's exactly right.
Pat: Yes.
Scott: You don't end up with rental houses by spending 100% of your paycheck.
Pat: Yeah. And by the way, based upon your investment experience and you're very, very disciplined, I would take the pension lump sum, roll into an IRA, and I would do 70 to 80% equity portfolio based on the little we know about you with that stated goal that you had.
Roshna: Yeah. It's just, the 6.5% was guaranteed. And I was like, we could then turn around and then put it in an IRA.
Scott: Then do it if, in fact, you can roll those annual distributions out and then invest them as they come to you.
Pat: Yeah. You'll get in the same place.
Roshna: Yeah. Okay. But you like the idea of just taking the lump sum and moving forward.
Pat: Yeah, depending upon how disciplined of an investor you are to weather the markets.
Roshna: Okay.
Pat: Right. I mean, I know how I would manage it, but I'm not you.
Scott: Yeah.
Pat: Not nearly as smart.
Roshna: How would you manage it, sir?
Pat: I would go 70%...
Scott: No, you would be 100% stocks in this situation.
Pat: Yeah, 100% stock in this because of the pension.
Scott: The pension's all fixed income.
Pat: Your pension is all fixed income. You're like, just go.
Scott: I mean, your time horizon is...
Pat: Look at how far your time horizon...your time horizon before required minimum distributions is 17 years, 15 for your husband. That's a long time.
Roshna: It is. And the market has time to do its job.
Pat: That's right.
Scott: That is exactly right.
Pat: You answered your own question, but appreciate the call.
Scott: And we're in Texas talking with Hunter. Hunter, you're with Scott Hanson and Pat McClain.
Hunter: Hi. How are you doing today?
Scott: Good. How you doing, Hunter?
Hunter: Doing well.
Pat: What can we do for you?
Hunter: So my wife and I are both 64, planning to retire 68 or later. I think my wife is pretty set on retiring at 68.
Scott: Can you afford to...
Hunter: But I might go a little later.
Scott: Can you afford to retire in four years?
Hunter: Yes, I think we can. We've got about $1 million in investable assets currently. But my question is, about a year and a half ago, I had a financial advisor, sell me some annuities, fixed-index annuities, which I think are decent products. I'm just not sure that they were the right product at the time. So about $700,000 of my net worth is in those three annuities.
Pat: Wait, wait, wait, wait. He sold you three different annuities all at the same time?
Hunter: Yes. One of them is an IRA in my name. One of them is a Roth IRA in my name. And one of them is an inherited Roth IRA in my wife's name. Okay. And each one is in a separate annuity.
Scott: Okay. And what's the maximum you could earn in any one 12-month period on those?
Hunter: I think the maximum is capped around 10%.
Scott: So we have two years in a row of the market up 20% and you're capped at 10%.
Pat: And so what's your question for us?
Hunter: My question is, how much of my... I expect to live into my nineties based on my family's life expectancy history. I'm looking at a 30-plus year time horizon for retirement and I'm just not sure that it was a wise decision to put that much in safe money that early.
Pat: Yes, that's correct. You explained it better than we could. Your analysis of what you did was a better analysis because it was much more...you can be much more honest with yourself about the decisions you made. Here's the problem. You've got a surrender charge on that annuity.
Hunter: Yes.
Pat: And depending upon the size of the surrender charge...
Scott: How big is the surrender charge? Do you know?
Hunter: Don't have that information in front of me. It goes down every year.
Pat: That's right.
Scott: And it starts like a 9% or something.
Hunter: Yeah, something like that.
Scott: Where were the dollars invested beforehand?
Hunter: They were invested in...you know, to be honest, I don't know.
Pat: Okay. How'd you come about this annuity salesperson?
Hunter: One of these things on Facebook where I clicked on an ad and ended up booking a consultation.
Scott: And were you nervous about the market at the time?
Hunter: Maybe a little bit.
Pat: All right. Yeah. So you got to dig into this. So you know what you did and you said right, which was my timeline is so long that I'd be able to weather any of the market conditions. By the way, it's the same thing that these index annuities...if you tear them open, they use financial derivatives that...
Scott: Well, you're paying for a lot of insurance.
Pat: That's right.
Scott: There's no such thing as a free lunch, so it results in lower returns.
Pat: Correct. That's what it does. And that's what they package them. And by the way, any advisor could build these same products outside of an annuity. And in fact, they do.
Scott: Not any advisor, not most annuity salespeople.
Pat: Well, they're not advisors. They're annuity salespeople disguised as advisors. So you should look at the surrender charge on that and decide whether you should get out of the product, but a large portion of the decision-making will be driven by the surrender charge and the anniversary date. Because if the surrender charge moves every year down, you might be close to a new anniversary date and that surrender charge difference could be 1% or 2%.
Scott: At a minimum, you could take...they probably allow some sort of penalty-free withdrawal each year, 10% or 15% or something.
Hunter: Yes, they do.
Pat: Do that and go hire yourself a...
Scott: Put that in another IRA and just put it at 100% stocks.
Pat: And hire yourself...
Scott: A hundred percent stocks.
Pat: Hire yourself a fee-based financial advisor that's going to do a financial plan for you and say, "You can retire in four years," or "No, you can retire in three," or "You might have to work six. And this is what your social security..." Part of the overall picture of your financial situation is this income, but you can't go it alone. And you tried to do it, but you didn't get an advisor. You got a salesperson. Anyway, sorry that happened to you. Appreciate the call.
Scott: Yeah, we wish you well, Hunter.
Hunter: Okay.
Scott: And I tell you, if you've listened to this program for a while, you hear the two of us talk about the issue with the insurance industry, with the annuity industry. And while I...I state on the record, and I'll state it again right now, the world would be a better place if annuities had not been created, these commercial annuities. Having said that, there are times when they are appropriate. We as a firm have clients with them.
Pat: And occasionally we recommend them.
Scott: And there are fee-based annuities now where you're not locking your money up for several years and your advisor's not receiving a big commission.
Pat: That's correct.
Scott: But for the life of me, the fact that the regulators still allow these products to get sold the way they're sold with these huge commissions paid to brokers and the money's locked up for probably 10, 15 years.
Pat: And the way they're sold is they're quasi, "You get the best part of the stock market."
Scott: "You get into the stock market gains without the downside."
Pat: You don't get the gains.
Scott: Because we just had two phenomenal years, 20% roughly.
Pat: And he's capped at half of that.
Scott: Well, unfortunately... I was about to say we're out of time, but I guess we could talk as long as we want, but maybe we just get to a point where...
Pat: Maybe we're at the end of the attention span.
Scott: By the way, if you don't get our newsletter, I'd encourage you to sign up for our newsletter.
Pat: We believe there's lots of good information.
Scott: And on our website, we just did a whole refresh on our website. I'm pretty proud of it. But we've got a lot of good educational material there on lots of different topics. And so I'd encourage you to go to allworthfinancial.com and check out some of that. Just the same way this podcast radio program is very educational-focused, not salesy-focused, you'll find the same thing from our website.
Pat: Or better yet, if you want a second opinion, just reach out to us and we'll set up an appointment and talk to our advisors.
Scott: Chat with one of our...we've got what...150 or so advisors across the country. Great team. So anyway, we certainly appreciate you being part of our "Money Matters" community. We'll see you next week.
Announcer: This program has been brought to you by Allworth Financial, a registered investment advisory firm. Any ideas presented during this program are not intended to provide specific financial advice. You should consult your own financial advisor, tax consultant, or estate planning attorney to conduct your own due diligence.
Scott: Welcome to Allworth's "Money Matters", Scott Hanson.
Pat: Pat McClain. Thanks for joining us.
Scott: Yeah, glad you are taking your time to... This program is about financial matters. Both myself and my co-host, we're both long-time financial advisors and we've been doing this radio show podcast for almost...
Pat: Thirty.
Scott: ...30 years talking about all kinds of things that are going on in the markets.
Pat: Yes, and this too, good or bad, shall pass. Wherever we're at in the markets, good or bad, it shall pass because everything reverts to its mean.
Scott: That's right.
Pat: Everything reverts to its mean. And, you know, been doing this in this industry for 35 years and I think of all the jubilant points in time where clients were so happy they were making so much money and I'd say, "Don't get too excited." And all the times when the markets were in turmoil and the world's coming to an end and I said, "Don't get too depressed." And the good investor is the one that walks in with a thesis, an investment thesis, which means typically an allocation. And if their money outside...
Scott: A strategy of how they're going to manage their money.
Pat: Yeah. And then if it's outside an IRA, a tax program that actually sits on top of that to make it as tax efficient as possible. Or if you're high net worth, a gifting program, but whatever it is, a strategy. And the markets come and go and the political environment will change, but you're not reacting.
Scott: Tariffs, no tariffs, all that stuff comes and goes.
Pat: Yeah. You're not reacting to outside forces.
Scott: But Pat, it's so tempting to think, "This is going to happen." Because you turn on CNBC or Fox Business or whatever else is out there. Does "Money Magazine" still exist?
Pat: I actually don't know.
Scott: I don't know. Or MarketWatch or whatever it is. They write articles and have stories and packages on the news for what? What purpose?
Pat: To draw your attention.
Scott: To draw your attention, right? We all understand how it works. So they can sell advertising. That's their product. They've got to deliver eyeballs so they can sell to their advertisers. So they're constantly having stories about, you know, "What's the right thing to invest in now?"
Pat: "What's the next big thing?" And this is...
Scott: All stories like that. "How the wealthy are investing now." "Four things you can do..." All that garbage.
Pat: Seven things. Nine things. It's never 28 things you should do to get your financial...
Scott: That's too many. I'd like one.
Pat: Seven-minute abs. But I go back to the creation of the Dow Jones Industrial Average.
Scott: Late 1800s.
Pat: It was...what was it?
Scott: Eleven stocks.
Pat: Eleven stocks. What were they consisted of?
Scott: Nine of them were railroads.
Pat: Nine were railroads.
Scott: What else could there be?
Pat: Right.
Scott: What was the most important technology of the time?
Pat: What else was...
Scott: You think how railroads transformed our country.
Pat: Incredible. Right? That was the newest technology. What people fail to understand is that many of the railroads went bankrupt. And many of them did very, very well.
Scott: That's right.
Pat: Right? They did very, very well. And many of them went bankrupt. So what does that tell you?
Scott: And the average investor in railroad stocks in the 1860s, 1870s lost money.
Pat: Yes.
Scott: Because of the amount of bankruptcies.
Pat: Because of the amount of bankruptcies. But if you had a diversified portfolio of railroad companies and as new technologies came online you added them to your portfolio while keeping your existing, you did well over time. So the Dow Jones...
Scott: What would come out of it? Was it 100, the index number, the numerical value?
Pat: Yeah, I believe it was 100. I think it was 100.
Scott: I think it was 100.
Pat: Yes, it was 100.
Scott: And what, $44,000, $45,000?
Pat: It's not a weighted average either, unlike the S&P 500.
Scott: Today it's 30 stocks.
Pat: So today it's 30. How many railroads are in there?
Scott: I don't know. I haven't looked at the Dow. I don't pay attention to it. I have no idea. Actually, I have no idea what...I mean, I can make some guesses.
Pat: But the point being is don't get too excited about the latest, greatest thing. Just don't.
Scott: Both on the positive and on the negative.
Pat: That's right. Don't feel like you're missing out on this or missing out on that.
Scott: It's funny, Pat. So we get tempted sometimes to have more commentary on the current market stuff. And then we're like...
Pat: What's the point?
Scott: How is that going to be helpful to people? And there's enough of that out there.
Pat: The closer you get to retirement, the more your interest should be in not being poor than it is in getting rich.
Scott: Maintaining your standard of living.
Pat: Maintaining your standard of living.
Scott: That's what most people are mostly concerned with. You get your retirement, you've got a couple million dollars saved. Like, "Boy, it'd be great if it was $10 million, but it's probably not going to be $10 million. I just want to make sure it doesn't go back to zero."
Pat: So you had clients, I had clients during two market cycles where there was great exuberance. One was in the housing and the other was in tech. And against our advice, we had clients that permanently ruined their financial well-being, their lifestyle, by putting big bets into those. I still remember when one guy said to me, "You don't get it, Pat."
Scott: "It's different this time."
Pat: "Everyone's going to move to Florida." Bought seven houses in...and the only thing that was left when it was done...he bought seven houses in Florida, condos.
Scott: It's the client of yours?
Pat: Yes. The only money that was left after the whole thing was over was the amount of money that his wife left in an IRA with our firm. That was the only money left.
Scott: Because he had debt on them all.
Pat: Because he had debt on them all. Or the tech, same thing.
Scott: I remember, Pat, we had...this was in the year 2000. So 1999, if you're 55 and older, you probably remember, particularly if you had any money saved at that time. The market was on fire the late '90s and everything was dot com. If your company had a dot com part of the name, you had a tremendous valuation. It was just crazy. And in 1999, the NASDAQ returned...I believe it was 85% that year.
Pat: It was crazy.
Scott: NASDAQ goes up 85%. I remember two lessons from this. NASDAQ goes up 85%. The S&P was up about 20% that year. I had a client come in, in January, February, was upset. He said, "Scott, you're obviously not doing a good job in paying attention to this portfolio." And I'm like, "What are you talking about?" And we had about...I think his account was up about 20% or 21%. We had the same return as the S&P 500, even though we had bonds in there. But he says, "Here's what I'm frustrated about, you've got real estate in this portfolio." This was in 2000. "You've got real estate in this portfolio. I don't know why you have real estate in portfolio when the stock market's doing so great." So he fired me. Said, "I'm taking my money elsewhere," he says, "because you don't have enough technology in the portfolio." Well, I think we all know what happened after that. Tech stocks, how far did they fall?
Pat: They were down 80-some percent.
Scott: Disaster. And what happened with real estate?
Pat: It went up.
Scott: It had the best eight-year run as ever.
Pat: A tear. It went on a tear. So before we go to the calls, remember, this too shall pass, good and bad.
Scott: Another story. Someone was bragging about...they had a side account they were investing in tech stocks. And they said, "Scott, my account trading, I made 78% last year, 78%." And I said, "Wow, you did kind of poorly." He looked at me. I said, "The index did 85%. You did all that work for nothing. It cost you money for all that work. You should have just bought the index and went out and golfed every day or whatever."
Pat: You have a bedside manner that's incredible.
Scott: I don't think I quite said it like that.
Pat: It's amazing we have any clients at all.
Scott: We'll go back. It happens on both ends, on the euphoria...
Pat: And on the downside.
Scott: I remember the financial crisis. This one client... And look, we were pretty highly diversified. When downturns come, one of the things that's helpful is looking at your portfolio. All right, what's actually not in stocks? Like, what's protected? What do we have in conservative bonds and cash? What do we have outside?
Pat: And especially if you're taking income now or you believe you're going to be taking income in the next few years.
Scott: So this is a particular client that had been retired for a few years. He had been a client for a number of years before this. Many years, actually. And he was really nervous about the markets declining. And he called like every three weeks. And I'd tell him the same thing. I'll call him Steve. "Steve, like you got to stick with it. We've got 62% in stocks," whatever the number was, "Like, we're going to ride this thing out. They always come back." So he called about every three weeks. And one day he calls and didn't want to speak with me, talked to someone in our trading team and did a trade without...
Pat: Yeah, without your input.
Scott: "I'm going to do what I want to do anyway." And of course, he missed out on the recovery. And the Dow...what did the Dow fall down to, $7,000 or something? It's at $45,000 today.
Pat: Your memory is much better than I. And so they missed a large portion of... They did get back in at some point in time, I'm sure.
Scott: But not to the extent... He ended up needing a reverse mortgage to make his monthly net work.
Pat: But you understand how emotionally hard it is to stay invested.
Scott: I do understand. That's why it's important to be wide-eyed on your portfolio today. Like, what might come in the next...what will come in the next 20 years? If you got 20 years left of life expectancy, have a pretty good idea. Like, what's kind of...we'll have some bear markets. We'll have some nasty downturn. We'll have some recessions again.
Pat: That's right. And we'll have some great times.
Scott: And we'll have some great times.
Pat: This too shall pass. If you'd like to join the show, 833-99-WORTH or 833-999-6784, or you can email us at questions@moneymatters.com and we will get you on the air.
Scott: We're in North Carolina, talking with Brian. Brian, you're with Allworth's "Money Matters".
Brian: Guys, greetings. Thanks for taking the call.
Scott: And thank you.
Brian: As a long-time podcast listener, I really appreciate what you guys do. Thanks for all you do.
Scott: Thank you. How did you find us?
Brian: I listen to another podcast regularly and you were advertised through that podcast. And so I thought that's a topic I should be more...
Scott: I didn't know we advertised.
Brian: Yeah. So I've been listening to you for a couple of three years now. So thank you.
Pat: I did not know we advertised on another podcast.
Scott: Me neither.
Pat: Well, thank you, marketing team.
Scott: Yes.
Brian: So my question relates to some incremental savings that I've built up that I want to deploy better than I've got it deployed right now, I think. And so let me give you sort of some core sort of financial info about me. I'm 44 years old, married, two children, 15 and 12. My wife and I both work. The household income, it's a little bit hard to tell you what that is because it fluctuates a lot, but I'm going to peg it at $300,000 a year. We have currently about $660,000 in pure retirement savings across 401(k)s, IRAs. I also have a brokerage account with a broker. That's got about $140,000 in it. And of course, I pay a fee for him to manage that. And just candidly, I've been pretty underwhelmed with the performance of that account, which has led me to start thinking, okay, as I've built up this incremental cash, which I'll talk about in a minute, how can I deploy it better?
So initially, my goal in saving up cash was to just build a sort of traditional, you know, six-month kind of an emergency fund, which I would say I would be comfortable at, you know, $60,000-ish in that account. Well, over time... And I've been keeping that money in a high-yield savings account, which currently gets a yield of about 3.8%. But over time, I've been fortunate to...I've maxed out 401(k)s, so I've done everything I can on those fronts. So with the extra money I have, I've continued to throw it into this high-yield savings account that currently has a balance of $275,000 in it. I think it's not doing the work it ought to be doing, but I've had great inertia about how to deploy it better. I've thought, okay, maybe I need to open a Vanguard, a Fidelity. Should I get into index funds? But then I wonder, should I do it in one big chunk? Should I do it over time? I'm just not sure how to start navigating towards those options. Yeah.
Pat: Brian, how much term life insurance policy do you have on yourself?
Brian: So I've got about...good question, I've got both the max I can get through my employer and some supplemental, so I've probably got about $1.5 million on me, and probably about a $0.5 million on my wife.
Scott: All right. And what do you owe on your house?
Brian: So I just bought a new house several years ago when the rates were great. So I do owe about...here, I'm going to pull that, I just pulled that before this call. Let's see, I owe, let's call it $390,000.
Scott: And when do you hope to... And I'm sure it's a rate of 3% or a ballpark in that range, right?
Brian: 2.875%, yep.
Scott: And when do you hope to retire? Is that part of your goal? Like, are you saving for retirement? Like, what's the objective here?
Brian: Yeah. So I mean, I sort of think of this extra money...I say extra, the stuff sitting in the high yield as what I would call retirement or retirement adjacent, right? Like, if I needed it, I could reach for it, but it's really for a longer term than a high yield.
Scott: And what about your two kids with...
Pat: Yeah. Is there money in a 529 plan for them?
Brian: Yes. Across both of them, I've got about $150,000 in 529. I'm glad you asked. I was going to say, you know, should I throw more into those? I mean, that's another thought.
Pat: You're a poster child. You're doing a good job. I think you should deploy some of those dollars outside of that cash account into...
Scott: Yeah.
Pat: Absolutely.
Scott: Maybe even use like a direct indexing strategy.
Scott: Actually, it would be perfect for you. Would be perfect.
Brian: Meaning just buy some market index funds?
Scott: No.
Pat: No, no, no, no.
Scott: No, build your own.
Pat: Okay. So let's explain. Well, this is a perfect scenario for direct indexing. And by the way...
Scott: Even two years ago, you might not have been a good candidate because...
Pat: Because the account balances weren't high enough. So they're going down. So let's explain what direct indexing is, Scott. Let's explain why it's relatively new, why most people don't understand how it works, and why it's such a great place for what we call fresh or new cash.
Scott: That are outside of retirement accounts.
Pat: Outside of retirement accounts.
Scott: Because inside a retirement account, the only time we pay taxes is when we take money out. When we have securities that sit outside of a retirement account, the stocks will pay dividends, right? We might have some capital gains we need to incur. So with an index, an index strategy is just simply saying, instead of trying to...let's pick the S&P 500 for a second...instead of trying to figure out which stocks to own or not own, let's just buy the whole index of the 500 largest companies and let's live with the return that's going to have. And historically, it's done about 10% a year over 100 years.
Pat: So that'd be buying...
Scott: And you can do that...you can buy Fidelity or Vanguard or Schwab. Everyone's got an index fund.
Pat: That's what you actually...
Scott: Super low cost.
Pat: Brian, that's what you said. You mean like an index fund. We said like an index fund, but not an index fund. This is called a direct index.
Scott: And so not too many years ago, when we bought or sold a security, we'd have to pay a commission. Right? So it was...
Pat: Whether it was Schwab, Fidelity, wherever.
Scott: So that was a pretty significant cost it would be on a portfolio. Today, there's lots of places you can buy and sell without any sort of commissions at all.
Pat: So there's no friction in the trading of the security.
Scott: And so with a direct index strategy, rather than buying a fund or an ETF that owns those securities, you actually buy all those individual securities yourself. The technology behind it buys this. And they don't buy all 500. They could get a 99% confidence level with maybe 300 securities. And then they're actively managed not just to maintain that index strategy, but they're managed from a tax standpoint.
Pat: So, as an example, let's say you need exposure to the airlines in your index. It may not own Delta, American, United, and Southwest. It might own three out of the four or two out of the four. But let's say United falls, not saying it will or did, but let's say it falls by 20% United. What does the direct index algorithm do, Scott?
Scott: It will sell that and buy something very similar.
Pat: Buy something similar, but not identical.
Scott: Because there's tax loss rules, wash rules.
Pat: It will wait 31 days for the wash rule to play itself out and then decide whether to hold that alternative security or to sell the alternative security and go back to the United shares.
Scott: So the benefit to you and the benefit to people who use this strategy is a couple of things. One is there are some tax loss harvesting that occurs throughout the year. And you can dial it in how much you want or not want. Rather than having capital gains, you can literally generate capital losses. And then second, when it's time to use the money, you can cherry-pick which stocks. You might, matter of fact, maybe the $150,000 is not enough to get your kids all the way through school. And you might say, hey, let's take a few dollars of the most highly appreciated securities as part of my index and let's transfer them to the kids. They can sell it and they're not going to pay any capital gains tax because their tax rates are so much different than yours.
Pat: Or you might say, I need money. And you actually sell something that doesn't have much gain or very little gain. And then you take it one step further. And if you're charitably inclined...
Scott: Even if it's a small amount on an annual basis, you can cherry-pick.
Pat: You take that individual stock, you put it into a donor-advised fund. And then you actually...
Scott: You get a tax deduction on the fair market value and you avoid the capital gains.
Pat: Yeah. And then you get great tax strategy behind it where you actually maybe just fund the donor-advised fund once every three or four years so that you actually really dig in. Right? And so there's so many things around it that...by the way, if we sound excited about it, it's unbelievable. I mean, it is all driven by technology and the fact that there's very little friction in the marketplace to buy and sell these securities. And no one's touching this. It's all algorithmic run. The only time you touch it is...
Scott: What's surprising, Pat, is...I've been pretty bullish on the strategy the last couple of years, but the adoption of it is still relatively nascent.
Pat: So the only people that you're getting involved in is when you actually say, "Okay, I need money," or, "I want a gift." Otherwise, the algorithm runs it. The last thing that to kind of keep in mind here is as this technology has been not as widely as adopted, the account values that you can actually do this with has fallen.
Scott: Dramatically.
Pat: It used to be $500,000...
Scott: Millions.
Pat: ...or $2 million or $3 million. Right?
Scott: Yeah.
Pat: Now, I think you can do it...it's down to 100 grand or...
Scott: The fees are more expensive.
Pat: There's no question, but they're worth it.
Brian: So thank you for that. I mean, conceptually, I follow what you're saying. It makes a lot of sense tactically. Where do you access these things? How does one start?
Pat: Any big brokerage firm.
Scott: Or advisory firm.
Pat: Yeah. And if they say what are you talking about, never talk to them again.
Scott: That's right. So I mean, it's really... And I would use $200,000 of it. I don't know how the rest of the brokerage stuff is.
Pat: Yeah, I don't know how your brokerage looks, but I would... And if I was worried about the market, maybe I'd go $50,000 now, $50,000 in 6 months, $50,000 in 18 months, $50,000 in...
Scott: You're 44, though.
Pat: I'd go all in.
Scott: I mean, you're not going to touch these dollars for 20 years.
Brian: The one last variable I wanted to throw out to ask about is I've I still got lingering...I'm an attorney, so I've got law school debt still. I've paid most of it off. I've got about $10,000 left at 4% interest. My thinking has been my money can do better elsewhere, but should I go and pay that off?
Pat: I would pay it off. I'd get that behind me.
Scott: Just from a psychological standpoint. Yeah, I would've paid it off.
Pat: This administration...
Scott: It's not going to make any difference to your net worth one way or another
Pat: It's behind you. And Brian, this administration is not going to forgive it.
Brian: Oh, no chance. I have no thought about that. No, that has nothing to do with my hesitation.
Pat: I would just pay it off. I mean, economically...
Scott: It's not going to make any difference.
Pat: What's it make? I mean, let's say you could get 5.25% in a high-yield, it's 10 grand, you know?
Scott: I mean, you have a $1 million saved. The 10 grand, whether it's paid off or not, it's not going to make any difference. But I think psychologically, having it paid, for me, I would feel good.
Pat: What type of law do you practice?
Brian: Mostly commercial litigation.
Pat: There we go. Good times.
Brian: Yeah. Yeah.
Pat: Good times.
Brian: Thank you. I really appreciate it.
Pat: One other question. Are you self-employed or are you part of a big law firm?
Brian: Well, the answer is both. I'm part of a big law firm, but I'm an owner. So I'm technically, you know, for tax purposes, I'm self-employed.
Pat: Got it. And you guys don't have a non-qualified deferred compensation plan set up for you guys?
Brian: So we do, but I've done everything I can in my contributions to those as I understand it. Maybe I'm not asking the right questions on that.
Pat: It's called a non-qualified deferred compensation.
Scott: But you say you're self-employed. So you guys just share the expenses and then...
Brian: That's correct.
Pat: Wait, wait. So wait, what do you...for tax purposes...
Scott: So you just share expenses.
Pat: He's a partner.
Brian: That's right. And then we share in the profits. I mean, we're all equal partners.
Pat: Yeah, it's a partnership.
Brian: It's a partnership.
Scott: Okay.
Pat: You're not self-employed.
Scott: Okay. All right.
Pat: Okay. Listen. Yeah. But you're doing a great job. How is the 529s invested?
Brian: So I'm actually in...for reasons that I can't recall, I'm in the South Dakota 529 across several funds in there, but I couldn't tell you off top of my head the exact allocation. I sit down once a year with my broker that I work with and we just look at the allocations relative to the ages of the children. And frankly, I've wondered, you know, my kids...I went to a private university. And if they wanted to go there, I'm nowhere close to well enough for that.
Scott: Yeah, that's right.
Pat: That's right.
Brian: I mean, I'm well enough funded to cover up the average in-state tuition. And I've kind of wondered, should I be throwing more in? Should I be, you know... I've struggled to think about that and know what the "right answer" is.
Pat: Yeah, it wouldn't hurt to fund it some more. And I'd look at the allocations based upon the age to make sure that that was appropriate. So in that, that's why I said I'd leave at least $75,000 in cash.
Scott: Your broker you're working with, is he a financial advisor or just like kind of a traditional?
Brian: He is. He's a certified advisor, CFP. Someone I know well personally and trusted candidly. That's what took me to them. But also when I feel a little underwhelmed by performance, it complicates the relationship.
Scott: Well, then I would ask a quick question, like trying to understand why the performance...why you're disappointed. Maybe he hasn't been aggressively investing for you. Like, is this a misallocation?
Brian: Yeah, we just had that conversation where when I first opened the account, it was with the only incremental kind of extra money I had. And so I was pretty risk averse and he several years ago put me heavy into bonds because he heard that and that was a terrible time to be in bonds. And so we've readjusted and had conversations to clarify risk appetites and such.
Pat: Yep. Yep. I mean, you understand the dance, you're a civil litigator.
Scott: And you know, the younger we are, sometimes it's a bit irrelevant how you feel about things. You just need to suck it up a bit on the risk side of things, to be a successful investor. Right?
Brian: Yeah. I mean, I don't want to pay daily attention to this. I want to have confidence in the long-term plan and set it and forget it.
Pat: That's right. You're a poster child for direct index. And then I'd come back and revisit the 529s and I would look at funding those some more.
Brian: Okay. Well, great, guys. Thank you very much. I really appreciate you.
Pat: Well, thank you. And share this podcast with the rest of your partners.
Brian: I will do my best.
Pat: Well, probably not this one because then you'll get all your personal financial information is going to be out there.
Brian: Three months from now, I'll start praising your name.
Pat: Perfect. Thank you.
Scott: That's funny. I appreciate the call.
Pat: He's never going to share this with anyone now in case they're likely to hear.
Scott: All right. Let's now continue on calls. Let's talk with Roshna in California. Roshna, you're with Allworth's "Money Matters".
Roshna: Hi, Scott and Pat.
Scott: Hi.
Roshna: How are you?
Scott: We're wonderful.
Roshna: Good. I have a bunch of questions, but I'll try to limit myself to one.
Pat: You can ask as many as you'd like.
Roshna: Oh, wow. Okay. Well, you might be sorry you said that. I'll start with the one I was originally calling for and then other things happened in the day and a half. So the first question is, we're getting ready to retire in the next probably year. We're probably a year out from it. I'm 58, my husband's 60. And we will have a pension. We also have a pot of money that we're going to annuitize. And we will get it when we retire.
Pat: I'm sorry. So let's stop for a second here.
Roshna: Okay.
Pat: You have a pot of money you're going to annuitize. Tell me what that means. Like, where did it come from and how and why would you annuitize it?
Roshna: Yes. Good question because if you have a pension, why do you need an annuity? We're both in the CalSTRS system. And I have, in 33 years, never taken a summer off or not worked anything extra I could work. So it's that extra money that's been built up over time. And we can either take it as a lump sum... And it's not an insignificant amount.
Pat: It's your accrued vacation or sick leave that you can either decide to stay on payroll, so you declare a retirement date, and then you use this up over the remaining 18 or 24 months. And it helps accrue...
Roshna: No.
Pat: No?
Roshna: It's something completely different.
Scott: Okay. Is the pot of money in...does CalSTRS control that pot of money? Or is this in a 403(b)?
Roshna: No, they control it until we retire.
Scott: Got it.
Roshna: And then we can then take that pot of money and either just roll it over into an IRA or take it out, which we wouldn't do, or we can annuitize it with them. And we did the numbers and like, I don't know how they can afford to do this, but it's a really good rate of return.
Scott: Yeah, do it. You're going to want to do it with STRS not...
Roshna: No, we're not going outside of STRS.
Scott: So, yeah, yeah, no, it makes total sense what you're doing.
Pat: Pension versus a lump sum. So you choose the annuitization versus the lump sum.
Roshna: Right. And then we have our regular pension that is totally separate in the sense that...that is, you know, the formula that you're all familiar with. So we have that. So this pot of money, the question is, it's going to be about...we do it for a nine-year period and it'd be $93,000 a year in income. And my question is, we can either take it as income or we can have it go directly into an IRA, into a tax-deferred account. My concern is having it go...
Scott: Is that right?
Roshna: Yeah.
Pat: You take it as income or you take the lump sum and put it into an IRA or you take the $93,000 a year and put it into an IRA.
Roshna: Any and all of the above.
Pat: Okay.
Roshna: So I can either just take the whole...it's $625,000. I can either take the whole thing and put it in an IRA or take it, or we can let them annuitize it, keep it for that amount of time and then they would pay us $93,000 a year. And then the money's gone after nine years.
Scott: Got it. Have you calculated what that rate of return is?
Roshna: Yeah. I don't have my spreadsheet up at the moment. And I kept doing it again and again thinking this could not be right. But it seems right.
Pat: It's probably about 6.7%, 6.8%?
Roshna: Well, it's more than that because basically for $93,000... Let me see if I can pull out my spreadsheet. I'm sorry. I knew it would be right here. Too many tabs on the spreadsheet. So basically, the end of those nine years, we would end up with, both my husband and I, separately. So got to see it together. Yeah, we end up with a $212,000 gain. Yeah,
Pat: But that's not the math we're using here.
Scott: I just calculated...
Pat: We just calculated. The return is...
Scott: 6.277%.
Pat: Yeah. So the return is...
Scott: What did you guess? 6.3%?
Pat: I said sub-seven, right?
Scott: Yeah.
Pat: So what that means is you looked at the gain, but it has to do with the time value of money calculation. So what Scott did was he ran a net present value calculation in the stream of income. Essentially said, okay, if I take $625,000 now and put it in an account, and I made payments of that account over nine years at $93,000, what is the rate of return I need to get on that money in order to make sense? And the answer comes out to 6.27%.
Roshna: Okay.
Pat: So that's what we call the hurdle rate.
Scott: That was a rough, by the way. I didn't calculate the time of the year or is it monthly or quarterly?
Pat: It's somewhere around 6.5%. Let's just go with that.
Roshna: Yeah.
Pat: And my guess was somewhere...
Scott: That's where you were right there.
Pat: Yeah, it was close.
Scott: Pat is really sharp with numbers.
Pat: That and you know the interest rate and what the pensions are doing behind it. So the question that I would ask is, okay, well, that's great. It is 6.2%. It depends on what it's invested in. But the question more than that is, do I need that $93,000 a year in income now, or should I roll the $625,000 into an IRA and defer it even longer?
Scott: Well, she can defer... What she's telling us, she could take the 93 grand a year and have...
Pat: That's wrong, Scott.
Scott: Yeah, I question that. I don't know how that could be.
Pat: That's wrong.
Roshna: Okay. I can tell you how I came up with that number. Basically, they have a sheet that I met with them to go over everything. And you can get that period certain annuity.
Scott and Pat: Yeah.
Roshna: It can be 1 year it can be 10 years.
Scott: Yeah, I get that.
Roshna: So for the nine year, $50,000 is $620 dollars a month.
Pat: No, I understand that. We understand that.
Scott: What I question is, how can you take what is technically a qualified pension plan, you receive an annuity on that...
Pat: And you said that you could put it back into an IRA on an annual basis. And I've never seen it before.
Scott: Me neither.
Roshna: I don't know if it's an annual basis or a monthly basis.
Scott: It's neither. I don't know how you get it back into a retirement account. I don't know how you get 90 grand paid from a pension and turn around and get back in a...I don't care what it is.
Pat: I think that there's been some confusion in the description of what this is. So it's either you take an annuity for a series of years and you select those years, or you take a lump sum. But what we do know is that the rate of return on that lump sum on the annuitization is...call it 6.5%.
Roshna: Okay.
Pat: So the question is, how much of the other pension is coming out, and is that enough to live on? And should I take that $625,000 and roll it into an IRA and I'm 58 and my husband is 60 and I defer that until 68, 69, 70, 73, 75, whatever the number is until the required minimum distributions? And maybe I can convert some of it into a Roth and maybe I don't.
Roshna: Okay. So yes, that's the second part. That's part of this question, which is we currently have about $1.6 million in tax-deferred accounts.
Scott: There we go. You're answering all the questions we were going to ask. So you have $1.6 million in 403(b)s and in IRAs and that sort of thing, correct?
Roshna: Yeah. So it's fully tax deferred. And we won't really need those in retirement because the pension is a little over $200,000.
Pat: And what is your income today?
Roshna: More. So it's around three-something, but we put a lot away.
Pat: That's right. And you have no mortgage on the house now, correct?
Roshna: We do. We do.
Pat: How much is it?
Roshna: We have a mortgage of $165,000. We have several houses.
Pat: Okay. So you want to take this as a lump sum, not as annuity over that nine-year period. Of that $1.6 million you have in 403(b)s and IRAs, how's that invested?
Scott: Going back to your point, I think the reason behind why Pat made that recommendation is these aren't dollars that you...you chose a nine-year payout, but you don't need the money in nine years.
Roshna: No.
Scot: So you actually have a much longer investment horizon than suddenly pay these dollars out, give me essentially one-ninth each year for the next nine years.
Pat: And this is based on the premise that you said to us, you could take those on an annual basis and move it back into an IRA.
Scott: We don't believe that.
Pat: I don't believe that's the case.
Roshna: I appreciate that. So the reason it's 9 years, not 10 years, because the 10 year they said you cannot put it into a tax-deferred account, but at 9 years you could have it automatically go into a tax-deferred account.
Pat: If that's the case, if you...
Scott: I learn something new every day.
Pat: If that's the case, then if you want...
Scott: It qualifies as a rollover, that's what it would technically...a direct transfer of a rollover.
Pat: If that's the case and the CalSTRS...if you're happy with a 6.5% return, 6.25%, then do it that way. If you think that you could do better in the open markets, right, then take it as a lump sum and invest it yourself. That's the only question.
Scott: If these were dollars that you were going to spend in the next nine...
Pat: I'm going to go with the fact that you're right in the nine-year thing because your, your description was pretty exact. News to me how CalSTRS would treat it that way. But who knows? Why wouldn't you take this $650,000 and invest it thinking that you're going to get over 6.5%, net of fees, over the next 10 years?
Scott: Twenty years.
Pat: Ten years because remember, Scott, it comes out over nine years.
Scott: Yeah. But she's going to turn around and reinvest it.
Pat: Yes. Part of it, longer periods of time.
Roshna: Yeah. And you know, at 75, we're going to have RMDs.
Scott: Yeah. You know, I know we say this often, but you got a lot of moving parts here. A lot of moving parts. Like, hire yourself a financial planner and do a good plan and do a bunch of what-if scenarios. You got millions of dollars here. These are huge decisions.
Roshna: They are, which is why...the question was really like, can I do better than 6.5%...
Scott: I think so.
Roshna: ...based on the last three years? Yes.
Scott: Well, not the...
Pat: No, no, no, no, no. Based on the last 50 years. Let's take it based upon how disciplined of an investor you are and how aggressive a portfolio it is.
Scott: It may or may not. And maybe after they're doing the analysis, you'll choose to take the 6.25%.
Pat: And maybe you actually say, you know what, we're going to actually increase our...
Scott: Equities in the other pieces of the portfolio...
Pat: ...in the 403(b)s...
Scott: ...and use this as fixed income.
Pat: ...and use this as fixed income, which is...actually, I could make an argument for that. Right?
Scott: Yes.
Pat: So if we opened up your portfolio today at this $1.6 million, how much would be in equities and how much would be in fixed incomes or bonds?
Roshna: I have 5% in bonds and the rest is stocks.
Scott: Five percent?
Roshna: Yeah. It's in a balance...part of it is in a balanced fund that we've had forever. And then I started listening to you guys and I was like, what am I doing? I have a pension. Why do I need bonds?
Pat: Well, that balanced fund is about 40% to 50% fixed income.
Roshna: It's a small amount that's in the balanced fund.
Pat: Okay. So the point being, if that's the case, I could make an argument as that this should be the [crosstalk 00:39:43.316]. And then I'd make the argument to counter that, which is your pension so big. If it were me...
Scott: You'd take the lump sum...
Pat: ...I'd take the lump sum...
Scott: ...and move on.
Pat: ...and move on. If it were me.
Roshna: Okay.
Scott: Yeah.
Pat: Your risk tolerance could be pretty high if you're living off those pensions and you've got time for markets to play themselves out.
Scott: That's right.
Roshna: Yeah. We don't see ourselves needing to touch the 403(b)s.
Pat: That's right.
Roshna: Because we also have rental income.
Pat: You're fine financially.
Scott: Yeah. But then all this is like, what are we trying to accomplish over the rest of our lives? Right? You're at this point, you've worked your entire life. Suddenly you're looking at retirement.
Pat: You're 58 and 60. You've got plenty of money.
Scott: More money than you probably thought you would have.
Pat: You know what I'd say? Where do you want to go on vacation? And by the way, it's hard to go on vacation when you're retired because you're not really vacating anything, you're going on trips.
Scott: You've got rentals. My guess is you guys have always lived a little bit below what you're making and probably the first half of your careers, you weren't making that much anyway. In the last decade, things have gone phenomenally well for you financially. This is just my guess. Tell me if I'm way off base.
Roshna: Yeah, 100%.
Scott: Right. But you've always lived below your means and now you've got all these assets and you're like, "Oh, my gosh, our pensions, can you believe how large our pensions alone are going to be? And now we've got a couple million bucks in retirement accounts and we have these rentals like, holy crap. Like we've got a lot of money." So really all of this comes down to like, what is it you're trying to accomplish? What do you want these dollars to do for you? You have this responsibility now for these dollars. What?
Pat: Do you want them to go to your kids?
Scott: Do you want to increase your standard of living?
Pat: Relatives?
Scott: You want to fund something else?
Pat: Charities.
Pat: You want to go to a really awesome safari in Africa?
Roshna: No.
Scott: But I mean...
Pat: In the Okavango Delta?
Scott: ...it's all those things. And then it's getting clarity on like, what do we want these dollars to do? Then we can build the plan on what's the best way to structure this. And based upon what you guys...and you're not going to come up with the answer overnight either on this, but based upon what you and your spouse decide, what's best, that might dictate taking the $93,000...I mean, the $625,000 over 15 years or over 5 years or whatever. I don't know, but that's where I would start.
Roshna: Okay. Am I ridiculous to worry about RMDs?
Scott: No.
Pat: No, not at all. Not at all, but that's just part of the picture.
Scott: But to your point, you're going to be in a high-tax bracket going forward regardless.
Pat: Yes.
Roshna: Yeah.
Pat: I mean, you're asking all the right questions, but you don't know what direction you're going.
Roshna: I mean, you asked me my goal, I'd like it to grow and I'd like it to...obviously, legacy for the kids. But other than that, I don't have any grand plans because, Scott, you hit it on the head, exactly described my life.
Pat: Yeah. Well, most people with money, that's how they live.
Scott: And most, I mean... Yes, that's exactly right.
Pat: Yes.
Scott: You don't end up with rental houses by spending 100% of your paycheck.
Pat: Yeah. And by the way, based upon your investment experience and you're very, very disciplined, I would take the pension lump sum, roll into an IRA, and I would do 70 to 80% equity portfolio based on the little we know about you with that stated goal that you had.
Roshna: Yeah. It's just, the 6.5% was guaranteed. And I was like, we could then turn around and then put it in an IRA.
Scott: Then do it if, in fact, you can roll those annual distributions out and then invest them as they come to you.
Pat: Yeah. You'll get in the same place.
Roshna: Yeah. Okay. But you like the idea of just taking the lump sum and moving forward.
Pat: Yeah, depending upon how disciplined of an investor you are to weather the markets.
Roshna: Okay.
Pat: Right. I mean, I know how I would manage it, but I'm not you.
Scott: Yeah.
Pat: Not nearly as smart.
Roshna: How would you manage it, sir?
Pat: I would go 70%...
Scott: No, you would be 100% stocks in this situation.
Pat: Yeah, 100% stock in this because of the pension.
Scott: The pension's all fixed income.
Pat: Your pension is all fixed income. You're like, just go.
Scott: I mean, your time horizon is...
Pat: Look at how far your time horizon...your time horizon before required minimum distributions is 17 years, 15 for your husband. That's a long time.
Roshna: It is. And the market has time to do its job.
Pat: That's right.
Scott: That is exactly right.
Pat: You answered your own question, but appreciate the call.
Scott: And we're in Texas talking with Hunter. Hunter, you're with Scott Hanson and Pat McClain.
Hunter: Hi. How are you doing today?
Scott: Good. How you doing, Hunter?
Hunter: Doing well.
Pat: What can we do for you?
Hunter: So my wife and I are both 64, planning to retire 68 or later. I think my wife is pretty set on retiring at 68.
Scott: Can you afford to...
Hunter: But I might go a little later.
Scott: Can you afford to retire in four years?
Hunter: Yes, I think we can. We've got about $1 million in investable assets currently. But my question is, about a year and a half ago, I had a financial advisor, sell me some annuities, fixed-index annuities, which I think are decent products. I'm just not sure that they were the right product at the time. So about $700,000 of my net worth is in those three annuities.
Pat: Wait, wait, wait, wait. He sold you three different annuities all at the same time?
Hunter: Yes. One of them is an IRA in my name. One of them is a Roth IRA in my name. And one of them is an inherited Roth IRA in my wife's name. Okay. And each one is in a separate annuity.
Scott: Okay. And what's the maximum you could earn in any one 12-month period on those?
Hunter: I think the maximum is capped around 10%.
Scott: So we have two years in a row of the market up 20% and you're capped at 10%.
Pat: And so what's your question for us?
Hunter: My question is, how much of my... I expect to live into my nineties based on my family's life expectancy history. I'm looking at a 30-plus year time horizon for retirement and I'm just not sure that it was a wise decision to put that much in safe money that early.
Pat: Yes, that's correct. You explained it better than we could. Your analysis of what you did was a better analysis because it was much more...you can be much more honest with yourself about the decisions you made. Here's the problem. You've got a surrender charge on that annuity.
Hunter: Yes.
Pat: And depending upon the size of the surrender charge...
Scott: How big is the surrender charge? Do you know?
Hunter: Don't have that information in front of me. It goes down every year.
Pat: That's right.
Scott: And it starts like a 9% or something.
Hunter: Yeah, something like that.
Scott: Where were the dollars invested beforehand?
Hunter: They were invested in...you know, to be honest, I don't know.
Pat: Okay. How'd you come about this annuity salesperson?
Hunter: One of these things on Facebook where I clicked on an ad and ended up booking a consultation.
Scott: And were you nervous about the market at the time?
Hunter: Maybe a little bit.
Pat: All right. Yeah. So you got to dig into this. So you know what you did and you said right, which was my timeline is so long that I'd be able to weather any of the market conditions. By the way, it's the same thing that these index annuities...if you tear them open, they use financial derivatives that...
Scott: Well, you're paying for a lot of insurance.
Pat: That's right.
Scott: There's no such thing as a free lunch, so it results in lower returns.
Pat: Correct. That's what it does. And that's what they package them. And by the way, any advisor could build these same products outside of an annuity. And in fact, they do.
Scott: Not any advisor, not most annuity salespeople.
Pat: Well, they're not advisors. They're annuity salespeople disguised as advisors. So you should look at the surrender charge on that and decide whether you should get out of the product, but a large portion of the decision-making will be driven by the surrender charge and the anniversary date. Because if the surrender charge moves every year down, you might be close to a new anniversary date and that surrender charge difference could be 1% or 2%.
Scott: At a minimum, you could take...they probably allow some sort of penalty-free withdrawal each year, 10% or 15% or something.
Hunter: Yes, they do.
Pat: Do that and go hire yourself a...
Scott: Put that in another IRA and just put it at 100% stocks.
Pat: And hire yourself...
Scott: A hundred percent stocks.
Pat: Hire yourself a fee-based financial advisor that's going to do a financial plan for you and say, "You can retire in four years," or "No, you can retire in three," or "You might have to work six. And this is what your social security..." Part of the overall picture of your financial situation is this income, but you can't go it alone. And you tried to do it, but you didn't get an advisor. You got a salesperson. Anyway, sorry that happened to you. Appreciate the call.
Scott: Yeah, we wish you well, Hunter.
Hunter: Okay.
Scott: And I tell you, if you've listened to this program for a while, you hear the two of us talk about the issue with the insurance industry, with the annuity industry. And while I...I state on the record, and I'll state it again right now, the world would be a better place if annuities had not been created, these commercial annuities. Having said that, there are times when they are appropriate. We as a firm have clients with them.
Pat: And occasionally we recommend them.
Scott: And there are fee-based annuities now where you're not locking your money up for several years and your advisor's not receiving a big commission.
Pat: That's correct.
Scott: But for the life of me, the fact that the regulators still allow these products to get sold the way they're sold with these huge commissions paid to brokers and the money's locked up for probably 10, 15 years.
Pat: And the way they're sold is they're quasi, "You get the best part of the stock market."
Scott: "You get into the stock market gains without the downside."
Pat: You don't get the gains.
Scott: Because we just had two phenomenal years, 20% roughly.
Pat: And he's capped at half of that.
Scott: Well, unfortunately... I was about to say we're out of time, but I guess we could talk as long as we want, but maybe we just get to a point where...
Pat: Maybe we're at the end of the attention span.
Scott: By the way, if you don't get our newsletter, I'd encourage you to sign up for our newsletter.
Pat: We believe there's lots of good information.
Scott: And on our website, we just did a whole refresh on our website. I'm pretty proud of it. But we've got a lot of good educational material there on lots of different topics. And so I'd encourage you to go to allworthfinancial.com and check out some of that. Just the same way this podcast radio program is very educational-focused, not salesy-focused, you'll find the same thing from our website.
Pat: Or better yet, if you want a second opinion, just reach out to us and we'll set up an appointment and talk to our advisors.
Scott: Chat with one of our...we've got what...150 or so advisors across the country. Great team. So anyway, we certainly appreciate you being part of our "Money Matters" community. We'll see you next week.
Announcer: This program has been brought to you by Allworth Financial, a registered investment advisory firm. Any ideas presented during this program are not intended to provide specific financial advice. You should consult your own financial advisor, tax consultant, or estate planning attorney to conduct your own due diligence.