In this episode of Motley Fool Answers, Alison Southwick and Robert Brokamp are joined by Douglas McCormick, author of Family Inc.: Using Business Principles to Maximize Your Family's Wealth.
Not just a writer, he also graduated from West Point and served in the Army. McCormick's transition back to civilian life showed him how much veterans and members of the military need special guidance for their personal finances. Tune in to learn more.
A full transcript follows the video.
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This podcast was recorded on Jan. 31, 2017.
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I'm joined, as always, by Robert Brokamp, personal finance expert here at The Motley Fool, and he's also the advisor on Motley Fool's Rule Your Retirement newsletter. Hello, Bro!
Robert Brokamp: Well hello, Alison.
Southwick: This week we're taking a look at the money challenges of those in the military. We're doing it with the help of a letter from Sergeant Yi, who is trying so hard to get his soldiers to take better care of their money through the teaching power of push-ups. We'll also answer your question about frontloading your Roth IRA. All that and more on this week's episode of Motley Fool Answers.
Southwick: It's time for Answers, Answers, and today's question comes from Josh. Josh writes: "With tax season coming to an end, I was wondering your thoughts on frontloading my Roth IRA. I've always deposited $200ish dollars every two weeks so that I'm maxing out at the end of the year, but I always see articles about how much better frontloading an IRA is. What are your thoughts?"
Brokamp: Good question, Josh. First of all, congratulations for maxing out your Roth every year.
Southwick: Gold star to you.
Brokamp: That's right. And by frontloading, what he means is just maxing it out as soon as possible in the beginning of the year rather than putting in regular contributions throughout the year. And so the question for anyone who is contributing to an IRA but also anyone who comes into any sudden wealth (maybe you got an inheritance or something like that), [is] people often wonder [if they should] invest it all now or [if they] should gradually invest it over a period of a year and so. Fortunately, Vanguard just did an analysis of this question.
They came out with a study entitled, "Invest Now or Temporarily Hold Your Cash?" What they did is looked at a portfolio with 60% stocks, 40% bonds in the U.S, looked at the numbers from 1926 to 2015, and they found that generally speaking, two-thirds of the time you would have been better off just getting the money in the market immediately and historically you would have had an outperformance of 2.4% over if you had done it gradually over the year.
Southwick: That's not bad.
Brokamp: It's not bad. And what was really interesting is they also looked at the UK market and the Australian market. They looked at a 100% stock portfolio, 50/50 stocks/bonds and all bonds, and across pretty much all of those scenarios it came out to be that about two-thirds of the time, you're better off getting the money in immediately.
Southwick: Huh! OK!
Brokamp: So the evidence is pretty clear that generally speaking, that's the way to do it.
Southwick: All right!
Brokamp: If you can't afford to do it, though, it's still better to get it in eventually. One thing, though, to take note about this is while that may be a good idea with your IRA, it may not be a good idea with your 401(k) when it comes to your company match, because depending on how the plan is arranged, if you put all the money in [and] you max out the account before the end of the year, you may not get the full match. I don't want to go into all the details about why, but if you are tempted to max out your 401(k) before the end of the year, talk to your HR folks to make sure that's OK and that you won't miss out on part of the match.
Southwick: Well, Doug McCormick joins us again. Thank you for coming back!
Doug McCormick: Thank you. Glad to be here.
Southwick: So you last came on to chat about your book, Family Inc.: Using Business Principles to Maximize Your Family's Wealth, but you are also on a mission to help members of the military and their families manage their finances better, and so today you're joining us to talk about that.
McCormick: That's correct. Thank you.
Southwick: Thank you for coming in. Can you give me a little bit of background on your career? I know we talked about it on the previous episode, but just remind our listeners who you are and why we think you're so special.
McCormick: Well, I'll tell you who I am and then I'll let you decide. I went to West Point. I did my undergrad degree there. Active duty Army. Decided that it was a great experience but not going to be a good career choice for me, so I got out and went to business school. I did that at Harvard. I've been basically pursuing professions in finance for the last 20 years. I worked at Morgan Stanley in Manhattan for a couple of years, in a private equity firm, and then co-founded my own firm. So I'm an investor but consider myself an entrepreneur and small business owner.
My own personal challenges in transition have led me to appreciate (a) how hard transition can be for veterans; (b) the importance of that kind of window of opportunity (call it six months before you get out to two or three years after), because that's the key time when their financial security is really going to be determined for the rest of their lives. So I wrote the book for all Americans, but I have a particular passion in making sure that these principles get to our veteran community, because I think there's a real opportunity to have an impact there.
Southwick: Well, we received a letter from Sergeant Yi, and I'm so sad that he sent it in April and we're only now addressing it. Oh, I'm so sorry, but it's a great letter. The thinking, here, is that we're going to go through his letter and unpack it. I have asked a Fool, Mike Klesta, to read the letter and be my Sergeant Yi for us, and we'll break in at points to talk about the letter, and the concerns, and the specifics about it.
Mike Klesta: To Motley Fool Answers: Love the show. Thanks for making the most of my daily commute. I've been in the Army for eight years, having recently become much more assertive in my investments, thanks to your show. I've increased my contributions and allocations in my TSP; moved away from mutual funds in my IRA to indexing stocks; and feel very good about where I am and will be down the road.
What concerns me at this point is seeing the soldiers in my unit neglect to take steps toward saving or make poor financial choices. Very few soldiers partake in TSP that is available to them; and if they do, they don't contribute nearly enough, or their allocations are in securities that don't grow.
Southwick: I have never been in the military, so I don't know what a TSP is.
Brokamp: It's the thrift savings plan, and it's available to all federal employees.
McCormick: It's like a 401(k). You can do a pre-tax or a Roth approach, so you can defer or not depending on your tax situation. They've got a couple of different funds -- I think five -- and they're very kind of plain vanilla. But it's a low-cost option and I think, in general, a good vehicle.
Brokamp: You opt in, just like a 401(k). It's as low cost as you'll find out there. So certainly if you have access to the TSP, it's a great option. It's all index-based investments, so you won't have any actively managed funds, but it is super low cost.
McCormick: One thing I would comment on. I'm much more knowledgeable about the DoD policies versus federal government broadly, but for the most part, there's not a matching program with TSP. The Department of Defense is undergoing a transition from a defined benefit plan to a hybrid plan that [comes into effect] in 2018, and so there are some big changes on the horizon for the active duty population. But as it stands currently, there's very little matching.
Klesta: To further compound the problem, this isn't a new phenomenon. It's a running joke in the military that young soldiers will buy a Mustang at double-digit interest rates or get married at 19. There's monetary incentive for having dependents in the military, which is great for families but terrible for younger guys who really don't know what they're doing.
McCormick: So first of all, full disclosure. I graduated from West Point in 1991 with a brand new Mustang convertible.
Southwick: Either a baby or a Mustang.
McCormick: A big engine. You've got the 5.0 liter, so I hear Sergeant Yi in the back of my head right now. I would say I think Sergeant Yi is being a little tough on his service members, because I don't think their actions, or the way they're thinking about the world is very different from the broad, young community ...
Southwick: Any other 19 year old.
McCormick: Yes. Having said that, I think there are some unique challenges that veterans face that make these decisions more important to them. Eighty-five percent of active duty service members will transition out of service with no retirement benefits, so I believe the day someone enters service, statistics would say they're going to separate. They should start planning for that separation, because [with] that separation they encounter some different challenges around employment, etc.
The other thing I would say is [active duty service members compound this problem], because they have a propensity to have families sooner and financial obligations associated with those families, so the consequences of this kind of behavior are magnified.
Southwick: Yeah. I mean, having kids at a younger age just makes everything harder. And then if you get sent on active duty, and you only get to come back every six months, ugh!
McCormick: It's challenging.
McCormick: Yes, and I think there's a really under-told story, here, that I just want to comment on for a second, which is the economic opportunity for military spouses is not nearly as good as their civilian counterparts. So let me give you a couple of statistics.
Military spouses are four times more likely to experience unemployment. Across the country, 4.5% roughly and 18% in the military spouse community. And if you're lucky enough to be employed, statistics say 35% to 40% are underemployed, meaning they're making less for the equivalent work.
And there's a lot of reasons on why this is. It could be the geography of the posts. It could be the fact that the culture is one of deployment for the soldier, which makes it difficult for the spouse to hold a job and keep the family together. But for a variety of reasons, we're losing potential, here, among these spouses and I think there's a big opportunity to improve economic security among the veteran community by improving that. It's a big challenge, but a big opportunity.
Klesta: In combat arms, the part of the military whose principal mission is fighting (such as infantry and armory), we are nigh legendary in our inability to grasp adult financial concepts, and if we do, it's from someone or one's own costly mistakes. Sure, we get financial counselors from time to time to explain this stuff ...
Southwick: Is that true? Do they have a lot of resources available to them do you feel?
McCormick: I do. I've got to say I'm a little bit dated, so my experience may not be indicative of today's experience. My big complaint about the way the Department of Defense teaches financial literacy is I think we teach to the lowest common denominator and I think we play defense, not offense.
By that what I mean -- and this is my interpretation -- is success, in terms of teaching financial literacy to the soldier population, is keeping them away from payday loans, keeping them away from high-cost credit cards, and ensuring they have enough money to make rent.
That's survival, but that's not success. Success, in my mind, is giving them the tools to really accumulate wealth and financial security, and I don't think we're doing enough about that side of the equation. We're keeping them out of trouble. We're giving them the basic survival skills. I don't think we're doing enough on the wealth creation side.
Klesta: The majority of the guys are too young to care and have little interest in the matter. The only people who listen are usually the senior guys like the sergeants and the officers.
McCormick: Yes, I think that's probably right. Again, I would say if you compare it to your civilian counterparts, that's probably very similar. As people age, they begin to start appreciating the need. I think the way to make this relevant for young folks is to emphasize the fact that they are likely to transition. You know, being an active duty service member is a young person's game, and in three, four, or five years they are going to be navigating a career transition. They're going to be going back to school and so this should become important to them pretty quickly.
Klesta: I just had a new guy who has already been in for four years, including an Afghanistan deployment, who just started his TSP. Had he started earlier, his tax-exempt combat pay would have gone to his Roth and it could have been 100% tax-free. He's a smart kid, and it pains me to think how so many soldiers haven't even put thought into their retirement.
One of my soldiers just got a fat reenlistment bonus and asked me what expensive thing he should buy. He couldn't even finish his sentence before I was yelling in his ear the error of his ways, and he was doing push-ups while I whispered the magic of compound interest and how it would be in his best interest to start a retirement plan. It was a weird day.
Southwick: This is both sad and hilarious at the same time.
McCormick: You know what? I love Sergeant Yi. Good for him. I think he's sending the right general messages to his soldiers.
Klesta: To make a long story short, while I am in charge of a handful of soldiers, I'm in a unique position to influence a company of 150 soldiers. I want the guys to enroll in TSP and start their IRAs, but ultimately convey to them that saving is a mark of responsibility and adulthood. Most of my audience has the attention span of a five year old, and I don't have enough crayons to explain it to them without boring them. What do you think is the best way to get young people started when they lack the knowledge and/or interest in saving? How should they start when they have a starting wage and think all their income is for discretionary spending?
McCormick: So I'm a little bit of a broken record on this part, because I think these are challenges that we face with all of our younger population ...
Southwick: Oh, all of my money in my 20s went to beer.
McCormick: Yes, exactly.
Southwick: It was all discretionary.
McCormick: You probably have a lot of great memories, right?
Southwick: I do.
Brokamp: The ones you remember.
McCormick: Who's to say that was wasted? So I get back to highlighting for the veteran community the unique circumstances. Eighty-five percent will transition. When they transition, about one-third take a year or more to find their first job, and in many cases, they're going to go to school with the GI Bill. Fifty percent of eligible veterans use the GI Bill, so when you can frame it in ways that are relevant to them and help them understand that these choices are really going to benefit them in the very near term, I think that's the valuable lesson here.
So if I was Sergeant Yi, I would change the way I'm positioning it a little bit differently. Retirement's obviously important, but for these veterans, it's not retirement. It's effective transition, because they're likely to get out and that's much more of a near-term goal for them. That's likely three years. So to frame it that way, they're likely to be more receptive to why this matters to them.
Southwick: It kind of gets also to your point that we talked about when you were on the show last time, about focusing on your labor potential and that is going to have such a big impact in the long run as opposed to your investment returns, which also impact you, of course.
McCormick: My concern with the veteran community -- why I'm spending a lot of time there -- is I think if veterans are getting out ... and by the way, these are not small numbers. About 175,000 veterans will leave active duty service every year for the next ten.
McCormick: So these are big numbers.
McCormick: And if they're required or forced to take a job that's not the best use of their skills, because they couldn't afford to keep looking, I think they're impairing their lifetime income here for many years to come. So these are big stakes questions, and if we can teach them to have the financial flexibility to find the right job (because they have savings, or they've limited their fixed costs and their obligation from a family, or the Mustang example), I think that really serves them well.
Southwick: How long did you end up keeping that Mustang?
McCormick: Still got it.
Brokamp: That's impressive.
McCormick: Yeah, I'm a keeper. I'm a keeper. I think it's worth like $2,000, but I got it. I don't drive it much. It sits in a garage up in Pennsylvania.
Klesta: I hope the questions aren't too broad to make bad radio. A lot of people I work with see investments as too esoteric a subject, and I hope you can break it down for them as you did for me. Best regards and thanks, Sergeant Yi.
Southwick: Sorry, Sergeant Yi. I'm reading the whole thing on air. Bro, what's your best piece of advice about getting young people to care about managing their money and their potential?
Brokamp: Well, one of the things that Doug talks about in his book (and he has a calculator on his website, FamilyInc.com) is creating a present value of your income. Of your labor. Instead of thinking, "I'm making $40,000 a year," when you use the calculator and figure that actually over your life it has a present value of $2 million or so. If you can instead earn a little bit more and you see that value grow, I think that's pretty powerful to see.
And then when you think about someone who's just saving like 10% of their salary how much they'll have even 10 years down the road (if you're making $40,000 versus someone who's making $50,000 to $60,000) I think that's powerful as well.
McCormick: The way I like to describe it is I would much rather grow wealth than try to save it. So you can grow wealth by making good choices with your labor and making good asset allocation choices with your financial capital -- embracing equities and that kind of thing.
Saving your way there, when you're not using your labor effectively and you're not investing effectively, that's tough. It's like being on a diet for life.
Southwick: Sounds like less fun. Definitely less fun.
Brokamp: Right. One thing you talked about in your book, and that is somewhat addressed in Sergeant Yi's email, was he said if they are participating in the TSP, they're often investing in low-returning assets, so I'm assuming he's talking about bonds. In your book, you go into a good bit of detail about why actually over the long term, stocks are actually less risky than bonds.
McCormick: Yes. I come at it, again, from I'm looking at it as a business, and I think if you look at yourself as a business, you would say, "I may need some contingency funds for unexpected things," but everything else in a young person's life is really very long duration. So I'm a huge fan of other than contingency funds, I would really significantly allocate that to equities. And when you look at it over the long run (call it 20 or more years), the volatility of equity returns dramatically compresses relative to fixed income.
The other thing that I think people miss is the right metric for evaluating performance is not nominal return. We all use nominal return because it's easy and your tax rate could be different than my tax rate, etc. But the right answer is after-tax, after-inflation purchasing power, and when you look at it that way, again, equities look less risky.
Brokamp: One of the stats you had in your book was (and I think you got it from Vanguard) that since the 1920s, there's only one decade that stocks lost to inflation, whereas Treasuries lose to inflation in about half the decades.
Brokamp: So you're losing purchasing power. Even though it may look like it's growing, you're losing purchasing power if you're just sticking with bonds.
McCormick: Yup. And in that decade, the dispersion of outcome is much tighter, but you're probably playing a loser's game a lot more of the time.
Southwick: Any closing thoughts for Sergeant Yi?
McCormick: Keep at it, Sergeant Yi. A lot of times I find that young folks act like they ignore you, but it sticks with them and at some point it will change behavior.
Southwick: More push-ups.
Brokamp: More push-ups and whispering in the ear.
Southwick: And whispering in the ear.
Brokamp: Compound interest.
Southwick: All right. So thank you for joining us, again. This has been a great chat.
Southwick: That's the show. Thanks to Doug McCormick for joining us. His book, again, is Family Inc.: Using Business Principles to Maximize Your Family's Wealth. You can get it where all fine books are sold. Also, thanks to Fool Mike Klesta for being the voice of Sergeant Yi, and thanks to Sergeant Yi for sending the letter.
I have many more thanks, by the way, because I also want to thank him, along with all of the other men and women who are serving or who have served our nation in the armed forces; like listeners [Alan], Kirby, Austin, and [Sharaz], to name a few.
And final thanks to ... I don't know how to read this. It looks like Glitto, Getto. Either way, it's awesome because he or she sent a postcard from Western Australia. And we also got a postcard from Richard in New Mexico. So thanks, you guys, for still sending them in. I'm not going to give you the full-court press, again, until summer, but I'm still happy to get them.
All right, the show is edited precisely by Rick Engdahl and our email is [email protected] For Robert Brokamp, I'm Alison Southwick. Stay Foolish everybody.