Regular listeners to the Motley Fool Answers podcast will know that Alison Southwick and Robert Brokamp are full of excellent investing and personal finance advice. But for this episode -- which they are dedicating totally to listener questions -- they've called in reinforcements: Ross Anderson, a certified financial planner from Motley Fool Wealth Management, a sister company of The Motley Fool. Among the topics they address are asset allocation, Social Security benefits, market timing, the best financial planning software, and when you really don't need an annuity.
A full transcript follows the video.
This video was recorded on Feb. 27, 2018.
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.
Robert Brokamp: Hello!
Southwick: And for a limited time only, Ross Anderson! He's a certified ... financial ... plan ... planner?
Ross Anderson: Yes. Correct.
Southwick: With Motley Fool Wealth Management, a sister company of The Motley Fool. It's time for another mailbag episode!
Southwick: We're going to answer your questions about financial planning software, finding the right benchmark, and shopping for annuities. All that, and more, on this week's episode of Motley Fool Answers.
Southwick: Yes, it's that time again for another all mailbag extravaganza episode where all we do is just blow through a bunch of questions. And have some amount of fun doing it.
Brokamp: A little bit of fun, here.
Southwick: Just a little. Er, not too much, though. And joining us is Ross Anderson. Hey, Ros! Thanks again for coming.
Anderson: Of course. Thank you, guys, for having me!
Southwick: We really appreciate you taking the time to join us. What's new in your world? Anything exciting?
Anderson: There's plenty exciting in Motley Fool Wealth Management all the time. We're open for new clients at the moment. FoolWealth.com for those that are interested in checking us out. But other than that, life goes on.
Brokamp: How's the deejaying going?
Anderson: Oh, that's different. We don't talk about that here.
Brokamp: Ross is a professional deejay, just to make that clear.
Southwick: I feel like you probably do weddings and stuff like that, but you also play legit bars and places in D.C.
Anderson: I've called it a profitable hobby for a long time. It's been a lot of fun.
Southwick: But it, in a way, undermines what good advice you offer financially.
Anderson: It's funny that you started there. Nobody ever takes you seriously from the other world, so I've lost all credibility with everybody listening today.
Southwick: Well, what about in the world of deejaying? When people find out you're a financial planner, are they like...
Anderson: Totally disinterested.
Southwick: Not undermined, just disinterested. All right, Ross. As our special guest, you get the first question and it comes from John. "Where does The Motley Fool stand on modern portfolio theory?" It sounds so, like, serious! "That is a diversified mix of stocks and bonds. Most of The Motley Fool recommendations are stocks and the same could be said of Warren Buffett."
Anderson: Keep in mind I'm answering really for myself and then secondarily for Motley Fool Wealth Management vs. The Fool overall, so I will qualify the answer. I think that we look at a mix of stocks and bonds as being important, particularly as you're getting closer to retirement.
Warren Buffett -- the thing that I take away from him -- he's 87 and what he does, every day, is he gets in his car and he goes to work. For people that don't necessarily want to work into their late 80s, which I think is most folks, having something that starts to prepare you for that retirement drawdown is pretty critical, so the portfolios that we design do tend to have a combination of both stocks and bonds.
The other big component is investor temperament. I think we believe in stocks as being the long-term growth engine for your portfolio. That's why The Motley Fool and Fool Wealth have had the type of track record that's been there. Really, if you're close to needing some of the money, you've got to start taking some of that risk off the table so that you're not walking into a buzz saw as you start to need the money.
Southwick: What's that old rule of thumb? Your age minus a number is how much you're supposed to have in stocks and bonds. I didn't just make that up. I did butcher it, but I didn't make something up.
Brokamp: Yes, that's true.
Southwick: I'm kind of in the ballpark.
Brokamp: It used to be 100 minus your age was the amount you should have in the stock market. And then it got moved up to 110 minus your age. Either way, those are still pretty conservative, but in my Rule Your Retirement service, I have three model portfolios based on where you are along the road to retirement, and each one of those has a little bit of bonds, as well as international stocks, small caps, large caps. We do believe in diversified portfolios.
Anderson: I think it comes down to how much of the money and when you need the money that you're going to be drawing in the distribution phase, because when you lose control of that timing, if you're having a bad year in the market and you need the money this year, you're selling good assets at bad prices. That's what we're trying to help people avoid in most cases. So, that is the real risk. For folks that don't need a significant piece of their portfolio, or if they have other income coming in, they might look at it differently, but that's the real critical component for us.
Southwick: The next question comes from Alan. "Tomorrow I turn 64 years old." Hey, happy belated birthday, Alan! "And plan on retiring in one year." Good for you. "I am very excited." I'm excited for you. "We are selling our house and moving to the Florida Panhandle." Which is so beautiful.
Brokamp: It is, depending on where you are, but, yes...
Southwick: Oh, places like Destin. The water. Oh, my goodness. So lovely. I don't know why they call it... No, I do know why they call it the "Redneck Riviera," but it is so beautiful. And that's no commentary about you, Alan. Whatever. Let's keep moving on.
"My question is about the bond allocation in the Rule Your Retirement model portfolio for retirees." Hey, another bond-related question.
Brokamp: What do you know?
Southwick: "Is this where I should keep three years' worth of living expenses, or should that be separate from the portfolio?"
Brokamp: Well, Alan, first of all congratulations, and as someone who grew up in Florida, I do think it's a lovely place to retire. The retiree portfolio in the Rule Your Retirement service is pretty standard -- 60% stocks, 40% bonds -- but I really like to think of it as 60% in the stock market and 40% out. And what you do with that 40% depends on when you're going to need the money, and that is where you would put that three-to-five years' worth of expenses that you'll need.
In Rule Your Retirement we call it the "income cushion." You just estimate how much you're going to need over the next three to five years, subtract Social Security, subtract anything you get from a pension, anything you get from an annuity, and then that remaining amount you put in cash, CDs, short-term bonds, maybe individual Treasuries. And the rest you can put in the stock market if you are aggressive enough but, generally speaking, about 60% in stocks, 40% is good. That income cushion is part of that 40%.
Southwick: And then every year I assume you have to feed that income cushion.
Brokamp: Exactly. Every year you have to replenish it. The original concept, or at least the term "income cushion" came from a guy named Dave Braze who used to write the Retiree Portfolio for The Motley Fool back in the early 2000s. And according to his methodology, you would replenish it every year, except in years where the stock market is down, and then you don't replenish it, because you don't want to sell your stocks while you're down. You just live off the income cushion until stocks recover.
Of course, that might take a while. Historically it takes three to five years for a bear market to get back to where it was. Sometimes, though, historically it's taken six to eight years, so you could run through that income cushion. At some point you have to sell, but generally live off the income cushion. Hold back on your expenses, if you can, and then replenish it when the market is back up.
Southwick: Our next question comes from Matt. "Previously I worked for American Funds." Is that a mutual fund company?
Brokamp: Yes. It's an actively managed mutual fund company for the most part. I don't know if they have an index fund, but it's mostly sold through advisors.
Southwick: Matt was able to buy their mutual funds commission free. "I see that as an automatic 5.75% return." That means that the fees on those funds are like wow.
Brokamp: Yes, that's the upfront commission at the lowest, what they call, break point in the smaller amounts. If you invested more, it would be a lower commission, but that's the amount of a haircut off the top.
Southwick: That is a big haircut. "My question is with the diversified funds available to me with no sales charge, is it worth it to try to pick stocks, too? I know it can be. Unless there are stocks that I really love, is it worth the time and research or should I leave it to the pros?"
Anderson: The 5.75% that he's referencing is really the sales charge. That amount goes to a selling agent or a broker that is having a client invest in that. Being able to bypass that is a good thing, but there is still a cost of investing in a mutual fund which is going to come in the form of the expense ratio. That doesn't mean that it's free investing. It just means that you aren't paying the second tier that's between you and the fund company.
If you're going to compare mutual funds, I think you should really be looking at that set of funds vs. other no-loads and things that you can get into without also paying that sales load. Whether or not you want to choose stocks or offload that to a professional comes down to how much time you want to invest in putting together a portfolio for yourself.
Motley Fool Wealth Management is on the side of the business that is trying to construct portfolios on behalf of our clients. It's for folks that either don't have the time, don't have the interest, or aren't comfortable building their own stock portfolio. I live in that world, but for folks that like getting into the weeds and really finding stocks that they love, I know that that's a huge passion for so many investors.
I would try to ignore what you're considering -- that automatic 5.75% return -- because I think really that's leveling the playing field between your options. Then consider whether or not you want to spend the time.
Brokamp: And, of course, it's not either/ or. You can do both. In fact, I often recommend that people do both. You have a diversified portfolio of low-cost mutual funds and then pick stocks, as well. I've met plenty of people who just find that they love picking stocks. It makes them more engaged in their personal finances. They try to find more ways to save more money, so they can invest more. I think that's great, so it doesn't have to be either/ or. I think a mix of both is pretty good.
Southwick: I think I fall in the camp [of not picking stocks] unless they are stocks that I really love, as Matt writes in his letter. I like investing in companies that I really love, but I don't love digging into income statements, or looking at all the numbers and crunching everything. That's just not me, and that's fine...
Brokamp: And that's perfectly fine.
Southwick: ... and that's OK. Right, Rick?
Rick Engdahl: That's why we have Stock Advisor.
Southwick: That's true. Someone else can do it for you. Our next question comes from Levi. "I'm 23 and recently married while attending school full-time and working full-time." Whoo!
Brokamp: A lot going on.
Southwick: Wow! "My wife just graduated. We have a three-month emergency fund and are saving $400 a month. Should I invest now or wait until I have a six-month emergency fund? Also, the company I work for doesn't offer a 401(k), so I'm wondering where to invest my money."
Brokamp: Well, Levi, congratulations on being married and having the emergency fund!
Southwick: Oh, my gosh! Saving $400 a month, and you're 23? Wow!
Brokamp: First of all, you sort of adjust the size of the emergency fund for the number of your financial obligations. I think the advice to have a six-month emergency fund is really for someone who has kids, a mortgage, a car payment. I think for someone in your situation, a three-month emergency fund is actually pretty good, because if something happens to your income or times get tough, you and your wife probably can find a way to live pretty cheaply. You don't have to worry about making the mortgage payment.
Southwick: Child care.
Brokamp: The other thing about an emergency fund is it's not just to cover income, but some other big expense which is more likely to happen if you own a house. If something happens to your roof, or something like that. I think three months is fine with you.
As for where to put the money, I would say a Roth IRA is probably your best bet. I'm going to guess that you're not in a high tax bracket. With the Roth IRA you give up a tax deduction today, but since you're not in a high tax bracket, that's OK. In exchange you get tax-free withdrawals in retirement, but the other good thing about that, tying it to the emergency fund, is if you do need the money, you can get the contributions to a Roth IRA out tax and penalty-free if you need them. So, if you do have a big-ticket emergency you can get access to that money.
Anderson: But try not to.
Brokamp: But try not to.
Anderson: Every time you tell people that, I don't want them to consider the Roth IRA to be emergency fund money. If you absolutely have to, you can get to it, but try not to think of it that way.
Brokamp: Right. Forget everything I just said.
Southwick: Next up on the The Two-Handed Financial Advisor, we're going to offer all this conflicting advice.
Southwick: All right, Ross, this one's for you and it comes from Holly. "After interviewing financial planners and getting frustrated with the type of service they offer and the cost, I have decided I need to explore finding financial planning software to help me manage our family's financial plan. I've used Quicken for years, but don't feel it offers an overall look at your financial picture. What have The Fools found that works for tracking your budget, investments, and allows for a family to run scenarios for what if decisions, like buying a new house or car? Listening to The Fools for years gives us confidence we can manage our finances without paying someone 1% of our assets. Thanks for all your great information."
Anderson: All right, Holly.
Brokamp: She's basically asking if a computer can replace us.
Southwick: How can I get rid of you guys in my life?
Anderson: Yes. While I'm only mildly offended by the question... No, I'm just kidding.
Southwick: We're replacing you with machines.
Anderson: I think it's tough to do right now. Luckily, I feel like our role is a little bit safe. I can tell you personally that for budgeting I really haven't found anything that works better for me than Mint.com. I have all my stuff linked to Mint. Everything that I basically spend money on runs through a card of some sort, and so that, for me, is the easiest thing. I find them to be very difficult for looking at future scenarios or investing. I think they really struggle in that, but for budgeting they're a great tool.
On the actual software side, what we use is really a market-leading financial planning software called MoneyGuidePro. It is not consumer facing in terms of its intent, so it is for professionals, but if you want to do some really deep dive scenario analysis, it's very good at that, but that may be more horsepower than you need.
Bro, I know you've featured other Monte Carlo engines and things like that. Are there other tools that you've shared with RYR readers?
Brokamp: Here and there. Personal Capital is another one that I know people here at The Fool use and like. I'm a little surprised that she doesn't find Quicken to her liking because a lot of people really love Quicken.
The calculator that I have mentioned online, a retirement calculator, is with CalcXML and it's kind of a long URL, so here we go. Ready?
Southwick: Here we go.
Brokamp: www.CalcXML.com/calculators/retirement-planning?SKN=606. Duh, duh, duh! Anyways, that's a good retirement calculator. I would say to Holly that...
Southwick: I feel bad.
Brokamp: You don't like that? I would say to Holly that there are other ways to get financial planning help that you don't have to pay 1% for. There are fee-only planners who will charge by the hour or by the project. Let's say you have a what if scenario. You don't know if you want to buy this house, or you don't know if you're on track for retirement, you can hire them for just a few hours and they will have access to these higher-powered tools like MoneyGuidePro and some of these other professional-level tools to help you analyze that single question, and then you might be fine being on your own for a few more years until you have another situation where you want help.
Anderson: We were talking about this right before the show started. Some of the tools, if you ask them a specific question, might give you a really specific answer that doesn't take into context the rest of your picture.
Anderson: Some of these Social Security tools, for example, will help you get the maximum from Social Security, but they don't take into account that there's a drawdown from your portfolio while you're waiting. You've solved one problem and created another, and they're not looking at it in context.
So, be careful with them. Part of what we do is try and help people see those blind spots and certainly if you're doing it on your own, you're taking that into your own hands.
Brokamp: There was a couple of studies that came out in 2016 looking at various free calculators online, and one of them looked at 36 free calculators. They ran a scenario through the calculator, and the scenario they created was of a couple that was not on track to meet retirement, but 70% of the tools said they were on track because they used faulty assumptions and unrealistic returns in terms of their investment returns. Unrealistic projections of what they'd get from Social Security. All kinds of reasons. I really do think when it comes to big life decisions [can I retire, am I on track], it actually is worthwhile to pay a few hundred dollars [even a thousand dollars] to get a good assessment on where you are.
Southwick: But it sounds like Holly has the desire and the smarts to manage a good bulk of her financial life.
Brokamp: I think so. It certainly is a situation where if you are making most of your investment decisions, there's really no need to pay someone 1% to do that. You just need to pay someone to do some of the other financial planning things.
Southwick: The next question comes from Kathy. "I'm writing because I'm confused about Social Security divorce benefits. I thought it was 50% of the higher-earning spouse, but according to Social Security's website, if you are eligible for retirement benefits on your own record and divorced spouse's benefits, we will pay the retirement benefits first. If the benefit of your ex-spouse's record is higher, you will get an additional amount on your ex-spouse's record so that the combination of benefits equals that higher amount. I won't get any benefits if my benefit is greater than 50% of his?"
Brokamp: Right. She included a quote from the Social Security website.
Southwick: That was pulled straight from it, which is riveting stuff.
Brokamp: It is riveting, and it's not clear at all. So much of Social Security is pretty complicated, including benefits for divorced spouses. Let me talk a little bit about that.
You can receive benefits based on your ex-spouse's record if you were married for at least 10 years and you have not remarried. It doesn't matter if your ex-spouse has remarried, but you cannot have been remarried. The benefit is 50% of your spouse's benefit at his full retirement age or your own benefit, whichever is greater.
Here's what is confusing, though. Let's say, for example, you would get $300 based on your own benefit [just on your own work record] and your spouse would get $1,000. You would get either $300 or half of the spouse's thousand, which is $500. So, you'd think, "Of course, $500 is easier," and they would just say, "Your $500 is your divorced spouse benefit." But that's not what they say. What they say is, "You get your $300 plus we're going to make up this difference of $200 as the divorced benefit." I don't know why they do that, but that's the way they do it, so when you read about divorced benefits, it's part of why it's kind of confusing.
A few other things to keep in mind with the divorced spouse benefit. If you take it at age 62, which is early, it will be reduced. If you delay past your full retirement age, which for most people around these days is 66, you don't get a bigger benefit. So, if you're going to get the divorced spouse benefit, it doesn't pay to delay it past your full retirement age.
If your ex-spouse is deceased, you might be eligible for survivor's benefits, and that you can take as early as age 60. And you can still get it, even if you got remarried after age 60. This is all kind of confusing.
Anderson: Clear as mud.
Brokamp: Clear as mud. To answer your fundamental question, which was, "So, I don't get any benefits if my benefit is greater than 50% of his," the answer is yes, you will get benefits, but it will just be based on your own record. You won't get any benefit as a divorced ex-spouse.
Do you have any experience, by the way, of calling the Social Security Administration?
Brokamp: Here's the thing. I would normally say to people you should call the Social Security Administration to get all this clear...
Anderson: It's not personal experience. I've talked to people that have done it.
Brokamp: Yes. And I would say half the time when I've talked to people that have done that, the Social Security Administration has given them incorrect information.
Southwick: Oh, really!
Brokamp: It's kind of common knowledge in the financial planning industry. I don't want to slam the people who work for the Social Security Administration. I'm sure they're all hard-working, nice people, but it's so complex. It's another situation where I think it actually could be worthwhile to pay a pro who's an expert in Social Security to help you on the decision of when to take it.
Anderson: The other thing is that they're not strategists. So, if you ask them a very specific question, they're not going to try and look through your question to figure out what you're really asking. If you say, "Can I do X and you can do it," they'll be like, "Yes."
Southwick: You are legally able to do that.
Anderson: And that may not be the best option for you, but they may have still been correct.
Brokamp: Right. It's not their job to maximize your benefit.
Southwick: Right. Ross, here you go. This comes from Joe. "Have you ever done an episode on the investment potential of peer-to-peer lending platforms, such as Lending Club, Prosper, etc.? I'm curious about your take on them as a potential alternative to CDs, money markets, etc., for stashing emergency or savings for other items like cash we don't intend to put in the market.
For background, my wife and I are 30 with two young kids. We maxed out my 401(k), our IRAs, and 529s for the kids, matched to the state deduction, and these peer-to-peer lending platforms advertise a 4-7% historical return, but they also seem a little too flashy and slick, and I'd be curious to hear your take, so I don't accidentally dive into an over marketed, underperforming option."
Before we get to the question, can you explain a little bit about what it means to invest in a peer-to-peer lending platform?
Anderson: Peer-to-peer lending tries to match up borrowers that need funds for something, whether it's a home improvement, credit card consolidation, anything...
Anderson: They're unsecured loans in most cases, so anything that the borrower needs it for. And then they are trying to do the credit analysis, figure out how risky is that person, and then match them with people that are looking to lend money to other people. They're just a facilitator -- they're a middleman -- trying to match you with borrowers if you're on the investor side.
The benefit, there, is that you're going to get a piece, or the majority of that interest rate that the borrower is paying. They're saying banks have been lending money for years, whether they've been easy to deal with or not. How can other people get into this space? That's what peer-to-peer lenders are trying to facilitate.
Southwick: Let's say Bro wants to put on an addition to his already massive mansion house that he has. I'm just teasing.
Brokamp: I do not have a mansion house.
Southwick: A mansion house. That's not even a phrase people use. Welcome to my...
Brokamp: A mansion.
Southwick: ... mansion house.
Brokamp: Mansion house.
Southwick: So, Bro wants to do an addition and I want to loan someone some money. Does this peer-to-peer lending platform say, "OK, Alison, we've matched you. We're going to Match.com you to Bro." Are you literally waiting for him to pay you back, or does it all go into a great big fund and it all gets dispersed?
Anderson: It's not all pooled. What's actually happening is most of the time you're not funding a single person's whole loan. There's a bunch of people satisfying any single loan. You might say, "I need $25,000 for my llama farm or something." They're going to then put that out there as an offer. This is a borrower. This is their credit rating. This is roughly what they want to do with it and then people can bid on that loan. So, you might end up with 300-400 people that have leant into what makes up the full $25,000.
And so, they're trying to spread that risk, that if there's a single default, it doesn't take one person down. But you can choose how much of the loan you want to fund on any given product.
Southwick: So, with that in mind, that's how it works. Is this something that Joe should use for an emergency fund or saving for other items fund? That's how he described it -- saving for other items.
Anderson: I would not ever use that for an emergency fund.
Southwick: OK, Joe. It's no.
Anderson: I think of it very much like buying a bond. If you're otherwise investing in debt or buying bonds, I think this is an alternative to that. Or if you were having longer-term money in CDs. But this is much higher risk than a CD. There are defaults on these platforms. Nobody gives away 4-7% risk-free, so there is absolutely an additional risk for the additional return that you're getting.
But if you've got some mid-term money [not emergency fund, but maybe not long-enough term to be in stocks], I think that these are an interesting intermediary vs. corporate bonds or municipal bonds that you can get a little bit of a higher return. You're also going to have to do a little bit more work for it, because you do have to look at the loans that are available to issue, and bid on those, and decide how much you want to put into each loan. There is some work on your end as the lender, so be prepared for that, but definitely don't do this with your emergency savings.
Southwick: The next question comes from Janet. "I love your podcast and look forward to it every week." Oh, thanks! "As a part owner of a wine shop in Washington, I especially enjoy Alison's references to our very own Walla Walla wine country." Yay! A city so nice they named it twice.
"My spouse is 70 years old and I am 60 and a pretty aggressive investor. I am still working full-time at a new business I started with a younger partner. This one's a pharmacy to go with the wine shop." That's so Walla Walla.
Brokamp: What a great combo.
Southwick: That's so perfect Walla Walla. "And could continue to work full-time or part-time for the next 10 years. My question is that I frequently get dissatisfied with the returns on my mutual funds because I'm always comparing them to the S&P 500. Can you give me an index or ETF with which to compare my returns that would be appropriate for my age and closeness to retirement?"
Brokamp: Janet, it sounds like you might be asking two questions. There's benchmarking your overall returns, and then given your age and proximity to retirement, but also benchmarking your individual funds.
For the first one, I think it's good to look at just a regular old Vanguard target retirement fund, and for you I would look at the Vanguard 2025 Fund. It's a fund that's designed for people who plan to retire at some point in the next five to seven years. It's currently 65% stocks, 35% bonds. I would compare your portfolio to that.
Based on what you've told me, you're probably doing better because you said you're an aggressive investor, but if you're not, that could be a clue that maybe you should be trying something different if you're not beating that fund. And a target retirement fund does get gradually more conservative as you get closer to that day, which is what most people should be doing.
As for your individual funds, you start by finding out what type of fund it is -- what kind of category -- and then finding an index fund that invests in a similar way. For example, if you have a small-cap value fund, go find a small-cap value index fund from Vanguard or anyone else and just line up those returns. You want to make sure you're making an apples-to-apples comparison.
The truth is, the S&P 500 is a large-cap index fund that's kind of getting growthier because its largest holdings are now Facebook, Microsoft, Apple, and Amazon, and it has done very well over the last few years. Large caps have beaten small caps and midcaps. Growth has beaten value. So, a lot of funds are not looking good compared to the S&P 500.
But these things always turn. It's called the "investment hokey-pokey." Right now, large cap and growth is in. At some point it's going to be out and some of these smaller-cap and value-oriented funds are going to look better.
Anderson: So, if you're looking for an easy way to figure out what each of those funds is comparing itself to, they all have to declare that. If you go to Morningstar.com, the free version of the site [you don't have to have a premium membership to see this], put in the ticker symbol of each fund. They don't tell you what they're comparing their success to, so that's probably the easiest way to see whether this fund is actually beating what it's trying to beat.
Southwick: Sounds easy enough. The next question comes from Nick. "I have reached 62, so retirement is looming. I have more than $200,000 in a government TSP retirement account. I'm shopping for annuities and am befuddled as to whether this would be in our [my and my wife's] best interest. I receive $41,000 per year as a retiree from the U.S. Air Force and I'll receive $11,000 a year from the VA when I retire, plus I'll get $17,000 a year from Social Security if I retire next January. Any info you can share would be most appreciated."
Anderson: Nick, the thing that's toughest about doing this show for me is that I don't get to ask follow-up questions, because I have quite a few.
Southwick: We ask questions. He thought we have answers. No!
Anderson: I normally get to pick at these types of things before I give a real answer. The real question, here, is what are you trying to accomplish. It sounds like you've got a number of pretty solid income sources between the military retirement, Social Security, and all these income streams.
If you're feeling like that is not enough income on an annualized basis, an annuity is another way to potentially add some income in a guaranteed way, but you're losing a lot of liquidity and you're losing a lot of flexibility when you do that. I would be very careful before you make that sort of a choice, because that's almost an irreversible choice if you're going to invest all that money into an annuity, and then you'll have all your assets in annual income mode, and nothing to pull from, potentially, if there is maybe an emergency, or the roof on the house... Well, we'll keep going back to that.
Southwick: A classic.
Anderson: I really worry about whether or not I would lock that money up into an annuity where you don't have as much flexibility with it. That being said, if guaranteed income is the goal, there might be an appropriate case to be made, but I'd be very careful with that.
And zoom out to look at what you are really trying to solve, and then find a strategy that supports the goal, vs. looking at the tool, first.
Southwick: It sounds like he's got almost $70,000 in guaranteed income a year.
Brokamp: Yes, I'll go even harder than you on this and say he's got enough guaranteed income right now. I don't think an annuity is going to be the best bet because he's got a lot of guaranteed income. But in terms of liquid assets, $200,000 for someone who's about to retire is not a whole lot.
Anderson: It's only a couple of roofs.
Brokamp: That's true. So, I would keep that in more liquid investments, without being able to ask him a question.
Anderson: Yes, it's true. Some people are truly discomforted by market fluctuations, and if that's the situation we're in that we have to have guarantees, maybe an annuity could make some sense, but other than that, I agree with you. I wouldn't do it.
Southwick: The next question goes to Bro from Ryan. "My girlfriend and I have a 529 set up for a kid that we hopefully plan to have in about four years. For now, the 529 is in my name; however, I'm going to grad school next year. Will the 529 count against me in regard to receiving financial aid?"
Brokamp: I always love people who are saving for their eventual children. It's very impressive.
Southwick: They're so honest.
Anderson: We have a couple of those that work here.
Brokamp: I know.
Anderson: It's fantastic.
Brokamp: Megan's one of them. She discussed it on the last mailbag. When it comes to financial aid, the key is who is considered the owner of the asset. Generally, assets owned by the student reduce financial aid by 20%, whereas assets owned by parents reduce aid by just 5.6%. A 529 owned by the parent for the beneficiary of a kid is a parent-owned asset.
If the kid owns the 529 and they're still dependent on the parent, it is also considered a parental asset. However, Ryan, since you were talking about grad school, I am assuming you are no longer a dependent of your parents, so it is probably going to be considered your asset and count more against your financial aid.
That said, it's just a general rule. It's always good to contact the schools that you are interested in to see how they handle financial aid. I was thinking if they do count it against him, what's something that he could do. I looked into maybe he can gift the 529 to his girlfriend -- transfer it to her. Not just change beneficiary but transfer ownership of the 529 to her so it's out of his name.
The thing is when I looked into this, depending on who's running the plan, you may or may not be able to do that. Some plans don't allow that and there are probably some gift tax issues involved there, as well, so definitely get some expert opinion on that, at least, from an accountant, and then look at what's available for your plan, but I think that's something to consider if that's really going to harm the amount of aid you're going to get.
Anderson: If it's more than $14,000, I believe he's going to have to file a gift tax return to do that. It may not actually cause any taxes; but having to file that return is sometimes enough of a hurdle.
Brokamp: Yes. Actually, for 2018, the gift tax exclusion has moved up to $15,000.
Anderson: Oh, gosh. Sorry. I haven't even updated my stats for the year.
Southwick: And today's last question comes to us from Nick. Nick writes, "My wife and I are 30 years old. We're entirely invested in a diverse allocation of equities through a variety of Vanguard ETFs and a small pool of individual stocks. I know we'll benefit from the recent dip in stocks with our buy monthly automatic investments, but this recent dip has made me think about building up a cash reserve held in a money market fund in one of our IRAs for buying opportunities like this. What are your thoughts on keeping some percentage [like 2-3%] of our portfolio in cash? We have an emergency fund in a regular, old savings account, but I don't want to use that for investing."
Anderson: This question comes up a lot, and I understand where it comes from, because every time we see stock prices drop, for those of us that want to be aggressive and have a long time horizon, hopefully we're getting excited by that. Wow, these things are on sale.
Southwick: Let's go shopping.
Anderson: I can't wait to go shopping. And it's tough to go shopping unless you have some cash, but it's almost impossible to really make this a plan unless you're going to really market time. It always comes down to whether it is the right time to be in the market and whether it is the right time to buy.
We normally try and caution people not to try and do that. 2% to 3% is not a large enough portion of your portfolio that would really concern me. If you're going to keep 2-3% in your cash bucket and 97% stays invested, that's still a very aggressive allocation, so that wouldn't bother me. When you put 10-35% in cash -- if you're a long-term investor -- I think you're ultimately going to do more harm there.
Really, if you think about a year like 2017, which was an abnormal year from a stock market perspective, you saw 21% increases on the S&P 500 and not once did it give you a 5% pullback. That would have meant you were sitting in cash the entire year waiting for that opportunity to buy. You're missing upside.
So, I think mathematically it makes more sense just to stay fully invested, but if you wanted to tinker around with a small percentage, I don't think it's going to hurt you that bad, but behavior-wise I would encourage you to stay fully invested.
Brokamp: There's really two ways to invest. You buy a diversified portfolio of stocks and funds and hold on for a long time, or you analyze individual companies. He owns a few stocks. If he feels like those stocks are now fully overvalued and he feels like there's not much upside to those stocks, and he has a proven record of showing that he's pretty good at making those kinds of judgments, I think it's perfectly fine to sell those stocks and wait for good buys.
Talking to the analysts here at The Fool, I know there are many of us, here, who feel that way. That right now, it's harder to find a cheap stock, so they have cash on the side waiting for that opportunity. I think that's different, and it's probably fine, compared to someone who has just diversified stocks in general and thinks, "Oh, I just don't feel comfortable with this. I'm going to sell some just so I can wait for the perfect time to get back in." Usually that does not work out, as well.
Anderson: I think that's true, but when you talk to people that have that feeling now, I also wonder how they felt a year ago.
Anderson: Or the year before that. We've been hearing people say for years, "Well, the market's been going up a lot since 2009. The crash is coming. It's got to go down at some point." How much upside are you willing to lose? Was it a Peter Lynch quote that there's a lot more money lost waiting for market corrections than actually in them? That tends to not be the best mathematical strategy. It can make us feel better, but the math doesn't really support it.
Brokamp: Back in 2014, Morgan Housel, who worked for The Fool back then, wrote a report on the optionality of cash and why he keeps as much as 40% of his assets in cash. And it talked a little bit about waiting for good-valued stocks as well as having money on the side for emergencies and stuff like that. Anyone who had a lot of cash since 2014 has missed out on a lot of upside, so it's just one of those things you have to accept.
Southwick: It sounds like you're calling out Morgan for bad financial advice.
Anderson: Just fired.
Southwick: Please come back on the show, Morgan. It's OK. Bro didn't mean it. He didn't mean anything personal.
Brokamp: Well, Morgan did have some stats behind it. He looked at someone who started investing in 1929 and he compared one person who invested $100 a month every month in the stock market vs. someone who put $100 in cash and then when the market dropped 20%, that person put all the cash in the market. And from 1929 until I assume the end of 2013 to 2014, the person who built up cash and waited for the bear markets did come out ahead. So, for his argument there were some numbers behind it. But, that does mean sometimes you have to wait a long time before you get that pullback.
Anderson: And that takes so much discipline.
Brokamp: It really does.
Anderson: So much discipline to do that. That's harder than it sounds. It really is.
Southwick: That covers it for the questions, but we do have some other letters that came in. We received a lot of feedback about our Valentine's Day episode.
Brokamp: The one we were both very sick for and slightly drugged.
Southwick: It got a little weird. I don't know if you heard that episode, Ross, but it got a little weird. Did you hear it?
Anderson: I heard pieces of it. I didn't hear the whole thing.
Southwick: Well, I want to thank everyone for all the well wishes, because we got a lot of letters saying I hope you feel better. It was a crazy episode. And one listener named Al was inspired to write a truly remarkable poem about that episode, something that would make Solomon, himself, blush. Here's just one little excerpt from it.
"So, come to me, my darling, and let me feed you these 1950-style San Francisco inspired meat tidbits one by delicious one."
It was a much longer poem than that. This is the safest for radio part. We got a big kick out of that.
Brokamp: It was impressive.
Anderson: That's one way to eat RiceARoni.
Southwick: Yeah, it's good. So, the Loofies are coming up, and for those of you who don't know, the Loofies are our annual award show. It's incredibly disorganized and not at all consistent, reliable, or scientific. But this year we're looking for your help to make the Loofie awards even greater than mediocre -- which is maybe what it's been in the past -- so I want to hear from you guys, our listeners, on the categories that we should give out awards for the Loofies. And then we'll have our team of analysts at The Fool vote for the winners.
Maybe you want to know The Fool investing team's favorite Bitcoin play. I don't know. Or maybe you want to know their favorite Whisky. Send your suggestions over.
Brokamp: Favorite investment book. Favorite fund.
Southwick: Favorite fund.
Brokamp: Most memorable investment. I don't know. What have we done in the past? We've done all kinds of crazy stuff.
Southwick: Anyway, send us what you want to know. What you want The Motley Fool to give out awards for this year. Let us know.
Engdahl: Favorite safe withdrawal rate.
Southwick: Oh, yes.
Brokamp: A classic.
Southwick: We've got some strong feelings on that. That's going to be a tough category to win. Anyway, send us your suggestions. I'm sure they'll be better than what we just tossed out there.
Brokamp: Send them to...
Brokamp: There you go.
Southwick: That's our email. You can send everything to Answers@Fool.com. You're also welcome to follow us on Twitter. We have a Facebook group, Motley Fool Podcasts. It's private. Just ask to join and you can come on in. I'm just going to start plugging everything. What else do we have?
Brokamp: Those are the things.
Southwick: Those are enough of the things. Ross, thank you so much for joining us!
Anderson: Of course. Thank you, guys!
Southwick: That is the show. It is edited unseasonably by Rick Engdahl. And again, our email is Answers@Fool.com. Send us your Loofie category award-winning suggestions. Rick is laughing at me like this is all falling apart. That's fine.
Engdahl: You're so close, Alison. You're so close!
Southwick: I'm so close. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody!
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Alison Southwick has no position in any of the stocks mentioned. Rick Engdahl owns shares of Amazon, Apple, and Facebook. Robert Brokamp, CFP owns shares of Facebook. Ross Anderson owns shares of Amazon and Facebook. The Motley Fool owns shares of and recommends Amazon, Apple, and Facebook. The Motley Fool has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, short March 2018 $200 calls on Facebook, and long March 2018 $170 puts on Facebook. The Motley Fool has a disclosure policy.