In this episode of Motley Fool Answers, hosts Alison Southwick and Robert Brokamp are answering a record number of questions this month including more on 20-30-50 budgeting, stashing your emergency fund in CDs, required minimum distributions, 15- versus 30-year mortgages, and more.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
10 stocks we like better than Walmart
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, the Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Walmart wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of April 1, 2019
The author(s) may have a position in any stocks mentioned.
This video was recorded on April 30, 2019.
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: Greetings, everyone!
Southwick: In this week's episode we're heading to the Mailbag to answer your questions about 15- vs. 30-year mortgages, investing in IPOs, and clarifying the 20/30/50 budgeting rule. You guys can't get enough of that! All that and so much more on this week's episode of Motley Fool Answers.
Southwick: Hey, Buck Hartzell is here in the studio this month!
Buck Hartzell: Hi, Alison! Hi, Robert! Thanks for having me!
Southwick: Buck, did you know you and I were ships in the night at a 12- and 13-year-old volleyball tournament in Philadelphia last weekend?
Hartzell: Oh, I did not know you were in Philadelphia!
Southwick: I was! I was there rooting for the Rochester Mystics. Go Cousin Ella!
Hartzell: Nice! Did you go to the Reading Terminal and get some good Philadelphia food?
Southwick: We did! We went to the Reading Terminal. The tournament was right there at the Philly Convention Center. I had never sat through a 12- and 13-year-old girls' volleyball tournament, but it is surprisingly good.
Hartzell: It's exciting, and your ears will never be the same because there's also a kind of roar that goes over the crowd there. It's pretty loud after you've been in there about 20 hours.
Southwick: How did you guys do? All right?
Hartzell: We did very well! We qualified and got an open national bid.
Southwick: So you're going to Indiana!
Hartzell: We are going to Indianapolis.
Brokamp: Which makes it clear that we're not talking about Buck playing volleyball. We're talking about his daughter.
Hartzell: That's right!
Brokamp: Who is a star!
Southwick: Buck's daughter and my cousin. They did not qualify. They went pretty far, but they're still hoping to get in some other way. I don't know how this all works. It's very complicated.
Hartzell: Different levels from open, and then national, and American. So, yes, that will make other chances for them to get in. There are some other qualifiers.
Southwick: Yes, I think so. Bro, whenever you go to big events where there's a ton of people in a room do you ever think, "Maybe someone in this room listens to this podcast and would be mildly impressed if they knew if you were also in that room?" Do you ever think that?
Brokamp: No, not really. I think if they ever did meet me, they'd be like, "Oh, that's Bro?"
Southwick: Seeming mildly disappointed.
Brokamp: "I kind of had a different idea of what you'd look like. But hey, it's great to meet you!"
Southwick: And then they'd sit you down and be like, "OK, so, I've got X amount saved..."
Southwick: "...in my Roth IRA and I've got blah blah blah." Buck, thank you again for joining us...
Hartzell: Thanks for having me!
Southwick: ... and we have a lot of questions to get to, so let's just get to them, huh?
Brokamp: Let's do it!
Southwick: The first question comes from Tony. "I often hear Motley Fool hosts discussing Berkshire Hathaway and Markel as companies that invest in other companies and produce a nice annual return for shareholders. But since they buy stock in other companies, aren't they like buying an actively managed mutual fund instead of an individual company?"
Hartzell: A great question, Tony! Yes, when you look at Berkshire and Markel, they're both diversified companies, but they're different. Berkshire is really big. They're an over $500 billion company. Just to give an example, one little piece of Berkshire Hathaway owns about $200 billion worth of publicly traded stocks. These are huge companies like Heinz, Kraft, Wells Fargo, and American Express and they own big stakes in them. Markel is like a $14 billion company, so 500 vs. 14.
I'd say Berkshire is larger and more diversified than Markel is, but they both are doing the same thing. They own whole other companies in diversified revenue streams and I think they're a good idea to have in one's portfolio in addition to the S&P 500. As a matter of fact, if you look over the last few years at the performance of the S&P 500 in aggregate how much revenues grew and profits, Berkshire has grown much faster, their performance has grown much better, and I actually like them better than the S&P 500, although [they're] not quite as diversified and they trade about like the financials ETF.
You'll find them go down. In 2008-2009, when the financial ETF went down about 37%, so did Berkshire Hathaway. It trades with it, but the business did much better. I like the idea of having some Berkshire Hathaway or Markel in your portfolio. I think right now Berkshire is a little bit cheaper, so maybe that's a good choice for you if you don't mind having a company instead of just the S&P 500.
Southwick: With Berkshire there's always a lot of concern with Buffett. It's all about Buffett.
Brokamp: He's now 88.
Southwick: So there's good reason to have some concern that he maybe is not going to live forever. Maybe he is the Night King. I don't know.
Hartzell: Do the actuarial tables say that?
Southwick: [laughs] Is Markel similar in how it's structured? Is there one person at the top?
Hartzell: Well, it's similar in that it's been in the Markel family for a long time. It's a third generation, now, that's running it but their next group of leaders is already in place and running the business. So co-CEOs Richie Whitt and Tom Gayner are in their 50s. They're running the businesses while they're overseen by Steven and Tony Markel and Mr. Kirshner who was the CEO before, so they have a younger group.
I would also stress that nobody's as good as Warren Buffett is, and that's a fact, but he's not running all the individual businesses. Those are all run by great people and now they're overseen by Greg Abel and Ajit Jain. Ajit is going to run the insurance businesses and Greg will oversee the other businesses that they have. These are very capable, great people that they have in place, and all those people running those other businesses have done it themselves. Buffett has basically allocated the capital and a few years ago he hired people to help with that, too, so they're getting more. The bench strength is really strong there.
Does anybody want to see Warren Buffett go? No. But the people that are behind him are more than capable and Berkshire will do just fine. I think that's overblown a little bit.
Brokamp: The only thing I'll add is if you really are considering owning one of these stocks, or both of these stocks vs. an actively managed fund, just know that if you buy the stocks you just pay the commission and that's it. You don't pay any actively managed fee which is anywhere from 0.7% to 1%. Actively managed funds are not very tax efficient, so if you were looking for money outside of an IRA or a 401(k), one of these stocks would be worth considering and I should say that I own both of them.
Hartzell: I own both of them, as well.
Southwick: I own neither. Next up. The question comes from Brad. "After listening to your Foolish Guide to Buying a Home episode, I felt you left out an important piece of advice. I recommend to all my younger first-time buyer friends to stay within a price range that allows them to afford a loan with a 15-year term vs. the more popular 30-year term. At the beginning making the payments can be tough, but the reward of the lower interest rate and building equity so much faster is worth it. What are your thoughts?"
Brokamp: Brad, I think that's actually a very good point! I think the best way to see the differences is just break it down to numbers. According to Freddie Mac now, a 15-year mortgage charges a rate of 3.64%. A 30-year mortgage, 4.2%. You're paying more than 0.5% a year to have the 30-year mortgage. Why would you do that? Because you're spreading the loan over a longer period, which means you'll have lower payments.
I compared what the payments would be on a $350,000 mortgage which, according to the Mortgage Bankers Association, is the average size of a new mortgage. The all-time high, by the way. So if you get a 15-year mortgage for a $350,000 loan you're going to pay about $2,500. For a 30-year mortgage it's $1,700. So it's an $800 difference. If you choose that 15-year mortgage, you have to be able to afford that extra $800 a month.
That said, you'll pay it off sooner and you'll have lower overall payments. If you look at the total cost of those loans, a 30-year mortgage is actually going to cost you over $150,000 more because you paid that interest over a longer period. I think it's worth considering, but I should say that I've always done 30-year mortgages, but then paid a little extra on the principal because I like the flexibility that if something happens, and I need to cut back on my payments, I can do that.
Southwick: You can always pay more, and it doesn't hurt.
Hartzell: Back in the old days, they used to have pre-payment penalties and that kind of stuff built in, but basically those don't exist anymore. So a lot of people will pay an extra payment at a time that's good for them during the year. Not right after the holidays when they spend a lot of money, but maybe in the summertime they make an extra payment, and that will bring your mortgage down quicker, too.
It all depends on knowing yourself, as Bro says. That extra $800 a month, if you're going to spend it on Jelly Bellies, or vacations, or whatever else; or if you have other alternatives like I can't fund my Roth IRA, but if I pay an extra mortgage payment I can do that with a lower payment. If you're going to use that $800 well, it might be worth it to go with a 30-year mortgage. I have a 30-year mortgage as well.
Southwick: The next question is from Ziv. "I was wondering what you have to say about investing very short term in IPOs just for the pop. It seems that big-name IPOs like Lyft almost always pop on the first day. Why not make a quick 5-15%? Am I missing something, or is this Foolish?"
Hartzell: Everybody loves a quick 15%, right? Sure, we'll always take that. Ziv, a good question! Here's the problem with this. Those investment banks that underwrite the IPO reserve a certain amount of those shares, but it's usually not for you or me. It's usually their big clients. Pretty typically they get them, they sell it, and they get the pop.
What happens in a lot of cases [I went down to Discount Broker a year or so] when there was a big IPO coming down the pike. I said, "How's it going?" He was like, "Oh, my gosh!" He was shaking his head. He said, "People are putting in orders. They don't realize they're not going to get the IPO price, because it's priced at $22 and it opens at $28." What happens is people put in market orders. You've got to be very careful not to do that. You're not going to get the IPO price.
So Ziv, it's a good idea, but it's unlikely you're going to get that pop. I would say further for The Motley Fool, in general, you've got to remember. Insiders are selling on these IPOs now. They go on their market tour and tell everybody how great the business is and then they're selling off some shares. Oftentimes -- not every time -- but The Motley Fool likes to sit back and wait for a few quarters to see how well this company performs and that initial pop, a lot of times, will dissipate.
We did this with Facebook. Facebook came out and there was a big pop. We recommended it later and got it at a much better price. So be patient. You're probably not going to get that 15% pop.
Brokamp: I'll just point out that if you're looking for an academic source on IPOs, the guy to go to is Jay Ritter at the University of Florida. Go to his website. He has tons of great information and data on IPOs.
Southwick: The next question comes from Cliff. "In an earlier podcast Bro mentioned stashing the emergency fund in a CD for a better yield. I always thought of CDs as fixed term and you can't withdraw them before the end of the term, so how does that help me in an emergency if I need the cash?"
Brokamp: That's a good point! With most CDs you can get the money early. You just have to pay a penalty. Like on a 12-month CD or a one-year CD, the [penalty] is 90 days' worth of interest. You can get the money, but you'll pay a little bit of a penalty.
The decision as to whether you should go with the CD or not is to look at what's available as just a regular savings account and compare it to a one or two-year CD. I went to The Ascent, the Motley Fool's website where there's lots of good information about banking and mortgages. You can get a savings account that's 2.25% and you can get a one-year CD that's 2.8%. It is a little bit more.
You might want to split up your emergency fund and have some in the savings, but some in a one or two-year CD because given where rates are now, they're probably not going to go up. Nowadays the market is betting it's more likely that they will go down, so it might be a good idea to lock in some of your money at today's rate.
Hartzell: And you can ladder those CDs so you always have some maturing. If these are short term in nature, you don't put it all in at one time. You spread it out and then every couple of months you have some money coming available and you can decide to roll it into another CD or use it if you need it.
Southwick: The next question comes from Daniel. "When buying a 'basket,' does that typically mean buy each position so the entire basket is equivalent to a standard position, or buy each position in the basket at your standard position size?"
Hartzell: That's a very good question, Daniel! When you do a basket, typically if you add up all those positions in the basket they should be one position if you want exposure to a particular sector. Buffett mentioned years ago in a Berkshire meeting that he thought pharmaceuticals were good companies, but he couldn't pick the company that's going to develop the next blockbuster drug like Lipitor or whatever else, so he said, "Here's the way I would do it. I would just buy five of those big pharmaceutical companies. One of them will do really well. Maybe one won't, but the basket of them will do well."
When you look at each position you add them up. If your whole position size is 3%, then all of them together should equal 3%.
Brokamp: Out of curiosity, how many Berkshire annual meetings have you attended?
Hartzell: That's a good question! I think about four. I haven't been to that many, but they started live streaming them, now. They have them on Yahoo, so you can watch them. I've watched what's been available there. The nice thing is The Fool usually sent groups of people there, so we were live streaming even when they didn't. I feel like I've been to more, but I think it's probably around four.
Brokamp: I've been to one, and it's definitely one of those things that if you're an ardent investor, especially a Berkshire investor, you've got to do it at least once and you've got to hurry at this point.
Hartzell: Yes, you should do it. It's a fun event and it's coming up in May.
Brokamp: Yes, very soon.
Southwick: The next question comes from Kevin. "I enjoy your podcast and listened attentively to the episode on the relevance on the 4% withdrawal rule for today's retirement portfolio. I'm 69 years old and am anticipating future events that may impact my retirement income strategy. Do you have any thoughts of the impact that required minimum distributions have when a retiree has most of their retirement assets in an account that requires RMDs? The first years don't have much impact on a planned withdrawal strategy, but when one is in their 80s, some serious percentages are required to be withdrawn and taxes paid."
Brokamp: Kevin's talking about when we had Wade Pfau on the show a few episodes ago talking the so-called "4% rule." One thing that's important to know is that is for people who are retiring when they're around age 65. So if you are in your 70s, you could actually take out more because you'll have a shorter retirement.
He's talking about [the fact that] with requirement minimum distributions, you have to start taking those at age 70 and a half. What's the percentage of withdrawal at that first year when you're 70? It's only 3.65%. It's pretty low, but it does creep up, so by the time you're age 85, you're required to take out 6.76%. Again, we're talking about from traditional retirement accounts and 401(k)s, not from your regular taxable account.
That does get to be higher, but the interesting thing is there's more and more research showing that RMDs are really good guidelines for withdrawal rates and that at 85, you can safely take out 6.7% from your account and feel pretty comfortable it's going to last as long as you do.
I'll give you one example. That was a study by the Stanford Center on Longevity, which looked at 292 retirement income strategies. The one they decided was the best [was the one that] relied on several factors, but one thing was delay Social Security until age 70 and then use the requirement minimum distribution withdrawals as guidelines for how much you could spend. It may sound like a lot if you're told you have to take 6-8%, but I think you'll probably save based on your age.
Now, if you don't need the money, you don't have to sell the investment, take out the cash, and then rebuy it. You can actually withdraw the investment from your account. It saves you some commissions, there; but, unfortunately, you are going to have to pay the taxes.
Southwick: The next question comes from Dustin. "I see a lot of public Motley Fool articles pop up around the internet on my newsfeed. Some of those articles are bearish on stocks that are current and even recent Stock Advisor recommendations. I trust Tom and David's picks, and I know they are in it for the long game, so maybe the discrepancy is on short term vs. long term? I was hoping you could comment on the somewhat mixed messages I'm getting from time to time from The Motley Fool."
Hartzell: We get this question a lot.
Brokamp: We do.
Hartzell: This happens all the time. I'd say we don't have a company line on any stock at The Motley Fool. We're a motley group. We have lots of smart people writing for us. We all have divergent views, experiences, and insights to bring to those stocks and we think that we're ultimately smarter because of those. I'd say when you read somebody else's -- and this goes for people outside of The Fool, as well -- often we'll get some questions from people when a short report comes out about a particular company that The Motley Fool really likes.
They say, "Man, this report came out. It's a hundred pages long and they say how much they hate this particular company." And my answer is they could be right and we could be right. You mentioned duration, there, or time frame. We're long-term thinkers and investors, here, so when we make a pick, we're looking out three to five years at least, and hopefully a lot longer with that pick, where people that have a negative view, particularly if they're short the stock, that's usually a very short time horizon. They put out these reports because they have to have action on the stock, otherwise, they have to buy another short and that costs more money.
So we could both be right, but I would just say we're pretty good. Tom and Dave have a good track record but understand the argument. We don't have a company line on any particular stock and we would encourage you to read negative things about your company so you have a better perspective.
Southwick: I stumbled upon one of these examples today. I was on Fool IQ, which is where we aggregate all of our analysts' stocks. I needed someone to talk about Tesla with a reporter, so I went to Fool IQ. And it said "negative conviction" for Tesla, but it's recommended at eight of our services.
Southwick: And I'm like, "Yes, that's a mixed message. I can completely understand why our members are confused."
Hartzell: Yes, and it happens.
Southwick: I'm confused! I don't know.
Hartzell: Tesla is a perfect example of a company like that, because the optionality for this business is so wide. I mean, there's Elon Musk. There's a lot of things around Elon Musk. He makes headlines every day, some good and some bad. But he's ridiculously smart and has accomplished a lot. And then as far as the business, there's some debt. They only hold about $10 billion in debt on their balance sheet and there's some questions about that. And then they're launching into new countries and developing new models, and self-driving and all this kind of stuff.
So this is one of these businesses where there are just a lot of questions around them, but also a lot of opportunity, so that means there's going to be a lot of divergent viewpoints on that business, and there are within the company and outside of it.
Southwick: The next question comes from Brandon. "I work for a great insurance company that is willing to pay in full for me to get a graduate degree." That's awesome!
Brokamp: It is.
Southwick: "I initially thought of just getting a general MBA, but I found multiple specialized graduate programs that range from finance to entrepreneurship and innovation. If ultimately a career investing is my goal, what would you recommend?"
Brokamp: If you're looking to get a job somewhere, every company will have their own take on this. If you have a specific company in mind that you'd like to work for I would start with them and see what they favor and what they like.
Generally speaking you could even start your own insurance company, because insurance companies do manage portfolios. You might be asking to work at a different position in your own company. I would start with those folks and ask which degree you should get.
I asked some of the folks here, at The Motley Fool, who are in charge of hiring for our investing group, and the only thing they said that's a company line is that The Fool does not pay more for people who have graduate degrees.
That's good to know, but then of the people I asked they each had different opinions about whether a master's degree was helpful or not. One said he has a bias toward people with a finance degree, but it's not necessary. There are also designations, so maybe the insurance company will pay for you to be a CFA, for example. Mutual fund companies really favor people who have a CFA. The Motley Fool is kind of mixed on it.
So that's what I would say. Find out where you want to end up and find out what they're looking for. Buck, you might have an opinion as someone who has an MBA.
Hartzell: I do have an MBA and they don't pay me more because of it, either. I'd say do what you want to do. Study what you're interested in. When I look across our pool of analysts, we're a pretty eclectic group of people, starting with Tom and Dave who are both English majors. That's a pretty nontraditional route.
I think among our pool of 35 or 40 analysts we maybe have two finance majors, which is very strange for a company. We have art history people. We have people with their PhDs in chemistry or biology. I was a sociology major and then got my MBA. We like critical thinkers -- people that can think well and solve problems. I think whether you get an MBA, or a degree, or a CFA, or something else, it shows you have an interest. Do what you like and you'll be a better thinker because of it. That's what I would suggest.
Southwick: The next question comes from Amar. "I am a subscriber to Stock Advisor and have been following the recommendations for about 20 months. As a result I now have more than 110 different stocks in my portfolio. I think it's getting too much for me to handle, understand, and follow with a full-time job of 12 to 14 hours a day." I would agree.
"It seems to me it might be more prudent and easier to somehow narrow this down to 20 to 30 stocks and choose index funds for the rest of my money. What are your thoughts?"
Hartzell: You're hired, Amar! If you can cover 120 stocks you'd be a good member of the team, here.
This is a question that we get frequently, as well, and it's a difficult one to answer because it's so personalized. Shelby Davis was a great investor. I know Tom Gardner likes a lot about Shelby Davis and he often mentions he owned 1,200 stocks when he died.
And he had a great track record. Walter Schloss was similar. He had a similar amount of stocks and he collected them, almost never sold them, and did wonderfully. He had a great return. Charlie Munger, on the other hand -- vice-chairman of Berkshire Hathaway -- is comfortable having billions of dollars in only three investments. There's a wide range.
I'd say, Amar, it's more about you. From this question it sounds to me like you think it's getting to be too much, and that's OK. That's totally fine. We have some people that are fine with owning 120 that are in our service and they love that. It's their passion. Maybe they're retired or they have a lot of time to dedicate to it. There's others like you that are working a full-time job and they don't want to spend that amount of time. It's fine to cut down your number.
I'd say 20 to 30 is probably a pretty good mix of stocks. We tell people in Stock Advisor at least 15. I think 20 to 30 is a reasonable amount to have, but if you go a little bit over or a little bit under, that's fine, too.
Southwick: And then how do you recommend he choose those 20 to 30 stocks?
Hartzell: Pick your favorite ones.
Brokamp: Pick the ones that are going to go up.
Hartzell: I would use Stock Advisor as your guide. We have a core list of stocks that we think are fundamental to people [joining Stock Advisor], so I would certainly hold that core group of stocks. Then I would hold a list of some from Tom's side and Dave's side. You can make your favorites, or you can use Best Buys Now to indicate which ones that we like the best.
I'd also say, Amar, we're there for you. We're not unattached from these stocks. We're following them for you, so don't feel like you need to do everything. If something big happens to these stocks, we have a promise. We cover them for you, so we're there to help you.
Brokamp: That's what I would say. That's part of why you subscribe to one of our services -- that there's someone who's keeping an eye on it -- and they'll tell you whether it's time to sell that stock. It's why you can have a portfolio with that many stocks and not have to know each company individually that intrinsically.
Southwick: Tiger writes, "In retirement what should we spend first and what last? At present I am 5% REITs, 5% bonds, 10% cash, 25% stocks, and 55% mutual funds. I figure I will maintain that allocation until I finally retire, but I'm not sure what to tap first. My wild guess is cash first, taxable mutual funds second, non-taxable Roth third, and individual stocks with big capital gains last. Some I've held for more than 20 years."
Brokamp: Cash should definitely be first because every retiree should have what we call an income cushion, which is the next three to five years' worth of portfolio-provided income out of the stock market. You rely on that every year, and then after you've spent that, as that year goes on, the next year you replenish it.
The next thing would be the types of accounts. We've mentioned before that several studies have found that when you're in retirement, your portfolio will last longer if you tap your taxable accounts first, then usually traditional accounts, and then Roth last. The Roth and traditional can be flipped in some situations, but basically drain your taxable accounts first.
I can't really answer you about the mutual funds because it depends on whether those funds are invested in cash, stocks, or bonds. Whether it's international or U.S. But I will say it definitely makes sense to evaluate your funds every year and if you have a fund that has been underperforming its peers for the last three to five years, that's definitely a candidate for where you could get some cash.
You mentioned the stocks that you've held for more than 20 years. Generally speaking, you don't want to hold onto a stock just because if you sell it there will be tax consequences if it's not a promising investment anymore. But I think what you're suggesting, or what could be a strategy is if that money eventually will be left to the next generation, it could make sense to hold onto that for a long time because when you pass on and your heirs get it, they get a stepped-up cost basis and they won't have to pay those capital gains.
The last thing I'll say, in terms of what to sell, is whatever will bring your portfolio back into balance. You have an asset allocation that you've decided is appropriate to you. After one, two, or three years that's going to change, depending on what has performed well and what has not. Generally speaking you sell what has performed well to bring your portfolio back into some sort of balance. These days that would be U.S. large-cap growth stocks. They have significantly outperformed most others, and if there's anything that has become overweight in your portfolio, it's probably that category.
Hartzell: You didn't ask this, but to the extent you're gifting some of these things, cash always makes sense. That goes at its cost basis, but if you have something you've held for 20 years with a low cost basis as a stock, that's probably not the thing that you want to gift to your grandchildren because they're going to get the same cost basis.
Brokamp: It's better to just hold onto it and wait until you pass away. Or, if you donate to charity every year, donating highly appreciated stock is a great strategy.
Southwick: The next question comes from Ryan. "In a recent episode the advantages of real estate were discussed, largely regarding buildings and land inside a city. What about farmland? Does investing in farmland compare differently to investing in buildings or stocks? I believe farmland will behave differently with IRS and other regulations. It has a similar return as buildings, but I believe it's classified differently." Buck, I had no idea that you would have the answer to this question.
Hartzell: Well, I'm not the tax expert on farmland vs. buildings, but I grew up on a farm in Lancaster County...
Southwick: Oh! I didn't know that!
Hartzell: ... and my mom still lives there. She's 80 now, so she's not farming the farm. But this is a broader kind of suggestion as you look at this. We also own some commercial real estate. Farmland is probably not going to earn you the return that you want from an asset that generates cash. Having worked a farm -- at least a small farm -- there's larger farms that have different economics with them. It's a hard business. You've got commodity pricing and you've got weather that impacts this. All kinds of stuff that can happen on farms.
There's a large move from people -- and this not just the United States, but is all around the world -- from rural areas into the cities. So to the extent that you're looking to make investments to make money off of, I would probably look toward those places where people are moving. I don't think they're moving out to the farmland. I know there's other people that manage pensions and do that kind of stuff, and they own farmland and timberland.
I think there's some value in that from a diversification and asset standpoint. For an individual investor, I think they probably have some exposure to real estate with their house that they own, and to get extra diversification through farmland I wouldn't suggest. I don't think it's the best course of action.
Southwick: The next question comes from Artie. "Regarding the 20/ 30/ 50 budgeting guideline you discussed during the Loofie episode, does the 30% for home costs also include utility bills, repair costs, and internet streaming cable costs, or does it only include fixed costs such as mortgage payments, property taxes, HOA fees, and insurance? I understand it's just a guideline, but I want to track this to determine where to reduce if possible to increase the 20% savings goal." I love how people say, "Just tell me what to do. Give me a guideline."
Brokamp: Everyone loves a good rule of thumb. Everyone loves it, which is why this won number one of the year in the Loofies, our award show. Let me remind everyone what the rule is. 20% of your budget should go to savings, 30% to housing, 50% to everything else. He's asking what falls under that 30% for the housing.
If you ask different people you get different answers. I think it's the fixed or mostly fixed stuff that you decide upon when you buy that house. That's going to be the mortgage, property taxes, and the insurance. Those are things that you're going to have to pay. They're either fixed or they're really not too much under your control. You can raise your deductibles or change your insurance, but that's about it. Property taxes are just part of the deal.
Southwick: You can cancel your cable bill next week if you need to.
Brokamp: Exactly. All that other stuff -- the utilities -- is more manageable. You can try to be more energy efficient. You can fiddle with the thermostat. In terms of repairs, that's what your emergency fund is for, and that's where part of that 20% savings comes from, is building up your emergency fund until you have it.
I'll also just again point out the other version of this rule, which is the 50/ 30/ 20 rule developed by Elizabeth Warren back when she was a professor at Harvard before she became a presidential candidate. That was 50% for your must-pay expenses and your needs, 30% for wants, 20% for savings. For those who also like another type of guideline that's something to consider.
Southwick: I'll bet Artie's trying to beat that 20% savings.
Brokamp: Good job, Artie!
Southwick: Go for it!
Southwick: The next question comes from Bruce. "I have some very basic questions about stocks, in general. How does the money flow with stocks? When a company issues stocks, is that the only time it makes money from the stock? Is there any other time actual money comes back to the company from that stock without buybacks? Are there tangible or other benefits from a stock price going up? When someone purchases a stock where does the money go? Is there just another stockholder that I'm buying from and not from the company?"
Hartzell: Yes, Bruce, you're right on. When you buy a stock, if Bro's selling it and I buy it, it's just a transfer of money from me to him and I get the stock. In between there is the brokerage that takes a little commission and they take a commission on each side of that for the sale and the purchase, so they like it when you trade a lot.
You're right. When the company does an initial public offering, IPO and they issue shares, typically -- but not always -- they will get that money and that goes into their coffers and fuels their growth as a business.
Nowadays we're seeing more and more of these IPO companies where it's actually just a recapitalization. They've taken venture capital -- and they've taken a lot of it along the way -- and those people are selling their shares according to the IPO and that company gets none of the money. It's going to pay back the people that had loaned them money. Not all of those, but a lot more of them than it used to be.
I generally don't like those as an investor when they come public and they're just giving the money to somebody else. I like it when the company gets it and they can use it to fuel their growth as a business.
The other thing I want to make a point about is we hear some people that are pretty big on the ESG movement [environmental, social, and governance]. You'll hear people say, "I'm not going to buy that company's stock because I don't believe in what they do." It could be a tobacco company or an alcohol company.
That's fine, but according to your question, Bruce, you're not really hurting that company by not buying their stock. They don't get that money. That's just coming from someone else. And to the extent you want to make a social stand or do something like that, I would consider every dollar that you spend on a discretionary basis is probably more important.
So it's more important what you buy every day and where you spend your money because that's a larger percentage than what you save and invest. So if you want to be in an activist role like that with your capital, consider where you spend all your money and not just what you do with the investment dollars that you spend.
Southwick: The next question comes from Ben. "I currently have 529 accounts for my son and daughter opened when they were each born. If they don't use all the money, what are their options? Can a 529 account be transferred to a subsequent generation within the family, for example, their unborn children?"
Brokamp: So, Ben, the benefits of having the 529 account are that you put the money in, you can invest the money, and when you take the money out it's tax-free as long as you use it for qualified expenses. If you don't use the money, you can always take the money out. You'll just pay taxes and a 10% penalty on the growth. So not the whole amount. If you put in $20,000 and it grows to $30,000 you're only going to be taxed and penalized on that $10,000 worth of growth.
Also, if one of the reasons that you don't need the money is maybe one of your kids got scholarships, or they're going to a military academy, there are some ways in which you can get the money back. You still pay the taxes, but you avoid that 10% penalty.
Also, it's important to appreciate all the things you can do with the money. Everyone knows about tuition. Room and board. But any other things that are considered necessary expenses for attending the college -- even computers in some cases, books, supplies -- can be used.
Also, if your student decides to live in off-campus housing, you can use that money to pay for an apartment as long as it comes under the university's stated cost of attendance. As an example, my son is going to Virginia Tech next year...
Southwick: Hey! Go Hokies!
Brokamp: ... and the cost of attendance officially for board is $5,478. As long as our apartment doesn't cost more than that, you can use that. Now for Buck's son, who's going to UVA next year, he has the higher allowance.
Hartzell: National champions.
Brokamp: That's true. You get $6,720. You do have to know that number, but you can use that and a lot of people don't understand that, so make sure you are using the money in as many ways as you can.
Then graduation. Didn't use all the money? Yes, you can just leave that money in that account, wait until you have grandkids, open a 529 for them and you can transfer the money. Or if only one of your kids has kids, you can transfer the money to nieces and nephews. To cousins. You can transfer it back to yourself and you can go back to school. As long as it's some relative, you can use the money.
Southwick: And our last question comes from Janet. "My husband and I both came late to investing in our late thirties." I would argue that's not too late.
Hartzell: Not as late as some.
Southwick: "We'd like to give our kids, ages 12, eight, and five, a better start. We've already taught them about savings and they each have a small savings account. Now our kids are asking us questions about investing as they overhear us talking about our stocks and brokerage accounts. It seems like a good time to formally introduce them to investing.
"Our questions are what is the best way to set up a brokerage account for them? Should we put their respective names as a joint owner? We don't want them to have control over transactions, yet. Should we simply make our own sub accounts with the understanding that X,Y, and Z accounts are meant for each child?
"Do you recommend any fantasy investing account where they can buy and sell for 10 shares without playing with real money? Are there any safe games apps that teach kids about investing in a fun way?"
Hartzell: First of all, congratulations! I know that your children will thank you later on in life for getting them started because as we know with investing, this compounded interest is a great thing and it's really when you start -- not even how much you save -- and getting a start at 12 and eight, they're going to have such a head start in life. So congratulations on that!
What should you do? I think you should consider setting up a custodial account. I would set it up in their names. You're going to have to oversee that until they're 18 years old. We did that for each of our kids. But you can go in there and they can watch you make the trade and do all that kind of stuff. They can see what they own. That's a great way for them to get started, so I think a custodial account is probably the way to go.
Southwick: And then when they turn 18, does the money automatically go to them and it's out of your hands?
Hartzell: They take it over. Yes, it's all theirs when they're 18.
Southwick: And there's nothing you can do if your kid ends up kind of a clunker?
Brokamp: A clunker! [Laughs]
Southwick: Is that something you would call a kid?
Hartzell: Well, there's a couple of ways to think about that. I would say that this is probably not going to be all your assets, so if the kid is a clunker, and they're going to make some mistakes, you'd probably want to have them make those mistakes with that account before they inherit what you've saved, because I imagine if you're starting with your kids, you're going to have a decent amount of savings.
They've got to learn at some point in time, and so learning with a little bit less is probably better than when they inherit it all and go, "I've never done this before." I would suggest a custodial account.
And then for fantasy, I would say Caps.Fool.com is a good place for people to go here. It's free. They can enter whether they think that stock will beat the market or not. Once they get seven stocks they'll have a rating. That's a good way to learn what other people like and just get them interested in stocks.
A couple of other things that my kids enjoyed when they were younger. One is we played The Market Cap Game. That is you can take 20 different companies, put two rows of stocks there, and we used to give out $1 for every right answer. They would just say which company is bigger by market cap. You could have General Motors and Microsoft and go down the list.
The great thing about it is it fosters discussions about these different companies. Also, they could have hints. They were free. They were always truthful, but sometimes misleading. They could ask, "Who has more sales in those companies?" You'd tell them General Motors has many more sales than Microsoft. They would say, "OK, that's the bigger one." Wrong. We have a discussion about how profitable Microsoft is vs. General Motors and it leads to good discussions about that.
And the last thing I'll suggest, and I think this is great to get somebody interested in investing, is encourage your children to start their own business. That may sound funny because they're 12 and eight, but they can. You'd be surprised how entrepreneurial kids are. Give them a little bit of seed money -- $100 or $200 -- and let them figure out a business for themselves. They'll learn about shoebox accounting. What are my expenses? What are my revenues and what are my profits? There's all kinds of great lessons that come out. It doesn't have to be a big business. It could be babysitting, dog walking, making lemonade, shoveling snow. It's a great way to learn about investing and kindle that fire.
Southwick: The Motley Fool also has a mobile game coming out in the next few months, so keep an eye out for that, Janet! I haven't played it. You look like you don't believe me.
Hartzell: No, I believe you! We've got people slaving away on that game.
Southwick: It should be out in the next few months.
Hartzell: I'm sure it's going to be awesome! Do kids like mobile games? Do they play them these days?
Southwick: They're probably on to something else. Something we don't even understand.
Brokamp: One thing I'll say about custodial accounts is it is an asset owned by the kid. We talked about how they get possession of it at the age of majority. Also, when you apply for financial aid for college, assets owned by the kid will reduce your aid more than if it's an asset owned by the parent. For a lot of people it doesn't matter because they're not going to get financial aid anyhow, but if you think that is in your future, you might consider having the account yourself and you're just going to hand it over at the right time.
Rick Engdahl: Can I add something really quick?
Engdahl: This works for my kids, anyway. We use Stockpile as our brokerage. It allows the kids to have a window into their own account. They can actually make a trade and it comes to me as the guardian of the account to approve their trade. That way they can have a little more hands-on and still it's in your control to make the trades that they do. And they also do fractional shares, which is important for a small balance. It lets them buy companies like Berkshire, or whatever, that are high-dollar stock price but still good companies.
Hartzell: That's great!
Southwick: Can't you easily gift stocks through Stockpile as well?
Engdahl: Yes, that was their shtick at the beginning, is you could buy gift cards in the grocery store and hand them to them. "Here's shares of Microsoft." That's kind of a neat, little gimmick, but I think that there's other aspects of that particular brokerage that are even more conducive to investing for kids. There may well be other brokerages out there that are equally good for different reasons, but that's one that I like. They don't do much. My kids are a little young, but I like the idea that they can make the trade and it comes to me for approval. That's cool!
Hartzell: That's cool. And FolioFN has the ability to, in one trade, buy portions of a whole portfolio of stocks. So you could put in $10 or $15 and in one trade they get a spread across that, which is really nice if you have a small amount of money and you want to spread it and get some diversification across a basket of companies. That's another option for folks.
Brokamp: Dunk it!
Southwick: Well, Buck, thank you so much for joining us!
Hartzell: Thank you for having me! I appreciate it!
Southwick: That's it for the questions today! Please come back again!
Hartzell: I will!
Southwick: You guys covered a lot of territory.
Southwick: Now it's my part of the Mailbag where we talk about the other stuff you guys sent in that is not question-related. First up, Bro messed up!
Brokamp: Uh-oh. What did I do?
Southwick: As Dan pointed out...
Brokamp: Oh, yeah!
Southwick: ... the linebacker who saves 90% of his income and is working to teach kids about money is Brandon...
Southwick: Not Cope.
Brokamp: Right. I said Cope, because his nickname is Professor Cope when he teaches at Penn, but just a slip of the mind.
Southwick: Sorry about that! Out of all the things that come out of this space, here, that's not bad. Just one wrong thing.
Brokamp: Oh, there are many more. Many more!
Southwick: I think you've got a pretty good batting average. Let's get to the postcards! Rich wrote a postcard from Biloxi, Mississippi, which I guess is our first one from Mississippi, but I've been doing badly about keeping track. He wants to know if any Fools want to do a listener meetup at the Berkshire Hathaway shareholders meeting.
Brokamp: That's a good idea!
Southwick: So listeners, if you do, why don't you drop us a line at [email protected] and I'll try to connect all of you.
Engdahl: It seems like a good thing for the Facebook group.
Southwick: Yes, we can also post something on the Facebook group. What else? Jim is still swimming, and he sent us a postcard all the way from Miami.
Brokamp: There he is!
Southwick: Shoots says hi from Wyoming and did a little fact checking. He said the Devils Tower is not actually in this county. Whatever.
Brokamp: Hi, Shoots!
Southwick: Hi, Shoots! (unclear: 43:43) sent us a card from Bali and Gene and Patty are back on the road. I believe this is our first card from Rhode Island and another one from the Isabella Stewart Gardner Museum, which reminds me of a great podcast. Have you guys listened to the podcast Last Seen?
Southwick: It's about the art heist that took place at that same museum back in 1990. $500 million worth of art was stolen and it has never been seen since. It's a really good podcast. It's a good road trip podcast because it's a contained, eight-episode story. It's very good! Last Seen. I highly recommend it!
So summer's around the corner, and if you want to send us a postcard from your travels, we would love it! Our address is 2000 Duke St., Alexandria, VA 22314. You can also join our podcast Facebook group. It's Motley Fool Podcasts. You have to be let in and we'll let you in. Or follow us on Twitter. I'm @Alison Southwick. Bro, what are you at on Twitter?
Brokamp: I haven't the slightest idea. @RobertBrokamp, I guess. I don't know!
Southwick: Rick, what are you?
Engdahl: @REngdahl, and if you can spell the name, follow me!
Brokamp: Good luck!
Southwick: Good luck! Way to go! So we're totally invested in this social media stuff.
Brokamp: Big at Twitter. Oh, my gosh!
Southwick: Come hang with us! We're at the cool kids table in the social media world. All right! The show is edited stark-i-ly by Rick Engdahl.
Brokamp: Another Game of Thrones.
Southwick: Maybe. I don't know. For Robert Brokamp, I'm Alison Southwick. Stay Foolish everybody!