Get on the bus, kiddos! We're going to combat the summer slide with our biggest mailbag yet. We're answering your questions about selling grandpa's stocks, stop-loss orders, retiring on $1.5 million, and more.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on Sept. 24, 2019.
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I'm joined, as always, by -- what have I not called you yet...
Robert Brokamp: Is that what you say on the air?
Southwick: I've called you Bobert. I've called you Bert.
Brokamp: Roberto.
Southwick: Berty. Roberto. Rob.
Brokamp: Blobert? Did you do Blobert?
Southwick: Blobert Brokamp.
Brokamp: As long as it's not Blobert Blowcramp, which is what they used to call me when I was a kid.
Southwick: Oh, kids are so mean.
Brokamp: They're the worst.
Southwick: Hey, he's a personal finance expert here at The Motley Fool.
Brokamp: It's the truth.
Southwick: And this week...
Brokamp: It's Mailbag!
Southwick: It's Mailbag.
Brokamp: And a really long Mailbag.
Southwick: Don't make it sound like a...
Brokamp: I mean a really great Mailbag.
Southwick: ...drudge. No. This is exciting. With the help of Buck Hartzell, we are going to tackle a lot of questions.
Buck Hartzell: Thank you for having me again!
Brokamp: Always a pleasure.
Hartzell: I think it's the third time you brought me back. Thank you!
Brokamp: I think so.
Southwick: All that and more on this week's episode of Motley Fool Answers.
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Southwick: All right. As promised, we have a lot of questions to get through, so let's just marathon through it. Buck, thank you so much for joining us!
Hartzell: Sure.
Southwick: I mean, this is going to be fun!
Brokamp: Woohoo! Yay.
Hartzell: Knowledge is power.
Southwick: The first question comes from Phoebe. "I'm relatively new to purchasing individual stocks; but, have been doing a lot of research and have bought some stocks in a few individual companies as well as ETFs and sectors that I'm interested in but are still pretty new, like cannabis and clean solar energy. [This is] partially because I don't feel confident enough to pick the winners and partially because these industries are so new I'm not sure I feel confident in anyone's ability to pick the winners yet. Is there a benefit to buying multiple ETFs within the same sector? There are four cannabis ETFs out there right now and they all seem to be pretty similar. I own two of the four, currently, and I'm wondering if I would be better off consolidating or if diversification within sub-portfolios is advisable."
Hartzell: Congratulations for starting and your interest. I like your humility. You're like, "I can't pick the winners, so I'm going to get an ETF." The quick answer to your question is I don't think there's any need to own multiple ETFs within the sector of cannabis or whatever else. Just go with one if that's where you're comfortable.
A little warning, though. I'm not a huge fan of sector ETFs. I think people have a tendency to trade in and out of those pretty quickly. That's one of the benefits of ETFs is you can buy them and sell them like a stock, but I'm not a huge fan of that and I think within the sector ETFs for cannabis there's a lot of new companies that are really unproven and there's a lot of hype, so there's some pretty high valuations. I wouldn't be a big fan of owning that sector ETF myself, but if you want to own it and you want to get exposure, just get one. You don't need multiple ones.
Southwick: So you personally don't love cannabis as an investing thesis right now.
Hartzell: I don't like the sector ETFs and that goes for a lot of different sectors. I think most research has shown that people tend to trade those sector ETFs. They trade in and out of them. They don't necessarily do it at the right time. We're long-term investors, here, so I think there could be a few ETFs, but unfortunately there's too many of them and as soon as there's something new that's popular, they'll go create a ton of ETFs around it.
Southwick: So if you were to go after this, you would probably research the individual companies that you like and then invest in those directly.
Hartzell: Exactly.
Southwick: To diversify the number.
Hartzell: Yes. And if you look at those companies and you're uncomfortable picking the winner, I don't feel like I would hand that off to an ETF person and say, "Now I've washed my hands of that." I'd say, "Then avoid that sector if you're not comfortable picking."
Southwick: I think there's a lot of excitement around cannabis and so I can understand why people who are new to investing are excited about it, because it does seem like a lot of exciting possibilities. But if you think it's already a bit hyped and a bit rough, then that might be a tough thing for a new investor to start with.
Hartzell: Yes, but like all new things, there's a ton of expectations and for the companies that are rushing to get out there, become public, and get that capital really quickly, a lot of those business models aren't fully baked at this point in time. The future is kind of uncertain, so between the hype and then getting to where they need to be to create a great return for shareholders, there's a lot of uncertainty there. That's my opinion.
Brokamp: I'll just add that if you're going to go that way, the more specialized an ETF is, the more likely you're going to pay a higher expense ratio. That's something to keep in mind. And if you were to own more than one, it certainly makes sense to look at what's in them, because in a small industry there probably will be a lot of crossover and there's probably no need to own more than one.
Southwick: The next question comes from Zack. "I just finished listening to the FoolFest 2019 Day 2 episode during which Take-Two Interactive was discussed and Activision was on the list of the top ten stocks owned by Fools. I'm a college senior and I have been playing Call of Duty since fifth grade. But I recently started playing Grand Theft Auto, as well, and I want to choose one of these stocks for a long-term investment. It's a tough choice; because, I enjoy games from both companies. I feel like Activision has the edge with esports; but, Take-Two might do better with sales and blockbuster games."
Hartzell: A great question, Zack. I think you're more of an expert at both these companies than I am.
Brokamp: It's the quintessential buy what you know.
Hartzell: Yes, you're at an advantage and what I'm hearing from you, Zack, is you're interested in them and you like parts of both of these companies. So my quick answer to you is go ahead and buy both.
Southwick: Like do it. Go for it, Zack.
Hartzell: Go for it. You don't have to be perfect. Keep your commissions under two percent of what you invest and go ahead and own some of both of them. I did a quick look at these. Take-Two Interactive's stock is down about 10% over the last 12 months. The price-to-earnings ratio sits about 46, so that's kind of expensive. It's got a $13 billion market cap.
Activision Blizzard is down about 30% this year, so a lot more than Take-Two. It's got a P/E of 25, which is still fairly high and it's a $42 billion market cap. So if you're looking at which one is just cheaper, it's Activision Blizzard, but I'd say to go ahead and buy both, Zack. You'll be happy you did. You've enjoyed playing both and you'll make money off it, so that's a sector where you don't have to have just one winner. This is a growing market. It's a huge market. They can both be very successful companies.
Southwick: The next question comes from Jerry. "Can you explain why it would ever be wiser, aka Foolish, to buy an individual stock among the Dividend Aristocrats rather than a low-cost dividend index fund or ETF based on all of the Dividend Aristocrats?"
Brokamp: Let's first talk about the Dividend Aristocrats. Those are companies in the S&P 500 that have increased their dividend payouts for 25 years consecutively and they haven't cut their dividends. Currently there are 57 companies on that index.
Why would you buy them? There are two primary reasons. First of all, there is some evidence that companies that consistently grow their dividends outperform the market and with lower risk, so that might be attractive to you. But you also might be retired and you're looking for income from your stocks and you like the idea of companies that are growing their dividends.
The biggest ETF that follows this strategy is the ProShares S&P 500 Dividend Aristocrats, symbol [NOBL]. Nobl for aristocrat. But the thing is just because a company is growing their dividends doesn't mean they're particularly high-yielding stocks. For example, the yield on that ETF is only 2.2%, just slightly above the S&P 500's 1.9%. So the good thing about it is you can buy all those companies very easily with the ETF. A pretty low expense ratio of 0.35.
That said, it's not a high yield so you might want to buy individual companies because there are companies within that index with higher yields. For example Pepsi yielding 2.8%. Kimberly Clark and then Caterpillar yielding 3.1% each. AT&T is yielding 5.4%. I don't know enough about those companies to say whether those are better investments or not, but that might be one reason why you would buy individual companies rather than buying all of them in the ETF form and getting what is just basically slightly above the S&P 500 right now.
Hartzell: And as Robert mentioned, about 1.9% for the S&P 500 right now for a yield is pretty much an all-time low. If you go back historically and look at that, you're looking at about a 4.6% average yield. So dividends have kind of fallen out of favor by a lot of large companies and instead what they tend to do with that money is buy back stock. So a lot of money goes into stock buybacks and the nice thing about that from a CFO's standpoint is if you don't have a whole lot of extra money in that quarter or that year, you can just not buy back stock. If you announce that dividend and you pay it, everybody expects it every quarter and it becomes a thing you need to meet.
So more buybacks have been happening than dividends, so yields are fairly low and, of course, yields on bonds are low.
Brokamp: We'll get into that later one, too. It's a tough call these days.
Southwick: The next question comes from Billy. "I just started investing in individual stocks this year and have used both Stock Advisor and Rule Breakers to put together a portfolio of 40 companies with the two picks that come out each week. How do I decide which stocks to sell so I have the cash to buy new ideas? When a company in my current portfolio seems to be trending down after a couple of quarters, it is so tempting to cut my losses and either add to my winners or invest in a new company."
Hartzell: First of all, congratulations, Billy! I'm going to give you the same answer I gave Zack a little while ago, which was you can own more than 40. There's no problem with that. The other thing I'd say is be careful about trying to sell stocks you haven't owned that long. They might pay short-term gains. You certainly pay commissions for most places if you're selling those stocks. And when we go out and research companies and look at them, the lens that we use is we're thinking three to five years when we make that recommendation. So anything can happen in the short term with the stock market, as we know; so, if you're selling those continually in less than a year, you haven't given the full thesis time to play out and appreciate it.
What I'd suggest to you instead of selling something is invest at the rate you save. So when you save up enough money to buy the next one -- maybe it's two months of Stock Advisor, so you have four picks to choose from -- then pick your favorite and go ahead and do it. Invest at the rate you save and don't just continually cycle out and sell stuff. Let them run, because the best investments that have been made in this world have gone down 50% several times. Look at Amazon and all these great companies.
Brokamp: Netflix and all those.
Hartzell: So if you're always cutting and running too quick, you're not going to get the benefits of getting a five-bagger, a 10-bagger, or a 20-bagger.
Brokamp: And something I've mentioned on previous shows is that often the default in a brokerage is to reinvest dividends, but instead, just let them accumulate in cash if you're looking for more cash to buy investments.
Southwick: The next question comes from Petey. "Hi, Brothwick. I was listening to a non-Foolish podcast and the guest was explaining the need to rebalance every year. My question is when is rebalancing foolish? For example, she was stating that a 60% stock, 40% bond portfolio might need to be rebalanced since we've been experiencing a bull market in equities.
"But isn't the point that you've had it balanced in the first place? Were you expecting your 60% exposure to stocks to do nothing? This is related to David Gardner's philosophy of adding to winners, but not exactly. But when you first balance your portfolio, aren't you accounting for the fact that it's very likely your equities will outpace bonds? Why rebalance when that happens?"
Hartzell: A great question and there's been a lot of research around this. I think Robert's done a lot more study of it than I have. I generally suggest that folks rebalance about every three years or so...
Brokamp: I agree with that.
Hartzell: Things go in cycles, here. I know now, with technology and all these things, you can set it to rebalance literally daily or monthly or annually. I think three years is a decent number to give some time for that cycle to run out. So three years is good. You don't have to do it every year, every month, or every day.
Brokamp: I'll just point out there are really two reasons to have a significant portion of your portfolio out of the stock market. So to have this 60% stocks, 40% bonds. No. 1 is you're planning to spend some of that money in the next three to five years. You're retired, or something like that, so you have to have some of that money out of the market. But also because you can't stand the volatility of an all-stock portfolio.
According to Vanguard, when you look at 1926 to 2018, an all-stock portfolio returned 10.1% but its worst year was a decline of 43%. When you look at a portfolio of 60% stocks, 40% bonds portfolio, the return was 8.6%, but the worst year was only a drop of 26%. So if you have that 60/40 portfolio because you just don't want the volatility of an all-stock portfolio, you should rebalance every few years because you do expect your stocks to eventually grow more to be a bigger part of it, but then it becomes riskier and then when the drop comes, it's going to be a steeper drop and you may not want that. That's why you would balance every few years.
Hartzell: And a cheaper way to do that rebalance, assuming it's in a taxable account, is just with new money. Put new money toward the one that's a lower allocation than it should be instead of just selling out and paying taxes and all that kind of stuff. If it's in a tax-deferred account, then you don't have to worry about that so much.
Brokamp: And the flip side -- the way to rebalance if you're retired -- is to take money from what has done the best over the last three years or so.
Southwick: The next question comes from Darryl. "I recently got married and I'm now trying to merge our finances. We both thought we were saving about 20-25% of our income; however, after some investigation I found that my wife has been saving a much higher percentage of her income. This was due to some differences in our assumptions on how to calculate our savings rate. For example, using pre-tax versus post-tax income and including principal payments on a mortgage as savings. Am I wrong for including principal payments into our savings rate? Are there any other things we should consider in calculating our savings rate?"
Brokamp: Let me cover a couple of things, there. First of all, we often get the question about whether you do it pre-tax or post-tax and most people when you calculate your savings rate, it's your pre-tax or your gross income. And the same, by the way, with your 401(k) match. So most matches are based on a percentage of your income. Here at The Motley Fool, if you contribute 9%, we match 6%. It's 9% of your gross income. That's not debatable for the most part.
What do you consider savings? Well, it starts with anything that goes into any kind of account where the money isn't going to be spent anytime soon. So money that goes into your checking account that's going to be used for bills, you don't use that for your savings account. But any money that goes into any other account -- brokerage account, savings account, IRA, 401(k), even 529 accounts -- that's considered savings and that's part of calculating your savings rate.
The mortgage thing is actually kind of debatable. I don't want to go so far as to say controversial, because that sounds like it's more interesting than it really is. Most people would say, "No, you do not consider the principal payment on your mortgage as part of your savings." But when I did some research on it over the last couple of days, there are tons of debates about it. The debate in the Bogleheads has over 400 replies as to whether you consider it or not.
So on the one hand, a mortgage is going toward something you're using. It's not really an investment. On the other hand, it is an asset that you're buying that you can use down the road. You downsize or do a reverse mortgage, or some kind of thing like that. I would say either way is probably OK. I would think, if you're going to tilt it one way or the other, what you are thinking of your house as. Are you buying this house? You're going to live in it for the rest of your life and you have no plans of downsizing or ever using the home equity? Then I would not.
If you are buying a big, four-bedroom house in an expensive part of the country and you know in retirement you're going to sell that house, downsize, realize some capital gains that you can use to live off of; maybe it makes more sense. If you're making extra payments on the principal of your mortgage, like my wife and I are doing, then I would much more lean toward counting that as part of your savings rate.
[...]
Southwick: The next question comes from Kyle. "I've been a Motley Fool follower for a few years and I really enjoy the education I have received thus far. Now I'm trying to pass that on to my children and anyone else who will listen. Just wondered if anyone had any comments about the idea of buying stock not just to make a buck, but for the ownership and especially for the realization that you are contributing to the world when you invest in a company that performs a necessary service for others.
"Obviously, the day traders have missed the value in this, and I feel even some of the bigger, supposedly long-term investors tend to work cyclical stocks in a similar fashion, almost like they are ripping someone off at a garage sale and selling it on eBay for 10X the profit. They've made money, but what real service have they done for the world? I was just wondering if you had any further thoughts." Kyle, are you a millennial? Wanting to make the world a better place?
Hartzell: Right. Why don't we? And the worst thing about companies is that I think the way they're portrayed in the media and particularly within Hollywood is always the villain. The role of a big company trying to mess up the environment or put the little guy out of business. In reality, companies are super-efficient and they should be celebrated. Much of the standard of living we have in this country is as a result of companies doing great things.
I think that's a great idea to pass that on. I would start by investing in companies that your kids or the young people that you're talking about enjoy very much. It could be video game makers. It could be other companies that they like the products and services that they sell and provide to them. So keep it relevant.
The other fun thing that you can do is play The Market Cap Game Show. I know that's something David Gardner has talked about a lot. But have them guess between two companies on which is the larger company out there. That's kind of a fun game. We used to play that with my kids.
The other thing I would say is go ahead and [let them see a] small business venture. You can learn about companies by buying a piece of them, and that's fun, particularly if they're companies that they like. The other thing you can do is give them a couple of hundred bucks and start their own business. It could be a lemonade stand or it could be something else that they enjoy. Our kids did lemonade. They did dog-walking services. A variety of stuff. Here's two hundred bucks. Go start a business and learn about it.
I'll tell you. When you do shoebox accounting and you have that $200 and you have to pay for your services and products and at the end of the day see if you made any profit, all those accounting terms and all that stuff becomes real and pretty easy to understand. So buy business and celebrate companies that create great products and services for all of us. That's a fun thing and a great lesson to pass on.
Southwick: Our next question comes from Jimmy. "With mortgage rates dropping down to low levels, it looks like a good time to take some equity out and invest in the stock market, but I wonder if it's too late in the game for me to dive in. I'm a 56-year-old man with a wife and two teenagers ready for college.
"I have six years remaining on my mortgage -- approximately $90,000 at 3 7/8% -- and five years on my home equity loan -- approximately $60,000 at 3.5%. I would be interested in taking $100,000 in equity to invest and combining the loans into a 10-year mortgage. Is there some kind of formula to figure out if this is a good idea? If I took the money to invest, it would be invested just like most of my portfolio -- in blue-chip type companies paying a dividend."
Hartzell: My short answer is probably not a great idea and if you had come to me in 2008 or 2009 I probably would have been all over that. We've had an 11-year bull market run in stocks. And the other thing I would mention is you only have a few years left on your mortgage, so as that mortgage accrues over time, probably most of your payments are going toward the paydown of principal, now, and not interest. So to refinance and take that money out, now, when you've only got five years left probably doesn't seem like the best use of time. I like the way you're thinking, but you've only got five years left, so it's not that bad. I'd probably dissuade you from doing that.
Brokamp: It feels like years that we've talked on the show about how the market is above the average valuation and, of course, it still keeps going up...
Southwick: So why listen to us?
Brokamp: So why listen to us? But the bottom line is it's just not as attractive a valuation as it was in 2008 and 2009. I know people back then who did take money out of their house and invest in the stock market, and it worked out very well; but, right now I just wouldn't feel as comfortable with that. Plus, as I've said on the show before, I'm a huge fan of going into retirement without any debt. I think that's a good idea, too.
Southwick: The next question comes from Scott. "There is a group for value investors that I belong to that meets every month or so. One of the investors said that if you could individually buy the companies that are in the S&P 500 but take away a stock that you know is a loser, you would automatically beat the market with your 499 remaining stocks. It could be hard picking winners, but I'm usually pretty good at recognizing losers. I keep thinking that if I can take the S&P 500 and eliminate the 100 worst stocks, then I should really do well. Do you think this would work?"
Brokamp: I chose this question because I listen to a lot of podcasts from a lot of investors, financial advisors, asset allocators and it just seems, particularly over the last few months, I've heard, over and over about them attributing their success to avoiding big mistakes and big losses.
When Scott sent in this question, I thought, "Well, maybe Scott's onto something here." I think there is something. I would say first of all that he says he's pretty good at recognizing losers. I would just make sure that he's right about that.
Southwick: Do you mean be honest with himself?
Brokamp: Well, sort of. When Buck was on the show we talked about keeping journals and keeping track of your picks. I think it's a good idea. I think this is a lousy company and I'm going to write it down in my journal and see if I'm right in a year, two, or three from now. So if he's established that and he is good at that, that's great.
His specific question, logistically, sounds like a lot of work. Like looking at all 500 companies and being able to pick out the worst 100 and buying the other 400; that's a lot of work. I think that's probably very difficult. But first of all, I also want to say I love that he's going to a value investing meet-up club. I was thinking about where they go. Like Denny's? Is that what he means? They get their Grand Slams.
But to a certain degree, what he's doing is already doing that. By picking individual stocks he's saying, "I don't want the whole stock market. I think I can pick the winners and I think I can avoid the losers." So he's already doing that to a certain degree.
There's also the question, too, of if he's really good at picking bad stocks, there's the question of does he short those? It's not something we do often at The Motley Fool, but we have done it in some of our services and that, in itself, can be profitable.
Hartzell: Yes, it's just hard. Like Robert said, write it down, keep track, and see if you are that. The hedge funds had their biggest negative bet on energy companies here in August and they got killed, so it's just hard to predict these things.
Brokamp: And why did they get killed? Because...
Hartzell: ...well, it was hotter than people anticipated in August and in September, as well, it continued, so usage went up and then, of course, we've had some dislocations, now, in the market with Iran, Saudi Arabia, and that kind of stuff.
Brokamp: Which is something you just can't predict.
Hartzell: You can't. It's not predictable and the commodities are inherently volatile. The other thing I'd say is when you're doing this, I think it's hard to buy 499 companies and do all that kind of stuff. But the other thing is if that loser is in the bottom 100 companies, remember these indexes are market-cap weighted. Even if that company does poorly, it's not going to have nearly the impact of an Apple or one of the larger companies on the index that you thought.
Brokamp: So Microsoft is the biggest company in the index and it makes up more than 4% of the index. The smallest company is Boston Scientific and it makes up just 0.23%. So even if it plummeted and you were right to avoid that stock, it wouldn't make that much of a difference.
Southwick: I feel like this is the reverse of what my thinking was on how these indexes work and that generally it's a few that outperform and pull the index up with [them] while there's a ton of underperformers or stocks that are just OK. I feel like this is the reverse of what I thought. Someone go do a study!
Brokamp: Well, generally you are right. I mean, the returns of the market are due to a handful...
Southwick: Right, just a handful.
Hartzell: During 1999, the peak of the dot-com bubble, I think there were four companies that made up about 75% of the returns at that particular time and those companies were really highly valued and did not do so well for the next decade or so.
Southwick: All right, Scott. Send us the study. Send us what they're basing this on. The next question comes from Ross. "I'm 24 years of age and I'm starting to invest." We're getting a lot of "starting to invest" questions, here. This is awesome. "I balance my investing between a Vanguard index tracker and some individual stocks." Sounds great. "I am loving the investing world, despite all the recent volatility and wanted to ask how much I should keep back as cash? Should I do it as a percent of how much I have invested? For example, if I have $10,000 should I keep 30% as cash or should I just say I'm going to keep $3,000 as cash as long as I have that money there and invest the rest?"
Hartzell: We typically say six to nine months' living expenses in cash. If you have three kids and a mortgage, you probably want to keep a little bit more than that. Beyond that, then I think you're good to invest it. We don't guide anybody toward a certain percentage of their portfolio that needs to be in cash. Scott, you're 24 years old and you're a saver. Once you get that savings -- six to nine months of living expenses -- then go for it. You're good to go.
Southwick: So outside of the emergency fund question, we sometimes talk about keeping some cash on the side so that you can act when the market makes you want to act. The dry powder or the dry tinder, we say. How do you approach that?
Hartzell: I think it's always a good idea to have some money on the sidelines so you can invest. Now when you're 24 and he's saving and he's got 60 years, I wouldn't be worried about parking a ton of my portfolio in cash at basically 0% interest. If I find a good investment, I would go ahead and invest in it. But having a few bucks laying around that you can take advantage of dips when they occur; sure, that's fine.
The way I would do it is if I couldn't find anything that month to invest, just leave it in cash and then next month you come back to it. You've got a little bit more. Maybe you can find something. And if you can't, put it in cash. But I wouldn't build up a big cash holding. If you're like four years from retirement or if you have a big outlay of cash that you have coming up in the next three to five years, that's different. But that doesn't sound like Ross's situation.
Brokamp: In our model portfolios that we have in the Rule Your Retirement service here at The Motley Fool, portfolios for people who are more than 10 years from retirement, it's 5% out of the stock market. And again, it's just that dry tinder. The honest truth is you'll probably have higher long-term returns if you're fully invested, but we have that small allocation just because I think people feel better about having just a little bit of cash on the side.
Hartzell: And I would add, since you mentioned retirement folks; my goal, when I managed some money for my father when he was around was to have three years' living expenses in cash. And when the downturn did come in 2008 and 2009, he didn't have to sell any stock at all. He had three years' worth of cash. We actually bought some stock and took advantage of the cheap prices and then in a couple or three years stocks were back up again and then we could sell them off a little bit. So a goal, as you get toward retirement, is three years' living expenses in cash is a good one.
Southwick: The next question comes from Jevin. "I'm 21 years old and have been investing for over two years. I inherited some stock from my grandfather when I turned 18 in an account with a broker that my grandfather had been with for many years. However, I have opened a discount brokerage [account] that is slightly cheaper that I would like to transfer the stocks into.
"While I am grateful for the stocks I received, over 50% of the portfolio is invested in GE and I'm very conflicted about what to do with the holding. I feel like I can better allocate the funds if I sell off a significant portion of that stock and purchase Rule Breakers recommendations that have been on my watch list. How can I maximize my returns without breaking Grandpa's heart?"
Hartzell: Yeah. I mean, what a wonderful gift to give to somebody, though. I think that's a great thing and I understand why you're a little conflicted. My short answer is just to go ahead and do it. There's no reason not to, and I think your grandfather would be happy to know that you're managing that portfolio and taking over and running it the way you want to now.
So you're going to save on commission. When you inherited there was a stepped-up cost basis in those things, and certainly if GE's in 50% that's gone down in value, so you're not going to have, I would imagine, much tax liability to do that. So go ahead and transfer it and then run it the way you want to now, because somebody that may have been in their 70s or 80s is probably going to own a different portfolio than you would. Do it guilt-free and move on.
Brokamp: Just to follow up on what you said, the cost basis will be the value of the stock on the date of your grandfather's passing. I would get that information before you transfer it to another account so you have that with you. GE stock is down like 60% over the last couple of years, so unless you inherited this several years ago, you're actually going to have a taxable loss that you could use on your tax return.
Southwick: The next question comes from Bill. "When it comes to stocks, I can readily learn about what most companies do and a little about their financial circumstances to evaluate these investments. However, I know next to nothing about bonds and how to select bond investments to ensure that I'm appropriately diversified. How do I get started in understanding bonds or bond funds and evaluating what would be the best choices for my portfolio?"
Brokamp: Boy, this is a tough one these days. Interest rates are so low...
Southwick: A whole episode here...
Brokamp: It really is...
Hartzell: Save your time.
Brokamp: It's so hard to recommend bonds. Again, the Rule Your Retirement model portfolios have bond funds with Vanguard's Total Bond Market Fund, Vanguard Intermediate-Term Bond Market Fund. Very low cost, very diversified, easy way to do it. And they're up 8-9% this year because interest rates have gone down, but that's going to reverse when interest rates go up, and they've shot up over the last week or so.
So I have to say for the most part, when it comes to money that you want to keep safe, these days I think CDs and high-yield savings accounts are almost as attractive as bonds. I still have a little bit of bond exposure because I'm willing to take a little bit more risk for the slightly higher long-term return. Historically bonds have outperformed cash by 1-2% or so, so I'm willing to do that.
If you want to do that, too, good places to start at least learning about bonds is first TreasuryDirect.gov, which is run by Uncle Sam. You can buy Treasuries there commission free, but it has a lot of good education about Treasuries, which are very safe; the safest investments in the world. Also free of state taxes which is good if you live in a high-tax state. And they're not callable, which means if you buy a five-year Treasury, you get to hold it for five years. If you were to buy a five-year corporate, some of those corporates can be called, which means they say three years later, "We're going to redeem these bonds." So that's a good place.
InvestingInBonds.com used to be one of my favorite sites. It still has a lot of good information, but it looks like they're not updating it as much as they used to. It's still got a lot of good, basic information. If you are in a high tax bracket, especially if you live in a high-tax state, municipal bonds might be better for you and you can go to MunicipalBonds.com. They have a lot of great education there.
But also a good site is your broker's website, because they'll have some information, but they'll also have the inventory of bonds that you can buy for your account. You can actually call up one of their brokers and say, "Can you help me choose the right bond for my situation," if you want to do that.
If you don't want to do individual bonds and you want to do something beyond index funds, the bond funds that I like come from Dodge & Cox, TCW, PIMCO, and Metropolitan West, and I name them because they're companies known for particularly good bond funds, so I would start there.
Southwick: The next question comes from Robbie. "I am a recent Stock Advisor member and the question I have is how do I limit my losses? In the past I have used stop losses at the 5-8% level, but I have been whipsawed a lot. I like to believe that as long as the company has not changed fundamentally I should hold onto it; however, I don't want to hold a position with a 20% loss in the hope that it will come back. I'm not sure if The Fool sends sell recommendations. If so, what is the logic used? Is it a stop rule or is it a mix of factors such as fundamental deterioration of the company? Should I still have stop loss of 10-15% maybe on my stocks?"
Hartzell: I'm not a big fan of stop-loss orders. I don't think they do what you're hoping they will do. You're trying to protect the downside. If you want to really do that, you can hold some cash on the side and that will help buoy you and give you money to invest when those things drop.
We've talked about this many times on the show and even earlier today that the best-performing stocks that go on to be 20, 30, 50, or 100X higher than when you bought them have multiple drops of 50% plus. So what is going to happen is during a time of panic or bad times, you're going to be selling out of that stock. We've seen it happen in the same day that it pops up and goes back up again. I just don't want to be auto-sold out of a position by a robot.
Most of my emphasis, and I think all of our analysts, here at The Motley Fool, are not on the movements or the up and down of the price of the stocks. These are long-term investments. We anticipate we're going to hold these at least five years or so; so the up and down doesn't really bother us that much. All of our time is spent thinking about the business and how the business is done.
I would say avoid the stop loss. If you want to tame the volatility, hold some more in cash and have some money available for when that time comes where that great stock goes down a little bit and you can add to it.
Brokamp: As one of our more senior analysts, Buck, you've been at The Fool for more than 20 years. How often do you say you sell a stock within five years or even at five years?
Hartzell: Very rarely.
Brokamp: You own stocks for a long, long time.
Hartzell: We collect stocks. It's kind of like a museum, so you add to them, and you add to them when you think they're more attractive. Sometimes that happens when they've doubled or tripled. Then you still might like it even more. Sometimes it happens when it goes down 50% and you get an opportunity. Those tend to be broad-based market sell-offs like 2008-2009 or when everything goes down at once. And those are wonderful, but we just like to add to that collection.
Timing the sells and buys and using stop loss is not something we do very much to also help a little bit with that volatility. And I don't know your allocation stuff, [but] limit your allocation on buy-in to 10% in any given position, so only 10% of your portfolio in one stock at a max on buy-in and then no more than 30% in an individual sector. You don't want to have 90% of your stocks in one sector. That will help a little bit with the volatility, as well.
[...]
Southwick: The next question comes from Megan. "Last year when Nvidia was doing really well, I became irrationally exuberant and bought a lot of it at a high price of $277 and then it plummeted by 50% and I'm now looking at a $7,000 loss. This makes me sad and think bad thoughts about Nvidia. However, I believe that Nvidia will eventually recover and go on to do great business. So, should I buy more stock at today's much lower price so I can benefit from the ride back up or should I stop throwing money in the Nvidia hole and patiently wait for it to come back up and then sell a bunch of shares at a break-even price? Can you share your wisdom about these situations?"
Hartzell: Well, I like how you're thinking about this and the way to frame it up is really to separate the business performance from the stock performance. And it hurts. We all feel pain. We've all bought stocks literally the next day when they go down. Stuff happens and that's difficult for all of us. But don't freak out and don't panic, but step back.
The 10,000-foot view is how is this business actually doing? A quick look at Nvidia. I don't own it, but it's about 40X earnings now for Nvidia, which is about twice what the S&P 500 is, so a good way to frame that up and [think] if you had a choice of investing in the S&P 500 or Nvidia, do you think Nvidia is going to do about twice as good? Do you think they'll grow about twice as fast as the average S&P earnings? And that's, by the way, in single digits for the S&P 500. So if you like the business and you like their prospects going forward, it's no shame in adding to it.
If, sometimes, you're a little uncertain and thinking, "Oh, I had written down here's why I bought it, and I got a little carried away. I thought X, Y, and Z would happen and I missed on all of those." Then I might say to take a step back, here. You haven't been proven right on your other stuff, but if it's just a stock price movement it's fine adding to it at 50%. I like that you're separating those. Don't freak out.
Southwick: Rick writes, "I'm 54 years old. After a recent inheritance, my wife and I have roughly $1.5 million invested with no debt. When would you recommend retiring? I do not have health insurance outside of my current employer, certainly a huge factor in decision-making." Oh, yeah, that health insurance question. That's a tough one.
Brokamp: So if you were thinking, "Can I retire now," it really depends on how much you spend each year. So if your annual expenses are around $50,000 -- that might be the case because it says you don't have any debts -- then it's actually possible because $50,000 on a $1.5 million portfolio is about a 3.5% withdrawal rate, which studies indicate is probably reasonable for a 35-to-40-year retirement.
Of course, more and more of these days you read lots of articles about the FIRE community (Financial Independence/Retire Early) and you read about these people in their 30s and 40s who are retiring on less than $1.5 million. I'm not sure all of them are actually making the right decisions, but if you read their blogs and read their books they have some pretty good tips on how to retire early.
The most well-known is Mr. Money Mustache. We had the guys from ChooseFI.com on our show. They have a new book that's coming out on October 1 and they're going to be on the show in November. Then there's Billy and Akaisha Kaderli, RetireEarlyLifestyle.com. They retired at age 38 back in 1991 and they're still going strong living on less than $30,000 a year. So it's possible.
You do have to solve the healthcare one. If you're in good health, maybe you can get by with a low-cost, high deductible healthcare plan. If you and your wife are not in such great health, it's probably going to cost more and it may not be workable, at least until 65 when you're eligible for Medicare.
The other thing to know is if you retire early, your Social Security benefit won't be as high because it's based on your 35 highest years' earnings. It's not going to cut it in half, but it's something to be aware of.
And my final point is -- and I say this to everyone who's thinking of retiring -- go see a qualified fee-only financial planner to get that professional second opinion and make sure that you have all your bases covered before you actually retire.
Hartzell: And I think Bro has talked about this a lot. When you first retire, you want to spend a lot of money. You want to go play golf and do all this kind of stuff. Just realize you're in work eight hours a day, so when you're not, what are you going to do with that time? If you're spending money and doing stuff that costs, you might need more than that $50,000 that you expected.
On the other hand, if you're going to work and get paid for something that you really love but maybe not make as much as you used to, and you're really going to enjoy it, that's awesome. That's like the real retirement. You're going to do what you love to do.
Southwick: I find if I'm not earning money I'm spending money. The last question comes from Dylan. "I'm looking for a bit of advice on diversification within a taxable brokerage account. I'm 27 years old and have a very high risk tolerance but have recently seen three stocks -- Okta, The Trade Desk, and PayPal -- grow to make up a total of 49% of my 13-stock portfolio. I tend to fall in David Gardner's let your winners run high camp and have been hesitant to trim any of these positions up to this point. Would you recommend selling a few shares and reallocating the money elsewhere?
"I add roughly 5% of the portfolio's value in cash each month and have been trying to dilute the numbers by adding new stocks, but those three just keep climbing up. A nice problem to have, but am I overexposed?"
Hartzell: Darn, those stocks keep moving up. You can't rebalance them.
Southwick: He's so good at investing!
Hartzell: Right. Congratulations, Dylan! That's awesome. First of all, I wouldn't add any more to those stocks. We've talked about this before. No more than 30% in a given sector. You have 49% in stocks that I would say are probably all in the same technology sector with Okta and PayPal and The Trade Desk. You're a little overallocated. I think you're right there. You can rebalance with new money.
This is a personal decision, so it's a tough one to make a definitive call on. The way I would think about it, though, is how would you handle a 40% decline in any one or all three of these stocks and how would that impact the way you live? If it doesn't impact the way you live and you're a long way from retirement, do you say I'd add to these because I really like these businesses and I know them very well? Then I'd say let it ride, but don't put new money in there. Put it in other things like you've been doing. I think you're thinking about the right thing.
The other one is just a sleep-at-night test. It sounds like this question is starting to make you feel a little uncomfortable with that allocation. If that's the case, go ahead and trim a little bit. Nobody's going to get mad at you for doing that. You don't have to sell out all of it.
The last thing I'll add in [is a] sell tip. Sometimes people need to raise money to buy something or whatever else and they have to pick which stock to sell. We love all of our stocks. We've collected these over years and it's difficult to make that decision. My suggestion is to sell a little bit of everything. That way you keep your portfolio intact. You don't sell out of the whole position and then it goes up eightfold afterwards. You just sell a little bit of everything until you get to your number and you have roughly the same portfolio allocation.
If it's bothering you, go ahead and sell some. Don't feel guilty about it. It's profit. Don't knock it, Dylan.
Southwick: That covers it for the questions. Buck, thank you so much for joining us!
Hartzell: Thank you for having me! I appreciate it. Thanks for doing that. It's always fun.
Southwick: You guys blew through so many questions. Way to go! Good job!
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Southwick: Let's head to the other mailbag, shall we?
Brokamp: Let's do it.
Southwick: We've gotten some feedback from you guys, on some previous episodes so I'll just blow through some of it. First is from JCP. He writes his friends all call him JCP so I'm going to call him that, too. "Dear Answers crew: I finally listened to all the episodes you have so far."
Brokamp: Oh my gosh! That's over 200 episodes.
Southwick: Almost five years. "I've learned so much that I wanted to teach you about video games. In games there are usually skills or powers you acquire as you level up. These skills can either be active or passive. And active would be like pressing a button to use a power like a fireball. A passive skill is an effect that stays on in the background permanently, such as getting 10% more experience in money from defeating a monster. The latter is my favorite since you are investing a skill to get more returns in the future. It's thanks to you guys that I have acquired the active skill of managing my portfolio. Now I will keep upgrading my passive income skill to get this snowball rolling. Thank you and keep up the good work."
Carey writes after listening to our episode about entertainment and the cost of cable and how that feels so frustrating -- and getting internet in particular -- that he no longer has internet service to his house. He has WiFi at work, the gym, and the library, where [he] downloads the Netflix shows [he] wants to watch and then can watch them anywhere including [his] home. "Love, love, love that download feature." I don't know if I could survive without internet to my house.
Brokamp: That'd be a tough one.
Southwick: Way to go, Carey! Good for you. Having the discipline to not have to pay that internet bill? So good. Kirk writes, "Last week you answered a question regarding rolling one's 401(k) into either an IRA or a new employer's 401(k). One thing you didn't mention is that 55-year-old retirement clause that lets you pull out equal substantial payments from your current employer's 401(k). I find this hugely motivating. It would cause me to roll into a new employer's 401(k) rather than an IRA if I moved jobs at this time because I'm 47."
Brokamp: There's a couple of things. Some plans will allow you to do an in-service distribution when you reach a certain age -- usually it's, I guess, 55 or maybe 59 ½ -- where you can actually take some money out while you're still working, but your plan has to determine that.
And the other thing he might be talking about is generally when you take money out of a 401(k) before you're 59 1/2 you have to pay the 10% penalty, but some 401(k)s if you retire, you can take money from just your last 401(k) at 55 and not have to pay a penalty. It's certainly something to consider, but the rules vary from plan to plan.
Southwick: Also Nathan writes that [pick-tet] is pronounced [peak-tay]. I have no idea what that is, but I believe him that I mispronounced it. Sorry, Nathan. I don't know how I was supposed to figure that out outside of just being a smarter human being. I'll try. I'll try to be better.
It looks like I just missed Eddie on his 50-state tour in Yellowstone by like a few weeks. He said our shows are getting too depressing. He may be right. Well, we're tackling kind of sad topics.
Brokamp: OK. Let's do more happy ones.
Southwick: [Gene] and Patty sent us some postcards from Hawaii.
Brokamp: Gosh, Yellowstone is beautiful.
Southwick: I know, isn't it great? Well, here's also some postcards from Hawaii.
Brokamp: Oh, Hawaii is even more beautiful.
Southwick: They enjoyed listening to "Last Seen." I don't remember recommending that podcast on air...
Brokamp: Yes, you did.
Southwick: ...but I'm glad they enjoyed it.
Brokamp: I remember.
Southwick: My new podcast recommendation is "Something True." Not all the episodes are safe for work but they are all fascinating and funny. Do you guys listen to "Something True?"
Brokamp: No.
Southwick: Oh, you guys would love it.
Brokamp: I started to, based on your recommendation, but I have listened yet.
Southwick: It's so good. You guys would love it. Collin says hi from Talkeetna, Alaska, but he's from South Carolina.
Brokamp: Alaska is also beautiful.
Southwick: Also beautiful. Hey, look. David sent a card from Iceland. He couldn't send us a card from Moldova but here's one from Iceland. We really could have used that Moldova one to cross it off our list. PT says hello from New Mexico. PT, I think we answered your question earlier on the show, as well.
Brokamp: I think we did.
Southwick: Thad sent a card from Windsor. Did I already talk about this one?
Brokamp: It's even shaped like Windsor.
Southwick: Isn't that great. There you go.
Brokamp: Yes, Windsor's beautiful, too.
Southwick: Daniel and Rachel sent a card from Paris, where they survived the hottest day in history of 108.7 degrees. Can you imagine? Rich sent a card from Bethlehem, Pennsylvania. Stocks! Bonds! Josh sent a card from South Carolina. He said he's been listening since the first episode. Yowza! Jim sent a card from Mount Fuji. He climbed it with his son John. How cool is that?
Ben sent a card from Barcelona. Very nice. Look, there's the [Gaudí]. And we also have Jim from Arlington sent a card from New Hampshire. And this card doesn't have a name on it, but it's from North Dakota. Reindeer. Yum. I'm not seeing a name.
Brokamp: That's a nod to Ross.
Southwick: Yes. So thank you guys, as always, for the postcards.
Brokamp: We do love them.
Southwick: We do love them. They're so amazing.
Engdahl: Those are all beautiful. Where's all the postcards from like Camden or Newark?
Brokamp: Well, the one from Bethlehem is a factory, so...
Southwick: All right, everyone from Camden or Newark, you can send your hate mail to Rick (not me). I've actually never been to Camden or Newark. So yeah, thank you guys for sending postcards, as always. If you are still on vacation and want to send us a postcard, our address is 2000 Duke Street, Alexandria, VA 22314.
Brokamp: Did you see the comment, by the way, about what's at 200 Duke Street?
Southwick: Yes. Oh, yes.
Brokamp: Apparently someone kept sending postcards to 200 Duke Street and they weren't happy, right?
Southwick: Yes.
Brokamp: So Don wrote us to say that home is currently for sale and it's worth more than $2 million.
Southwick: Sorry, people at 200 Duke Street. They're probably just jealous that we get more mail than they do.
Brokamp: Probably.
Southwick: Fun places from a 50-state tour. Well, that's the show. It's edited adverb-ingly by Rick Engdahl. For Robert Brokamp I'm Alison Southwick. Stay Foolish everybody!
[End]
