In this episode of Motley Fool Answers, host Alison Southwick explains "hipster antitrust" and wonders how we should feel as investors and consumers. Plus, Robert Brokamp, personal finance expert, shares the Roth five-year rules, and Ron Gross, senior analyst at The Motley Fool, discusses the impact of dominant companies. Finally, David, a listener, asks how to choose what to sell under the 4% Rule.
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This video was recorded on August 24, 2021.
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. Hey, Bro.
Robert Brokamp: Hello, Alison.
Southwick: Welcome back. Yes, that's right. We took a bit of an extended summer break. As we like to do every now and then, we're changing up the format as gauche. But don't worry, it's not that drastic, a new rug, maybe some throw pillows. All that and more, on this week's episode of Motley Fool Answers.
The other day I was driving in my car, listening to NPR like the Mid Atlantic Coast metropolitan area resident that I am, when I heard the phrase 'hipster antitrust.' At first I was like, "Is 'hipster' a thing we're saying again?" The answer is -- not really. Then I wondered, what is this antitrust business about? Well, way back in 2017, a woman named Lina Khan wrote a now famous piece for the Yale Law Journal, arguing that the rise of massive tech companies like Amazon, Google, Apple, etc., proved that modern American antitrust laws were flawed, and how we decide if a company has an unfair monopoly is outdated and ineffective. To oversimplify the status quo that she was railing against, one of the joys of a free market is that you have many companies competing to sell the same product and they keep each other in check by trying to offer the better price or the best service or some other value proposition to customers. If one company has a monopoly then they can charge whatever exorbitant price they want, because the customers have nowhere else to go for the same product or service. This is bad. Judge Bro, did I explain that correctly enough?
Brokamp: Of course, Alison, because you always get everything right. But as you point out, one of the main reasons that monopoly can be bad is because they have all the pricing power. Thus as long as prices don't go up, there are really no problems, at least to some people. However, I think what's happening now is there's this evolving idea of what constitutes ill effects of big businesses with extraordinary influence on their industries. I'll even give you a personal example. I'm going to tell you the tale of John Loader, who was born in Germany in 1832 and came to America and then opened a flower shop outside of Cincinnati. John Loader was my great, great grandfather. That business continued on with my great grandfather and my grandfather and then my uncle, who opened up a spin-off of sorts which had a full greenhouse and sold all kinds of flowers and plants and equipment. Then my cousins took it over. But it's no longer in business. Why? Because they couldn't compete with Lowe's and Home Depot, which thanks to their size, combined merchandise from wholesalers at much lower prices than a local shop owner, and thus can charge lower prices to consumers.
Of course, we've seen this with other companies like Walmart and Amazon putting mom-and-pop shops out of business. Some would say, too bad, consumers are getting a better price and that's just part of the creative destruction that comes with capitalism. But I personally think it's worth questioning what impacts there are on a community when local businesses have trouble surviving. Just interestingly, this is actually one of the few topics that has bipartisan appeal. Both democrats and republicans are becoming concerned about the power of big companies, though maybe for somewhat different reasons.
Southwick: I think I'm going to get a shirt that says creative destruction on it. I have never heard that phrase before, it is so good. Yes, going back to Lina Khan's piece that she wrote. She argued that antitrust laws should consider other negative impacts that a massive company can have, not just high prices for customers. After all, Amazon offers extremely low prices, but it is still a juggernaut that Khan argued has a disproportionate impact on the economy, stifles competition and other negative outcomes in the world. Why are we talking about this? Well, a few years later that same author was named the chair of the Federal Trade Commission. Which leads me to wonder how much should investors think about hipster antitrust and its potential impact on how antitrust laws are applied to some of our highest performing stocks like Amazon, Facebook, Google [Alphabet], etc. Now, full disclosure, I am an Amazon investor. I don't think I own Facebook or Google. But Amazon has been very good to me as an investor. It's crazy to think that $0.51 of every dollar spent in online retail in the U.S. goes to Amazon. One in every 169 workers in the U.S. works for Amazon. In addition to selling stuff online, of course, they make money by publishing books, selling groceries, selling online ads, designing their own clothing, and producing TV shows. Of course, they are one of the world's largest providers of Cloud storage. They have their fingers in all the pies, because they are vertically integrated, it's hard to say that they have a monopoly in any single industry. But they are a force to be reckoned with, right?
Brokamp: Yeah. First I want to congratulate you for being an Amazon investor. I'm sure that's worked out very well for you.
Southwick: It has worked very well, thank you.
Brokamp: Yeah. But I think it's also important to know that most of us likely own some shares of these behemoths, even if we don't own the individual stocks. That's because of the biggest holdings in index funds that many of our listeners own. Like, Apple is the No. 1 holding in the S&P 500, it's 6%, Microsoft, 6%, Amazon, 4%, Google, otherwise known as Alphabet, more than 5%. We probably all have a stake in this, but it's also an indication of how big and powerful these companies have become. As for their power, I remember a story in Fast Company from many years ago, but it stuck with me. It was about how Walmart changed the pickle industry just by being one of the biggest buyers of pickles and the world. Walmart wanted gallon-sized pickle jars. If you've never seen these, these things are huge, they weigh 12 pounds. The problem is, if Walmart wants it, you pretty much have to do it and at the price that they decide. The article focused on Vlasic, of course, the pickle company. The article said that Walmart's demands "distorted every aspect of Vlasic's operations from farm field to factory to financial statement." This is one example of how really big companies can throw their weight around.
Southwick: Yeah. The reason why critics call it hipster antitrust, I guess, is to make it sound like some hippie-dippy anti-business attack on capitalism. But like fun fact, when Amazon purchased Whole Foods, its market cap rose by about $15.5 billion, $2 billion more than what they paid for the chain. Meanwhile, the rest of the grocery industry collectively and immediately lost $37 billion in market value. That's something like $15 billion in shareholder value just got poofed, destroyed, gone, because Amazon purchased just one tiny little grocer. When a company has so much power, it can cause this reaction from even dipping a toe in an industry, is it too powerful? Economorality questions aside, what does this mean for you as an investor? I asked Ron Gross, he's a senior analyst here at The Motley Fool for his take.
Ron Gross: I think it makes sense to update antitrust regulations so they take into account the realities of the 21st century and the Internet. But it still should boil down to my opinion as to whether or not the dominance of any company is anti consumer. But nowadays this really isn't an easy thing to determine. We all get incredible benefits from Google, for example, but are we also losing something because of its dominance in search, for example? The answer is maybe, but it's not an easy question to answer because the world has changed, it isn't as cut and dry as it once was, especially when looking at antitrust or monopolistic practices. It's not necessarily just about pricing power and profits anymore. Let's use Google and Facebook as an example. They're theoretically free to the consumer. But there are other factors to take into consideration now, such as access to information and the fact that in many circumstances, it's the consumer that has actually become the product that didn't used to exist back in the day.
From an investment perspective, if you decrease the dominance of a particular company by breaking it up, you're likely decreasing the value of that company as well. Although it's possible the appropriate value could accrue to the various pieces of that business. But in general, I think breaking up a dominant company would be bad for investors of that company, at least in the short run. Perhaps it would be good for society in the long run, but we would have to wait to see what happens down the road. I personally would want to make sure that competition is still the driving force behind capitalism, and I would not want to see regulators step in every time a company just gets too successful. But competition does need to exist on a fair and open playing field.
Brokamp: Ron makes an interesting point. One of the things that can happen with the company, if it's determined that it's a monopoly, is like it basically split it off. Some of the business units get spun off to a separate stock, a separate company. If you're a shareholder in that big company, you get some of those shares. Studies that have looked at the historical performance of spin-offs are somewhat mixed, as Ron indicated, might not be good for a company. But there's definitely evidence that many do quite well. If a spin-off allows the company to unlock value, as they say, then it might actually end up being good for investors and consumers, but it definitely depends on the company.
Southwick: In a recent year's Times article about how Amazon has surpassed Walmart, pickle purveyor of choice for many of us as the largest retailer outside of China. Barbara Kahn, a professor at Upenn Wharton School of Business, said the big bad wolf is Amazon now. The question is if regulators believe this big bad wolf could blow the whole house down.
Brokamp: A couple of weeks back, the U.S. Treasury Department announced that the federal budget deficit in July was $302 billion. That's how much more Uncle Sam spent than he took in via taxes, and it's a record figure for the month of July. For the fiscal year so far, which for the federal government began on October 1st, the deficit is $2.5 trillion. Of course, this is nothing new. In the last year, the government had a surplus in 2001. We can keep running these deficits because we keep borrowing money. Currently the value of all U.S. debt is $21 trillion. Meanwhile, on the income side, we're currently enjoying the lowest tax rates in decades. As our country, we Americans love spending more but paying less.
Southwick: Who doesn't, Bro? Actually, apparently Macau, but it's a casino nation, someone's going into debt.
Brokamp: I was aware of that fact.
Southwick: Yeah, fairly, they're one of few countries that really doesn't have any debt.
Brokamp: That's so funny. Anyways, here's the thing though. Many investors believe this can't last forever. In fact, the lower tax rates from the cuts passed in 2017 will automatically expire at the end of 2025. But some believe that won't be enough and much higher tax rates are in our future. Which is why Roth retirement accounts are increasing in popularity. With a Roth account, you don't get a tax break today, but withdrawals are tax-free as long as you follow the rules. So you bite the tax bullet now while rates are low and don't have to worry about higher tax rates in retirement, at least on some of your money. Today I'd like to talk about those rules, particularly the five-year rules because they can be very confusing and I'd hate it for an Answer listener to open a Roth thinking all the withdrawals are going to be tax-free only to get an unwelcome surprise on April 15th. Grab a cup of coffee because this is not the most exciting stuff in the world and let's dig into how to keep Uncle Sam from grabbing your Roth gains.
First of all, I do want to make sure that everyone knows that contributions to a Roth account will always come out tax and penalty free. For the growth to be free of such nasties, you generally have to wait until you're 59.5 and you have to obey the five-year rules, and I say rules with an s because there's not just one five-year rule, they are different for each type of Roth. So let's dig into the five rules of the five-year rules.
Southwick: Did you do that on purpose? It's five rules and its five-year rules and it just worked out so perfectly.
Brokamp: I didn't make up any rules to make this work, but I do think I'm the first person to say this. I'm trade marketing it right now.
Southwick: There you go. Oh man, we're going to get so rich off of that one. Five-year rule No. 1, contributory Roth IRAs.
Brokamp: A contributory Roth IRA is just you putting cash into a Roth account and the five-year clock starts the year you opened your very first Roth IRA and that clock applies to all the Roth IRA accounts opened thereafter. That includes conversions which we'll get to later. This also means that if you're 57 when you contribute to your very first Roth IRA, you may have to wait until you're 62 to access the earnings without paying taxes, though after 59.5, you don't have to worry about that 10% early withdrawal penalty. Here's the interesting thing about what five years means. The clock begins ticking on January 1st of the year the account is considered opened regardless of the date you actually sent in the money and you do have to send in money, by the way. Just opening the account doesn't count, you have to put in money. Because you have until the tax filing deadline, which is usually April 15th of the year following any given tax year to make a contribution to a Roth IRA, the five-year rule actually could require that you hold your assets within the account for less than four years. Let me show this by example. Let's say you opened your first Roth IRA on April 15th of 2020 and you made a contribution that counted toward the 2019 tax year. Then the effective start date was January 1st of 2019 and thus your five years are up on January 1st, 2024.
Southwick: Time for five-year rule No. 2, contributory Roth 401(k)s.
Brokamp: Yes. These are Roth accounts that are offered at your office by your employer-sponsored account. With a Roth 401(k), each account has its own five-year clock. So if you opened a Roth 401(k) with one employer when you were 54 and then switched jobs and opened another at age 58, the assets in your first Roth 401(k) can be distributed tax completely free after age 59-and-half, but you'll have to wait until you're 63 to tap the assets in the second without taxes. But there are two ways around this. First, if you roll the old 401(k) into the new 401(k), the entire account has the holding period of the oldest account. Secondly, you could roll the 401(k) into an older Roth IRA, which brings us to.
Southwick: Five-year rule No. 3, Roth rollovers.
Brokamp: If you rollover a Roth 401(k) to an existing Roth IRA, the five-year clock for that IRA is what's used to satisfy the rule. What if you don't have an existing Roth IRAs and you have to open a new one in order to receive the rollover from the Roth 401(k)? That starts a whole new five-year clock, even if the Roth 401(k) had been opened for several years. This is important to note because many people choose Roth IRAs because they don't have required minimum distributions at age 72. However, Roth 401(k)s do have required minimum distributions. You can get around those by transferring the 401(k) to an IRA but if you didn't have a pre-existing Roth IRA, you've now started a whole new five-year clock.
Southwick: Five-year rule No. 4, Roth conversions.
Brokamp: A conversion is when you move assets currently in a traditional retirement account into a Roth account. Now, the amount that you convert will be added to your taxable income in the year of the conversion. This isn't a free ride, but any growth thereafter will be tax-free, again, if you follow the rules. Here's the confusing thing about conversions because they almost have two of their own five-year rules. First of all, the earnings on the conversion follow the same rules as the contributory Roth IRA. However, the converted amount actually has its own five-year rule, and here is how that works. If a distribution of a converted amount is done within five years of the conversion and the owner is younger than 59.5, the distribution will trigger a 10% penalty. Each conversion receives its own five-year clock. However, once the account owner reaches age 59.5, the 10% penalty will no longer apply to the converted amounts even if it's been open for less than five years.
Southwick: Finally, five-year rule No. 5, inherited Roths.
Brokamp: Someone passes away and they leave you a Roth account, the original five-year clock gets inherited along with the assets. You do not have to worry about a 10% early distribution penalty when you inherit a retirement account, Roth or traditional. But with the Roth, taxes do apply to any earnings contained in the distributions until five years have elapsed. After that, all the withdrawals are tax and penalty free.
Southwick: You know what, Bro? Whenever you preface a topic with getting a cup of coffee or this is going to be tough, what I appreciate is that yeah, it can be tough but you had the tougher job of making sense of it to begin with. So you're the one who has to read all the fine print, read all the forms, read all the everything. So, thank you for making a tough topic just a little less tough. Now, bring us home.
Brokamp: Well, I appreciate that Alison, and I will bring you home. That's it, just about everything you need to know to protect your Roth from taxes that will likely be higher in the future. As you can tell, this is a bit confusing. If you're not sure whether you satisfied all the rules, talk to your tax advisor, broker, or financial planner or visit irahelp.com, the website of retirement account expert and gadfly, Ed Slott.
Southwick: It's time for Answers answers. Wait, what? Answers answers? We're using the word 'hipster' again and we're talking about answers, answers. Yes, that's right. We're bringing back answers, answers. So instead of having a big mail bag at the end of the month, we're going to try to answer a question at the end of every episode, just to space them a little bit. Today's question comes from David. "I have been a Stock Advisor member for almost 10 years and a Motley Fool Answers biggest fan." Aw, thanks, David.
Brokamp: Thanks, David.
Southwick: "My question is about the 4% rule. While I understand how it works, I'm not sure about the details. For example, how do I take the 4% from my stock portfolio? Do I take it from my winners, losers, my largest positions or what? Should I take it as a lump sum, quarterly or monthly? I'm 74 living in Japan and the 4% will make up the vast majority of my yearly $70,000 income."
Brokamp: David, I'll just start with what I consider the foundation of a retiree portfolio and that is the income cushion. That is 3-5 years worth of portfolio provided income that you need out of the market, keep it in cash, CDs, short-term bonds. You set that up, over the course of a year, you spend it, and then you replenish it annually. I would say annually is about the time frame that you'd look to sell some of your investments to raise cash in retirement. Next, you might have a question about, well, which accounts do I tap first? Studies indicate that it's best to tap your taxable brokerage accounts first and leave your IRAs and 401(k)s to grow. However, since you're over the age of 72, you may need to take required minimum distributions from any retirement accounts. I say may because you mentioned that you're living in Japan. I don't know if that means you're a citizen of Japan or a U.S. citizen, but if you're a U.S. citizen, you have retirement accounts, you do have to take required minimum distributions even if you're not living in the U.S. As for which investments to sell, it's like a rebalancing question. I would start with any investment that has taken up more of your portfolio than you're comfortable with. Maybe it's a stock that is now 10% or more of your net worth, maybe it's a particular asset class or sector.
We often talk about once you have 30% of your portfolio in a single sector, it's time to start thinking about cutting back a little bit. You asked about losers and winners and at The Fool, we tend to like to let our winners run. Plus, if the losers are in a taxable brokerage account, you might be able to take a capital loss that will reduce your tax bill, but if selling your losers means your portfolio will become too concentrated in your winners, then consider cutting back on some of them as well. I'll repeat a good Foolish framework for pruning your portfolio. Pretend your portfolio was all in cash, look at each of your investments and ask if I didn't own this investment, would I buy it today? Anytime you say no, that could be a candidate for what to sell when you need to raise cash in retirement. Finally, just a little bit about the 4% rule, even though I know we've talked about it a lot. It was established by a financial planner named Bill Bengen in 1994 as someone who had a 30-year retirement. So generally, someone who is around 65. Subsequent research, he determined that it's actually 4.5%, but despite that, we still think of 4%. So a safe withdrawal rate for someone who is 74 could be higher, but what should it be? Well, I reached out to the man himself. Bill Bengen is actually 74 years old and I sent them an email and I said, "Bill, how do you determine how much to withdraw?" He said when he retired in 2013 at the age of 66, he did use 4.5% as his initial withdrawal rate. This year at age 74, his withdrawal rate is actually just going to be 3.5%, because his portfolio has done so well and he doesn't really need that much in retirement, but he did send along a screenshot of his book that he published in 2006 and he said according to his research from back then, if you have 20 years to live, so that'd be reasonable for someone who's in their mid-70s, you could take 5.2%. He also said that his recent research indicates that it could be even higher, maybe 5.7%, but he noted that this is preliminary. He's finalizing his research and he hopes to publish a new book next year. I will say that some people think that the framework that determined this 4% or 4.5% safe withdrawal rate might be a little outdated because it relies on historical returns and going forward, returns might be lower especially with bonds. So, some people might think that these withdrawal rates are a little too high given current conditions, but I would say that it's probably safe for someone in their mid-70s to take out more than 4% if you feel that that's appropriate for your situation.
Southwick: Well, that's the show. It's edited renovating-ly by Rick Engdahl. Our email is [email protected], For Robert Brokamp, I'm Alison Southwick. Stay Foolish everybody.