IFB183: Investing in the 40s, Bond Allocation, Early Roth Withdrawals

Welcome to the Investing for Beginners Podcast. In today’s show we discuss a few diferent topics:

  • How to invest in 40s, with an aggressive mindset
  • Asset allocation and Bonds
  • How Roth IRAs work and options for early withdrawals
  • Having dry powder for special circumstances

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Announcer (00:02):

I love this podcast because it crushes your dreams and getting rich quick. They actually got me into reading stats for anything you’re tuned in to the Investing for Beginners podcast led by Andrew Sather and Dave Ahern. Step-By-Step premium investing guide for beginners. Your path to financial freedom starts now.

Dave (00:32):

All right, folks, we’ll welcome you to the Investing for Beginners podcast. This is episode 183 tonight. Andrew and I are going to read some great lists for questions we got from our guests. And we’re going to go ahead and do our little give and take. So I’m going to turn it over to my friend, Andrew. And he’s going to go ahead and read the first question.

Andrew (00:50):

Thanks, Dave. Let’s get into them. We’ve got some good ones. So this one says, I was hoping you might address this on the podcast. I keep reading about how asset allocation is an investor’s most important decision, but nobody agrees to do it more specifically. My question is about bonds. I’ve read suggested allocations everywhere from 0% to 80%. How much should I dedicate to bonds? If it helps, I’m for the two and have about 250,000 investments.

Dave (01:20):

Thanks, Matt. Well, that’s a great question, Matt. And yes. So you are correct. Nobody does agree with it on how to do it. There are as many opinions about this. As blog posts and people give opinions about this, there is a lot of detail and a lot of data out there on the range of things. Here are some of the thoughts, which is the way I look at it. You have to boil it down to your risk tolerance is really what it comes down to; bonds, by and large, are considered safer air quotes, safer investments, mostly because of the nature of how they work. And they generally have a lot less volatility, and they also have a lot less growth potential. Stocks by far are going to earn more money over the long-term than bonds will.

Dave (02:17):

However, bonds have less volatility and help anchor a portfolio and help you the weather when times are tough, because generally, when stocks go down, bonds do well and vice versa. It doesn’t always work that way. But as a general rule, that’s kind of how it goes. Now, the old school method used to be a 60, 40 split was kind of what many people would always kind of suggestions in that. What that meant is you would do 60% in stocks, and you do 40% bonds. And a lot of that comes down again to your risk preference and your risk tolerance. Because generally again, going back to stocks, they can be more volatile, and there’s a lot more risk of drawdowns of a company going bankrupt and losing your capital that you invest in the company. So there’s more risk associated with buying stocks than there are bonds generally.

Dave (03:24):

So that’s why they usually have a skew such as a 60 40 mix. That used to be the kind of the standard cookie cutter. Everybody goes with that. And then you kind of go off of there. Some things have changed over the years, and the portfolio that I have is what I do is I, I go around 70 30. And so I go about 70% stocks and 30% bonds. Now I’m 54. So I’m quite a bit older than Matt is, but I also have greater risk tolerance. So I’m comfortable owning stocks because of the nature of the companies that I buy. I’m not buying super-aggressive, very volatile companies. I’m generally buying more, I guess, risk-averse type companies, not boring companies, but some of our boring, I’m not going to lie, but some of them are great companies.

Dave (04:22):

Many of them are great companies, but the point is that I build on the risk that I want with the companies that I buy. So there are different aspects of asset allocation, but I want to focus on bonds for this part of it. So one of the things that I was taught when I was in the banking world was to go with a bond house, asset allocation based on your age. So, in other words, if you’re in your twenties, having zero to very minimal bonds was recommended because you had a longer timeframe to invest. And the stock market is going to do great over a long period. And if there are bumps in the road, you have time to overcome those bumps in the road as you get closer to retirement. And the recommendation generally is to start allocating more and more of your portfolio to bonds or fixed income to help offset any of those fluctuations that may happen in the stock market, because nothing would suck more than, as you get closer to retirement to have all of your stock portfolio crash three days before you retire.

Dave (05:38):

And it’s happened to people before. And fortunately, it hasn’t happened to me. I’m not retired yet, but anyway, it is something to consider. You know, being 42, you know, I’m not a licensed investor. So take this for what it’s worth you’ll. My suggestion would be to go with whatever you’re comfortable with. And if you are comfortable with being a little more aggressive and having a bigger portion of your investment portfolio in stocks, maybe go something like 80 20. And if it’s something that you’re a little more conservative and you’re a little more nervous about how things are going, you can always go 70, 30, or 60 40 kinds of, depending on again, going back to whatever your risk tolerance is. The biggest part of that is making sure that you don’t just buy one bond; a great way to do it is looking at bond ETFs and having maybe a basket of those and having two or three of those kinds of things.

Dave (06:41):

And some of that kind of stuff can help kind of, I guess, even out everything w what you’re looking to try to do is kind of smooth out the returns and everything is you don’t have to it just because this is something you decide right now in a couple of years when maybe the market conditions change, you can always adjust it then too. So it’s not something where you just decide I’m going to do 80% stocks and 20% bonds. And that’s the way it’s going to be until you’re done. You don’t have to, that. You can adjust, you can, you could move things back and forth as you wish. So there is a lot of flexibility. So I hope that helps answer your question, Matt and Andrew, did you have any thoughts on this?

Andrew (07:21):

high, the follow-up question for you, which you kind of touched on a little, but what kind of things went into Your decision to go 70, 30? And based on what you said near the end, it sounds like just because that’s your allocation now doesn’t mean that’s written in stone, but what about your specific situation? I guess your risk tolerance made you pick 70, 30 versus something like 60, 40? Was it market-driven? Was it completely investor Profile Driven? What, what, what do you think it was for you?

Dave (07:55):

For me, it was probably more investor profile-driven than it was necessarily the market conditions per se. Right now, the market is heated, obviously, but for me, where I am in my financial world is I just, I wanted to be more aggressive. I didn’t have as much money set aside for me. And so I felt like I needed to be a little more aggressive to try to catch up, but by the same token, because I am closer to the end than you are, Andrew. I wanted to have a little bit more allocation to bonds to help balance out any fluctuations are drawdowns that might happen in the long-term. So, you know, my, my idea is I’m not going for the 25% a year kind of thing that Warren buffet did when he was a young guy, young lad you know, I am, I am okay with, you know, doing less than that, understanding that my, my goal is different than some other people’s.

Dave (09:02):

And so it, for me, it comes down to, I guess, investor preference, is it to say the timeframe too, to have like a ten year or 20-year timeframe versus like for the year timeframe or 50-year timeframe, does that factor into that a lot more than maybe some of the other stuff? Oh, yeah, for sure. Because I, because again, I’m, I’m farther along in my path than, than I would want to be. I mean, if I were 25, I would be in all stocks, and I wouldn’t even think about it, but because I’m older, I want to have, I guess I want a hedge against something happening that would take a longer period to recover. One of the issues that many people struggled with during the great financial crisis was a huge drawdown, and the market was down for several years before it started to recover.

Dave (09:56):

And as we’ve talked about in the past, some companies still haven’t recovered. It took years, you know, almost a decade for a company like Microsoft and Coca-Cola Cisco to recover from the.com boom. I don’t; I didn’t want to, I don’t want to be in that position. So if something like that happens, you know, God forbid, four years from now, and it goes on for another ten years. I don’t want to be in that position. And by allocating more of my portfolio to bonds helps me ensure that I won’t be in that same position. I like that. I think it gave us a good insight into your brain and how you’re thinking about it, and why that allocation makes sense. Thanks. Thanks. I’m trying to do a lot of research and read a lot and try to think about all these things to help myself and other people because that’s what we’re here for.

Dave (10:50):

All right. Let’s move on to the next question. Hello. Can you talk here on your podcast about investing and wanting to be able to take money out of an account before agent 65? I know Roth IRAs are super beneficial for tax reasons, but what if you want to take out money out of your retirement account before you’re 65? Investing in an individual brokerage account makes sense for that enjoying the information you provide. Thanks, Andrew; what are your thoughts on that question?

Andrew (11:21):

So let’s break it down quick. So a Roth IRA shields you from a tax perspective so that you can put money into it. And then when you take money out, you’re not going to be taxed on the gains. Now, like the person who asked the question eloquently, Roth’s problem is you can’t take money out before the age of 65. So there are a few rules to keep in mind with the Roth. Number one, you have to wait until you’re at least 59 and a half, which is,

Andrew (11:54):

I don’t know, kind of an arbitrary age in my opinion, but you have to also have money in there for at least five years. And if you don’t make those two requirements, then you pay an early withdrawal penalty, which as of the date that we’re recording, is 10%, and you could also pay income taxes on your gains. So, Dave, you pointed out to me before the show, there’s a difference between the taxes you would pay on the Roth. For example, I’m going to steal the example that you had; if you bought a stock like Disney, say $150 in your Roth IRA and say, it went up to $200, and you sold it. So if you’re taking that money out early, before the age of 65, you’re going to be taxed, not on the $200 that you sold to that, but not the $50, which is the gains you made on that stock. You’ll get income taxes on that. Plus the early withdrawal penalty of 10%.

Andrew (13:00):

If you’re looking at another option, the individual brokerage account is an option, which is kind of like opening a checking account. You just open the account and then put money into it. You can then buy stocks, sell stocks, collect the dividends, all those sorts of things, and not have to worry about rules about when you take it out. You know, you don’t have to wait until retirement, but the problem with that is you’re going to face capital gains taxes. You’re going to face dividend taxes. Depending on how much you make determines what your dividend rate, your tax rate is and your income tax rate. So also how long you hold the stock. So if it’s less than a year versus one year or more, then that’s going to change your dividend tax rate and your capital gains tax rate. So some positives and negatives too, obviously, if you want to invest, but you also want to have money to spend now, then having either retirement account can feel like it’s kind of controlling you or having a brokerage account can feel like you’re not making much because you’re being taxed on it.

Andrew (14:17):

There are a few good things about the Roth that you can use the money for early. So if you are paying for education expenses, if you’re paying for a first home, if you’re paying for expenses for a birth or adoption, those can, those can qualify as exceptions that don’t fall against the early withdrawal fee, and those, all those taxes that go along with it. But other than that, if you do want the money early, you probably don’t want to put in a Roth. Suppose you’re looking at money that you want to spend in the next two, three, five years, that you probably don’t want to have it in the stock market. Anyways, because, as Dave mentioned in the first question, the stock market is so volatile, and you can have stocks crash and not recover for even a decade or longer. So if you want to pull money out soon, you probably don’t want to put it into stocks.

Andrew (15:19):

And maybe you look at something more conservative like you could do a short term bond or, you know, short term bond funds, or you can put it into treasury bills, you know, lots of different options. You don’t have to buy stocks. And so, if you’re looking at shorter periods, that’s a way to do it. Then again, you know, if you have a lot of extra money and you don’t mind paying a dividend tax, you know, you collect your dividends and your regular brokerage account, make sure you put some aside so you can pay for your taxes at the end of the year. That’s a good way to go to, you know, really can’t go wrong there. But those are the things to keep in mind when it comes to wanting to take out money early and not necessarily wanting to put everything into a Roth, or if you have more money outside of a Roth, those are all things to keep in mind.

Speaker 4 (16:12):

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Dave (16:20):

Those are all great points. I don’t have much to add to that cause that’s a great answer.

Andrew (16:25):

Cool. Well, let’s, let’s move on to this last one. This one ties in nicely to what you were talking about earlier. A lot more questions about this lately. So must be something on people’s minds. This is from Phil. He says, hi, Andrew. I’ve just started listening to your podcast, which I am enjoying to start investing in the new year when my compensation has returned to full. My question is, I’m arriving late into the investing scene. I’m 42. When I listened to the podcast, you’re often talking about 20 somethings, and I can see the longer-term benefits for those guys that as they have an extra 20 years on me in terms of growth, my question is, what would you suggest for someone who’s starting later in life? I’m sure that is a more in-depth conversation, but there’s one I’m interested in hearing your views on for context.

Andrew (17:11):

I am a UK citizen living in Dubai. So I have some tax advantages that some of your listeners do not am. My compensation being later in life, is probably on the more generous side. Anyway, I would be interested in hearing your thoughts. So it goes to what you’re saying earlier, but you know, sort of a different conversation. So why don’t you start us off, Dave?

Dave (17:31):

Okay, thanks. That’s a great question, Phil, and, and this is something that over Christmas break I was having with my family because my two younger sisters were asking me a similar question. So I guess by them asking me this, I

Dave (17:50):

I can help answer Phil’s question, I guess, with my thoughts. So here are some of the things that I have been thinking about and have thought about. So I guess the, again, it comes back to your, your risk tolerance, and I’m gathering that he feels like he can be more aggressive. And if that’s the case, then probably what I would do. And this is what I’ve done is find a few companies that you think have long-term prospects. That can be kind of your anchor, if you will. So for me, I looked at some different companies that I felt were going to be around in 20 years and have good growth prospects and will be solid, stable companies. And then I start building around those. So, in other words, I pick companies that I think are good; great companies can make a lot of money.

Dave (18:50):

They pay dividends, they have good growth prospects, and our solid financial companies have great balance sheets, a lot of cash, a lot of free cash flow, and all the great things that we want to see. And they’re going to be around for a while and have been in businesses that are not going to go anywhere. And so I bought two or three of those, and those are the kinds of things that I suggested to my sisters. And then, from there, you can start building out. So if those companies are more on the, I guess for lack of a better word are more on the conservative side. In other words, they’re not going to be the huge monster growers that you’re, you, you can see in, in the stock market today that, you know, they’re not the Airbnbs and the snowflakes, and anything else that you want to could want to add to that list, but it doesn’t mean that you can’t take fliers on some of those as well.

Dave (19:50):

So, in other words, if you have this great portfolio and you have two or three things in your portfolio that are going to be a great basis, and you can build around those, then you can start taking some chances with some other things. For example, you know, some of the things that I was suggesting to my family were things like maybe something like a company, like a Microsoft, or maybe a Facebook or something along those lines. These companies are great companies that have great financials for me, they’re too expensive, but they’re not for my sisters. And they feel comfortable taking a chance on something like that. For me, it’s, it’s not my, not my cup of tea, but by expanding your horizon and taking other companies that you feel like can grow at a little faster clip than your base says, but your base is still kind of the safe, secure ones.

Dave (20:45):

Then, your portfolio will be a little more aggressive, and it’s going to grow maybe a bit faster than a standard recommendation would be. Now there’s nothing wrong with just going out and buying. I wouldn’t say just that there’s nothing wrong with going out and buying ETFs or index funds that match the S and P 500, for example, the S and P 500 Bay, which is 16% this year. So that’s nothing to sneeze at. So buying something like that, that is, is, is great as well. Suppose you want that to be your base. And then you build on that; that’s actually what my sister-in-law has done. She has built a portfolio using some ETFs, and now she’s in branching out and trying to look at some other stocks, individual stocks, to build on that. So those are the kinds of things that I have done.

Dave (21:35):

And those are the kinds of things that I’ve been recommending to my family to help them kind of get started because my middle sister is closer to my age. I won’t say her name cause I won’t say her age because I am a gentleman, but she is feeling the same way she wants. She feels like she’s a little bit behind, and she wants to catch up. So she’s trying to be a little more aggressive. And so those are, those are the kinds of things that, that I would recommend is sticking more with stocks and going lower on the fixed income. And then just trying to find a great base of things you want to build around and then start branching out from there. And I’ve bashed Tesla on here more times than we could count, but in all seriousness, if you want to throw a 1% or half a percent of your portfolio at a company like that, for, by all means, go for it.

Dave (22:27):

There’s nothing wrong with doing something like that because it makes you feel good that you see something going up like that, but you’re not risking your whole portfolio on it by the same token. And that’s where I get concerned about companies like that. So I guess those are some of my thoughts. What are your thoughts, Andrew?

Andrew (22:45):

My thoughts would be in the range of being somebody with a longer timeframe; I guess I’m still pretty conservative for knowing that I have, let’s say, 35 years now to screw it up. Right. I, I still like to buy companies, you know, maybe, maybe to a fault. I, I don’t like the idea of being lavishly loose with hard-earned money. And that goes for myself and for the people I give recommendations through to, through the newsletter. And so, for me, it’s about paying a fair price or buying a stock at a discount. So what it should be worth. To me, that is the same conversation, whether we’re talking about ten years, 20 years, period, or for the year. And so the thing to keep in mind about the stock market, you know, next year, we don’t know what’s going to happen.

Andrew (23:46):

It could crash 50% next year in three years, the same thing it could crash. The Sierra could crash next year could crash in three years. And really, we don’t know as each year goes by, but the longer that the years go by, the less of a chance you have to lose money because the stock market does eventually recover. And we’ve seen that over time and time. Again, sometimes it takes ten years, 13 years, maybe two or three years, or in the case of 2020, something like five, six, seven, eight months. But the stock market does tend to recover even after big recessions and bear markets. And so if you’re in long enough, then you’re going to have a good chance to recover; that all being said, you know, so I don’t think the timeframe necessarily needs to factor into the kinds of stocks that you’re going to buy in my mind.

Andrew (24:42):

The timeframe doesn’t matter so much when it comes to the stocks you want to buy; you always want to buy a good company at a good price. And as Dave said, you want to have the financials there who want to be a strong company, with good prospects for the future. But, you know, having that limited timeframe, starting later, I think an allocation to bonds does sound really like a good idea too because, with a limited timeframe, you don’t have as much time to screw it up as like maybe I would have with a 35 or 40 year kind of frame. So in that sense, you do want to have some of that wealth intact. And when you do have that wealth in bonds and have a good allocation there, you have fire power to attack when the market is down.

Andrew (25:32):

And that’s something I think that’s even more critical as you get closer to 65 or wherever your retirement goal is. And I think that’s another benefit to putting stuff into bonds if you can get the timing right. You can use some power, some like dry powder and some, some new allocation to stocks when they’re down, then that could be a benefit to be kind of starting from behind because it’s almost like your conservative nature gave you more opportunities. I can’t tell you if that’s really how it’s going to play out or not. We don’t know what the market will do, but those are just some thoughts, and those are really good thoughts.

Dave (26:11):

And I agree with that. The idea of having fresh powder is fantastic. And I know that’s something that honestly when COVID hit, and the lockdown started, and the market tanked, I wish I had had more because there were so many opportunities at that time to find great companies that now I wish I had had more, more powder too, to choose. And the ones that I did choose done well, but I just wish I had had more powder at that time. And so there are going to be times when the market is going to go down and having all of your money in the stock market at that time, depending on what it is that you’re trying to do is, you know, it’s, it’s obvious you want to have money in the market, but having opportunities when they do present themselves to take advantage of those is really, really how you can make a lot of money in the stock market. And that is, think about it as like when you buy socks, you know, like Warren Buffet likes to say, he likes to buy stocks. Like he likes to buy stocks when they’re on sale. So that’s kind of where that comes down to. But I agree with what Andrew was saying. You need to stick with what you’re comfortable with and what your risk tolerance is.

Dave (27:32):

When I talked to my family, for example, my sisters were both telling me they wanted to be more aggressive. And so when I think of that, I think of more aggressive kinds of companies. Still, I also would recommend for me, and anybody else that’s not wanting to be that is having some sort of allocation towards bonds because that will help offset anything that might happen in the future. And like Andrew said, we don’t know when that’s going to happen. It could happen tomorrow. It could not happen for another 12 years. We don’t know. And anybody that says they know they aren’t, they don’t know. But my point being is, is that it’s, it’s always great to have an idea of a plan. And it doesn’t mean that, as I mentioned earlier, it doesn’t mean that the plan that you have today doesn’t have to be the plan that you have five years from. Now, if a situation changes, you can change your plan as well. So it doesn’t have to be written in stone, and you don’t have to take it to the mountain. So you just need to have a plan and then work on your plan. And if things change to change plan, you know,

Andrew (28:34):

He did a great job of having dry powder for the recent crash we had to tell Andy Schuller. He wrote a post about that on the website. So this is something I think we should share because I had never thought of it before, but it’s pretty brilliant. So he talks about having a rainy day fund, and basically, he has this money set aside. It’s not so much for a rainy Davis, Like an opportunity fund. And so what he does is when he saw the market go down and he took this money that could, I guess it could be for a rainy day or could be, For example, now I’m not doing him nearly enough justices as he wrote about, but like these kinds of unexpected expenses. So basically, this rainy day fund that works as an opportunity fund.

Andrew (29:22):

And he essentially made his whole Roth contribution for the year, right at that time when stocks were really, really low and just was able to capitalize and do very well for himself. And you share the bottle on the blog. And I thought that was inspiring and a good thing to keep in mind, because for me, I’m always thinking, you know, maybe a dollar-cost averaging method is great, which it is, but at the same time, if you have extra money stashed somewhere, keep that in the back of your mind. When you see an opportunity, you can fund them more money and take advantage of the market when the market gives you what you want.

Dave (30:01):

Yeah. That’s a brilliant idea. I wish I had thought of that for sure. I’m going to make a plan for that right now. So that’s a great idea. Thank you for sharing that. That’s awesome.

Dave (30:10):

All right, folks, we’ll that is going to wrap up our conversation for this evening. I wanted to thank everybody for sending us those great questions. Those were great questions. I appreciate it. So without any further ado, I’m going to go aside as off you guys go out there and invest with a margin of safety emphasis on the safety, have a great week. We’ll talk to you all next week.

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