🔍
How Do You Diversify Investments for the Best Returns or Tax Efficiency? - YMYW podcast - YouTube
Channel: Your Money, Your Wealth
[5]
We got Steve, he’s our friend here in San
Diego, right in our backyard.
[10]
Or front yard.
[11]
“Hi, Joe and Al - and Andi!”
[14]
Oh, he throws Andi in- I bet she typed that in there.
[17]
With an exclamation point.
[18]
Thank you, Steve, I appreciate it.
[19]
Thank you for recognizing me, even though these guys don't.
[23]
“Your folks - “
[24]
You folks.
[25]
Oh, I thought he was talking about my parents.
[28]
I was gonna be like, "Steve, Dad died.
[30]
Ruthie's awesome."
[31]
"You folks continue to be great.
[34]
Every week the show has something interesting
and new."
[38]
Wow.
[39]
That's very nice.
[40]
Thank you, Steve.
[41]
"I was wondering if you could share your thoughts
on ways to diversify an investment portfolio
[46]
to bring in the best returns?
[48]
If you're unable to answer from an investing
perspective, maybe you can answer from a tax
[53]
strategy perspective.
[55]
Thank you so much.
[56]
And please keep up the good work.
[58]
Your answers are always helpful."
[61]
All right.
[62]
Well, there are a couple different angles
we can tackle this.
[65]
So let's talk about investments - and we'll
just talk broad strokes.
[73]
And we can get basic and then we'll get into
the weeds just a smidge, just to give Steve
[78]
some perspective because it sounds like he
is a fan of the show and he's probably listened
[83]
to other podcasts and has a probably good
keen on the investment world.
[90]
Yes OK.
[91]
We're making that assumption.
[93]
Okay.
[94]
So Steve, when you build an overall portfolio,
of course, it really depends on the goals
[98]
that you're trying to accomplish.
[100]
Is it for retirement?
[101]
Is it for college education?
[102]
Is it for wealth transfer?
[104]
Whatever.
[105]
So that's the first step.
[106]
But he wants the best returns.
[108]
So you can have the best returns depending
on what goal that you're trying to accomplish.
[112]
If I'm trying to buy a house next year, the
best return that I'm going to receive is probably
[118]
50 basis points.
[120]
Yeah, cash.
[121]
Maybe 1% in a one year CD.
[123]
That's where it should be.
[124]
That's my best return that I'm shooting for
because I don't necessarily want to take on
[128]
extra risk because I could lose money and
then I need it for that timeframe.
[134]
So I'm going to assume that this is for a
longer-term goal.
[138]
So if Steve is shooting for the best returns,
then you have to look at, what's your timeframe
[143]
in regards to the goal?
[146]
But I think more importantly it's like what
target rate of return does Steve need to generate
[149]
to make sure that he can accomplish the goal?
[152]
So we believe that you take the least amount
of risk possible to try to get that best return.
[157]
And how do you do that?
[160]
The answer is somewhat simple, but it's not
necessarily easy to implement.
[167]
So the first thing Steve needs to figure out
is how much money he needs in
[171]
stocks versus bonds.
[172]
Over time, stocks will produce a higher expected
return than bonds because there's more risk
[177]
in stocks.
[179]
So let's say it's 60% stocks, 40% bonds.
[182]
Fair enough, everyone with me so far?
[185]
Yeah.
[186]
OK.
[187]
So then you could say, in my bonds I can choose
several different types or flavors of bonds.
[193]
I can just go with plain vanilla or I could
go through a variety of different flavors.
[198]
See how I'm like doing some analogies here
to keep this thing interesting?
[201]
(laughs)
[202]
Yeah because you almost lost me before you
did the flavors.
[205]
Now I'm thinking ice cream.
[206]
So Steve could go long term bonds, you're
gonna get a higher expected rate of return
[210]
in long term bonds.
[212]
Not necessarily right now because we have
an inverted yield curve, but historically,
[216]
longer-term bonds will give you a higher expected
return because there's more risk - you're
[220]
lending your money to a company or a corporation
or bank or whatever for a
[224]
longer period of time.
[225]
A lot of things can happen.
[227]
So there's more risk, they gotta pay you a
little bit more.
[229]
We believe you don't want to take that type
of risk in bonds, so you might want
[232]
to go short.
[233]
Shorter term bonds will give you a higher
level of security or safety but a lower expected
[237]
rate of return.
[238]
First decision: how much stocks versus bonds.
[241]
Second decision now is how would you like
to invest your bonds?
[245]
You can go long term.
[246]
You can go short term.
[247]
You can go high, let's say risk, or high credit
risk.
[251]
So riskier type companies, or lower risk in
regards to the federal government.
[256]
On your stock side, this is where it gets
a little bit more interesting.
[261]
You could just say I want to buy the entire
U.S. or the entire global market.
[266]
And you can buy an index fund and you would
be completely diversified with all different
[270]
sectors and countries.
[272]
But it might make sense to break those up.
[274]
We believe that you want to break them up
into different categories.
[278]
One is large companies, two is small companies,
and three is value, four is growth.
[287]
So over time you look at how much money do
I want in larger companies, big companies
[291]
that you know the names of, versus really
small companies that you never heard of before.
[296]
The smaller companies that you never heard
of before will give you a higher expected
[299]
rate of return in the stock market than large
companies because there's more risk.
[303]
There's more room to grow.
[305]
Then there are value companies - lower priced
- versus growth companies - higher priced.
[310]
Which one we'll give you a higher expected
rate of return in the market?
[313]
Well, the lower-priced stocks would.
[315]
So if you do use all of this academic research
and study and Nobel Prize winning stuff, for
[321]
lack of a better term, you would use that
and say, "How do I get the best return?"
[327]
Well, you would tilt your portfolio a little
bit more toward stocks.
[331]
And then in your stock portfolio, you would
tilt it a little bit more toward
[335]
small and value.
[336]
Over time - no guarantees - that, hypothetically,
should give you a best return.
[342]
What'd that take?
[344]
Five minutes to explain modern portfolio theory?
[347]
Yes.
[348]
That's pretty good.
[349]
That was a good answer.
[350]
Let me add a couple of things.
[351]
To tax? You do the tax part.
[352]
No, I'm still on investments.
[354]
We only got three minutes to go.
[355]
All right, go for it.
[357]
So I would also add emerging markets would
be another tilt,
[361]
International.
[362]
Use that same philosophy with emerging markets
and international.
[365]
So still small, large, value, and growth in
the international?
[368]
Yeah yeah yeah.
[369]
Use that quadrant if you will, if you can
imagine it like small companies would be on
[372]
the bottom, large companies would be at the
top and then you'd cut it like...
[376]
But how much of that in your equities?
[378]
Well then you would look at how much risk
do you want?
[381]
If you're willing to take on a lot more risk
than you tilted more toward small/value.
[384]
And then you tilt it more towards emerging
markets small value.
[388]
I mean if you want the highest expected rate
of return, it's emerging markets, small/value.
[392]
Yeah I agree.
[393]
That's high octane.
[394]
That will give you the best return.
[396]
But it'll also give you the worst return in
any given year.
[398]
A lot of volatility.
[399]
I got a question.
[401]
What about alternatives?
[402]
What about them?
[403]
What's your recommendation?
[404]
Sure.
[405]
I mean we have alts in our portfolios, it
really depends on what your definition of
[409]
alternatives is, and Al's got still a couple
minutes for his point.
[413]
Go for it.
[415]
We can go a little bit longer in this one.
[417]
OK so let's talk taxes.
[419]
Because when it comes to taxes, we like to
identify three different tax pools.
[424]
And we'll call that tax-free for a Roth IRA.
[428]
We'll call it taxable, which is a non-retirement account.
[431]
And then we'll call it tax-deferred, which
is a retirement type of account.
[434]
And the reason we separate those is their
taxed differently.
[437]
The tax-free, when you take money out of that
for retirement, it's tax-free.
[441]
There's no tax at all.
[443]
The taxable account is monies that you've
already paid tax on.
[447]
So the only extra taxes that you have to pay
is any gains on investments, as long as you
[452]
held them for at least a year and you sell
them, you get a long-term capital gain rate.
[457]
And those rates are 0%, 15%, and 20%, which
are a lot lower than the
[463]
ordinary income tax rates.
[464]
Now we switch over to tax-deferred when you
take money out of your IRA, your
[469]
your 401(k), 403(b).
[470]
That's all taxed at ordinary income rates.
[473]
That goes up to his high currently, as 37%.
[476]
So what we try to do when you figure out your
diversified portfolio is you put different
[481]
asset classes in different pools.
[483]
You put your highest expected returns in the
Roth IRA.
[486]
Those are the ones that you expect to grow
the most over time.
[489]
Like for example, as Joe, you just mentioned,
the smaller companies, the value companies,
[493]
maybe the emerging markets, they're going
to be more volatile but over the long term,
[498]
they have a higher expected return.
[500]
And you want your growth there because you
pay less taxes.
[502]
Then you want your safest investments, like
your bonds for example, that produce interest,
[507]
you want those in your tax-deferred IRA, 401(k)s
and things like that because you don't know
[514]
they want your highest growth there because
you'd pay higher ordinary income taxes.
[517]
And then the rest goes into your non-qualified
account or your non-retirement account.
[523]
Now, that's the theoretical answer.
[525]
But in reality, a lot of people have almost
all of their assets in retirement accounts
[529]
so you're going to have a whole bunch of things
in your retirement accounts.
[533]
But if you had an even balance, let's just
say theoretically, you want your highest expected
[538]
return in the Roth tax-free.
[541]
The lowest expected return in the tax-deferred
IRA, 401(k).
[544]
And what's ever left in the middle goes into
your taxable account.
[547]
Well I think that brings us to another point.
[551]
Before you really look at how your portfolio
should be established, you need to look at
[557]
well what is the tax implication of what you're
trying to do, and where's the money held?
[563]
Because like you said, most people have all
of their money in a retirement account.
[567]
Well if I were Steve, now you have to be looking
at, well if that's me, maybe I should be thinking
[573]
about getting money into a brokerage account
that's going to be taxed at a capital gain
[577]
rate when I need the money in retirement.
[580]
Maybe it makes sense for me to get money into
a Roth IRA or a Roth 401(k), which is going
[583]
to be 100% tax-free.
[585]
So when it comes time for me to take distributions
from the overall account, I can
[590]
control my taxes.
[591]
I can pull enough from my retirement account
to keep me in the lowest tax bracket possible.
[596]
Maybe that's the 12%.
[598]
But I want more income or more cash.
[600]
I grab it from the Roth, or I grab it from
my non-qualified account.
[603]
I have more income, more cash, but I'm still
paying very low in tax.
[608]
So I think a lot of times we get so wrapped
up on "what is this best return?"
[612]
But it's not necessarily what you earn, it's
what you keep.
[616]
So if you're jamming everything possible into
the 401(k) plan, which is great, however,
[620]
you might be short-sighted.
[622]
You might be leaving so much money on the
table just because of where income rates are,
[627]
where we believe that they're going.
[628]
And if you're getting the tax deduction today
because you think tax rates are going to be
[632]
lower, your tax rate is going to be lower
in the future, that's one thing.
[636]
But most people that listen to the show are
savers that want to do a little bit better
[641]
in their overall financial situation.
[642]
So I'd be extremely aware of your tax situation
and I'm really glad that he asked that after
[649]
- it should have been first.
[651]
"Well, what's the best tax strategy?"
[652]
Yeah.
[653]
They go hand-in-hand.
[654]
Yeah.
[655]
One last thing too is that in the money that
you have in non-retirement accounts, you want
[662]
to look at that type of investment.
[665]
So if I have an exchange-traded fund or index
fund, that has very low turnover, so it's
[670]
not going to kick out a lot of interest and
dividends and it's going to keep it very tax
[673]
efficient from an investment perspective,
where we see sometimes there are actively
[678]
managed funds or could be alternatives, there
could be different, maybe, bonds.
[683]
They might have corporate bonds that are kicking
out interest.
[686]
They might have a lot of different CDs but
then their 401(k) plan is jam-packed
[690]
full of stocks.
[691]
You want to be careful too of like just the
interest and dividends that all this stuff
[695]
kicks out, just to keep that thing tight and
tax efficient as well.
Most Recent Videos:
You can go back to the homepage right here: Homepage