Should I Roll Over My 401k into an IRA? How to Decide

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

The WSJ article What to Do With a 401(k) When Leaving a Job did a good job summarizing the various things to consider when that time comes. Here is a chart showing what happens to the 401k and 403b plans held across Vanguard-sponsored employer plans:

Now, Vanguard-sponsored 401k plans are mostly from big employers and are highly likely to have both low-cost investment options and reasonable fees. I don’t know if these percentages apply to all 401k and 403b plans in general. I’ve seen some pretty bad ones with absurdly high fees, although that was several years ago. Here’s a summary of the right questions to ask:

Investment selection? Are the available investments better in your 401k or in your choice of IRA custodian? Some 401ks offer choices not available to retail investors. For example, access to mutual funds from Dimensional Fund Advisors (DFA). Or institutional shares of certain funds with low expense ratios. Or stable value funds with higher interest rates than retail bond funds. On the other side, you may be itching to buy something like real estate in a self-directed IRA. These days, both probably have some sort of all-in-one Target retirement fund, but is yours a low-cost option from Vanguard (Target Retirement) or Fidelity (Freedom Index)?

Account fees? Part of the total cost picture is the expense ratio of the funds inside, but you may also be subject to overall account management fees or maintenance fees. Some 401k plans have zero or minimal management fees. Other 401k plans have crazy-high fees on the order of 1.75% of assets annually. Nearly all of the major IRA providers now offer no annual fees and commission-free ETF trades.

Need Advice? Some 401k plans offer some level of included advice that you may value. Other people have their own personal advisor that would love to customize that IRA.

Age 55 Rule (Early withdrawal?). Starting in the year that you turn 55, you can make a withdrawal from your 401k without the 10% early withdrawal penalty. You will still owe income taxes for a pre-tax 401k withdrawal, just not 10% penalty. For IRAs, you would have to wait until age 59.5. Potential early retirees may value these 4.5 years of additional flexibility.

Asset protection needs? There is a lot of legal fine print here, but 401k plans in general appear to offer some of the highest levels of asset protection. IRAs do offer a certain level of asset protection as well, just not quite as high as a 401(k). The difference will probably not matter much for the vast majority of workers, but it may matter for high-income professionals with liability concerns like doctors.

Non-deductible / Backdoor IRA contributions? The article didn’t cover why I didn’t roll over my last 401k plan into an IRA when leaving the employer. My situation is admittedly somewhat uncommon, but not unheard of. Call it “finding-yeast-in-April-2020” uncommon.

Due to my higher income level at the time, I contributed to a non-deductible IRA each year and then converted that to a Roth IRA. (This is also known as a Backdoor Roth IRA.) However, when you do the conversion, if you have any other pre-tax “traditional” IRAs, your conversion must include the pre-tax IRA amount as well on a pro-rated basis. For example, if you had a $20,000 pre-tax deducted IRA and a $5,000 non-deductible IRA, and then decided to convert $5,000 into a Roth IRA it would be considered 80% from the pre-tax IRA and only 20% non-deductible. You’d have to pay taxes on the entire pre-tax IRA amount (contribution + gains) since you never paid taxes initially. By keeping my pre-tax 401k at the employer, I am able to take full tax advantage of all annual Backdoor Roth contributions. Thankfully, the old 401k was at Fidelity with solid investment options and no annual fees.

How much do you value simplicity? If you do a lot of job-hopping, then do you really want to juggle five old 401k accounts? Merging them all into one IRA can save you time and hassle. On top of keeping tabs on your investments and asset allocation, you’d have to do all the mundane things like keep all your contact info and beneficiaries up to date. I would worry also that my spouse would forget about an old 401k plan if I something happened to me.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

Kindle Unlimited Promotion: 2 Months Free Trial

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

(Update: Offer extended to June 30th, 2020.)

Amazon is offering a free 2-month trial of Kindle Unlimited. Must redeem by 4/30/20 6/30/20. The usual trial is only a month long, and you can have been a previous Kindle Unlimited member (but you can’t be an existing paying member). Thanks to reader Mark for the tip.

  • Enjoy unlimited access to over 1 million books.
  • Explore a rotating selection of popular magazines.
  • Listen to thousands of books with Audible narration.
  • Read anytime, on any device with the Kindle app.

You should be able to manually cancel your Kindle Unlimited membership early and it will let you keep your membership open until the end of the 2 months, and not renew automatically. If you don’t do anything, it will auto-renew at the end of 2 months at $9.99 per month. Remember that after you end your Kindle Unlimited subscription, you will lose access to all of the Kindle Unlimited books.

What personal finance and investing books are included? You can view all Kindle Unlimited books here. You can search Kindle Unlimited titles here after clicking the “Kindle Unlimited Eligible” box on the top-left. There are is a mix of a few bestsellers, some older classics, and a lot of independently-published titles of varying quality. Here are some business and finance-related titles that caught my eye:

Kindle Unlimited authors get paid per page that is read. Therefore, your reading actually pays authors for their work!

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

Investing In Stocks Requires Both Short-Term Courage and Long-Term Patience

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

Many investing articles basically keep telling you “Don’t worry! stocks always go up!”, but I appreciated the added perspective from the Morningstar article What Prior Market Crashes Can Teach Us About Navigating the Current One by Paul D. Kaplan and The Risk of a Lost Decade For Stocks by Movement Capital. Here is the growth of $1 in the US stock market since 1871, adjusted for inflation.

The first takeaway is that severe stock market drops are not uncommon. Having the emotional fortitude that the drops are not permanent is important.

This historical stock market return data provides clear evidence that market crashes aren’t as unique as one might have thought. The term “black turkey” is more apt, since they appear every so often—and today’s coronavirus-caused crash is only the most recent example.

The second takeaway is that there are many red periods where the stock market doesn’t reach the previous high-water mark for a decade or longer. You also need the patience to ride out those discouraging periods.

I think the average investor has an overly optimistic base case for how stocks perform over 10-year horizons. The S&P 500 has spent one-tenth of the time since 1900 with a negative inflation-adjusted return over the prior decade.

The 54% drop from August 2000 to February 2009, also known as the Lost Decade. The second-worst drop on the chart, this period started when the dot-com bubble burst. The market began recovering but not enough to get the cumulative value back to its August 2000 level before the crash of 2007-09. It didn’t reach that level until May 2013—almost 12 and a half years after the initial crash.

So often the takeaway from these long-term stock market charts is simply that the line always goes up eventually. Yes, but the line can also go nowhere for a decade or more. I’m not saying that this will happen now, but these are the hardships that create the “equity risk premium”. If stocks gave us stable price increases, they wouldn’t provide such high returns. As stock investors, we have to prepare for both the sudden shocks and the long, painful “lost” decades.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

Why You (Still) Shouldn’t Bet on Higher Oil Prices Using the USO ETF

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

Updated for crazy 2020. The big news yesterday was that one measure of crude oil prices actually went negative, because futures were coming due and nobody had any place to store the oil upon delivery.

Why did this happen? Part of the reason is that too many people had the following plan:

  1. Crude oil has dropped to $18 a barrel. These prices are multi-decade lows.
  2. Oil prices must go up again… eventually… right? Look at that historical chart!
  3. The futures market is kinda complicated… I know! I’ll buy an ETF like USO.
  4. Profit!?!?

Here are a few things you should know first about the United States Oil Fund (USO) and similar oil ETPs.

You aren’t the only one who’s thought of this. Billion of dollars have come and gone into oil ETFs in the past few years. Here are articles from 2014 and 2015 when oil dropped to below $50 a gallon after being over $100:

In April 2020, USO ended up having to actually change how the ETF operated in order to avoid some the market distortions that the speculation caused.

The usual market timing questions apply. Sure, the price will go up, but how long is “eventually”? It might be 1,3,5, or 10 years. If you have a specific time-frame in mind, then you can go out on the futures market and then buy a specific contract. But if oil hasn’t risen enough at that time – maybe it peaked earlier and dropped, or it peaks further in the future – you’ll have lost money.

If you buy the ETF, when is a good time to sell? $40 a barrel? $80? $100? What if you sell and then it rises another 50%?

What if it takes a while? The longer you have to hold these ETFs, the less likely they will track the price of oil (see below). Meanwhile, the ETF provider is happily collecting their annual expense ratios of 0.50% to 1%. At the current asset level of $4 billion times the 0.45% management fee, that’s $18 million a year in fees.

Your commodities futures ETF may not track the price of oil very well at all. To properly track the price of oil, you’d need to buy some oil and store it somewhere (and pay storage and security costs). These ETFs don’t do that, instead they buy oil futures contracts and keep rolling them over into new ones when they expire. That’s not the same thing. USO is designed to track daily price movements in the price of oil, not long-term movements!

Oil prices doubled from in 2009-2010. USO went nowhere. Visually, here’s a chart from Attain Capital that compares the change in USO share price (purple) as compared to the spot price of crude oil (red) when oil prices doubled between the start of 2009 and the end of 2010 (blue line adjusts USO underperformance for roll costs):

uso1

From the Bloomberg article above:

Since USO launched in April 2006, it has returned -71 percent, while the spot price of oil returned -26 percent. The last time oil roared back from a bottom was in 2009, when it returned 78 percent on the year. USO returned just 14 percent.

If you don’t understand the terms “backwardation”, “contango”, and “roll costs” then you don’t understand commodities futures. If you don’t understand something, you probably shouldn’t buy it. The more people crowd into this trade, the weirder the futures markets get. Who would think that you could get paid to take oil from someone? Take it straight from a USO executive:

John Hyland, chief investment officer of USO, says the fund is a “tactical trading vehicle predominately used by professional traders,” and not meant to be a buy-and-hold investment.

In the end, such a play is a speculative bet and it may just pay off, who knows. But it certainly isn’t a wise investment, especially if the tool you’re using doesn’t even do what you want it to do.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

Couch Potato Portfolios: Simple, Cheap, and Diversified Still Works

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

Scott Burns of the Dallas News is known for his “Couch Potato Portfolios”. These are literally the simplest, laziest, easiest portfolios that you will ever see. The Basic Couch Potato Portfolio is 50% Total US Stock and 50% Total US Bond funds/ETFs. The Margarita version is 1/3rd US Stocks, 1/3 International Stocks, and 1/3 Bonds. Can’t get much easier to remember than that! You may be surprised at how well they have performed despite their simplicity.

Indeed, Burns recently provided another update on his Couch Potato portfolios, this time for theoretical retirees from various periods including those who retired in the year 2000 to the end of March 2020 (emphasis mine):

In this scenario, you’d be:

– Retiring just as the Internet bust was starting.
– Getting run over by the 2008-09 financial crisis.
– And ending with the coronavirus crash through the end of March.

In spite of all that, you wouldn’t be broke.

Here is a chart of how a 65-year-old couple would have done if they retired in various years from 1989 to 2015 and went with a 4% withdrawal rate (adjusted annually for inflation).

These retirees may not be shopping for a yacht, but they are still hanging in there. Simple, cheap, and diversified does much of the heavy lifting required. I appreciate that he included the likelihood that one or both of the couple would survive until 2020 as well. You may be surprised by how long your portfolio might have to last, but we also have to balance the risk of running out of time with the risk of running out of money.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

US Stocks vs. International Stocks vs. US Bond Index Returns Since 2000

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

If you can take it, here is some more humbling food for thought. Here is a comparison of the growth of $10,000 invested in either the Total US stock, Total International Stock, or Total US bond index fund from the beginning of this century (1/1/2000) until the end of last week. The story is the same if you compare the S&P 500 and the US Aggregate Bond Index total returns. Via Allan Roth and the WSJ article Bonds Are Now Outperforming Stocks in Battle for Returns This Century.

These types of charts will always look rather different depending on the start date chosen. 1/1/2000 happens to be a nice round start date (and also happens to be the year I graduated college). Given the market swings these days, it may look very different again soon.

Still, who could have predicted in January 2000 that bonds would have outperformed US stocks (barely) and International stocks (by a lot) after 20 years? We do the best we can with the historical data that we have, but we should remember how much remains out of our control.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

Best Interest Rates on Cash – April 2020

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

The Federal Reserve further cut their target Fed Funds Rate to zero in March, so we continue to see a steady stream of rate drops on cash savings. I hope that some of you got a nice rate locked-in if you tried to refinance your mortgage.

Here’s my monthly roundup of the best interest rates on cash for April 2020, roughly sorted from shortest to longest maturities. I track these rates because I keep 12 months of expenses as a cash cushion and also invest in longer-term CDs (often at lesser-known credit unions) when they yield more than bonds. Check out my Ultimate Rate-Chaser Calculator to see how much extra interest you’d earn by moving money between accounts. Rates listed are available to everyone nationwide. Rates checked as of 4/2/2020.

High-yield savings accounts
While the huge megabanks make huge profits while paying you 0.01% APY, it’s easy to open a new “piggy-back” savings account and simply move some funds over from your existing checking account. The interest rates on savings accounts can drop at any time, so I list the top rates as well as competitive rates from banks with a history of competitive rates. Some banks will bait you with a temporary top rate and then lower the rates in the hopes that you are too lazy to leave.

Short-term guaranteed rates (1 year and under)
A common question is what to do with a big pile of cash that you’re waiting to deploy shortly (just sold your house, just sold your business, legal settlement, inheritance). My usual advice is to keep things simple and take your time. If not a savings account, then put it in a flexible short-term CD under the FDIC limits until you have a plan.

  • No Penalty CDs offer a fixed interest rate that can never go down, but you can still take out your money (once) without any fees if you want to use it elsewhere. Marcus has a 7-month No Penalty CD at 1.70% APY with a $500 minimum deposit. Ally Bank has a 11-month No Penalty CD at 1.55% APY with a $25,000 minimum deposit. CIT Bank has a 11-month No Penalty CD at 1.70% APY with a $1,000 minimum deposit. You may wish to open multiple CDs in smaller increments for more flexibility.
  • CIT Bank has a few competitive term CDs at similar rates: 12-month CD at 1.86% APY ($1,000 min), 13-month at 1.82% APY, and 18-month at 1.85% APY.

Money market mutual funds + Ultra-short bond ETFs
If you like to keep cash in a brokerage account, beware that many brokers pay out very little interest on their default cash sweep funds (and keep the difference for themselves). The following money market and ultra-short bond funds are not FDIC-insured, but may be a good option if you have idle cash and cheap/free commissions.

  • Vanguard Prime Money Market Fund currently pays an 1.07% SEC yield. The default sweep option is the Vanguard Federal Money Market Fund which has an SEC yield of 0.68%. You can manually move the money over to Prime if you meet the $3,000 minimum investment.
  • Vanguard Ultra-Short-Term Bond Fund currently pays 2.08% SEC yield ($3,000 min) and 2.18% SEC Yield ($50,000 min). The average duration is ~1 year, so there is more interest rate risk.
  • The PIMCO Enhanced Short Maturity Active Bond ETF (MINT) has a 2.57% SEC yield and the iShares Short Maturity Bond ETF (NEAR) has a 3.16% SEC yield while holding a portfolio of investment-grade bonds with an average duration of ~6 months. Note that the higher yield came from a drop in net asset value during the recent market stress.

Treasury Bills and Ultra-short Treasury ETFs
Another option is to buy individual Treasury bills which come in a variety of maturities from 4-weeks to 52-weeks. You can also invest in ETFs that hold a rotating basket of short-term Treasury Bills for you, while charging a small management fee for doing so. T-bill interest is exempt from state and local income taxes. Right now, this section probably isn’t very interesting as T-Bills are yielding close to zero!

  • You can build your own T-Bill ladder at TreasuryDirect.gov or via a brokerage account with a bond desk like Vanguard and Fidelity. Here are the current Treasury Bill rates. As of 4/2/2020, a new 4-week T-Bill had the equivalent of 0.09% annualized interest and a 52-week T-Bill had the equivalent of 0.14% annualized interest.
  • The Goldman Sachs Access Treasury 0-1 Year ETF (GBIL) has a 1.42% SEC yield and the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL) has a 0.88% SEC yield. GBIL appears to have a slightly longer average maturity than BIL. Expect these yields to drop significantly as they are updated.

US Savings Bonds
Series I Savings Bonds offer rates that are linked to inflation and backed by the US government. You must hold them for at least a year. There are annual purchase limits. If you redeem them within 5 years there is a penalty of the last 3 months of interest.

  • “I Bonds” bought between November 2019 and April 2020 will earn a 2.22% rate for the first six months. The rate of the subsequent 6-month period will be based on inflation again. More info here.
  • In mid-April 2020, the CPI will be announced and you will have a short period where you will have a very close estimate of the rate for the next 12 months. I will have another post up at that time.

Prepaid Cards with Attached Savings Accounts
A small subset of prepaid debit cards have an “attached” FDIC-insured savings account with exceptionally high interest rates. The negatives are that balances are capped, and there are many fees that you must be careful to avoid (lest they eat up your interest). Some folks don’t mind the extra work and attention required, while others do. There is a long list of previous offers that have already disappeared with little notice. I don’t personally recommend nor use any of these anymore.

  • The only notable card left in this category is Mango Money at 6% APY on up to $2,500, but there are many hoops to jump through. Requirements include $1,500+ in “signature” purchases and a minimum balance of $25.00 at the end of the month.

Rewards checking accounts
These unique checking accounts pay above-average interest rates, but with unique risks. You have to jump through certain hoops, and if you make a mistake you won’t earn any interest for that month. Some folks don’t mind the extra work and attention required, while others do. Rates can also drop to near-zero quickly, leaving a “bait-and-switch” feeling. I don’t use any of these anymore.

  • Consumers Credit Union Free Rewards Checking (my review) still offers up to 5.09% APY on balances up to $10,000 if you make $500+ in ACH deposits, 12 debit card “signature” purchases, and spend $1,000 on their credit card each month. Elements Financial has dropped to 2% APY on balances up to $20,000 if you make 15 debit card “signature” purchases or other qualifying transactions per statement cycle. Find a locally-restricted rewards checking account at DepositAccounts.

Certificates of deposit (greater than 1 year)
CDs offer higher rates, but come with an early withdrawal penalty. By finding a bank CD with a reasonable early withdrawal penalty, you can enjoy higher rates but maintain access in a true emergency. Alternatively, consider building a CD ladder of different maturity lengths (ex. 1/2/3/4/5-years) such that you have access to part of the ladder each year, but your blended interest rate is higher than a savings account. When one CD matures, use that money to buy another 5-year CD to keep the ladder going. Some CDs also offer “add-ons” where you can deposit more funds if rates drop.

  • Pen Air Federal Credit Union has a 5-year certificate at 2.20% APY ($500 minimum). Early withdrawal penalty is 180 days of interest. Their other terms are competitive as well, if you want build a CD ladder. Anyone can join this credit union via partner organization ($3 one-time fee).
  • You can buy certificates of deposit via the bond desks of Vanguard and Fidelity. You may need an account to see the rates. These “brokered CDs” offer FDIC insurance and easy laddering, but they don’t come with predictable early withdrawal penalties. Vanguard and Fidelity both have a 5-year at 1.60% APY right now. Be wary of higher rates from callable CDs listed by Fidelity.

Longer-term Instruments
I’d use these with caution due to increased interest rate risk, but I still track them to see the rest of the current yield curve.

  • Willing to lock up your money for 10 years? You can buy long-term certificates of deposit via the bond desks of Vanguard and Fidelity. These “brokered CDs” offer FDIC insurance, but they don’t come with predictable early withdrawal penalties. Vanguard has a 10-year at 1.50% APY right now. Watch out for higher rates from callable CDs from Fidelity.
  • How about two decades? Series EE Savings Bonds are not indexed to inflation, but they have a unique guarantee that the value will double in value in 20 years, which equals a guaranteed return of 3.5% a year. However, if you don’t hold for that long, you’ll be stuck with the normal rate which is quite low (currently a sad 0.10% rate). I view this as a huge early withdrawal penalty. You could also view it as a hedge against prolonged deflation, but only if you can hold on for 20 years. As of 4/2/2020, the 20-year Treasury Bond rate was 1.04%.

All rates were checked as of 4/2/2020.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

The Hype Cycle of DIY Investor Self-Confidence

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

In an article about the challenges of autonomous vehicles, I came across a chart of the Hype Cycle from the consulting firm Gartner that supposedly models the life cycle of new technology:

Maybe it’s just me, but I found this curve to also describe my self-confidence in investing over time.

  • Trigger. One day, something makes you want to learn about investing. For me, it was finally leaving broke academia and getting a “real job” that had triple the salary and this 401(k) match thing.
  • Peak of inflated expectations. Read some books! 8% annual returns… double my money every 9 years… yes! Asset allocation… backtesting… of course! 4% withdrawal rate… just accumulate 25x expenses… simple!
  • Trough of Disillusionment. I get laid off at the same time that my nest egg drops in half? No way. After an entire decade, which is 1/3rd of my lifetime so far, I could actually end up with less money than I put in? No way. Multiple countries will shut down completely for 3+ months at a time, one after another? No way.
  • Slope of Enlightenment. After some time, that advice about diversification, liquidity, understanding true risk, and knowing your temperament starts to feel a bit different. There is still more to learn.
  • Plateau of Productivity. Wow, that last crisis wasn’t as bad. I have a plan and have enough assets and liquidity to implement that plan. My overall vision has changed and it includes working for longer but at something that I enjoy and without short-sighted corporate metrics.

Of course, maybe I’m still be overconfident, and I haven’t truly hit that big trough yet. Good thing I stocked up on the antacid.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

Good Time to Convert Traditional IRAs to Roth IRAs?

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

It might be a little painful, but it may be worthwhile to check on your pre-tax IRAs during this dip. If you have been thinking of converting your “Traditional” IRAs over to Roth IRAs, your shrunken gains will lead to a smaller tax bill now, while your (hopefully) future gains from this point onward will be tax-free after 5 years and age 59.5.

Roth IRAs have a few unique benefits like a lack of minimum required distributions, but the primary consideration regarding conversions is still whether you think your tax rate will be lower today or when you withdraw. This is outlined in greater detail in the WSJ article A Strategy for Taking Advantage of the Market Meltdown (paywall?). One interesting suggestion is to convert just enough money from a traditional IRA to make full use of your current income-tax bracket. Here are the 2020 IRS marginal tax brackets (source) – remember the left column is adjusted gross income so it comes after subtracting the standard deduction of $12,400 (single) and $24,800 (joint).

Depending on your income situation for 2020, you might have a good amount of room to convert and pay a 10%, 12%, or 22% rate. For example, a married couple could make up to $105,050 in gross income (before the standard deduction) and still be in the 12% bracket. You get the most tax-deferred benefit if you can pay for your tax bill with external funds as opposed to the IRA balance itself.

Backdoor Roth IRAs. In case you aren’t already aware, you can make a “backdoor” Roth IRA contribution even if you exceed the standard income limits on Roth IRA contributions. This is primarily because there are no longer any income limitations on Roth IRA conversions. There are some finer points that experts debate, but the general idea is that you first contribute to a non-deductible traditional IRA and then quickly convert that to a Roth IRA (ideally with no gains and thus tax owed). One catch is that if you already have other deductible pre-tax IRA balances, then these would mix together and you’d have to pay tax on a pro-rated basis.

Given the recent stock market drop, if you made non-deductible IRA contributions in the past few years, but your “Backdoor Roth” was complicated by also having some other pre-tax IRA balances mixed in (say, from a 401k rollover), then this might be a chance to convert everything over to a Roth IRA with much smaller tax consequences.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

“This is a Temporary Setback – I’m a Long-Term Investor!”

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

When the market sell-off first started in February, there were several articles proudly pointing out how few 401k investors made any changes to their accounts. Nobody panicked! Yay! I remember thinking that such a declaration of victory was rather premature. If you have held onto your stocks so far according to your formal investment plan, then I applaud your conviction (or ability to not check your 401k balance). However, I also think it’s important to realize that the ride may be far from over.

This chart made the rounds in 2007 during the Great Financial Crisis, and has been copied so many times (you can tell by the blurriness) that I have no idea the original source. However, I still come back to it time and again.

Based on my own experiences, I can show you comments which gradually change from “This is just a temporary setback. I’m a long-term investor!” to “I can’t handle any more losses. I am selling and waiting this out!”.

My wild guess is that we are past the Anxiety stage and are somewhere in the Fear stage. There is still room for Desperation, Panic, and Capitulation. It’s like the awful seven dwarfs… I feel these emotions too, even if I don’t act on them. We are living through a historic moment. However, I see no permanent impairment in the power of productive businesses.

You won’t see a lot of market commentary on this site, as I don’t think adding to the noise is helpful. Thanks to the scientists and healthcare workers that will get us through this one, thanks to the other essential workers that have to stay out and about, and thanks to those that are helping by staying at home. Onwards (good movie BTW) to Hope and Relief!

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

Early Action, Long-Term Thinking, and Exponential Growth

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

I’ve been sitting on this post for a week, but I’ll feel better just letting it out. When we talk about investing, a lot of it is about long-term thinking and exponential growth. There are many charts showing that the person who starts saving early and stops completely after 10/15 years does better than the person who waits around but eventually saves twice as much per year. Once the ball starts rolling, it’s hard to stop. Here is one example from ForUsAll.com:

This is the power that comes from forced savings (pensions) and automated savings with default contributions (401k/403bs). Along the same lines, here’s a chart of Warren Buffet’s net worth over time from ValueWalk. Most of his money came very late in life. Look at that compound interest.

This understanding of exponential growth and the importance of early intervention applies to viral pandemics as well. If you act early and aggressively, you can stop the exponential growth. St. Louis acted aggressively during the 1918 Flu Pandemic, shut down the city early, and saved many lives. It was unpopular, but it worked. Taiwan has been aggressively screening, testing, and tracking since December 2019 and despite its proximity to China has only 45 coronavirus cases. Singapore acted similarly.

Meanwhile, Italy went from only 3 confirmed cases to 15,000 confirmed cases in a span of 5 weeks. (February 6th to March 12th. Source.) The other option is to take a slow, reactionary stance. You let the exponential grow happen. The result is that you will need to shut down the entire country and do it more extremely and for a longer time. You picked the “Save more later” option. Unfortunately, here it means a lot more dying people and overwhelmed hospitals. It also means bankrupt businesses, less hours available, less jobs available, and huge childcare problems.

Do you think the US will be closer to Italy or Taiwan? The US has only tested 5,000 people total, ever. South Korea has tested 200,000 and is 1/6th the size. That’s 240x the testing rate. If you don’t test, you can’t get a “confirmed” case and they remain invisible. If you don’t track the infected people down and isolate them, you can’t stop the spreading. This is bad!

I’m not saying the world is going to end. I have not sold any stocks and am following my established investment plan. I believe that we will eventually get through this together. Mostly, I am greatly saddened that our local, state, and federal leaders have collectively decided to choose to the option of deferred, greater pain.

Bottom line. Each day that we delay widespread testing and tracking, the longer we will have to shut down our lives to get back to normal. It’s coming. Be ready. Think about how you are going to manage childcare when schools are shut down. Make sure you’ve built up that emergency fund in case your job hours are cut. If you’ve been meaning to lower your interest rate on debt, now may be a good time to transfer it to 0% APR. If your financial situation is stable, try to refinance your mortgage and lower your monthly expenses.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

How Reliable Are S&P 500 Stock Dividends? Historical Drawdowns

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

While we see the live price of the S&P 500 index everywhere, there is much less talk about its dividends. Dividends are an important component of the total return from stocks. I love seeing my quarterly dividend payments arrive every quarter, and combined with our reduced work income, they are enough to cover our household expenses. How reliable is the income stream from owning an S&P 500 index fund (or similar total market fund)?

Here is the growth of the 12-month dividend per share of the S&P 500 on an inflation-adjusted basis (source).

Looks pretty good overall, but how bad were those drops? Inside this Movement Capital article about managing sequence-of-return risk, I came across a helpful chart showing the historical drawdowns of dividends (inflation-adjusted) from the S&P 500 index since 1900.

Chart of Dividend Drawdowns

William Bernstein has been quoted as saying that you can only treat 50% of your dividend income as reliable. Below is an excerpt from his book The Ages of the Investor that provides more context:

If you counted on your stock holdings to see you through retirement, you’re likely to be seriously disappointed. Yet, there is a small part of the equity portfolio that can be considered in the funding of retirement: the “safe dividend flow” from stock holdings. Although the value of stocks can fluctuate wildly, their stream of income is much more stable. At no point in the history of the U.S.stock market has its real dividend stream fallen by more than half, even during the Great Depression. During the most recent financial crisis, for example, although stock prices fell by more than 50%, dividends also dropped, but by only 23% from their peak, and only temporarily.

That pretty much agrees with the top chart. Dividends have dropped by up to 50%, but it has not dropped that much since around 1950. Since about 1950, the greatest drawdown of overall S&P 500 dividends has been about 25%.

Dividend payout ratio. The dividend payout ratio is the percentage of net income that a business pays out as dividends. For example, a company might earn $10 a share in net profits and pay $6 a share as a dividend. That is a dividend payout ratio of 60%. In the 1930s and 1940s, the dividend payout ratio consistently averaged above 60% (source). The majority of profits were paid out to shareholders. However, since then the dividend payout ratio has been dropping, with the average now in the 30% to 40% range (chart source):

In theory, it should be much easier to maintain a dividend when you are only paying out 30% of profits as cash, as opposed to 60% of profits as cash. Of course, anything can happen. At the minimum, your withdrawal plan should be prepared for a 25% drop in dividends at some point in the future.

Bottom line. The S&P 500 dividend has dropped by up to 50%, but it has not dropped that much since around 1950. S&P 500 businesses have been steadily decreasing the percentage of profits being paid out as cash dividends. Today, dividends only account for about 30% of overall profits (not 60%+). In theory, this should make the dividend less prone to large cuts.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.