Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Bonus Tax Refunds Will Be Sent Soon – Will You Get a Check from the IRS?
• Watch Out! RMDs Can Trigger Massive Medicare Means Testing Surcharges
• Is Your Retirement Portfolio a Tax Bomb?
• You Can Appeal a Medicare Premium Surcharge

Transcript:

David Muhlbaum: You've been told by plenty of people, us included, that saving for retirement is important. You've probably also heard that step one is putting aside salary in a 401(k) plan, if one is available to you, or some other retirement vehicle. But there's a catch. Saving for your retirement is a good thing, but in short, if you keep deferring the taxes, they'll likely bite you in the end. We'll talk to an expert in defusing what's sometimes called the retirement tax bomb. Also, more checks from the government? Well, maybe. All coming up in this episode of Your Money's Worth. Stick around.

David Muhlbaum: Welcome to Your Money's Worth. I'm Kiplinger.com senior editor David Muhlbaum, joined by my co-host, senior editor Sandy Block. How are you doing, Sandy?

Sandy Block: Oh, I'm doing great.

David Muhlbaum: Good for you. Well, you know as well as I do that one of the most popular things we've ever written about were the pandemic-era stimulus checks, because, you know, money from the government, whee!

Sandy Block: You got a check, I got a check, almost everybody got a check.

David Muhlbaum: Yeah. Good times. Good times, until the bill comes due for old Uncle Sam. But we're just going to slide right by that political hot potato. Anyway, you gave me a heads-up that some of us are going to get more checks from the government, and that is related in a way to the pandemic, but it's more limited, even if it's related. So that's my hype. What's the reality, Sandy?

Sandy Block: Well, filing your taxes is never fun, but it was particularly stressful during the pandemic. You were more likely to win the Powerball than get someone from the IRS on the phone, and I can speak to that personally. And on top of that, various changes in the tax code complicated the process, which is why people tried to get someone from the IRS on the phone. So the IRS gave taxpayers more time to file and pay in 2020 and 2021. But even with those extensions, some taxpayers and businesses failed to meet the deadlines and they were charged a penalty.

So here's where the checks come in. Some of those taxpayers will get that penalty money back. The IRS is sending out more than $1.2 billion in tax refunds to about 1.6 million taxpayers who paid penalties for late tax returns. So by now, you're probably wondering, "What do I need to do to get this money?" And the answer, according to the IRS and our colleague, Rocky Mengle, is nothing. The IRS says that most tax refunds will be sent out by the end of September and you don't have to do anything at all.

David Muhlbaum: Okay. What if you filed late but you didn't actually pay the penalty?

Sandy Block: Well, there's good news for you too, because if you were hit with a qualifying penalty but didn't actually pay it, you won't receive a refund from the IRS because you didn't pay the penalty, but the unpaid penalty will go away. Now, note that I said qualifying penalty. The refunds will only be sent to taxpayers who were penalized for filing their late tax returns for the 2019 and 2020 tax years that were due in 2020 and 2021 respectively. Second, only certain types of returns are eligible for a penalty refund. We'll publish the link with the entire list in the show notes, but for individual taxpayers, it pretty much covers Form 1040 and variations.

One more thing: The type of penalty matters too. There's actually several different types of penalties you get for not only filing late but paying late, and these refunds are only available for the late filing penalty, which is 5% of the tax due for each month or part of a month your return was late up to a maximum penalty of 25%. And as a side note, that's why we always tell people even if they can't pay their taxes, go ahead and file your taxes because these late filing penalties really pile up in a hurry.

David Muhlbaum: It's not for late payment, it's for filing late.

Sandy Block: Right. So paying late doesn't get you off the hook. And if you pay late, then you have interest on the amount that you should have paid. That's not covered by this. And just finally, that you won't get a refund if the IRS thinks your late return was fraudulent, which is kind of how they roll.

David Muhlbaum: Oh, come on. Oh, come on now. Really?

Sandy Block: No refunds for fraud.

David Muhlbaum: Yeah. Geez. Okay, Well, how about people who are late filing their 2021 tax return? It wasn't a whole lot easier getting the IRS on the phone this year. Asking for a friend.

Sandy Block: Okay. Sorry, your friend is out of luck. The penalty relief doesn't extend to 2021 tax returns. And that's an important thing to remember, that if you filed for an extension on your 2021 tax return back in April, you have until October 15th to file to avoid a late filing penalty. And like Halloween and pumpkin lattes, it will be here before you know it.

David Muhlbaum: Yeah. And late payment penalties could still be piling up too.

Sandy Block: Right. That's right. If you owed money back in April and you haven't paid it yet, then yeah.

David Muhlbaum: Just bringing that little distinction back into it. Okay. So all right. Thank you, Sandy. Checks for some, not for all, but if you get one, good for you. Coming up, we will talk to an expert about how to structure retirement savings so that you can sock away plenty of money without getting whacked by a giant tax bill. Stick around.

Defusing the Retirement “Tax Bomb” with David McClellan

Welcome back to Your Money's Worth. We are going to talk about a topic that we've broached before, how to minimize taxes on retirement savings, but with a new guest who's going to take us a bit deeper into some of these angles. And even though optimizing retirement savings is pretty dry stuff, we know it's popular based in part on the traffic we've been getting to the articles that our guest, David McClellan, has written for Kiplinger.

So at the core, David is a partner at Forum Financial Management, a financial advisory firm in Austin, Texas, but he's also VP and head of wealth management solutions at AiVante, a company using machine learning to forecast healthcare costs for the individual. Now, that second bit sounds fascinating, but not immediately germane to the retirement tax burden. But healthcare does get dragged into these calculations, and hopefully we'll get to that too. Welcome David. Thank you for joining us on relatively short notice.

David McClellan: Yeah. Well, thanks for having me. Excited to be here.

Sandy Block: So David, I understand that last night you were deep into your fantasy football draft, and I hope that went well for you.

David McClellan: I think so. I geek out on fantasy football, especially the auction format. I'm very analytical and I've developed custom spreadsheets to help me draft well, but I'm perpetually the bridesmaid and coming in second place. I've never actually won my fantasy league. So there's a lot of luck involved, more so than what I hope people have with the retirement planning.

David Muhlbaum: Well, you bring your analytics skills to the table there too. So Sandy handles sportsball around here, and she also knows more than I do about retirement tax bombs. But I have been educating myself in part by reading the articles you've been contributing to our Building Wealth channel. And these, well, they have a lot to say. You wrote over 5,000 words. But what I want to note for listeners, who really should check these out because we're only going to be able to scrape the surface in 25 minutes or so, is that David and his editor have divided those 5,000 words into a seven part series so you can both see the overarching principle and have it broken into digestible chunks.

Now, David, you clearly go deep here, and we do want to get into some of the finer, less obvious points so that people who are already deeply committed to retirement savings, maybe about to retire, maybe even drawing on their retirement savings, can come away with some useful guidance, possibly something that's new to them. But I think it would be helpful if we start with the test case, the sample couple you use in your articles, because that was very vivid in showing how people who are making good money, not yet really rich, can end up on a track that could cost them millions of dollars in taxes that they didn't have to pay down the road. So can you tell us a bit about this John and Jane Doe model?

David McClellan: So in the article, I used a case study of a working couple who was age 40 who have already saved $500,000 combined in pre-tax 401(k) accounts, and they're basically maxing out their contributions every year at $20,500 a year and then also receiving a $6,000 employer match. Now, that is a very common situation. This is a couple who are saving really well and following the conventional wisdom that the industry has, that they should be saving everything they can in tax-deferred accounts. Now if they keep doing that, by retirement at age 65, they will have saved $7.3 million tax-deferred, which sounds like they're in great shape. I mean, who wouldn't want to go into retirement with $7.3 million?

And the problem is that that tax-deferred savings also represents a growing tax liability, because tax-deferred savings is not tax-free savings, and sometimes investors forget that. When you start taking withdrawals from a tax-deferred account like a 401(k) or a traditional IRA, all of that income, the entire withdrawal, is taxed as ordinary income. And for this couple, when they first started taking required minimum distributions at age 72, when the government basically is forcing them to start making withdrawals so that they can be paid the tax bill, their first RMD is going to be $435,000, and that will continue to grow as they get older, reaching, for example, $739,000 in taxable income just from their required minimum distribution by age 80. So do you think they have a tax problem in retirement?

David Muhlbaum: Yes.

Sandy Block: They sure do. And I want to back up a little bit, because in reading your article, you go into a lot of strategies, but it seems like one of the easiest ways, and perhaps not used enough, for a couple to avoid this scenario is going back to when they're in their 40s and diverting some of those contributions to a Roth 401(k) instead of a regular 401(k). My understanding is a lot of people don't do that because they think, "Well, I'm missing out on a tax break," but maybe I'm not asking for another analysis. But how would that help them?

David McClellan: Yeah. It's a very common thing for people to do is to contribute on a pre-tax basis to their 401(k), and there's a lot of reasons for that. The conventional wisdom, the financial press, other financial advisors, CPAs, basically, they're all reinforcing the point save every dollar you can in tax-deferred accounts, and that's often the default setting in most 401(k) plans. So people, when they enroll in their 401(k), they basically start contributing on a pre-tax basis and never think twice about it.

Five or six years ago, I think there was something like maybe 30% of 401(k) plans even supported a Roth option, but I think now that number is maybe as high as 70 or 80%. So it's much more common now, but people don't know about it because they have to do a little bit of legwork on their 401(k) platform to research it and find out if that's an option. But it's the easiest way to get rid of this tax liability over a long period of time, and particularly impactful for younger savers. If you're 40, you got 25 years in which your contributions can either grow in a tax-deferred way if you're contributing on pre-tax basis, or it can grow in a tax-free way if you're contributing on an after-tax Roth basis.

So that makes a big difference as to the growing pool of retirement savings that you have. Do you want that pool to be pre-tax and you're going to have to pay taxes on it at some point, or do you want it to be tax-free Roth? The other thing about this is that investors often say, "Well I'm not eligible to contribute to Roth in a 401(k) because my income is too high," and that's a common misnomer. What they're referring to is income limits on wealth IRAs, which do exist, and many people make too much money to be eligible to contribute to a Roth IRA. But inside a 401(k), there is no income limit. So if your plan offers a Roth option, you can start contributing to it regardless of what your income is.

David Muhlbaum: So William Roth has entered the chat, so to speak. I'm referring here to the late senator who helped launch the very popular and often financially advantageous approach of prepaying the taxes on money you're putting aside for retirement. So we just talked about the Roth 401(k), which allows people to put money they make on the job aside in a retirement plan on a post-tax basis so that the growth they hope to enjoy in the years ahead will be tax-free.

Sandy Block: As long as their employer offers it.

David Muhlbaum: Yes, as long as their employer offers it. Yes. Good point, Sandy. But there's more to Roth than the 401(k). Senator Roth left quite a legacy. We sure do say his name a lot. So David, in your articles, you bring Roth up a lot because there are other solutions for people at other stages of the retirement path. I was hoping you could walk us through a couple of the other strategies for prepaying taxes, I'm thinking Roth IRAs and Roth conversions.

David McClellan: Yeah. Certainly. Well, each investor's situation is unique and so the strategies that are going to be most effective are going to vary for people. But oftentimes, you need to pursue all of the three strategies which I outlined in this series. So briefly, the first one, which we've already talked about, is basically shifting your tax-deferred savings to Roth accounts from pre-tax accounts. And because most things don't have a free lunch, the disadvantage of that is that you no longer get the tax deduction in the current year, so you're choosing to pay higher taxes in the current year with the reward that your taxes in retirement are likely to be much, much lower. So that's strategy one.

Strategy two is a concept called asset location, which we can talk about in more detail in a minute. But the third one that you referenced is Roth conversions. And Roth conversions are going to typically play a bigger role for people who are older and perhaps already retired. And it is if you are, say, 60 and you're retired and you have this really big tax-deferred account balance, then you have a window of time in which you can start to whittle away that tax liability by every year doing Roth conversions. So let me sidetrack for a second to explain how a Roth conversion works.

So in a Roth conversion, you're essentially moving money from a pre-tax account like a 401(k) or traditional IRA into a Roth IRA, and every dollar that you move is considered taxable income. So if you did $100,000 Roth conversion, that's $100,000 of income that you're essentially adding on for that tax year to all of your other sources of income. So Roth conversions typically don't make sense for people who are saving a lot who are currently earning a lot. If you wait until your income is low, such as in retirement, then you have an opportunity to do Roth conversions every single year. And with many of my clients, that's exactly what we're doing. We're doing significantly sized Roth conversions every year early in retirement trying to whittle away that tax bomb because you can't solve it in a single year.

David Muhlbaum: But there's a window, because you've got to get it done before the RMDs kick in.

David McClellan: Yeah. So the big closing of that window is at age 72 when your required minimum distributions come into play, because at that point, you don't want to be doing Roth conversions on top of your RMDs because both of those are considered taxable income. An earlier window is once you start to take Medicare at age 65, because if you have significant income from any other source, then you will face Medicare means testing surcharges, which is another major focus point of this article.

So the ideal time period, if you retire early, is up through age 63, because Medicare means testing actually has a two year look-back, meaning your premiums when you are 65 are based off of your income when you were 63, so that's the prime window to do big Roth conversions. And then as you start to hit Medicare, maybe you're doing smaller Roth conversions and you're probably stopping them altogether by the time your RMDs kick in at 72. So it's an ongoing strategy to try to bleed away this tax liability and smooth out the taxes that you're paying throughout retirement.

David Muhlbaum: Well, Sandy warned me against bringing up the Medicare means testing. "Too complicated," she said, but, well, David said it first.

Sandy Block: David did a really good job of explaining the two year look-back. That's what I was worried about. I think he makes a really good point there. But maybe, David, you could just briefly as possible explain what the debt Medicare surcharge means and how high your premiums could potentially go if you're hit by it.

David McClellan: Yeah. So I first stumbled on this topic in 2019 when I was doing some research around medical expenses in retirement for the technology firm AiVante that I work for, and I was shocked by what I discovered and ended up actually writing a white paper in 2019, which is referenced in my Kiplinger article for anybody that wants to go into the details, because I really explain the mechanics of how Medicare premiums work and what happens with Medicare means testing. And it is usually something that is completely shocking to people.

Most people, for starters, think that Medicare is free. You're paying into the Medicare system through payroll taxes throughout your whole life, and then you discover in retirement, once you start taking Medicare at 65 or so, that you actually have to pay premiums for Part B, which is basically the doctor services, and Part D, which is drug. Part B is by far the larger component of that. And what I came to learn is that in 2007, Medicare means testing was implemented for the first time. And what that means, it's also referred to as IRMAA surcharges, which is just a really complicated acronym, but basically, Medicare means testing.

David Muhlbaum: Yes. But it's memorable because it sounds like your great-aunt.

Sandy Block: Yeah, your mean great-aunt.

David Muhlbaum: Your mean grandma, definitely, because she's coming for your wallet. So the Medicare means testing surcharges, if you take a step back to the big picture of Medicare, you may be aware that Medicare has some significant solvency issues. In many cases it's in worse financial situation than even Social Security.

Sandy Block: And harder to solve.

David McClellan: And harder to solve. There are no easy solutions, and no politician really wants to touch this with a 100 foot pole because it's going to be very politically unpopular. But one of the things that they can do, and they first implemented in 2007, is means testing. And basically, what that means is if you have high income, then you are going to pay more for Part B and Part D Medicare premiums, potentially as much as four times as much. And that comes as quite a shock to people. So as an example, the premiums are $2,041 for Part B in 2022 if you are in the base income bracket, which has basically an adjusted gross income of under $182,000. So most people who are entering retirement think, "Well, this isn't relevant to me because I'm retired. I don't have a job. I don't have any income. So I'm just going to pay the base premium like anybody else."

Well, what about required minimum distributions? Recall back to that case study, the couple that was going to have hundreds of thousands of dollars of required minimum distributions. Well, at the highest means testing tier, that base Part B premium goes from $2,041 a year to $6,939 a year. Now, that's an increase of almost $5,000 a year. And if you think about that's just for a single individual, so if you're a married couple, that's $10,000 more every single year that you're going to be paying in Medicare means testing surcharges, or you certainly have the potential for that. Now, that's a very high income bracket, but if you're doing that every year over a 20, 30 year retirement, it starts to add up to real money, hundreds of thousands of dollars in surcharges. And basically, surcharges is just another word for tax. So these are taxes which I think can be largely avoided or minimized with proper planning.

David Muhlbaum: I mean, it's interesting because with time, we turned this four figure charge into an annual five figure charge, and then over lifespan, we're into six figures or more. And I guess this is in part where you're experiencing the actuarial and long-term Medicare costs comes into play in forecasting. Sorry, I didn't mean to say Medicare costs. Healthcare costs.

David McClellan: Yeah. Well, underlying the Medicare means testing is the basic problem that medical expenses keep rising at a much higher rate than inflation does. So if you look back at the period from 2007 to 2019, premiums for higher earners in Medicare increased from 5.0% to 8.6% annually depending on which Medicare means testing tier you are in. And inflation, which I think everybody has on the forefront of their minds now, any high inflation rate compounded over a long period of time can be absolutely devastating. So the masses, most people who are paying the base premium in Medicare, over that same period from 2007 to 2019, their premiums only increased by 3.1% annually. But higher income people, it was 5%-8.6% annually. Medical costs and expenses keep rising, and they have to make the numbers work somehow, and so the people who are earning more income are going to be paying a lot more.

Sandy Block: And one other thing I wanted to mention, David, because I hear this a lot from readers, is that those surcharge thresholds, there's a real cliff there. If you just go over the threshold by a dollar, you could end up paying a whole lot more for your premiums. Isn't that correct?

David McClellan: Yeah, but only for a single year.

Sandy Block: Oh, is that right?

David McClellan: Yeah. So it's not a permanent cliff that you've fallen off of. So your premiums will get adjustments every single year, and that's why the ongoing every year that the tax management decisions that you're making are going to be really important. And it may make sense, for example, one year to do a really big Roth conversion, even though it's going to trigger some Medicare means testing because you're going to have some tax benefits for the next 20 years after that. And in order to benefit from that, you're okay eating the Medicare means testing surcharges in that one year.

David Muhlbaum: I'd like to come back to a term you brought up in this podcast earlier, and it's one of the points in your pieces, but the words are a little hard to say on the air. I don't mean that I can't pronounce them, I just mean that this term sounds a lot like something that we commonly use in investing. You were talking about asset location, and that sounds a lot like asset allocation. So let's break this down.

Asset allocation is the longstanding idea of buying some of one thing and some of another and so forth. Some stocks, some bonds, some cash, some MLPs, different kinds of investments. Asset location, if I understand this correctly, is picking where you put different assets depending on the tax approach of the vehicle that holds them. Some types of investments go in your pre-tax accounts, some go in your post-tax Roth accounts. I just threw a bunch of terms out there and I'm hoping you can tell us a bit more about asset location.

David McClellan: Yeah, sure. So backing up, asset allocation is, highest level, a decision on what asset classes to invest in. So for example, a very common asset allocation for people in retirement at the highest level would be, say, a 60% stock, 40% bond allocation, conservative growth allocation, and the asset allocation is what defines the risk and expected return for the investor. And there's not necessarily a good or bad, every investor situation is different and their willingness to take risks to earn a higher return is different. So most people are familiar with asset allocation, at least in some level. Asset location is a term that even most financial advisors don't know about and don't implement. So asset location means what tax bucket are you placing different asset classes into?

So there's three basic tax buckets. There's taxable accounts, like a non-retirement brokerage account as an example, there's tax-deferred accounts, which we've talked a lot about, how to defer tax liability associated with them, and tax-free accounts like Roth. So there's three tax buckets that you have to work with. Now, a lot of investors and financial advisors will implement the exact same asset allocation, that 60% stock, 40% bond allocation, into each of those tax buckets, and that's a mistake. So go back to the big picture strategy of what we're trying to do, which is to limit the growth of tax-deferred accounts.

So if I have a 60% stock, 40% bond allocation, and remember that stocks are riskier and have a higher expected return than bonds, so if I'm going to pursue that particular strategy for a client with asset location, we would look to put all of the bond exposure into tax-deferred accounts and then load up especially the Roth accounts with the riskier assets that have higher expected returns and potentially doing the same in a taxable account. So for the same risk reward dynamic, that overall 60/40 investment strategy, you are essentially putting the bonds that are going to grow slower in the tax-deferred account and the riskier higher growth items, asset classes, into the Roth accounts.

And the net result of that over, say, 20 years can be enormous, because what you're doing is limiting the growth of the tax-deferred accounts and maximizing the growth of the Roth accounts. So this is a harder thing to implement. Oftentimes, you would benefit from working with a financial advisor to implement this, and the investments that you have, some lend themselves to asset location better than others. So one of the concepts here is you need asset class pure investments, meaning perhaps a international small-cap value fund would be a great candidate, very focused high expected growth investment.

David Muhlbaum: And the inverse being a target-date fund.

David McClellan: Right. The inverse, a target date fund, would be a great example, because it is essentially a blend, or growth and income fund would be another example, it's a blend of both stocks and bonds. So when you have a product like a mutual fund or ETF that is blending different asset classes, you don't have the ability to separate the asset classes and place them into the right tax bucket to optimize the taxes. So asset location can make a big difference in terms of reducing this tax liability over time.

David Muhlbaum: Well, I look forward to our listeners going back to their advisors and saying, "I want to talk about asset location," and those advisors going, "Yeah, asset allocation. No, we got that." No, no, no. Asset location. So if we have one solid takeaway, it's that distinction in terms. But I think we're going to have many more from what David has had to share with us. And again, as I warned, we're just scratching the surface. You really should check out his pieces at kiplinger.com about the tax bomb and how to defuse it. I will include a link. Thank you again for joining us, David.

David McClellan: Okay. You're welcome.

Sandy Block: Thank you, David.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you've already subscribed, thanks. Please go back and add a rating or review if you haven't already. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• USPS to Raise Rates for "Holiday" Season Again
• Paying for College, 2023: Everything You Need to Maximize Financial Aid and Afford College
• Tax Breaks to Help You Pay for College
• IRS Publication 970: Tax Benefits for Education

Transcript:

David Muhlbaum: Paying for college as tuition and other expenses continue to rise is a challenge for many families. Paying for college is a huge, complicated topic as well. So, today, we’re going to focus on a way we can be helpful, which is pointing out the tax breaks that can ease this financial burden, whether college is something you’re saving for in the future, paying tuition bills on right now, or still carrying debt from. We’re going to get some expert help from Kalman Chany, author of The Princeton Review’s Paying for College. Also, a quick look at postal rates for the holiday season. All coming up in this episode of Your Money’s Worth. Stick around. Welcome to Your Money’s Worth. I’m kiplinger.com senior editor David Muhlbaum joined by my co-host, senior editor Sandy Block. How are you doing, Sandy?

Sandy Block: I’m great. I’m headed for the pool soon to enjoy this sunny August weather.

David Muhlbaum: Well, good for you. Enjoy the dog days. As far as I’m concerned, summer is over. Not by the calendar, I understand that, but a week or so ago, I saw something that to me indicates there’s a fork stuck in summer: Mums for sale at the hardware store.

Sandy Block: Oh, that’s your marker? I used to use back-to-school sales, but now those start in May or June, and that’s just ridiculous, but I actually have seen displays of Halloween candy at the Safeway.

David Muhlbaum: Yeah. There was a rumor that there was going to be a candy shortage, but no, that didn’t pan out.

Sandy Block: I’m not seeing it.

David Muhlbaum: ... no. Well, okay. I got another one for us. The United States Postal Service has filed for a holiday rate increase for package shipping.

Sandy Block:

Right. Because they can’t just run off and change their rates like UPS or FedEx. They have to get approval from the Postal Regulatory Commission or something like that. But what’s that got to do with summer ending?

David Muhlbaum: Well, two things really. Number one that they said peak holiday season in August, which I guess I find triggering, but also the range of what they consider holiday season. These increases will go into effect between October 2nd and January 20th, 2023.

Sandy Block: Okay. So, I guess the four-month holiday season.

David Muhlbaum: Yeah. What holidays are we including here?

Sandy Block: Yeah. Guy Fawkes Day? I don’t know. But, well, it seems excessive, but I guess the postal service is still a little shell-shocked from the volume they had to manage in the first couple of years of the pandemic. They’ve done this surge pricing before, right?

David Muhlbaum: Yeah, you’re right. This would be the third year. But what’s different this year, besides the actual amounts of the increase, is that period we were just talking about. They’re tacking on almost a whole month. The surge used to end on December 26th, Boxing Day.

Sandy Block: Right. I guess even if you mail your packages after the holidays, you still get hammered. You mentioned the rates, but what are they?

David Muhlbaum: Okay. It’s not a percentage thing that we can shorthand and, notably, this doesn’t have anything to do with the cost of a first-class stamp, which is what used to get people all in a lather. As is always the case, there are different rates charged to commercial shippers and retail shippers like you and me. But one that I found relatable is for flat-rate Priority Mail, which is what I tend to use, they provide the box or envelope, you fill it, weight doesn’t matter. It’s pretty convenient. But starting October 3rd, those costs will be almost a dollar more each, 95 cents.

Sandy Block: Wow. That seems like a lot. How does that compare with last year’s surge?

David Muhlbaum: Okay. I have that. Last year, that one in particular for the Priority Mail was 75 cents. But, hey, that was in 2021 dollars. Yeah. Ain’t inflation fun?

Sandy Block: Yes, it is. Unless you’re buying eggs and gas. So, the money-saving tip here, because we need one, because we’re Kiplingers and we’re actionable, is: Mail extra early for the holidays. Have your packages in the mail by October 2nd?

David Muhlbaum: You’re killing summer. Please, go swim. Okay. Coming up next, we get way deep into college finance with an expert in the field, whether you’re saving for college, paying for college or working your way out of college debt, you’re going to want to learn from Kal Chany.

Paying for College with Kalman Chany

Welcome back to Your Money’s Worth. For our main segment today, we’re going to talk about paying for college. As I hinted in the introduction, this is a big topic. So, to come away with a discussion that both fits in our time slot and is quality, actionable Kiplinger personal finance guidance, we’re planning to concentrate on what sort of tax breaks can be used to offset the cost of higher education. But our guest today, well, when it comes to college finance, he knows the whole enchilada, soup to nuts, if I can mangle a food metaphor. In fact, he wrote a book, some might say the book on the topic, it’s called, straightforwardly, Paying for College. It’s published by The Princeton Review. I’m going to turn this introduction into my first question to Kalman Chany. Here it is. So, which edition of Paying for College are we on now, Kal?

Kalman Chany: Okay. Currently there’s the ‘22 edition. The 2022 edition is out. And the 2023 edition though, that will be published on September 20th. So, anyone who’s interested in getting the book, they could even pre-order now. That would make sense, because there have been a lot of changes that have gone on in the whole college funding landscape. So, there is a lot of new information we have. Even beyond that, though, the book has a free update service, because from the time we went to press, about a month ago, and it’s now with the printers and getting shipped, there’s been a lot of new information. So, we’re working on the update now to have that ready to go by September 20th.

David Muhlbaum: So, I’m holding in my hand here the 30th edition and we’re going to get the 31st edition. It’s interesting that you’re doing these running updates, because 30 years ago, that was before the internet was really a thing. It’s interesting how you’re meeting that challenge, because these days every Joe or Jane with a blog is presenting themselves as a college expert.

Now, in all honesty, I haven’t read all of your book. I read the fun parts? I definitely read the part where you laid out the underlying philosophy of your approach. You lay out who the players and the processes are. Also, I guess, kind of the moral questions: Is this fair? Is this legal? Is this ethical? But listeners shouldn’t take the fact that I didn’t finish Kal’s book the wrong way, because some of those sections I skipped are these really detailed ones that are basically a line-by-line walkthrough of the forms such as the Free Application for Federal Student Aid, which everyone calls FAFSA, that you would need to fill out if you’re filing for financial aid. Then, I bounced around to look at the tax angles, because that’s how we’re going to try to focus today. But a little bit more about you, if you please, Kal, you are the president of Campus Consultants, Inc. So, what’s that?

Kalman Chany: We’re a Manhattan-based financial aid advisory forum that guides families worldwide on how to maximize their eligibility for financial aid and minimize college costs. The book is based on my experience counseling thousands of families over the past 30-plus years on how to navigate the financial aid process and the college funding landscape.

Sandy Block: Well, thanks for joining us, Kal, I know back when I worked at USA Today, you were really the go-to guy for us whenever we wrote about paying for college, all of the intricacies of financial aid. I guess I’m going to take credit here for the idea of keeping us on taxes as a subset of the totality of knowledge you have to share, because it’s something I wrote about recently for Kiplinger’s Personal Finance magazine.

But I want to echo what David was saying, which is that college finance is a huge and complicated topic. Even when we try to say we’re just going to talk about tax breaks. It’s very hard not to get pulled into sometimes what seems like an entirely parallel accounting system. Even people like me, who think we have a pretty good handle on the federal tax system, end up looking into college finance and see something that makes you realize that traditional good tax guidance and optimizing your finances for college can be at odds. So my question then, Kal, is maybe you could start by telling us what do you think is the biggest tax mistake people make that may hurt them when it comes to paying for college or getting aid for college, the whole landscape there?

Kalman Chany: Okay. The biggest problem is, and the biggest financial aid trap is having money in the child’s name. There are some tax advantages, for example, of having funds in a custodial account or, in some cases, even setting up a trust fund. But those are financial aid traps, because money in the child’s name, a custodial account, a trust fund, even if the trust is not available to the child to say 35 years of age, those are assessed as assets and student assets in the aid formula are assessed far more heavily than parental assets.

For example, an extra $10,000 in assets in the parents’ name would reduce the aid at most $565. But that same $10,000 in the child’s name can reduce the aid by $2,500. That’s just for one year. Some schools will say, "If you start with the $10,000. We’re going to take four of those $2,500 chunks over the four years your child’s in college." Basically, having that money in your child’s name didn’t help you in terms of paying for college, because you as a family are still expected to pay as a parent toward college. So, if you want to have any hope of getting need-based aid, and in the book we cover how you can get an idea of doing that, there are worksheets, etc., you want to avoid putting money into the child’s name in custodial accounts.

Sandy Block: Right. I think to follow up on that, Kal, people probably do that because they think they’re getting a tax advantage by having their investments in a child’s account. But you’re saying this can backfire when it comes to financial aid. What about, a question I often get, I know that 529 plans do offer tax advantages, which maybe you can discuss. But I often hear from people who worry that if they put that money in a 529 plan, that will hurt their child’s chances for financial aid. Can you talk about that a little bit?

Kalman Chany: Sure. That’s a big mistake that people have. Certainly, in the book we are saying people should be saving for college. The key though is putting the money into buckets that don’t get assessed that heavily. So, whether you have money in a 529 plan that you own as a parent for the benefit of your child, and that’s the way it should be set up, generally, or you have the money in a bank account in our own name, it’s going to get assessed the same way. There are tax advantages of putting money into the 529 plans. Those are the qualified state tuition programs, where the funds grow tax deferred. If you use the funds then to pay for qualified higher education expenses, tuition and fees, room and board, if you use the money for that, then you never pay tax on any of the increase in the value of those plans.

In some states, for example, my home state of New York, if you put money into a 529 plan, married, filing jointly, up to $10,000 of that contribution for the year is deductible on your state and local tax return. Other states might match some of the funds. So, you want to always first look at what plan is in your own state, but you should not view this assumption that if I just spend every nickel and don’t have anything and don’t set any money aside, I’m going to be hurt in the aid process, because some of the aid is going to be loans.

The school may not meet your need in full. In other words, you might demonstrate eligibility, but the school might not meet it. So, having funds in a 529 plan is great. The big mistake though people make, when they fill out the forms, is they think, "That’s my child’s asset." They don’t realize they’re looking at who owns the plan. Generally thinking you want to have that as the parent, you as the parent own the plan for the benefit of the child and therefore then it’s to be listed on the aid form as a parent asset. It would be a mistake to list as a student asset.

David Muhlbaum: Right. So, even if the parent correctly sets this up as they being the owner and the child is the beneficiary, which I think is pretty much how everyone does it, it seems odd that you’d make that mistake of putting in the child’s name. When it comes time to actually filling out the aid form, they don’t allocate it correctly. They assign it to the child rather than themselves.

Kalman Chany: Right. Right. They don’t correctly list that. That’s one of the problems with the aid forms and the process is that they will catch things you do that result in you getting too much aid, the audit process. But they don’t correct things and ask you and tap you on the shoulder and say, "Oh, you listed this wrong. You didn’t classify this properly. You misclassified it." So, it’s very important that you don’t view the process of paying for college and going through the aid process as — you get a participation award. There are no participation awards just for filling out the form. But that’s how it’s branded. That’s how the process is branded.

To understand the high school is under pressure, if you’re in a public high school, from their administrators ,to get kids just to fill out the forms as soon as possible and get them in, because the high school is getting monitored by the federal government for how many kids in that high school fill out the form. Now, if a school district has 100% of the kids fill out the FAFSA form, but nobody gets any money, that’s a successful process for that school district. But for your case, it’s not very successful. So, you have to realize how the game is to be played and that a lot of the information is biased in favor of other people’s agendas, not yours.

David Muhlbaum: You brought up, you mentioned the word audit in there and I’m going to hang on that, because it actually is a way to reveal the parallels or this idea that we broached of the parallel tax system. You have the one, you have the sort of federal and state system by which a portion of your income is sent to pay for the government, basically. Then there is this other parallel system where your income and assets are analyzed for how much aid you can receive, the college aid process. If I understand correctly -- well, what I do know about the federal system is your chances of getting audited are way low. What I understand from the aid system is that your chances of getting audited are way high. I was hoping you could talk a little bit more about that and how people can understand it and in part not be alarmed by it.

Kalman Chany: In terms of the financial aid process, they don’t use the term audit. They use a term called verification. There’s federal verification. There’s also institutional verification. The federal process, though, with the FAFSA, 35% of the applications are selected for verification. It tends to be people who are eligible for federal grants, such as the Pell Grant, are more likely to be selected. But there are some strategies you can use to minimize the chances you’re going to get selected for verification. That would be in part doing the form online at fafsa.gov. And the new form for ‘23, ‘24 year aid will be coming out October 1st.

David Muhlbaum: Now, Kal, you mentioned the detail that’s in your book about this kind of process, but even so, I want to give it another plug and I’m going to wave it around here and say that when you’re sitting there going through the process, big chunks of this book are like having Kal over your shoulder going, "Yeah, do that. No, don’t do that." With remarkable precision about the process. That is a reassurance and a case in which I can just say, "Look, it’s in the book."

Kalman Chany: People compare me to a Marine drill sergeant.

Sandy Block: But that’s what you need.

David Muhlbaum: I envisioned three groups of people that we’re speaking to here today. We’ve kind of covered one of them, which is, in brief, we’ve covered saving for college. Really, the short answer there is: 529 plan. Then, we’re talking about what tax advantages are available to people who are paying for college. Basically whatever savings they’ve done, they’ve done. They’re on the hook, the kid’s at school-

Sandy Block: Right. Paying the bills.

David Muhlbaum: ... they’re paying the bills. The need has been sorted out. What does the federal tax code have to help?

Kalman Chany: Okay. The federal tax code has a variety of tax credits and other tax benefits that families can use or students can use if they’re independent, they’re an older student going to college, which is a growing demographic, to help pay for college. That’s also considered even financial aid. The biggest ones are the tax credits, specifically the American Opportunity Credit. That allows families, married filing jointly income of $160,000, up to that point, you can get the maximum credit. It phases out at $180,000. For a single or head of household, it’s going to start phasing out at $80,000 adjusted gross income. And totally phase out at $90,000 adjusted gross income.

This is very valuable because it’s a credit, which is much more valuable than a deduction, because a credit will save you on your taxes, dollar for dollar, by the amount of the credit you get, you can get up to $2,500 in a credit. If you have tax liability, you can get up to that, because up to $1,500 is to offset your tax liability. But even if you have no tax liability, you’re low income, but you have qualifying expenses, you can get up to $1,000 as a refundable credit, even if you have no tax liability. That’s very attractive to get.

Now, some people are of course saying, "Oh, those income levels are low. I’m not going to qualify. I have very high income. I’m making $500,000, $600,000." Well, at a certain point in the federal tax code, claiming the child is a dependent on your tax return gets you no benefit. In the past, it’s been $400,000. I don’t know going forward, that’s something you want to check and see about that. Because if there is no benefit to claiming your child on the tax return, don’t claim them.

The child can’t claim themselves. But then that child themselves could file a return, even if they have no income. In many cases, they can get $that 1,000 refundable credit. So, the parent isn’t getting any tax break. Even if they are, they’re getting only $500 for putting the child on there. They could get $1,000 with the credit. So, you have to balance your tax planning, overall, what your accountant’s telling you sometimes with this aid planning and point that out to the accountant, "I had a child." Now, the big mistake with those credits, though, is schools send out these forms called 1098-Ts. Don’t use them. Even the IRS guidance in Publication 970 says they may be wrong for indicating how much you’re paying toward college.

Because a big mistake many colleges do is they put down what you paid for the full term. For example, your child’s a first-year student, what you had in tuition expense, but they put down the whole year’s aid. So, it looks like you got more aid than what the tuition was for the full term. So, your accountant sees that and says, "Well, you didn’t pay anything. You don’t get the credit."

David Muhlbaum: Oh, Lord.

Kalman Chany: But even if you’re fortunate enough to be in a situation where, for that term, you had more grant money than you had tuition expense, all is still not lost, because as the IRS points out, you could claim some of that scholarship as taxable income on your child’s tax return, who gets over $12,000 as a standard deduction. So, may not pay any tax on that by reporting it. But then that means you have qualified expenses you can use for the tax credit. Again, this is rather complicated. That IRS Publication 970 goes over all the benefits, that’s freely available at irs.gov, that’s dozens of pages long. So, in our chapter called "Less Taxing Matters," we just say, "This is not a tax guide. There’s more detailed information, but these are some things you can get." So, there are certain tactics, strategies you can use, but you have to be aware of them and understand the fine print. And it’s a somewhat counterintuitive process.

Sandy Block: Well, and Kal, can you just talk briefly about the Lifetime Learning Credit, which I think has more value for graduate students?

Kalman Chany: Okay. The Lifetime Learning Credit, that’s another type of tax credit. Now, there has been a recent change with that. So that now the income limits that I discussed earlier for the American Opportunity Credit are the same income limits to qualify for the lifetime learning credit-

Sandy Block: Which are higher than they used to be. Right?

Kalman Chany: Yes.

Sandy Block: Yeah. That’s good.

Kalman Chany: Yes. Significantly more. They used to be like $110, $120 .... But now it’s, again, $160 married filing jointly up to $180,000 and then it phases out at $180,000, the AGI. $80,000 single or head of household. Married, filing separately, you’re not eligible for those tax credits. That’s something to be aware of, if you’re filing married, filing separate returns, you’re not going to be able to get those tax credits. But the Lifetime Learning Credit, that’s a 20% credit up to the first $10,000 of tuition that paid. But with the lifetime learning credit compared to the American Opportunity Credit, it’s a non-refundable credit. It can only be used against your tax liability. So, unlike the American Opportunity Credit, where I said you can get up to $1,000 if you have no tax liability, the American Opportunity Credit can only be used to offset tax liability that you have.

That doesn’t mean your refund or what you owe Uncle Sam on April 15th. But that means after you deduct your standard deduction from your adjusted gross income and take other deductions, if it says on the tax tables or the tax charts that you have a certain amount of taxes that need to be assessed on your income -- you may not pay them, because you may have over-withheld, but if you have tax liability, then you can claim up to $2,000. But that also is a per filer credit. In other words, if you have multiple children in college with the American Opportunity Credit, you can use that, if you have three in college and you haven’t filed for bankruptcy yet, you could use that to offset your tax liability or even get that $1,000 refundable credit per child. The Lifetime Learning Credit, whether you have one in college, two, three, four in college, doesn’t matter, it’s only up to $2,000 per tax filer.

Sandy Block: Right. But just to make clear, Kal, isn’t the point here that the American Opportunity Credit is only available for the first four years of full-time college. Whereas the Lifetime Learning Credit, you can claim late. Isn’t that the big difference between those two? I just want to make that distinction.

Kalman Chany: Right. The American Opportunity Credit is for undergraduates, but it’s important to even realize there that the four years of college are going to overlap five tax years if you start in the fall. So, it’s possible to get four years of the American Opportunity Credit and then do the lifetime learning credit. Now, you might blow that, and that’s because some schools may want tuition paid for that last semester before you burn the bill and you’re done with them. They might say, "We want that money in December." That’s a problem because you got to pay the money in the tax year to claim the credit. A way around that then is, even if you didn’t use it before, is to go on a payment plan if it’s available, so that you’re paying some money after you sing "Auld Lang Syne" for the final semester, when your child’s in college, and then you could possibly get that lifetime learning credit for that fifth tax year.

David Muhlbaum: Right. Yeah. The incremental cost you’d pay for an installment plan would be lower than the possible upside of claiming the credit. Now, I have an in-the-weeds question about both of these credits. Both of these credit programs, the money available to you cannot exceed what you actually paid out of pocket for education?Now, that seems improbable, because $2,000 or $2,500 is not a lot of money compared to the cost of education. But in theory, you could have someone with a absolutely total full ride, who then could say, "Yeah, I’m in college. I’d like my $2,500?"

Kalman Chany: Okay. So, the way that credit works for the American Opportunity Credit, it’s 100% for the first $2,000 in qualified expenses. Those-

David Muhlbaum: Qualified expenses, bingo.

Kalman Chany: ... expenses are different than the qualified expenses to use the 529. The 529 can be room and board as well as tuition and fees. The American Opportunity Credit that is just tuition and fees, mandatory fees. That’s an important distinction there and that’s why you need to understand the fine print. However, as I mentioned a bit earlier, the wiggle around that is if you’re getting fully funded with the grant money, if you use loans, even if the child takes out a student loan, that counts as tuition paid, and a parent, if they claim the child in the return, they could claim that credit. Even if the child’s taking out a loan, if grandma pays money to the college, which there’s a no-no oftentimes doing that, but it doesn’t have to be that you as the taxpayer paid that, but they don’t let you get two tax benefits.

The problem with the grants and scholarships is normally those that they’re used for tuition are not subject to federal income taxes, they’re tax free. But the workaround around that, again, is if you’re in that fortunate position to get so much grant money, is to then claim on the student’s return some of that scholarship, enough of it, to get the tax credit. Because, again, the student gets a bit over $12,000 in a standard deduction. Let’s say they had only $3,000 in another income for the year. Well, they could claim $4,000 of that grant and scholarship they got, add that onto their tax return, their adjusted gross income, $7,000, it’s below the $12,000 plus standard deduction they get, they’re not going to pay any taxes. But by doing that, and the IRS even tells you this in the Publication 970, by doing that, then you could set yourself up to get that $2,500 credit even if the amount of scholarships you got exceeded the amount of the tuition fees that were billed.

So, you really need to understand all these little nuances. They don’t make it easy to get these benefits. The politicians love to say, "Yes, we’re doing this. We’re doing that." But you really need to understand the fine print. And then that these alternate strategies you can use, because most people would say, "I don’t want to put that on my child’s tax return." Now, people are probably wondering, "Well, that’s going to raise my child’s income. That’s going to harm me for aid." That’s not true, because any taxable aid that you report on your tax return, you get to deduct as a Title 4 exclusion on the aid forms. So, it’s backed out that extra money you report on the child’s tax return for what you’re doing to get the tax break for you as a parent, that money is backed out against the student’s income.

So, they would say, in that example, $3,000 from work, $4,000 taxable scholarship, students income for aid purposes still only $3,000. Because they’re going to take the seven, subtract the four, because you report on the return you have that. Again, you really need to know the details doing this. If you just go through it and figure out, "Well, I’ll hope for the best," and have this, you’re going to pay a lot more money in college than you have to. That’s the whole premise of the book is to raise people’s consciousness of all these different options that are available. In part, also, that you have to balance your tax planning with your aid planning, to pay the least amount of money for college.

(Editor's note: Funds withdrawn from 529 plans to pay qualified tuition and fees do not count as qualified tuition and fees paid when determining eligibility for

those education tax credits. See bottom of transcript for more detail on this important exclusion.)

Sandy Block: So, Kal, the last question we have for you, federal student loans have been on pause for a couple of years now and there’s a lot of talk about some forgiveness, but we know that a lot of graduates have a large amount of student loans. A lot of them are really struggling to pay them back. Some are getting help from their parents. Could you talk a little bit about the tax break that is available for student loan borrowers?

Kalman Chany: Okay. Yes. I can talk about that. But it’s not just the students who borrowed. In some cases, if the parents borrowed and they can demonstrate that that debt they incurred was to pay for these qualified higher education expenses, they themselves, if they’re being charged interest while the student is in school, they may be able to qualify for this tax break, and they have different income limits for that. Again, that’s in Publication 970, but basically up to a certain amount of the interest that’s been paid is going to be deductible.

David Muhlbaum: Have we said what the maximum is available?

Kalman Chany: The maximum-

Sandy Block: The deduction is $2,500, isn’t it? Yeah.

David Muhlbaum: Yes. Right. I wanted to get that number out there.

Sandy Block: The other point I wanted to make, and this is relevant for the students is I believe, Kal, this is you don’t have to itemize to claim this deduction, which-

David Muhlbaum: Oh yeah, it’s above the line. Above the line.

Kalman Chany: Right. Right. Yes.

David Muhlbaum: Yeah.

Kalman Chany: It goes generally on Schedule 1 in the adjustments to income section.

Sandy Block: So, Kal, I believe this deduction is worth $2,500 in interest and students and/or parents can claim this even if they don’t itemize on their tax returns. Is that correct?

Kalman Chany: Yes, that’s correct that they can do that. They claim, it’s somewhere else on the return. It’s not an itemized deduction that you’re able to claim. But the important thing to understand about that, students and parents, that interest, the tax filer has to have paid that interest. In other words, a parent can’t claim the student’s loan interest that the loan their child took out on their return, nor can the student on their own return claim the interest the parent paid on an educational loan they took out. It’s that the tax filer, the person filing the return, had to have paid that interest on their own loan obligation that they had, not somebody else’s loan.

Sandy Block: Well, wait a minute, let me clarify that, Kal. Say I’m a student and my parents are paying my loan. They can’t claim the deduction because I’m liable for it. But can’t I claim the deduction even if I got money from my parents to pay it?

Kalman Chany: It’s the interest that’s paid. You have to read the fine print, all of there. But the key thing there is, if the parents borrow the money, they can get that deduction on their tax return if they meet the income limits. If the student borrowed the money, even... That’s the only person who can claim that if they qualify for it on their returns.

Sandy Block: It’s the person who’s liable for paying that loan, who’s eligible.

Kalman Chany: Loan. Yes. They’re going to get a statement at the end of the tax year saying how much interest was paid to use for the purpose of that. Of course, the IRS is then going to compare those forms that people are issued with what’s claimed on the return.

Sandy Block: Right.

David Muhlbaum: But the loophole, if this is the right word, is that, let’s say the parents are giving money to the child whose name is on the loan to pay it off. The child can still claim it.

Kalman Chany: Right. The child, I believe that to be correct. But again, they should always ask their tax advisor when they’re doing things, I’m going to give the standard disclaimer, even said in the book, "We’re not in the business of giving tax advice." They should consult their tax advisor or review Publication 970, which has pages and pages about all these different breaks to be aware of. One thing though, with the loans though, and the tax break, the big tax break though is, if you are eligible, for example, for Public Service Loan Forgiveness program, and that’s a key thing to realize, because they’ve changed the rules for that and there’s a waiver now that’s going to expire on October 31st. That people who previously were denied this, can file documents with the government before trick or treat day and possibly get credit for payments they made that previously were not going to be considered.

Now, the strategy is counterintuitive with Public Service Loan Forgiveness, which is you want to pay the least amount of money on your loans during that period of the 120 qualifying payment period to get it, and extend out the repayment, because then you could possibly get more of a loan forgiven. That’s a huge tax break because when that is forgiven, normally when debt is forgiven, it’s taxable income. But Public Service Loan Forgiveness program, that’s if you work for the government, if you work for qualifying nonprofit, full time, even during the COVID pauses, you didn’t pay anything. That’s counting as qualified periods. If you have these loans, you really want to look into that and see, because you have to file things. If you have loans, old loans, that were not direct loans, but were with lenders that were federal loans, you can consolidate them, get them consolidated and then they will count all those periods back for you.

Sandy Block: So, I think this is an important-

Kalman Chany: And in some cases you can even get a refund if you had more than 120 payments. So, you really want to focus on this, because this is a once in a lifetime opportunity, but the window of opportunity is going to close soon. So, if you worked for not-for-profit and you were paying off loans simultaneously while you were working there, even if you were dinged before, there’s a workaround to get that. You can look at that Public Service Loan Forgiveness and get that document in before October 31st, the application for the qualified employers that you worked for, and if necessary consolidating the loan sooner, rather than later, to get those payments, that before wouldn’t be considered now part of the 120 qualified payment periods.

Sandy Block: To your point, Kal, because this is important and I didn’t realize this. So, you’re saying that the amount of loan that is forgiven because you qualify will not be taxable, because usually forgiven debt is treated as taxable income, but you’re saying you will not be taxed on the amount that’s forgiven.

Kalman Chany: For the Public Service Loan Forgiveness program.

Sandy Block: Yeah.

David Muhlbaum: Since we’ve roamed into the question of loan forgiveness, which is a good topic and is potentially going to affect a lot of people, this concept of a broader forgiveness, the $10,000, something like that, that has been discussed. Again, this isn’t even at the fine print state, this is at the, "Mm, I had an idea that may or may not happen." But do we know if that forgiveness would be taxable?

Kalman Chany: Generally speaking, they’ve said under that tax law that’s going to expire in 2025, that’s due to loan forgiveness will be tax free if it occurs before you sing Auld Lang Syne on New Year’s Eve of 2025, unless they agree they’re going to grandfather that provision in the new legislation, because it’s going to sunset.

David Muhlbaum: Got it.

Kalman Chany: So, we don’t know if that happens. There’s a lot of debate about that. The higher education industry is not in favor of the forgiveness. There may be a different workaround though that some people have tossed around and that is, they will recalculate the interest and lower the interest rate on these federal loans. They will then give credits toward pay off. Or if you paid it all off, give you a refund back. So, they haven’t yet decided about that what they’re going to do nor have they decided-

David Muhlbaum: Tax-free refund?

Kalman Chany: Possibly. Yeah. Because it would be return of the interest. They might say, if you claim the interest at the deduction, then you’re not going to get it. But that’s going to be so hard for the IRS to enforce that may not happen. But again, until it passes or there’s executive action, don’t count your chickens before they hatch. But you want to be aware of that with certain things, though, for example, I’m telling some of my clients now, "Well, I don’t want my child to have a loan." I said, "Well, maybe you should have your child take out that loan. Maybe then it’s going to get forgiven. They’re just going off to college for the first year. Maybe that’ll get forgiven."

Because if you get these loans, you actually have up to 120 days to return the funds and you’re not charged any origination fees and there’s no interest. The same with the Parent PLUS Loans. Those might be forgiven or get some benefit there. I’m thinking they may go more with that interest deduction, because it makes sense.

Sandy Block: It’s more palatable, yeah.

Kalman Chany: If they forgive these loans, a lot of people are saying, "I lost to gene lottery. I paid off all my loans. I did this. Why are these people getting a benefit? I’m not."

Sandy Block: And all those people have written to us, yes.

Kalman Chany: And a lot of people, too, the colleges are going, "Look, if they give this to kids, they’ll keep thinking we can just borrow recklessly because eventually it’s going to get forgiven again in the future." So, I don’t-

David Muhlbaum: The old moral hazard.

Sandy Block: The moral hazard. Yeah.

Kalman Chany: Right. So, I don’t know if it’s the polls show that’s popular. But I think a lot of people who paid off these loans or maybe didn’t take out loans and did that, or they struggled to pay off their loans and were eating noodle soup every night or mac and cheese in a box, because they didn’t have much money for food because they were paying off their loans. Those people, I don’t think are going to be very happy to find out that, based on timing, "Someone else had their loan forgiven, but I had to pay." So, I think if they do that, that might be viewed more as fair to help people, because there happen to tax, for example, Senator Warren’s been saying, "The government is charging this money, the interest on all these loans, making this." But part of that had to be done, because to make the Affordable Care Act work, which is actually the Affordable Care and Education Loan Reform Act work. In the first 10 years, they had to get $50 billion out of student aid.

Graduate students, they got rid of interest-free loans while graduate students were in school. They got rid of the private lenders participating in the federal loan programs and all went with direct loans. The private lenders used to then have incentives to get the interest rates down. They’re not there as much as they were before. Like you paid off on time, you could get a reduction of up to 2% off your interest rate. But they don’t have that anymore. So, there’s a large amount of money the government is making on the interest they’re charging on these loans, of course, there’s defaults, too. That has to offset the cost of that. That’s why there are these fees and the interest. But that seems to be a maybe more fair way of doing this, so that people who paid off the loans before won’t be screaming like crazy like, "They gave this here and now I’m paying my taxes so that these kids can get their loans forgiven. What about me?" That may not be so popular come the midterms.

David Muhlbaum: Well, I now think I know who our guest is when we next get to talk about the prospect of-

Sandy Block: Loan forgiveness.

David Muhlbaum: ... student loan forgiveness and, Kal, I had seen from other content, you self-describe yourself as a policy wonk. So, I had that expectation coming in, but still, my mind is blown. But thank you very much for joining us and providing us so much interesting detail. I am not only going to put a link into Publication 970, but of course also to how to get yourself a copy of Paying for College, the 2023 edition, which is coming out September 20th?

Kalman Chany: Right.

David Muhlbaum: So, hang in there.

Kalman Chany: Paying for College, the 2023 edition. That’s what if you don’t have it, you can get it to book sellers or online book sellers. You want to get the 2023 edition.

David Muhlbaum: Right. Which will continue to be updated. So, yeah.

Kalman Chany: For some years, the old edition, they’ve run out of inventory and people have been selling it on the resale market for $1,000, $1,500 a copy for the old edition thinking that there’s not a new one. So, you want to get the updated edition. You can order it now and you’ll get that.

David Muhlbaum: You need to institute dynamic pricing. Well, thank you again for joining us, Kal.

Sandy Block: Thanks, Kal.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. If you’ve already subscribed, thanks, please go back and add a rating or review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. If you’re still here, because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

More on eligibility for American Opportunity, Lifetime Learning Credit

Kalman Chany followed up the recording of this podcast with more detail on claiming certain credits. Where the the money you used to pay for college came from matters, Here is his note:

When we discussed the federal education tax credits (the American Opportunity Credit and the Lifetime Learning Credit), I did not include a statement that funds withdrawn from 529 plans to pay qualified tuition and fees do not count as qualified tuition and fees paid when determining eligibility for those education tax credits. This is because under the IRS tax code one cannot get two federal education tax breaks with the same dollars. So one cannot get: 1) the federal education tax credit and 2) the tax-free treatment of distributions from 529 plans used to pay qualified expenses with the same funds.

In order to qualify for federal education tax credits, one must therefore use funds that have no other tax-advantage to pay the tuition and fees (i.e. one must use regular cash, funds from a checking or savings account, credit card transaction or loan proceeds - and so none of those funds used can be coming directly or indirectly from a 529 plan or Coverall ESA distribution, unless one elects to consider such a distribution as a non-qualifed distribution in which case there would be penalties and a higher tax liability.

This inability to get the two federal tax benefits with the same dollars is the reason why I stated that if one gets all their tuition and fees paid with grants and scholarships (i.e. gift aid) , they would want to weigh the benefits of claiming some of the grants or scholarships as taxable income reported on the student's tax return - especially if there is no tax owed after the standard deduction is claimed. (Such gift aid used to pay tuition and fees as well as required books /supplies has the tax benefit of generally not being required to be reported on a U.S tax return as taxable income as part of the response for Line 1 of the IRS Form 1040 - though the tax filer can opt to report some or all of the gift aid as part of their gross income on the tax return so that that can have qualified tuition and fees payments for the education tax credits.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Kiplinger’s Economic Outlooks: Inflation
• Fight Inflation with Series I Bonds
• TreasuryDirect: Buying Series I Savings Bonds
• Cars.com: Buckle Up With Jenni Newman, our Editor-in-Chief
• Electric Vehicles Take Charge in 2022
• Cars.com: Your Guide to EV Batteries

Transcript:

David Muhlbaum: Cars are expensive these days. In fact, they’ve been on the leading edge of the inflation surge that’s paining the U.S. economy. Maybe you’re trying to wait it out, hoping that prices will eventually fall, but maybe you don’t have a choice and need a car now. Jenni Newman of Cars.com joins us to talk about what you could expect to pay and how the way we buy cars is changing. Also, we’ll come back to the suddenly sexy US savings bond, all coming up on this episode of Your Money’s Worth.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com senior online editor David Muhlbaum, joined by my co-host, senior editor, Sandy Block. How are you doing Sandy?

Sandy Block: I’m doing great.

David Muhlbaum: Good. A few episodes back here, we were discussing Series I savings bonds — again — and I made a vague promise to actually buy one. And I am proud to report that I have done so. I just checked the account and I now have an investment backed by the full faith of the US government and it pays a 9.62% coupon. Well, for now it does.

Sandy Block: Yeah. That ‘for now’ is one of the catches and I’m sure you’re aware of that.

David Muhlbaum: Yes, I do. But actually, I do want you to enumerate all the other catches to my very smart purchase. We’ll get to those, but that 9.62% interest rate, that’s pretty insane. You’re not going to get that anywhere else these days, no matter how hard Jerome Powell and his friends yank on the brakes with rate hikes.

Sandy Block: No, that’s right. In fact, I was reading an article today sort-of celebrating the fact that some banks are now paying more than 1% interest on savings accounts. There’s nothing even remotely close to that unless you’re going out and taking a huge amount of risk. It’s just really unprecedented. And I’ve written about savings bonds for a long, long time.

David Muhlbaum: When they were boring.

Sandy Block: When they were very boring. That’s right. I just don’t think the government, when they created I bonds, ever anticipated that it would be paying out 9% interest.

David Muhlbaum: Yeah. Well that does raise some questions about the long-term viability of this, that I’d like to get to. But in the meantime, I thought, well, to pat myself on the back, I was doing a little bit of service journalism there because I know the website at TreasuryDirect has been crashed because of the interest in the I bonds. Apparently, it’s extremely hard to get anyone on the phone to talk about it. So I thought I would put my money where my mouth is and well, a little bit of it, and go through the process of buying one. And so the report is, it was a little nerve wracking, but I wouldn’t describe it as out of the ordinary for A) a government site and B) moving money. You’re expecting to have a higher degree of standards and using a good password and being sent to some secondary form of checking. I did note though, that it all seems it’s going to turn on your Social Security number. And I think, Sandy, you said that that could cause problems, at least, it had for you.

Sandy Block: Well yeah. And just to back up a little bit, I think where we’re hearing problems is if you have a problem, there is no one... Where people are running into problems is, they put in the wrong bank account or have a question or something, and there’s no one there to answer their questions. What I discovered, I’ve had a TreasuryDirect account for years, which I haven’t used. And when I went on to look and see if I could find my account number, I realized in order to get my account number, I have to put in a whole bunch of information, including the name of the bank that I had when I set up the TreasuryDirect account over 10 years ago and I don’t have that bank account anymore. And there doesn’t seem to be any way to fix that problem.

Sandy Block: And that’s the kind of thing that people are running into. If they want to change banks, maybe they put in a wrong account number or something like that, there really is no one there. And in fact, if you go onto TreasuryDirect right now, there’s a little box mentioning the high volume of activity and reminding people that they have until October to buy an I bond at this rate, so it’s almost like they’re telling people, please, please come back because we are really, really busy now.

David Muhlbaum: Now, okay, that’s an interesting point that you bring up the date. They have until October to buy the I bond at this rate. Let’s get into the nitty gritty about how the I bond works because there is a rate reset every six months. A portion of the interest rate gets reset, and that’s why it’s so stinking high right now.

Sandy Block: Right. Right. And I think if you somehow don’t buy one by October, I think given what we know about the inflation rate and where things are going, I think that the next six months, they’re probably going to be pretty generous too. But here’s the catch, I bonds consists of two components, a fixed rate that you get for the life of the bond and an inflation rate is set every six months. Right now, the fixed rate is zero. So if you buy an I bond now and inflation goes away, they won’t pay a negative rate, but you could end up with a very, very low rate I bond closer to a savings account. Now, at these rates, I think that’s a risk worth taking. You have to hold an I bond for at least a year. You’re required to hold it for at least a year, so this isn’t something you want to buy if you need the money soon. And if you cash it out in five years, you give up the past three months of interest. At this rate, that’s not that bad. You’d still come out ahead if you cash it out in five years, but you need to know these things about the liquidity of these bonds and the other-

David Muhlbaum: The term, too. The term is like 30 years or something.

Sandy Block: Yeah. The term, sure .. but you’re required to hold it for five years. You can redeem it after that. The other thing, and we’ve had a interesting conversation within our investing team about a limitation of the I bond is how much you can invest. The maximum you can put in an I bond is $10,000. That’s the electronic limit. If you happen to get a nice tax refund, you can use an additional $5,000 to buy a paper I bond, but that’s it. So this is-

David Muhlbaum: Yeah. Now that’s getting so arcane because you have to then cook your withholdings to get a refund so you can buy a paper bond. I’m like, oh my god, this is truly some sort of Washingtonian hell.

Sandy Block: Well, I think that was slipped into some bill to encourage people to save or something like that. But the $10,000 cutoff means that you’re not going to put your entire retirement savings in an I bond. For an emergency fund that you might need in a couple of years or something that you just want to put some money away, maybe as a down payment on a house you’re going to buy, well, $10,000 won’t get you very far, but part of a down payment or a car that you’re going to buy in a few years, I think a savings bond, an I bond, is a perfectly good use for that money. But it’s not as liquid as a savings account, and it’s not as generous as say a 401(k) or an IRA where you can put a lot more money in.

David Muhlbaum: Well, in terms of how much you can invest in.

Sandy Block: In terms of the amount that you can invest.

David Muhlbaum: But in terms of what it’s paying right now...

Sandy Block: In terms of what it’s paying right now, there is nothing out there.

David Muhlbaum: And I think, if my understanding is correct, part of the reason for those limits, the $10,000 and maybe $15,000 limit is in part because of this sort of fundamental generosity or potential generosity of the program. And it got me to thinking that the limit is not higher than that because if everybody started throwing big money at this, it would become, or it would become even more of potentially a federal subsidy. As you said, the people who created the I bond did not expect to be paying a 9.62% coupon. And there are real questions. How long can this last? By last, I don’t mean interest rates. How long will this program last?

Sandy Block: Well, and that’s a good question, Dave, because it’s been a few years, but I used to write a lot about savings bonds. And my understanding is even when interest rates were very low, the cost of administering this program exceeds the amount that the government takes in. The green-eyeshade folks at the government have wanted to get rid of savings bonds for years. It does not make money for the US government, but people love savings bonds.

David Muhlbaum: Yeah, I think Franklin Roosevelt bought the first one, right?

Sandy Block: Yes, people have this, the war bonds. People have this very emotional-

David Muhlbaum: Sentimental attachment.

Sandy Block: ... connection. They like to give them to their kids or their grandkids. So I don’t think savings bonds are going anywhere, but the $10,000 cutoff and eliminating paper bonds a few years ago were all steps in the direction of discouraging people from buying savings bonds. Because the government really, apparently, it is just a hassle to administer. You think about where the government does most of its borrowing. It’s with huge banks and financial services firms that take out enormous amounts of government debt. We’re talking, these are small amounts and lots and lots of people. And I think deep down, Treasury would really not like to deal with that, but they’re dealing with it now in a very big way.

David Muhlbaum: Yeah. In terms of those amounts, I tried poking around at the numbers here and I didn’t get to the specificity that I was hoping for, but I do know that like in 2020, the number of these I bonds being sold was in the millions, in the millions of dollars of I bonds being sold.

Sandy Block: Yeah.

David Muhlbaum: Now, it’s in the billions.

Sandy Block: Oh, I’m sure it is.

David Muhlbaum: And now, I know that that is just a drop in the bucket, in the complete realm of federal borrowing, but as a percentage change in this one program, it’s certainly proved to be popular.

Sandy Block: Yes it has. And will continue, I think, as long as inflation remains elevated.

David Muhlbaum: Yes. And that is our forecast as well. And I will pop in a link to our inflation forecast so you can read it and weep, or at least be informed. And also, I’ll put in some information about how to actually buy an I bond if you want to follow my path and go get your 9.62% – for now – coupon. Coming up next, we are going to talk about car buying in this overpriced market with Jenni Newman, the executive editor of Cars.com. Stick around

Car-Buying in an Inflated Market with Jenni Newman

David Muhlbaum: Welcome back to Your Money’s Worth. For this segment. I’ll be joined by the editor of Kiplinger’s Personal Finance magazine himself, Mark Solheim. A voice you’ve heard on the podcast before when the topic is cars. And that indeed is what we’re going to cover today. How to buy a car for a reasonable price as we enter the third year of a rather different and difficult market. Joining us to sort that out and talk about four wheels in general is Jenni Newman, editor in chief of the web site Cars.com. Welcome Jenni.

Jenni Newman: Hi, thanks for having me.

David Muhlbaum: Part of the beauty of Cars.com is that domain name. Whoever it was, 25 years or so ago, who thought to grab that domain was a genius because it’s so self-explanatory. I just had to say, you’re the editor of Cars.com and people know, okay, you know cars. But I would like you to take a moment to explain to people what Cars.com is and how you fit in because like some other automotive websites we’ve mentioned at Kiplinger or used as resources, you guys could be multiple things to different constituencies, dealers, consumers, journalists, podcast hosts.

Jenni Newman: Yes. Whoever picked out Cars.com did indeed choose wisely. So Cars.com is the leading automotive marketplace. What that means is we connect car shoppers with car dealers. And what I really, of course here’s my own bias, like to talk about is the editorial content that is available on cars.com. We have a seasoned editorial team, independent journalists that provide news coverage, reviews of vehicles, of course, as well as videos. And we’re basically here to help car shoppers do the homework. We know that buying a car is quite a journey and we want to help them find the car that’s best for them. That’s our goal.

Mark Solheim: So Jenni, I spent a little bit of time in the car journalist game, I guess. Reviewed cars for Kiplinger 15, 20 years ago. And I know from back then that this is a very testosterone-heavy industry. You talk about car guys and I suppose you talk about car girls, but I know there weren’t that many women around. So I’m curious how you broke into this industry. I also noticed from your bio that you’re very modest about your credentials and you do play up your role as a mom and as a car-seat tester. So I’m just curious how all that evolved before we get into some sound consumer advice here.

Jenni Newman: Sure. I started at Cars.com almost 14 years ago as a copy editor. And before that, I was in newspapers. So that’s another male-dominated industry. What I found at cars was a mission to help consumers. I think it was an early version of service journalism, to be honest with you. And it really spoke to me. I’ve always had a love of cars. I would not call myself a gearhead at all, but I find it fascinating. It’s always changing. And so I’m always just interested and always learning. And that’s what keeps me engaged. As far as our approach, we really do just want to help the shoppers and yes, I’m a mom of two boys.

David Muhlbaum: Cool. Hopefully we’re done with the grilling, such as it is. Let’s talk cars writ large, not cars.com. Now we at Kiplinger, we also have a mission statement of sorts. It’s right there in the name, at least the magazine Kiplinger’s Personal Finance. And the personal finance part means that at least when it comes to cars, we are more about the cost question, acquisition, financing, maintenance, insurance, that sort of thing than shall we say the experience? 0 to 60, miles per gallon, how many cup holders, how much range?

David Muhlbaum: So, two years ago or so, we thought we had a decent sense of how to buy a car and we tried to share that with our readers; shopping tips, how to negotiate, financing guidelines. Yeah. It sounds like what Cars.com does. But all of that has been deeply challenged during the pandemic. Or maybe I should say during the chip shortage? It’s hard to pry the two apart, but they both seem to be sticking with us. So big question, are we ever going to get back to a more normal car market where a new car isn’t something that a consumer has to scour the country for and possibly pay this hated additional dealer markup for?

Jenni Newman: Good question. Car shopping has definitely evolved during the pandemic. We saw a lot of dealers on Cars.com quickly pivot from a traditional car buying selling experience to a more online experience. And that was a really quick move that they had to make during those early months of the pandemic. That really ushered in more comfortability for shoppers, with online searching and even the online buying process. Seeing that translate from, “Oh, I’m going to buy something on Amazon” to, “Oh my gosh, I’m going to order a car online”. We’re seeing shoppers easily flow between these small purchases and massive purchases now these days.

Now, as far as getting back to normal, I don’t have a crystal ball. I don’t know anybody who does, but what I will tell you is I’m not sure we’re ever going to fully get back to normal. There has been so much evolution in the way that car shoppers are working these days, the way that dealers are working these days, that I think that we’re starting to see the path forward come together. Shoppers have become more comfortable with ordering vehicles when they can’t find what they’re looking for. We know that for instance, Volvo is pivoting to selling their EVs online only. And they’re going to be selling EVs only by 2030. So we’re already seeing some automakers shifting.

Of course, we know that Tesla is also an online buying opportunity. And then when it comes to more of the dealership side of things, what we’re seeing is of course, right now, when you drive by a dealership, there are fewer cars on the lot. There’s a lot of wasted real estate. And so I wouldn’t be surprised to see automakers and dealerships rethink the way that they use that real estate, whether it’s the building or whether it’s their lots, and perhaps scale back because they simply don’t have as many cars sitting around. So I think we’ll be onto a new normal as they say. I don’t think we’ll ever quite go back to what it was.

Mark Solheim: Is part of that new normal... You’re paying list price. And you talk about Tesla, there’s no negotiation with the Tesla. And more and more people these days I know are paying MSRP or a markup. Do you see that happening as well? And what does the consumer do now? There’s no longer negotiating over invoice. Now you’re paying MSRP, I guess.

Jenni Newman: Yes. It’s a really interesting market right now because there really isn’t a lot of room for negotiation if you want that vehicle. So I think that’s the big question. As a shopper, if you have time on your side and you don’t need to have that vehicle immediately, then you have a little more flexibility, a little more wiggle room. And perhaps you try to wait out some of the constrictions on the car market right now. But you could be waiting a long time.

We’re two years into this. We’re already in year three. It’s not easing up as quickly as anybody would’ve liked, so there’s that to consider. And I know that some of my colleagues consider that markup the price of doing business right now when it comes to car buying, I recently purchased a personal vehicle and paid a bit of a markup on it. And that was something I had to think through. But ultimately, I knew what car I wanted and I knew the timeline I wanted to get it in. And so in my mind, that was the price I had to pay to get that vehicle on my timeline.

David Muhlbaum: Literally the price you had to pay, yeah. Your answer earlier about all the macro factors like real estate that come into play with the existing dealership model are fascinating. I can go in so many tangents about that. One of the ones that came to mind is that the whole model before where a dealer would buy or order a whole bunch of cars and then hold onto inventory in hopes of selling it, was fundamentally inefficient now. My understanding is that they enjoyed backed up financing and incentives from the factory to support that model.

David Muhlbaum: But fundamentally, it does seem a whole lot cleaner to order or nail down what you want and get it. The sticking point of course, is that price. So we have this weird confabulation, to use a fancy word, of both this online evolution, which I think consumers were clamoring for, and literal sticker shock when people still have to go look at the piece of paper on the window and then, scribbled down in Sharpie at the bottom, it says, “and another $5,000”. The additional dealer markup. It’s weird because you both had this forward-looking approach of bringing it online and making it smooth and this like, “wait, what?” encounter when people actually see that they’re going to have to pay more, not for anything they’re getting, but except for the car.

Jenni Newman: Right. For the ability to get a car now. Yeah. And perhaps that will change and ease up a little bit as we see the new car inventory grow. I can share that in April of 2022, year over year, new car inventory was down 51%. We know that new car inventory has been hit so hard. And so as we see more new cars come into the marketplace, perhaps that $5,000 additional charge is cut in half. And then perhaps it’s cut down some more and then eventually it fades away as more competition comes back into car shopping. But for right now, paying $5,000 extra, that’s a little steep, that feels a little steep, but it’s not unusual right now.

Mark Solheim: May I ask what car you recently bought, Jenni?

Jenni Newman: Of course. I recently bought a Hyundai IONIQ 5. So we purchased an EV and we paid... I’ll be really transparent. We paid $2,500 over the price. So we definitely paid for it.

Mark Solheim: A real bargain. Yeah.

David Muhlbaum: That’s a cool car though. That’s one of the cars we included in our EV roundup. And I love the styling of that with the... It’s the sort of the Atari vehicle, right?

Jenni Newman: It is. We definitely get a lot of looks when we’re driving it around the city here in Chicago.

Mark Solheim: And you were able to pull the trigger on an EV because I assume this is mainly around town in a vehicle, not long cross-country trips or...?

Jenni Newman: So, we will use it mainly around town, but we are intending to do a couple road trips in it this summer and see how it does. At cars.com, we own a Tesla model Y and have been putting that to the test, not only as an around town vehicle, but also again for road tripping, just in all the ways that you use a vehicle. And so I’m really curious to see how my personal EV, the IONIQ 5, compares to the ease of which the model Y and the Tesla system already has set up as far as infrastructure. So, yeah. Basically my family will be living an experiment with me so it should be a lot of fun

David Muhlbaum: Since we’ve broached electrics, I just want to basically throw out a kudo to Cars.com and I’ll put in a link to this article. You guys had a really interesting piece about the long-term dynamics of electric vehicle ownership when it comes to battery life and battery performance, which is one of those bugbears. It always gets floated up when we talk about EVs, like, “Is the battery going to last?” And I’ve found it really informative. And so I’ll pop in a link for that because I know we’ve talked EVs before on this podcast, and I always get feedback. This is a good one to read.

Jenni Newman: Thank you so much. And I’ll say that we’ve been building out just a library of EV content, because there’s so much for consumers to learn around EV ownership, around battery, around range anxiety. There’s so much to take in. And so we want to help shoppers, as I mentioned, find the car that’s right for them, whether that’s an EV or whether that’s a traditional gas powered vehicle. So that’s our goal there.

Mark Solheim: Or a hybrid.

Jenni Newman: Or a hybrid.

David Muhlbaum: Or in between. Going back to pricing and the higher prices that people are paying for new cars and for used cars. Now there’s a flip side to this for the consumer too. Most people don’t own more cars than they need, and if they’re going to buy one, they’re going to sell one. And so those higher values should also translate into better trade-in offer from dealers. So I’m wondering what should someone do to make sure they’re getting the best deal on their trade-in in this market? Have the rules changed there?

Jenni Newman: I don’t know if the rules have changed, but I think there needs to be some education around what people should do. And really that is just put in the work to find the best offer. So that means, just like when you used to negotiate on a car price for a car that you were buying, when it comes to trading in or selling your vehicle, you want to shop around a little bit. Take some time. Get offers from various dealerships, whether they’re national brands, whether they’re your local brand, definitely visit the automaker of the vehicle that you own and see what kind of offers you can get and get it in writing, of course, so that you can then take those offers and play them off each other, and perhaps get an even higher price than you would’ve in the past.

Jenni Newman: Earlier, as we started to see used car prices increase, I actually had an extra vehicle. Don’t ask me how it happened, but I had an extra vehicle and I ended up selling it for about 50% more than I would’ve gotten had I sold it earlier. And so I was pleasantly surprised by that. I do kick myself for maybe being a little bit ahead of the curve when it comes to car prices, but it’s definitely worth putting in the time. It did take me about a week to get all those offers in and to make a decision though. So, it’s some work.

David Muhlbaum: That question of timing and doing it is what I like to call carbitrage. And it’s a tough game to play, but it sounds like it went well for you. With these values and these ongoing higher values in used car prices and for what people are paying for new cars, I’m wondering what the downside risk is to someone who’s paid that additional markup or paid what they had to pay to get that car now. They could be underwater if some sort of correction comes around. What does that really mean?

Jenni Newman: It’s a good question. I think it’s important to know that... If you’re concerned about this risk, then perhaps this is not the best time for you to be buying a car. We’re seeing higher interest rates, we’re seeing loan lengths grow. And so, if you can hold off on purchasing right now, and you’re not willing to take on this risk, then I would pull back a little. One thing to consider, of course, I think a lot of people tend to shop by monthly payment when they’re purchasing a car, when they’re thinking about how that’s going to impact their budget. One of the things that we like to advise consumers on is that you really should look at the out-the-door price. And so, when you’re talking to a dealer, whether you’re buying a new or a used car, you want to find out what that price is going to be for you to walk up the door, including taxes, fees, license. Any sort of question that any fee that can be added in, you want to know what that number is.

And from there, that’s where you need to... Normally, you’d start your negotiation. Truthfully, these days, that’s probably the price. But then if you’re looking at financing, we see loan lengths now that are 72 months, that are 84 months. You are increasing the length of time that you could be underwater. And so I know it can be a little bit rough, but if you want to shorten your loan, that might help you a little bit on the depreciation front.

Mark Solheim: As we’ve often said at Kiplinger’s, shop around for your financing too. Shop with your local bank, your credit union, as well as a dealer. And if you don’t qualify for the best rates from the dealer, from the manufacturer, those dealers do have lots of options. They’ll set you up. It may not be the cheapest, but you’ll get a loan, no doubt.

Jenni Newman: You will get a loan. And I think for people who have financial means, it’s a little easier these days. It’s a little easier to absorb the increases in interest rates and in inflation, where this tends to herd, of course, is shoppers whose budgets are limited. And you couple that with the increases in car prices, both on the new and used side. This can be a tough market for some shoppers.

David Muhlbaum: Yeah. I just come back to the idea of that we, you, we, others have been saying, wait, wait, wait. But you know, sometimes you need a car. Sometimes the tree fell on it and you need another car. There’s no choice in the matter.

Mark Solheim: So, what would you say then if, say, I’m telling you, Jenni, I need a new car right now. Is it no longer an advantage to looking for a sedan versus an SUV? Am I just stuck?

Jenni Newman: I think unfortunately, a year ago, we would’ve counseled you to maybe go look at sedans, to look at vehicles that are a little less popular. These days, you could be a bit stuck. I think if you are car shopping, it is all about being flexible and being ready. So you want to make sure that you have your financing sorted. You want to make sure that you know exactly what you’re looking for. And then when you can’t find it and you probably can’t, you’ve got some options. You’ve got a couple plans. You’ve got B, C, D E F of vehicles or trim levels that you’re willing to consider. So figure out what are your must-haves and where are you flexible? The car that I purchased, I did not get the color I wanted. And you know what, it’s fine. It’s fine. And that, for us, that was something we were willing to be flexible on. And so, that would be one area I would tell people like color, you’ll get used to it.

Mark Solheim: You’re driving a bright orange car around. That’s okay.

Jenni Newman: Not quite orange, but...

David Muhlbaum: They’ll see you coming. One of the potential advantages of ordering is though to have the color you want, the options you want, the car built the way you want. This mass customization could break for you, but I presume you still have to pay for the privilege.

Jenni Newman: So when it comes to ordering a car, it is the way to get what you want. If you don’t want to be flexible on anything from trim level or features or the color, then ordering is the way to go. Now, depending on the auto maker, you will likely have to put down a deposit which could just be a couple hundred dollars to create the order. And then as we get closer to the build, it could be a little bit more money to lock it in. One thing that we’re finding is of course, with various automakers, depending on what you order, the length of time to get that car in varies. If you are ordering a really specialized vehicle that not a lot of people are ordering, you might be low on the list to get it. Whereas if you managed to order a vehicle that is a volume seller, you could see that quickly. So you need to realize that ordering the vehicle means you’re probably going to wait and with all things, your wait time may vary. So just flexibility is the key.

David Muhlbaum: “Please hold the line; your wait time may vary.” I just wonder and I see anecdotally on social media and other places, stories, anecdotes about just bad dealership experiences. And car dealers were, of course never always that high on people’s lists of places they wanted to go. But the leverage that the current pricing situation seems to have given to dealers has made for stories of bad experiences. And I wonder if that will linger when/if things turn around. Are you hearing any of that sort of story from the front lines?

Jenni Newman: No. I haven’t heard many stories like that, to be honest with you. What I would tell any shopper who’s dissatisfied with the experience they’re receiving with the dealership is you can walk away. And I know it’s hard to do, especially in this market. Perhaps you finally found the vehicle you wanted, but you’re not happy with the way that the conversation is going or even worse, the way you’re being treated. Ultimately, you can walk away and you do not have to give them your business.

Jenni Newman: But what I will tell you is, a lot of dealerships these days, I think that they’re aware of that reputation and they work hard to counter it. And so, this is a Yelp world in a way, and so we know that people are very vocal with their reviews of dealers and even sales people. And in fact, on cars.com, we have ratings of dealerships as well as specific sales people. And so ultimately, it is customer service and it behooves them to treat their customers well, and there are ways to provide feedback should it go well or should it not.

Mark Solheim: I think that the fact that people hate to haggle. We know that people really, except a few individuals with exceptional gifts just are afraid to haggle. And in the past, with a dealer, you’re going for a lower price, the dealer always has the advantage. I’m just guessing that maybe there’s less conflict now that you know you’re paying MSRP or in an additional markup. So maybe that’s eased some of the tension, just a theory.

Jenni Newman: I think that’s a good theory and yes, haggling, Ugh. It’s kind of the worst then I think that sometimes it really, it turns a lot of shoppers off. It adds a lot of tension. I will say that thanks to technology, there are easier ways to haggle when we get back to being able to haggle. You can do it over email; you can do it over text message. There are chats, live chats that you can do. And so you can go back and forth. And if you are haggling, just know that you are going to need to get that offer in some sort of writing. You’re going to need to have a screenshot of it, a PDF of it, something like that to show where everybody landed. But here’s a version of life where haggling gets a little easier when you don’t have to maybe do it face to face.

Mark Solheim: I was just wondering what the landscape for leasing versus buying looks like these days. We have a lot of readers and a lot of podcast listeners that do like to lease.

Jenni Newman: So right now, leasing, you might not find the lowest monthly payment because of the inventory shortage. There’s been drops in incentives. There is higher monthly payments because of the supply crunch. And so we’re seeing not as many people turn to leasing right now, or at least taking a pause.

David Muhlbaum: We keep coming back to this market environment of high prices and ongoing demand and ongoing chip shortages. One of the things I remember driving that in the beginning of the pandemic was people who didn’t have a car or maybe only had one car deciding, “I need a car. I need a car in my life”. I would’ve thought A) That that would’ve been finite. They got their car. They don’t need a third car. And B) I was thinking, do you think those people have regrets at this point? And would that possibly, I’m really speculating here, lead to some of those cars coming back onto the market?

Jenni Newman: Great question about regrets. I do wonder about that as well, simply because we know that the cost of ownership includes things like insurance. And if you’re in big cities, perhaps paying for parking. And then right now, really high gas prices. So cost of ownership could be getting to a point where for some people who stretched their budget to afford a car, perhaps it’s a bit much these days. And with comfort levels increasing during the pandemic, they could be looking to offload their vehicle and if they are, then they will get a really good price for it right now.

Jenni Newman: As far as the number of people during the pandemic who needed new vehicles or who rushed to buy vehicles, I think that so many people have been putting off the purchase of a vehicle because of the constraints in the market that it’s going to be a while before we see things level off from a buying perspective. I do wonder, as automakers continue to slowly, slowly ramp up their new car inventory, how long will it take for us to finally see this crunch of demand level out a bit. So I’m also watching that with a lot of curiosity.

David Muhlbaum: Well, thank you for your insights on that. And for dealing with my complicated two part questions. This demand question is both interesting to explore at a macroeconomic level and really comes home when the tree falls on your car and you need one. So thank you, Jenni, for your insights on helping people get their four wheels, whatever they have to pay for it. Thanks again.

Jenni Newman: Thank you so much for having me today.

Mark Solheim: Jenni, thank you very much. It was a pleasure.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you’ve already subscribed, thanks. Please go back and add a rating or review, if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• 15 Best Things to Buy at Dollar Stores (Dollar Tree Included)
• 17 Worst Things to Buy at Dollar Stores (Dollar Tree Included)
• Kiplinger’s Economic Outlooks: GDP
• Why Inverted Yield Curve Panic Is Overdone
• Kiplinger’s Economic Outlooks: Fuel Prices
• How Gas Prices Are Determined

Transcript:

David Muhlbaum: There’s a lot of talk of recession out there. Is our economy going to experience one soon? Jim Patterson, managing editor of The Kiplinger Letter, will take that question head on. We’ll also revisit dollar stores for a deal or no deal review with Bob Niedt, Kiplinger’s retail specialist. All coming up on this episode of Your Money’s Worth.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com senior editor David Muhlbaum, joined by my co-host, Kiplinger senior editor Sandy Block. Sandy, how are you doing?

Sandy Block: I’m good, David. I’m just doing great.

David Muhlbaum: Okay, good. Well, good. Well, we’re going to break from tradition here today and we are going to have a guest on our opening segment. So say hi to the good people, Bob Niedt.

Bob Niedt: Hello, hello.

David Muhlbaum: Yeah. Bob has the retail beat here at Kiplinger, and that includes dollar stores. It didn’t go unnoticed, shall we say, that I made a somewhat sniffy sounding remark about dollar stores in our last episode. So in fairness to, well, dollar stores, I thought we should have Bob on to talk about what dollar stores do well and what they don’t, from a consumer point, that is. What’s the deal and what’s not? But before we dig in, Sandy, just to follow up, where did you buy that $3 bottle of wine when we were talking about this?

Sandy Block: Well, actually, I bought two bottles of wine. One was $5, one was $3. It was at a Dollar General outside Berkeley Springs, West Virginia.

David Muhlbaum: Got it. Now, okay, and so Bob, this brings me to one of my classic definitional questions to start out. First of all, it proves that not everything in a dollar store is a dollar anymore. Sometimes not even the dollar items are... Anyway, we’ll get to that. But you write about dollar stores in the generic, but we’ve got several big chains, right? There’s Dollar Tree, Dollar General, Family Dollar. And plus, sometimes there’s still some of these holdout independent little stores, right? So the guidance you’re going to give us, can we apply it broadly?

Bob Niedt: I would say for the most part, a little bit, but a little bit no. For example, Dollar Tree is the biggest dollar store in the U.S. And Canada. They also own Family Dollar, so they’re one in the same. Dollar General is a separate entity. Dollar Tree is the one that sticks more closely to the everything is a dollar, now $1.25, rule. The other stores, they may go up to $5. Not much higher than that, usually though.

Sandy Block: So as David hinted in his snarky way, I know my way around dollar stores and I do shop there. I got some very nicely priced dog treats there just last week. But Bob, am I doing it right? What are the best things to buy at dollar stores?

Bob Niedt: I have some of my favorites, and I think at the top of the list is greeting cards from Dollar Tree. They’re made by Hallmark. They’re quality cards. And usually, you can get two for a dollar. Straight dollar up, two of the cards. The really nicer ones, they’re a dollar each, but they’re never over that amount. Another-

David Muhlbaum: They’re not even $1.25.

Bob Niedt: No, they-

David Muhlbaum: They’re a dollar.

Bob Niedt: ... stuck those at a dollar.

Bob Niedt: Reading glasses is another one. If you’re like me and you have reading glasses everywhere, in your car, in different rooms in your house, you can get them for a dollar there, whereas they’re probably $7 or $8 at the grocery store. So those are two of the favorites for me.

Sandy Block: And those are really good ones, because I know from my experience with my father, he would lose them constantly. But now, Bob, maybe... And the greeting cards, I definitely see that, because in a drug store, they’ll cost you like $5 or more.

Bob Niedt: Yes.

Sandy Block: So that’s a significant savings. But what are some of the things that you shouldn’t buy at a dollar store? And please don’t say wine, because it’s too late for me.

Bob Niedt: Well, I haven’t seen wine at Dollar Tree, so not familiar if they’re doing that at all anyway.

David Muhlbaum: I really hope they do a private label, because that would just sell it. Dollar Tree Wine, yeah.

Bob Niedt: Some of your worst things to buy, it’s batteries. They’re mostly off-brand batteries. Sunbeam is what they usually carry. They’re really for like remote controls and stuff like that. They’re not really good batteries. What else?

David Muhlbaum: It’s like the chemistry is different, right? They’re not alkalines. They’re-

Bob Niedt: Right, exactly.

David Muhlbaum: Yeah, they’re like the generic things that get shipped to you with a new product so they can say, “Batteries included,” but you don’t actually want that battery.

Bob Niedt: Yeah, they won’t last, for sure.

David Muhlbaum: Right. You don’t want to go out and spend your own money replacing that battery with another not good battery.

Sandy Block: Absolutely.

Bob Niedt: Right. Other categories are wellness products. You should probably stick with the drugstore varieties or Costco or something like that. I’d steer clear of those. School supplies are usually pretty cheaply made. I’d steer clear of those. What else?

Sandy Block: Well, Bob, are there some things that aren’t necessarily bad, but not really a deal? I mean, some people think they’re saving money at a dollar store and they’re really not.

Bob Niedt: Right. Tools, for one thing. If you’re going to buy a tool from a dollar store, don’t expect it to last.

Sandy Block: That’s a good one.

Bob Niedt: Toys and costumes. There’s two other categories. The toys are very cheaply made, and I noticed that they have a lot of small parts in them too.

Sandy Block: Could be dangerous, yeah.

Bob Niedt: Yes.

David Muhlbaum: So we’re talking about comparing dollar store items to drug stores or big chains like Walmart, but Bob, it’s hard to make those comparisons sometimes because the quantities are so different. Can you talk a little bit about how you do that when you’re reporting on this and how a consumer should pay attention when they’re shopping?

Bob Niedt: Well, you could do it simply by the shelf tag. Let me backup a bit. As you mentioned, David, a lot of the items in the dollar stores are packaged by like food companies for dollar stores, so that the package size might be different. A can of soup might be a different size. So what do-

David Muhlbaum: But the brand is recognizable, but the quantity is different.

Bob Niedt: Yes. In some cases the name is recognizable. There’s a lot of off-brands in the food category as well. But the best way to compare is to compare what it costs per ounce. The item, the chicken noodle soup or whatever it is, compare it to what it’s being sold for in a grocery store. And you’ll find that you don’t have some really good bargains there at the dollar store.

Sandy Block: Bob, I like to buy, and tell me if I’m wrong here, is wrapping paper at the holidays.

Bob Niedt: Wrapping paper’s good. It’s disposable and it’s going to be thrown away anyway, so you don’t have to worry about quality so much. But the thing about the wrapping paper at dollar stores is it’s usually in smaller lots. The rolls are much smaller, different sizes. So you might be not making it out so well buying wrapping paper there.

David Muhlbaum: If you’re thinking on a square foot basis.

Bob Niedt: Right.

Sandy Block: Yeah.

David Muhlbaum: Right. Well, cool. Well, Bob, I know there are more in your lists, more details about what is good and what is not so good to buy at dollar stores, and obviously, we will link up so people can dig into the gory details there. Thank you for joining us today.

Bob Niedt: Thank you so much. It was a pleasure.

David Muhlbaum: Coming up in our main segment, we’ll talk about the prospect of an economic recession and whether we’re at risk of talking ourselves into one. Stick around.

Is a Recession Coming? (Jim Patterson)

David Muhlbaum: Welcome back to Your Money’s Worth. For our main segment today, Sandy Block won’t be joining us. She’s getting an early start on her Memorial Day weekend. Good for Sandy. It will just be me talking with Jim Patterson, managing editor of The Kiplinger Letter, about the economy and the prospects of recession. And yes, that’s the same Jim Patterson we had on a few weeks ago to talk about surging fuel prices, because it seems to be all economy all the time. So we’re going to have Jim on here to talk about the future of that economy. Welcome, Jim.

Jim Patterson: Thanks, David. Great to be back.

David Muhlbaum: Okay, I’m just going to cut to the chase here. Lots of people are talking recession. Are we going to have one soon? What is the forecast?

Jim Patterson: Well, let me give you the short answer first. We think that we probably can avoid recession here in the U.S., But there is a lot of legitimate reason to worry about recession. That’s why you’re hearing a lot of concerns about recession on Wall Street. That’s why you’re seeing the stock market act very nervously these days. So we certainly understand why people are worrying about it, and there’s a lot of legitimate causes for concern that we can talk about here. The big elephant in the room right now is the Federal Reserve, which is raising interest rates pretty rapidly to fight inflation. And there’s a long history of when the Fed hikes rates, that can lead to recession. It goes too far. It slams the brakes on the economy too hard as it tries to get inflation under control, and we end up with an economic downturn, oftentimes an actual outright recession. So that’s what you’re hearing a lot of from Wall Street right now. And that’s what we wanted to address in our recent page one story in The Kiplinger Letter. Is there enough reason to worry about a recession right now? And we think based on all of the economic indicators we’re seeing, we don’t see a sign of outright recession coming. We think the economy’s going to slow down, but stay out of a recession.

David Muhlbaum: Okay. Well, now I’m going to press you on timing. This is for 2022. The Kiplinger Letter is saying growth is going to weaken, but not go negative this year.

Jim Patterson: Right. Right. That’s right. We think we’re going to slow down under perhaps 2% or around 2% GDP growth, which is not a booming economy. It’s not exciting like what we had in 2021, coming out of the COVID downturn. But that’s a lot better than actually going into a recession. And we are staying alert to the possibility that things could slow down more perhaps in 2023. We’ve been telling our readers about some of the warning signs to look out for. If a recession really does appear to be imminent, there are certain indicators that are pretty reliable that tell you that one might be coming. It’s just that right now, we’re not really seeing those clear warning signs going off.

David Muhlbaum: Okay, so but what are they? What should people be watching for?

Jim Patterson: There’s a few big ones that our research indicates are pretty reliable indicators here. The first to look at is what happens with the unemployment rate. Right now, unemployment is really low. The unemployment rate that’s reported in all the headlines is 3.6%, and we actually think it could get a little bit lower even as the year goes along. But historically, if you see an increase in that unemployment rate of about half a percentage point from whatever the lowest point in the economic cycle is, that’s a pretty strong warning that a recession is coming. That shows a real weakening in the labor market, which is a big part of the overall economy. Another warning sign to look out for is something called the inverted yield curve, which is a-

David Muhlbaum: Yes. Yes, yes, yes.

Jim Patterson: Right. That’s a technical sounding term. I’ll talk about it in non-visual terms. That just means that if interest rates on long-term government bonds, which are normally higher than on short-term government bonds, if they fall so that the interest rate on those long-term bonds is lower than short-term bonds, that’s called an inverted yield curve. For instance, if the interest rate on the 10-year Treasury gets below the interest rate on the 2-year Treasury note, that would be an example of an inverted yield curve. And that’s usually a pretty reliable indicator that financial markets are betting on economic weakness in the near future. In other words, a recession.

David Muhlbaum: Did we reach that at one point earlier this year? Did we actually invert or we flirt with it?

Jim Patterson: We technically did, I think for a matter of a day or two. And we think that that’s probably not a great clear indicator of a recession coming. It literally was a matter of a day or two. And there are other parts of the yield curve that economists look at. For instance, the difference between the yield on the 10-year Treasury note and the 3-month Treasury bill. That’s a really bad situation if the yield on the 3-month bill gets higher than the 10-year note, and we didn’t come anywhere near that. So we didn’t see really a clear recession signal from that very brief inversion of that one part of the yield curve. It’s definitely something to pay attention to, but we don’t think that has the statistic sort of significance of a long-lasting inversion of the yield curve.

David Muhlbaum: Got it. Well, there are yield curves and there are yield curves.

Jim Patterson: Right, exactly.

David Muhlbaum: To go back to the question of the unemployment rate for a second to really dig in, the metric that I thought where I was supposed to pay attention to was job creation ahead of the unemployment rate. Am I missing something here?

Jim Patterson: Well, job creation tells you what’s going to happen with the unemployment rate in the future. Same thing with job losses. Actually, probably the best real-time data to look at for the labor market is the Department of Labor’s weekly-

David Muhlbaum: Weekly unemployment claims?

Jim Patterson: ... unemployment claims. That tells you how many workers are making new applications to claim unemployment benefits because they’ve been laid off. And if you are starting to have more layoffs now, that will probably mean there’s going to be fewer new jobs being created in the future. And if there are fewer new jobs being created in the future, eventually you’re going to get an uptick in the unemployment rate. So there are different parts of the labor market or different indicators about the labor market that you can look at to try to gauge what’s going on with the economy.

Jim Patterson: Right now, those workers filing claims for unemployment benefits are quite low. They’re close to their lowest in the existence of the data series, I believe. They’re certainly at a low enough level that we are not worried about a lot of layoffs happening right now. There’s not a sign of that. So that suggests to us the labor market’s going to stay very tight and probably the unemployment rate is not about to start rising anytime soon.

David Muhlbaum: Well, I think this is a good moment, since we’re getting to definitions, to step back and check another definition, because listeners know I love definitional questions. There’s a standard term for what a recession is. I mean, I may be a humanities grad, but I know there is one. But how about you explain it, Jim?

Jim Patterson: Okay, well, I’ll explain it one humanities grad to another here. The traditional rule of thumb definition of a recession is two consecutive quarters of negative economic growth. Two quarters where GDP gets smaller rather than gets bigger. But that’s not the official definition that we use here in the US. The official definition is a little ambiguous, actually. But the official designation of a recession comes from a group called the National Bureau of Economic Research, the NBER. They’re considered the arbiter of what is a recession, what is not a recession in the US. And they do not necessarily use that two consecutive quarters of negative growth rule of thumb that I just mentioned. I think typically if we were to have two consecutive down quarters, the NBER would probably label it a recession, but I don’t think that that’s their formal definition.

David Muhlbaum: In fact, didn’t that question come into play with the last recession? I mean, that was a weird one, right?

Jim Patterson: It was a weird one because we did have two negative quarters, but one of those was an extremely negative quarter. That was, of course, when COVID caused the shutdown of so much of the economy.

David Muhlbaum: Yeah, it’s like we fell off the cliff.

Jim Patterson: But then we bounced back very quick.

David Muhlbaum: Right.

Jim Patterson: Right, we fell off the cliff and then we bounced way back. We had something like a negative 20 or 30% GDP number and then a similar sort of rebound to the upside the next quarter. So we had a very brief, extremely sharp contraction of what you might call an artificial sort of recession. Certainly in a recession we’d never really seen before where because various state governments were trying to control the spread of the coronavirus, there were all these orders to curtail a lot of economic activity. People weren’t traveling, people weren’t going into work. A lot of people were laid off because they couldn’t do their jobs from home. So we had this really, really sharp drop in one quarter and then an extremely vigorous rebound as a lot of those restrictions were taken away and the economy reopened again. That’s not your typical recession, certainly.

David Muhlbaum: So if the pandemic recession doesn’t inform our future, it was a fluke, what are you looking to in the history for how things might go for us in the near term?

Jim Patterson: Looking back historically, I think whether you get a severe recession, a really deep, long-lasting one, or a shallower one, a lot of it has to do with whether that recession is related to some sort of financial crisis. Of course, storing 2008, 2009, we had the Great Recession, which was one of the worst economic downturns in US history. That was spurred, to a large extent, by the financial crisis we had involving subprime mortgages and how that affected our financial system. There was concern in the summer of 2008 that certain financial institutions were going to fail and what that would mean for the larger system.

So I think historically what you see is if there’s some sort of crisis or panic in the financial system that causes a recession or accompanies a recession, that recession’s probably going to be really severe, difficult to recover from. We certainly saw that after 2009. The recovery was slow. It was not a vigorous comeback. Growth was kind of anemic for a while. We had this slow but steady recovery of all the jobs we had lost. It took years and years.

Other recessions, where there hasn’t been that element of financial crisis, tend to not last as long. They tend to not be as deep. We tend to come out of them faster. Think the recession around the turn of the millennium in 2000, 2001. Of course, we had a terrible stock market sell-off, especially in tech stocks. But the actual damage to the economy wasn’t that bad, and we started to recover faster and more vigorously from that one.

David Muhlbaum: A terrible sell-off in tech stocks. Hmm.

Jim Patterson: Where have we heard that before?

David Muhlbaum: Where have I heard that before? But actually, in the Letter, you look to a situation to forecast how we might actually stay out of a recession. You look back to another time when the economy was wobbly, there was a sell-off in a market sector. But it turned out okay.

Jim Patterson: Right. That was 2016. A lot was different about 2016, but there were a lot of concerns about recession in 2016. We did see a pretty significant slowdown in the economy. What was going on then was a big part of the US economy, the oil and gas sector, was really struggling because commodity prices had really dropped a lot. There were a lot of energy companies that were either going bankrupt or flirting with bankruptcy because the price of the commodities they produced was so weak. And there was a lot of concern that that could spill over into the broader economy and cause an outright recession. And we didn’t get that. We got pretty anemic growth in 2016, something like 1.4% GDP growth for a while. And again, that doesn’t feel like great prosperity, necessarily, but it’s a lot better than actually going into a recession.

So that’s a case where there was a lot of legitimate concern about the R word, but we managed to... The damage stayed contained to one sector. It didn’t spread. Wasn’t enough to slow down the overall economy. And there’s, I think, a hopeful case to be made here that something similar could happen where even though there’s lot of headwinds, like the Federal Reserve raising interest rates, that there are also enough latent strengths in the economy to keep us growing even if it’s not growing very fast.

David Muhlbaum: A good-enough economy.

Jim Patterson: A good-enough economy is better than a recessionary economy.

David Muhlbaum: Right. Okay, I find this sort of thing interesting, and I hope our listeners do, but also I find it a little, I don’t know, futile. Because what is one supposed to do other than hope for the best outcome? But Kiplinger Letter readers, they can... Well, what can they do? I mean, if they’re a business owner or manager, they could change purchasing, marketing decisions.

Jim Patterson: Right. That’s been our advice to readers recently. That’s true. You’re right. When you hear about a recession coming, whether that’s actually going to happen or not, it kind of feels like this steamroller bearing down on you and maybe you just hope that it doesn’t hit.

Jim Patterson: But the practical things that people can do if they’re concerned about the economy, if you’re a business, this might be a good time to rethink some of the investments you were planning to make. Perhaps you might want to go slower or hold off on any sort of major investment, maybe whether it’s new equipment, new real estate, hiring new workers. You might want to be more cautious about things that would make you more vulnerable if the economy did really go south and perhaps you had taken on a lot of debt to finance a new investment of some sort.

And I think the same thing could be said about consumers. Might be a good time to be more circumspect about major purchases. Is this a great time to be buying that boat you wanted for a long time? Or something like that. Or a new car, or maybe moving up to a bigger, more expensive house. It’s not to say you stop doing your normal economic life day to day, but you might want to think more about the big risks that you could be potentially taking on, especially in terms of new investments, new expenditures.

David Muhlbaum: Well, that’s good advice to the individual, but perversely, it’s just the sort of thing that could make that recession actually happen, right?

Jim Patterson: Right. There’s an element of self-fulfilling prophecy here. If everyone gets nervous at the same time about the economy and everybody seizes up and stops making those big ticket sort of purchases or investments that keep their business growing, that could lead to a vicious circle where fear of an economic downturn actually brings on an economic downturn. There’s definitely always a large psychological component to the business cycle on the upswing and the downswing. I’m not saying that this is the root cause of recessions, but certainly recessions can be brought on or hastened or worsened by a lot of fear.

David Muhlbaum: Well, let’s talk about those consumers en masse then for a moment, because clearly you’ve taken their pulse to make your forecast. How is sentiment?

Jim Patterson: Sentiment is not great, but it depends on which measure of sentiment you look at. There are a couple of big ones. The University of Michigan conducts a long-running and highly followed consumer sentiment survey, and then The Conference Board does as well. How those organizations conduct their surveys, they place different points of emphasis on what affects consumers. So one measure might be more sensitive to things like the stock market decline, and the people responding to that survey may be more prone to change their spending decisions, for instance, because they’ve seen their 401(k) or their other investment portfolios’ value decline. Another survey may not put so much emphasis on that, but might put more emphasis on the labor market, which is very strong. Jobs are plentiful. It seems like practically everyone who wants to get a job can get a job right now. Wages are rising.

Jim Patterson: So sentiment varies depending on how you measure it, but there’s no question that it’s weaker than it was. There’s a lot of consumer pain out there, of course because of inflation. You’d have to be living under a rock these days not to notice that the price of practically everything is up a lot. And certainly, consumers are feeling that. It’s painful to fill up your gas tank. It’s painful to go grocery shopping right now.

But at the same time, there are indicators that people are still spending. Retail sales are holding up. They’re not necessarily doing great. And people are probably shifting more of their spending to things they can’t do without, the basics, and maybe aren’t spending as much on discretionary sort of goods. Whether it’s electronics or other things they don’t necessarily have to have. Things they might want to have, but maybe they can’t justify it when milk and eggs and gasoline and other staples are rising so much. So it’s not that consumers are feeling great, but it does seem like there are indications that consumers are holding up.

David Muhlbaum: I see. Yes, and I appreciate the attention being paid to the retail sector. I mean, the sales tell us what has happened, but there’s a lot of attention being paid now to what retail firms are saying in their quarterly reports, their forecasts about what they see ahead. That’s had some pretty dramatic effects on a number of retailers. Like, Target got whacked. Although, I can’t exactly remember why, but I do know that their shares went down by like a quarter.

Jim Patterson: Yeah, there was a lot of downbeat news on a lot of retailers’ earning calls, including Target warning about their rising costs eating into their profit margins.

David Muhlbaum: There you go.

Jim Patterson: Rising costs for freight shipping. They’re paying more for the goods that they put on their store shelves. Their profit margins are being pressured as costs rise. And retailers, especially the Targets and the Walmarts of the world, probably are doing everything they can not to hit their customers with the full impact of their own cost increases, because they know their customers are cost-sensitive and they don’t want to drive people away to some competing store. So yeah, we saw Target’s stock drop by a quarter after they issued this downbeat earnings outlook, and we’re seeing other retailers dealing with these same problems. This is the nature of high inflation. It puts a lot of pressure on budgets, whether it’s a household budget or whether it’s a major corporation’s budget.

David Muhlbaum: Since we’re talking about prices, let’s quickly check in again on fuel prices, which are, of course, a Jim Patterson niche. We are here on the cusp of Memorial Day weekend. Traditionally, the start of the summer driving season. In the face of $4, maybe $5 gas, do you think consumer demand will remain strong? There’s not some price point where people go, “nah, staying home”?

Jim Patterson: I think there is such a price point where it becomes too painful to take that road trip if you don’t have to go. And we’re already starting to see some indications of that. Fuel consumption is already starting to trend down. We are just about at record high prices for gasoline on a national average basis. I always follow AAA’s gas prices because they do such a great job of both providing a national average and then showing the state by state averages. I think currently there is no state in the country where gas averages under $4 a gallon. The overall national average is $4.60, which, again, when you don’t adjust for inflation, is the highest we’ve ever seen. Some states are well over $5. In California, it’s over $6.

Jim Patterson: So I think we are getting to that pain point where even though consumers really do want to travel, they want to get out. Sure, it’s Memorial Day weekend, and every year people want to go on vacation. Especially this year after a couple of weird years with COVID and a lot of people not traveling much, not going to the beach, not going to see family as much, there’s clearly a lot of pent up demand for R & R. People want to get out on the roads. And airline fares are very expensive, so more people are going to be driving, probably.

So demand is pretty good considering we’re at these high prices, but there are some signs that people are starting to say, “I think I’m going to stay home.” It’s not like people are just ignoring the price they’re seeing at the gas station. And as we get even higher, I think that effect will become more pronounced. We’ll see a little more of what economists call demand destruction.

David Muhlbaum: Demand destruction. That is quite a term.

Jim Patterson: An ominous sounding term. It just means-

David Muhlbaum: Demand destruction.

Jim Patterson: ... buying less of something.

David Muhlbaum: Yes, okay. I’m going to pop in a link to Jim’s most recent energy price forecast, as well as a couple of interesting articles he’s written about why gas prices are high, like what is going on in the market and what the factors and... You’re really sort of putting on display your deep knowledge of the energy sector. So that’s something to look at our show notes and check out.

But one last little sort of almost intramural question for you. At Kiplinger, we make forecasts for the stock market. We were just talking about those in a previous week. And we make forecasts for the economy, which is what your team does. And now the we I’m talking about is Kiplinger. Of course, there are individuals who do the research and the reporting behind those, but in the end, it’s a Kiplinger forecast. So here’s my odd question. Who do you think has it harder, the economic forecasters or the people saying what the S&P 500 is going to do this year?

Jim Patterson: Well, as the guy who’s in charge of the team that does the economic forecasts, I would say my colleagues who have to worry about the stock market forecast have it harder, because there’s so much psychology involved in trying to gauge what the stock market is going to do. I think it’s not a precise science to try to tell you what the economy is going to do, but there is a lot of objective sort of analysis that goes into that. We have a great staff economist here at Kiplinger named David Payne, who I work with closely, who crunches all these numbers and scrutinizes them. I think he does a great job of telling our readers what all this stuff means and what’s going to happen next.

Now, I think it’s even tougher to tell readers what the financial markets are going to do, because in the short term, stock market, the bond market, other assets are driven so much by sentiment and psychology and it’s very tough to predict what other investors are going to be doing or thinking. So I’m grateful that we can just try to say, “Well, here’s what the economy is going to do,” because to us, that’s more tangible. You can look at supply and demand and freight shipping and things that are concrete.

Jim Patterson: When it comes to the stock market, maybe the stock market has a great day or a terrible day because the chairman of the Federal Reserve said something that was interpreted as good or bad. And how do you guess what that’s going to be day to day? So I really take my hats off to my folks who try to handle the investing outlook. I think they’ve got the toughest job.

David Muhlbaum: Well, this could be an interesting conversation next time we all get together in a human space and over a cup of coffee or maybe even a beer, at a work happy hour. So a little behind the scenes there, but I think it’s insightful to understand how the sausage gets made, to some extent. And Jim, you do a great job of pulling it all together. Thanks so much for talking about the dismal science with us this week.

Jim Patterson: My pleasure, David. You made the dismal science fun today, so thank you.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you’ve already subscribed, thanks. Please go back and add a rating and review if you haven’t already.

To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Sell in May and Go Away? Here We Go Again …
• Midyear Investing Outlook: Where to Invest Now
• 5 Stocks to Sell or Avoid Now
• Fyooz Financial
• Getting Married? Don’t Forget to Talk Money First

Transcript:

David Muhlbaum: Whether couples choose to marry or not, they’re going to face money questions. Do you combine accounts? Who pays for what? These can be the thorny bits on the bloom of love so maybe you should let a couple help guide you with these issues. We’ll talk with a pair of financial advisors who have an interesting combination of qualifications and personal experience about love, money and business. Also, Mr. Market has been keeping us on our toes. A quick look at where stocks are headed in 2022. All coming up on this episode of Your Money’s Worth. Stick around.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com senior online editor, David Muhlbaum, joined by my co-host senior editor, Sandy Block. Welcome to May, Sandy.

Sandy Block: Well, thank you. It’s kind of a weird, slow spring here but I’ll take it.

David Muhlbaum: Yeah, it was a year ago in, well, May, that we explored the stock market maxim, sell in May and go away. You remember that? The idea being that markets underperform in the summer so you shouldn’t really be invested in stocks then. Which of course violates all kinds of guidance to not try to time the markets.

Sandy Block: Yeah. I think we agreed that sell in May and go away is not really a thing, at least for the average retail, long-term investor. Although there are some market watchers saying that this is the year it’s really going to break for sell in May and go away, given what’s going on in May with inflation, interest rates, war and COVID, et cetera.

David Muhlbaum: Yeah. Well, that’s just their opinion, man, as a wise dude once said.

Sandy Block: The Dude abides! How long have you been waiting to quote The Big Lebowski on this podcast?

David Muhlbaum: That was the first time? I guess you’re right. I did get Monty Python in, but those factors, inflation, interest rates, geopolitical tension, those are facts, not opinions. And stocks this year well, they seem to be feeling it. The stock market in 2022 is, well, I think it’s fair to say it’s struggling. The S&P is flirting with bear market territory and the NASDAQ, well, it’s already there. It’s already in a bear market. But as we just noted, it’s only May. Where are we going from here?

Sandy Block: From here? Like to the end of the year?

David Muhlbaum: Well, yeah sure. A 2022 update. Look, I know this idea of measuring stock performance by the calendar year is a bit arbitrary. We’ve said as much here, but in the long run, if you want gains, invest in stocks. But as I think it was Keynes who said, “In the long run, we’re all dead.” Anyway, but there are perfectly valid reasons to have shorter time horizons and to want to move, as some would say, more tactically. Maybe there’s a reason that you need money in the near term or going to need money in the near term. Maybe you want to invest in some sectors, not others. There are reasons. A market update, you got one?

Sandy Block: The person who should be answering this is probably our executive editor Anne Smith, because she just wrapped up her midyear forecast for the July issue of Kiplinger’s Personal Finance but I’ll do my best to channel Anne or rather, her story. First of all, those three terms, inflation, interest rates, geopolitical issues, they matter and she discusses them but the upshot of her piece and she talked to a lot of smart market watchers, is that really the forces for more gains or more losses are really quite balanced.

David Muhlbaum: You mean, so the market could go either way?

Sandy Block: Yeah. You don’t sound impressed but really that’s the situation. There’s both a lot of bullish sentiment and a lot of bearish sentiment. They’re evenly matched. But the result of that isn’t that markets stay flat, which wouldn’t be so bad, it’s that they get more volatile. It doesn’t help that this is a midyear election year. That tends to make markets less stable as well. But yes, the call is there isn’t any call. Any gains will come stock by stock, not by a big market move.

David Muhlbaum: Yeah. Well, I’d also quibble that if stocks stayed flat, that would be, we’d have a bad year.

Sandy Block: Good point, good point.

David Muhlbaum: But okay, so it sounds like there’s money to be made but it’s going to take selectivity. Given that, how about a stock pick? A buy of course. I know Anne and others hate doing sell calls.

Sandy Block: Yeah, because it can come back to bite you. But although we did publish a whole list of those. You can go find the link, David. But for buy recommendations, I’m actually going to give you two from Anne’s piece and there’s a reason for that. The big bank Credit Suisse, compiled two lists of recommendations. One is a top 50 beneficiaries of economic expansion and the other is top beneficiaries of economic recession.

David Muhlbaum: Oh, okay. That’s grand, so they’re hedging too.

Sandy Block: Yeah. Talk about going out on a limb but that’s their job. Anyway, from the first list, beneficiaries of economic expansion, well we’ve got energy equipment and services firm Haliburton that’s ticker, HAL. And on the second list, beneficiaries of economic recession, one of my favorites, discount retailer Dollar General, ticker DG. That one, come on. You can see how that would work.

David Muhlbaum: Yeah. I get it. Recession equals dollar stores. Well okay, let’s hope that doesn’t happen but if it does, dollar stores are a perfectly logical defensive investment. You’re a Dollar General fan?

Sandy Block: I bought a very nice $3 bottle of wine there last weekend, had good structure.

David Muhlbaum: Huh, okay. Alrighty, well thank you for the preview of Anne’s story. I look forward to sharing some of that three buck something. And now normally I’d say check out our show notes for the full piece but that’s going to depend a little bit on when you’re hearing this. I should have it up on or about May 20th, so please come back if you don’t see it at first because it’s got lots of detail that we had to kind of breeze by. Coming up, we will talk to a pair of financial planners who are a couple and advise couples as a couple, about money management. And we think you will find Fyooz Financial, that’s the name of the firm, endearing and informative. Stick around.

Fyooz Financial Planning Tackles Love and Money as a Team

David Muhlbaum: Welcome back to Your Money’s Worth. Joining us for our main segment today are Natalie and Dan Slagle. They are the founders of Fyooz Financial Planning, a firm that specializes in advising couples. And before I tell you more about them, I’m going to spell Fyooz because it’s F-Y-O-O-Z. We’ll put in a link to their website in our show notes and transcript, of course. But for those of you listening who want to hunt them down right now, it’s F-Y-O-O-Z Financial Planning. And yes, they’re a married couple and yes, they do financial planning together and they specialize in counseling other couples on money management. Dan and Natalie, I doubt you’re the first couple doing financial planning jointly but it doesn’t seem all that common. Why don’t you start by telling us your origin story? How’d you meet? And how did you decide to go into business together?

Natalie Slagle: Thank you, David. I love this story because it’s a combination of the beginning of Fyooz and it’s the combination of the beginning of our relationship. It’s kind of fun how it ties together. But Dan and I met in college, we kind of knew of each other in the same bigger friend group but really didn’t start dating until after college because after college we went into our industries, respective industries and started to get licenses to do all the things that we do. Well, Dan’s a year older than me and so he had taken all the tests and of course he passed all the tests and I got wind of this. My girlfriend said, “Hey, you’re you’re studying for this exam. Well, I know this guy Dan Slagle did it and he passed.” I reached out to Dan because I knew, well, he’s really smart. He’s really nice. What better tutor could a girl possibly ask for? Long story short, I asked him to be my tutor and now here we are married, doing business together related to financial planning. That’s really where the seed first got planted.

David Muhlbaum: Got it. And were those exams the CFP, the Certified Financial Planner exam?

Dan Slagle: This was the Series 7.

David Muhlbaum: Ah, for the SEC.

Natalie Slagle: Yes, exactly. We got to enjoy studying for the CFP exams during our engagement and married years, which I’m glad we had more of a committed relationship at that time because that one was a bit more crucial.

Dan Slagle: It was more of a challenge.

Natalie Slagle: And more challenging.

Sandy Block: So romantic. Well, let me ask you guys this, how does being a couple help you counsel couples? And has it ever been a disadvantage or a problem?

Dan Slagle: Great question. There are many advantages to working with other couples as a couple ourselves and it’s really mostly about giving couples a relatable, approachable, fresh feeling of talking about money. It’s similar to hanging out or going out to dinner with your best couple friend and this time really the conversation, rather than maybe talking about your neighbor or the community you’re in, you’re talking about your personal finances. It provides couples with a way to know that there are money conversations, whether good or bad, they’re happening in other households too. It’s happening in households across the world. We want couples to more so know it’s okay that you’re working on your finances together as a collective unit.

David Muhlbaum: I was thinking that ... financial planning sometimes bleeds over into broader questions of, what are you doing with your life? And that sort of thing. Does doing it with couples sometimes bleed over into — dare we say, therapy?

Natalie Slagle: Absolutely. Yeah, it does. And we kind of, sometimes we do just draw the line. Hey, as a reminder, we’re not therapists but this is going to feel a lot like therapy. Let’s just remember where our expertise lies, which is on the financial side. But you’re absolutely right. A lot of these questions have to deal with, well, what do you want out of life? We all make money to get us something, utilize those resources to really bring light to the values, the thing that’s most important to us. And so we want to have those conversations to at least make money, which can feel so maybe disconnected or arbitrary, at least feel a little bit more connected to your life. And so with these types of conversations, which we love to have because we’re a couple ourselves and we like to have these conversations just personally and privately, it can feel a lot like therapy along with the financial guidance along the way.

David Muhlbaum: We featured you guys in the June issue of Kiplinger’s Personal Finance and I’ve also been doing my good due diligence, looked at your website a lot. And I’ve noticed one thing that struck me is that you guys model yourselves as an example for your clients to work with. I don’t want to sound like you’re putting yourself on a pedestal, rather it’s more so that you guys make very vivid, the challenges and the dynamic of working together as a couple and showing people how, “this is how it can be done.” But it was interesting to see how essentially, transparent you guys are with what you’ve been posting to your website.

Dan Slagle: Yeah, absolutely. And it all comes down to transparency at the end of the day. And that’s what we want to bring to our clients. Our clientele is teaching them to have greater transparency when it comes to money. And, of course, there’s transparency in the technical aspects. We want our couples to be aware of what’s going on financially in the household but it’s also really important to have transparency about your money background, what money was like growing up for each of you individually because that plays a role into who you are today when it comes to your finances. You have your individual upbringings and I’ll think about it, you’re merging those together. And that can cause some points of tension. It can also just bring some points of beauty when it comes to a relationship. But it’s more so about how we manage those expectations going forward as a household. And that’s something that we’re really big on at Fyooz Financial Planning is just talking about money in general because it is such a taboo subject in our society.

Natalie Slagle: To add to that, if we’re going to ask our clients to be transparent about their finances and with each other and with us, it seems only fair that we provide that transparency too. We might not lay it all out detail for detail on our website but if a client asks about our money, our assets, we will tell them because it’s only fair in any type of relationship that you kind of give and take the same amount with all parties involved.

Sandy Block: I think one of the interesting points you made in our interview in June was that a lot of couples bring to the relationship a background in finance that can affect how they manage money going forward. If you grew up in a household where nobody ever talked about money, that’s going to affect how you manage money in your marriage. And I guess, sort of what that brings me to, one of the most interesting and common questions that I’m sure people ask and I ask other people is, should you merge your finances? Should you have a joint account? Or should you keep separate accounts? Because I think, especially now when so many couples have already established themselves, they’re not just out of college, how do people work that one out?

Natalie Slagle: We don’t have a hard and fast rule because everyone is different, and we do like to treat every couple with their unique qualities and aspects. There is that. We also have seen that transparency in sharing has a lot of benefits to it. It just tends to be a little bit easier if there’s less credit cards, if there’s less bank accounts, things like that. However, we can also see the impact of maybe taking some of that individual feeling, of just feeling a little bit more independent with your money and how that can be troublesome as well. There’s just this beautiful, delicate approach to figuring out as a couple and now as a household, how transparent you need to be, how do you merge your account so that you really feel like as a household, you’re doing everything you can strategically and you’re working as a unit, you’re working together but you’re also not losing just that independence and that individual freedom, especially when we have just dual income, separate jobs, maybe one person gets a bonus and they want to spend it on something only related to them. There’s these just aspects of money that happen that we need to just figure out for your household. How do we balance taking care of the household versus taking care of you as an individual?

David Muhlbaum: Since we broached transparency and since we broached the idea of merging accounts, I’m wondering if, do modern platforms like Venmo, where there’s this radical transparency of where people have the opportunity to say exactly — or to pretend to say — what they spent their money on. Are you seeing that as a factor when the people coming to you already know about what the other person’s doing from a spending perspective, thanks to that type of platform?

Dan Slagle: Yeah. Yeah. I think there’s definitely transparency there that’s built into modern platforms that we have out there in society today. I laugh when you ask that question because Natalie and I have a joint Venmo account as far as both of our names are on it and we’re probably the only ones who do that. But again, that just goes in line to the overall transparency that we preach at Fyooz Financial Planning. I think there are platforms out there that make things easier to see as a couple. And if there are other resources that couples can utilize, just to have more awareness of what’s coming into your financial household and what’s going out on a monthly basis, then we’re absolutely all for it.

Sandy Block: I want to take the conversation to the reason that we’re doing this now, which is it’s June, it’s wedding month and we’ve seen a lot of reports that there’s just going to be a record number of weddings this summer because so many people put off weddings during the pandemic. And one question that comes up a lot in etiquette columns, which I love to read, is whether it’s ever appropriate for a couple to ask for money instead of gifts. I guess it sounds tacky but a lot of older couples don’t need another Instant Pot, they need a down payment for a house. I wonder what your thoughts are on that.

Natalie Slagle: Sandy, I’m so glad you’re asking this question and you’re bringing it out into the world because it should not feel taboo. You as a couple know exactly what you need and no one should tell you otherwise. And I can speak from personal experience because I thought it would be rude to ask for money when we got married so I asked for help around my office on building out our registry list. I had no idea. I remember a garlic peeler was on there and I barely even cooked at that point. Why I needed a garlic peeler, I have no idea. And yes, we got a garlic peeler. What ended up happening over the last, our married years is Dan and I have moved across the country. We’ve started a business, lots has changed since we got married and we actually don’t own a lot of the gifts that we have anymore. We sold it for cash because that’s just what we needed. Instead, let’s just, let’s all just be aware that every couple is in a different situation. I think if you still are using your college pots and pans that you got from Goodwill, then it makes sense that having a registry with gifts that the two of you can maybe kind of just increase the things that go in your kitchen, sure, that totally makes sense. But to your point, Sandy, a lot of people are getting married later. They already have an independent life behind them and so maybe the physical things that they’re bringing into the marriage are plenty. They don’t need any more things. They just need cash to pay off those student loans, the wedding that you were invited to, all these other things. I’m an advocate for, if it makes sense for your situation, to just go ahead and ask for money.

Dan Slagle: I was just going to add another point and the couples that we work with who are engaged and their wedding is coming up, it’s fascinating and again, it speaks to how financial planning is really living and breathing and we adapt as life changes because we’ll be working towards certain goals up to the wedding. Whether it’s paying for the wedding or building that emergency fund or paying down some debt. And we get to a point when the wedding happens and these goals maybe haven’t been met yet but all of a sudden parents will gift to their kid, five, $10,000 and that shifts the whole mentality of where we’re trying to get to from those goals because we had the idea that, and maybe in, for example, in six months, you’ll be able to hit your emergency fund goal. We check that box and we move forward. We continue on with the planning process. But now all of a sudden, when a wedding comes and there’s a large gift for a down payment on a home or cash that can be utilized for that emergency fund, it really makes our job fun because we can then shift the outcomes of what’s to come. At the same time it’s also again, the word of the day seems to be transparency. Having conversations with maybe your parents about what they plan to contribute to the wedding, what they plan to possibly contribute to a future down payment. Those conversations should be had. Again, we don’t always want to count on those aspects coming into your financial plan but the more we know, then the better the plan and the outcome can be.

David Muhlbaum: Better no surprises. Better to know ahead of time.

Dan Slagle: Yeah. Yeah. And these are good surprises at the end of the day so if this is your situation, you should feel pretty blessed.

David Muhlbaum: Has anyone ever given your services as a wedding present? That’s going to cost more than your average serving tray or garlic peeler but it could be more useful.

Natalie Slagle: It could be. And I would say it is much more useful than a garlic peeler. We’ve actually looked into this. The answer to your question is no. No one has ever gifted our services. And we’ve been wondering how to crack that a little bit because we can work with clients on an ongoing basis or just come and visit and let’s talk about all the things you need to do and then be on your way. I think that would be very, very beneficial for those newly engaged couples. And then it makes prioritizing this part of your life that much more important. Someone paid for this kind of maybe more on the expensive end sort of service and so I’m going to take it seriously. Someone else is an advocate for us in this aspect of our life and so I think it could be a really, really powerful piece for those newly engaged couples or newly married couples.

Sandy Block: Going back to the planning process, it’s been a while since I got married and for years, my dad claimed he was still paying the bar bill for our wedding. My husband’s family’s Irish, so figure that. But what I realized and I was not all that young, it’s very easy to get caught up in the whole perfect day wedding planning and I guess if couples come to you before they get married and I think that’s a good idea, what advice do you have for them in terms of basically, keeping costs down, having the wedding they want within expectations, particularly now, as we talked about when so many couples are really struggling to buy a home, pay off student loans, credit card debts. How do you sort of get a handle on that?

Natalie Slagle: Yes. And the issue with this summer, going back to what you were saying earlier, Sandy, is because everyone’s trying to get married and have a more normal wedding, quote unquote, the venues can skyrocket their prices, which they’ve already started to do. Not only do you have just an expensive event happening in general but inflation is hitting the wedding industry, unlike anything else. You have to be aware for that. We like to recommend before you go off looking for venues, for wedding dresses, for caterers, you need to know what your budget is first. I think people tend to do the opposite. They find all the things and then they’re like, okay, how much money do we have? Which could lead to a lot of disappointment and then asking family for more money and just uncomfortable situations.

We would say, let’s flip that. Start with what your resources are. What do you have? What can you cash flow? What can you budget for between now and then? And then what gifts would people give you before the wedding? Because it’s hard to kind of calculate what you think people will give you on the wedding day so don’t worry about that. That’s your bonus. You need to know in hard dollars, if you’re getting any money from family, how much is it? When can you expect it? And then start the planning process with all the fun things.

David Muhlbaum: We’ve talked about how your clientele includes couples and that that is a thing that you can really speak to being one yourself. But it goes beyond that. You advise couples who are managing a business together, a bit like you are. What are your golden rules for that?

Dan Slagle: Yeah. We have three golden rules. The first is know your roles and responsibilities, have the mindset that you’re a team in life and in business, approach it that way but know when to understand when one person has the final say on a decision. We ran into some hiccups when we first started. And again, just having a better understanding of who is doing what and who has the final say when it comes to making decisions in your areas of expertise is crucial.

The other one is over communicate about everything and don’t make any assumptions. And the third would be set your personal boundaries. If you’re feeling tired of work and you just need a break, you need to communicate that with your partner because the last thing you want to do is sit down at the dinner table and one partner is really excited to talk about work or maybe landing a new project or a client and the other person is like, I need to check out. I can’t have this conversation anymore. Again, those three areas stem back to just communication. It’s definitely more of an art than a science at the end of the day and you just need to learn how to read the other person but again, just verbalize as much as possible.

Sandy Block: A lot of couples perhaps have already owned a business, inherited a business going into the marriage. And again, I’m thinking perhaps of older couples. What are your thoughts on prenuptial agreements? It’s not romantic but I read an awful lot of stories of people saying, “I sure wish we’d had one.”

Natalie Slagle: Yes. Usually, those stories are at the end of the marriage though. This is one thing that I love about prenups is it’s a clear sign that the couple is talking about money before they’re getting married. You just don’t get any more clear than that. It shows a lot right there. I think it is very, very dependent on the couple, their situation. Usually, the more wealth that an individual comes from, especially family wealth or money that will be passed down from an older generation, you have to think about, well, what happens if something happens to me? Whether it’s a death or divorce or incapacitation, how does that family wealth transfer to someone who’s married in? Something like that.

It can quickly get into the what-if scenarios. That’s why, if this seems like an area that you should just at least have a conversation with an attorney about, then you probably should. Most attorneys will let you do a phone call for 15 minutes for free and so you can just call someone up, tell them about your situation, about your preferences and they can just give you the facts about whether a prenup may or may not be in your best interest.

David Muhlbaum: We talked about the idea of financial planning as a wedding gift and that maybe that hasn’t quite panned out yet but tell us a little bit about what it’s like being in the business, how you are finding your clients, how they’re finding you and is how much of that is the fact that you guys are a couple and how much of it is just like another financial planner?

Dan Slagle: Yeah, I would say about 95% of it has to do with the fact that we’re a couple. I think specifically we work with younger clients who we’re talking millennial, gen-X couples specifically, and they’re not necessarily looking for or to work with their parents’ financial planner. They want someone who can be relatable, as I talked about earlier and approachable at the end of the day. And I would definitely say that we have a little bit of a biased sample when it comes to the clients that come to us. Meaning that they understand this is really important to work on their finances as a collective unit. Because as we go through our discovery process, we pick up things, maybe one partner had parents that separated due to financial issues. There are many issues or reasons why people come to us at the end of the day. When it comes to attracting clients, it’s really been online searches. There’s various find an advisor portals that we’re a part of. The XY Planning Network is really big for us as our business has continued to grow.

Natalie Slagle: Yeah. And then client referrals, of course. Clients, we like to take a survey on why clients chose us, why they stick with us. And like Dan said, a lot of the responses are, “Well, we really like that you’re a couple and you can relate to that. And we can talk about kind of the disagreements we have with money and it just feels like this authentic conversation.” And clients, obviously they tell their friends or their families about it. It’s been really humbling to see that the referrals have been coming in as well.

David Muhlbaum: On your website, you literally posted your asset allocation. We have this much in this and this much in this and this much in this and I believe roughly 1% was in cryptocurrency. And since you broached the idea of having a younger generation approaching you for advice, is that younger generation perhaps also showing more interest in cryptocurrencies? And what kind of guidance are you giving along those lines?

Dan Slagle: Yeah, it’s mixed. We have clients that come to us with a couple thousand dollars in cryptocurrency or clients that have maybe $50,000 in cryptocurrency. Our big take on cryptocurrency is that we definitely view it as a speculative investment. That doesn’t mean we’re not behind it at the end of the day. We do want to have an allocation because we feel like our financial foundation is in place. We have things like an emergency fund built up. We feel like we’re adequately saving for retirement. We put that percent, which you’re referencing in cryptocurrency more so as a way for us to personally learn more about it.

Natalie Slagle: As fiduciaries, we have to do what’s in the best interest of our clients, assets just need time to kind of play out. Any asset class needs time and history and data. And even though it feels like cryptocurrencies have been around for a while, a decade is not that long in the grand scheme of things. And so it’s our duty to stay up to date on anything financially related. Cryptocurrency isn’t going anywhere anytime soon and so we wanted to have that personal involvement, just like Dan said, to learn and then also to just stay up to date so we can advise our clients as well.

Sandy Block: I guess my last question, we are doing this because it’s June and the wedding month but you mentioned that a lot of your clients are millennials and what we see from numerous surveys is a lot of millennials aren’t getting married. They might be in a committed relationship, living together, but they’re not in any rush to get married or even have kids. What specific do you counsel people like that? And what kind of advice do you give them that might be different than the advice you’d give to a married couple?

Natalie Slagle: Yes. We do have couples that are living together but they’re not married. And some couples, they do have plans to get married. A lot of our advice is just, well, how are we saving for that? And then others that it’s just not a part of their long-term plan, at least for right now. For those couples, you have to think about, well, what rights do married couples have that you don’t have? And a lot of it has to do with more of the estate planning or even incapacity planning.

Let’s say Dan and I were a couple but we’re not married and something happens to me where I’m in, let’s just say a coma for a few months. Well, Dan might not have the authority to take care of my finances or make healthcare decisions since he’s not my spouse. There’s things like that, that you have to consider and have to have the appropriate planning items in place so that whoever is making the decision maybe you don’t want it to be your life partner and that’s okay. But if you do, you might need to take an extra step to make sure that authority is granted to your partner because a lot of institutions, they’ll see it as your roommate and not necessarily your partner who can make decisions on your behalf.

David Muhlbaum: Time to check with the lawyer. Well, thank you so much for your time today, Dan and Natalie. You guys have a fun dynamic that I hope comes through in audio as well. Thanks so much for joining us today.

Natalie Slagle: Thank you, David.

Dan Slagle: Yeah. Thank you very much.

Natalie Slagle: Thank you, Sandy.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review and if you’ve already subscribed, thanks, please go back and add a rating and a review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Now You Can Own Bitcoin in 401(k)s. Should You?
• Trading Options for Your 401(k)
• US Department of Labor cautions 401(k) plan fiduciaries to exercise extreme care as they consider cryptocurrencies
• Create a Financial Plan for Natural Disaster
• How to Protect Your Home from Natural Disasters with the Right Insurance

Transcript:

David Muhlbaum: What documents can you throw out, and which must you save, and where do you put them, is a debate as old as, well, writing things down. But technology and natural disasters have thrown in a few new twists.

We’ll explore the latest on keeping records safe and accessible with Rivan Stinson of Kiplinger’s Personal Finance. Also, you might be able to invest your 401(k) savings in Bitcoin, all coming up in this episode of Your Money’s Worth.

Welcome to Your Money’s Worth. I’m kiplinger.com senior editor, David Muhlbaum, joined by my co-host, Kiplinger senior editor Sandy Block. Sandy, how are you doing, and for chuckles, tell the good people where you are.

Sandy Block: I’m at a state park in West Virginia that has good wifi, and more importantly, a good bar.

David Muhlbaum: And a little room. You have your own little subsidized recording studio in there.

Sandy Block: I’m in the business center, which shockingly on a beautiful spring day, is totally empty. Everybody else is at the bar or the golf course.

David Muhlbaum: Yeah. Well, good. The truth is that we are still recording remotely here, with me and Sandy just waving at each other, and sometimes the guests, through a screen. But we have obtained a new mixing board for our studio at the offices. We are planning a return to recording in the shared human space. Will anyone notice? I don’t know yet. I’m looking forward to recording without worrying about leaf blowers, or one of our dogs barking in the background. Anyway, that’s the future, hopefully the near future. For now, Sandy, a story that absolutely caught my eye this week was the news that it’s going to be possible, at least for some people probably, to invest in Bitcoin in their 401(k).

Sandy Block: That’s right. The 401(k), which is going to be the pension plan for most of us, is messing around a little bit with cryptocurrency. Making matters even more interesting, Fidelity Investments, a giant in the 401(k) area, is the one that is involved in this.

David Muhlbaum: Yeah, it makes it this powerful headline. But splashy as it is, it hasn’t upended the retirement investing world, or 401(k)s. Look, I tend to think of it as like that’s where you invest a portion of your salary in a nice, diversified well-managed range of mutual funds, not Bitcoin, which is speculative. I’m not even arguing about the merits of crypto here. It’s not the time. I’m just saying, look at the trading range of Bitcoin, that’s volatile, that’s speculative.

Sandy Block: That’s right. If you think the stock market is volatile, take a look at Bitcoin.

David Muhlbaum: So, why?

Sandy Block: Well, I think that, certainly among young people, there is a lot of interest in Bitcoin. Fidelity is a business, and it wants to meet its customers needs. It certainly got Fidelity a lot of attention with this announcement. I think the more you hear about Bitcoin, for many people, that’s the only way they can invest is through their 401(k). So, maybe they think this is something that might catch on.

David Muhlbaum: Okay, but let’s sort out for a second who the customers are. Because Fidelity is the plan provider. They’re supposed to provide the platform by which you can invest 401(k) money. They don’t tell you what to do. Those choices of what options you can invest in, that goes to whatever company wants to use Fidelity to administer its 401(k).

Sandy Block: Right, and even then, just because they’re using Fidelity doesn’t mean that they’re going to automatically offer Bitcoin.

David Muhlbaum: It’s a choice for the customers to do that.

Sandy Block: That’s right. The customers, unlike Fidelity, have a fiduciary duty. They are required basically to make sure that the funds, and investments that they offer their workers ... It’s the federal law. It will be interesting. My guess would be that maybe some high tech companies that have a lot of young, crypto minded employees might wade into this. But really the trend in the most recent years is making 401(k)s simpler, not harder. What they found is people don’t like a lot of choices in their 401(k)s. That’s why such a huge amount of money now goes into target funds, where basically you put the money and then sit back and let somebody else manage it for you. A lot of people really do not want to get down and dirty in their 401(k)s. They would rather have someone else do it and not have to worry about it.

David Muhlbaum: At the same time, there is this subset of people who very much do want to trade and fiddle around. There’s the brokerage window, which you’ve written about, the ability to trade stocks in a 401(k). That’s popular?

Sandy Block: It’s not. The number of people who actually use the brokerage window is very small.

David Muhlbaum: Okay, but they care. I guess that’s what I was getting at, they care.

Sandy Block: Yeah. But what the brokerage window does, a large company 401(k) plan might say, "Here are three target funds," an index fund and a growth fund, and maybe offer 10 funds to invest in. Then they’ll also say, "If you would like to invest in more types of things, you can go into the brokerage window." Oftentimes a brokerage window will offer a much broader variety of mutual funds and individual stocks.

Sandy Block: Oftentimes the fees are higher, and as I said, the take up of these has not been that great, but it is a way for a company to say, "If you really want to go a little wild with your 401(k), we will let you in your brokerage window, but we are not selecting these funds for you." When you go into the brokerage window, you do that yourself.

David Muhlbaum: Right. But there is a potential tax advantage here too, for both the stocks, and very much crypto?

Sandy Block: I think one of the advantages of investing in cryptocurrency or Bitcoin in your 401(k) is that taxes on your gains are deferred until you take the money out. What a lot of newbie Bitcoin and cryptocurrency investors don’t realize is, for the purposes of the IRS, they are treated just like any other asset. If you make a lot of money in Bitcoin and sell it, you owe capital gains on that amount. If you trade crypto, if you trade Bitcoin, and it gets real high, and you take some money off the table and reinvest it, well you’re going to owe taxes on that money. The IRS is so concerned about this, that it’s right up there on your 1040, "By the way, if you owned any cryptocurrency and you made money on it, you have to pay up."

David Muhlbaum: Right. But for the 401(k) investor, yes, they won’t be taxed on those gains. On the other hand, they can’t touch them either because it’s a retirement account.

Sandy Block: That’s right, it has to sit there until you retire, and then you will pay taxes on your gains. But you’re right. I read all these stories about, "I invested in Bitcoin and now I bought a car." Well, you’re not going to buy a car with the Bitcoin that you buy in your 401(k), unless you take it out, in which case you’d pay both tax and penalties on it if you were under 59½. So, certainly the money that you invest into Bitcoin in your 401(k) is not money that you want to get at any time soon.

David Muhlbaum: Yeah. We’re not the only people sounding caveats about this idea. The Department of Labor has gone all Debbie Downer on it too, so how do they fit in?

Sandy Block: Well, yeah, this week, the Department of Labor said they have grave concerns about what Fidelity has done.

David Muhlbaum: Grave concerns.

Sandy Block: Grave concerns. That should be a concern for employers, because private employers that offer 401(k) plans have a fiduciary responsibility to manage their plans in the best interest of their employees. The federal government department that is in charge of enforcing that fiduciary responsibility is the Department of Labor. So, if the Department of Labor isn't crazy about this idea, that’s not going to go unnoticed by companies that want to stay on the good side of the law.

David Muhlbaum: Right. So, the company has the legal responsibility, and the Department of Labor is looking over their shoulder making sure that they’re staying in the lines?

Sandy Block: Right, they’re the ones who administer ERISA, which is the law of the land governing pension plans, and 401(k) plans, and things like that. Basically it’s the law of the land that says if you’re a company with a 401(k) plan, you can’t cash it out and go on a cruise or something like that. So, it’s serious.

David Muhlbaum: All right Sandy, we will see how this one shakes out. Fidelity and the crypto community versus the Department of Labor. Coming up next, we will talk to Rivan Stinson about documents. Which ones to keep, which ones to shred, and which ones to keep near you in case of emergency. All coming up next on this episode of Your Money’s Worth.

Which Documents to Keep, Which to Shred and Which to Scan

David Muhlbaum: Welcome back to Your Money’s Worth. Joining us for today’s main segment is Rivan Stinson, a staff writer for Kiplinger’s Personal Finance. While she’s covered all sorts of topics for Kiplinger, when we last had her on Your Money’s Worth, it was to talk about insurance coverage for natural disasters. Today we’ve got disaster on the brain as well, because we want to talk about, in part, recovering from disaster, the paperwork part, that is. So, welcome Rivan. It’s nice to have someone to turn to for a disaster.

Rivan Stinson: I guess.

Sandy Block: You know, we could have Rivan talk about the cost of pet care. That’s been another one of her big topics.

Rivan Stinson: Yeah, my cat takes all my money, and he probably wants a sibling.

David Muhlbaum: Well, I think it would be great if we could have Nikon join in. Will he sign the release?

Rivan Stinson: Yeah, I’ll put his paw print on it.

David Muhlbaum: Cool, because nothing sells online quite like pictures of cats. But how about this for a topic then, Rivan? What to do with your pet when disaster strikes? Like when you have to evacuate, nobody wants to leave their pet.

Rivan Stinson: Well, no. One, let’s hope that they get in the carrier. Bring them some food, water, their meds. Thank God I don’t have a sickly cat. But my problem would be getting him in the carrier.

David Muhlbaum: Yeah, of course. Okay, what about something like a rabies certificate in case you were being evacuated and having to go live somewhere else?

Rivan Stinson: Well, I wouldn’t have thought about that. I would just hope the vet still has it.

David Muhlbaum: Right. In some places they give you an actual physical tag, like a little piece of metal. On my dog, it's on her collar. You see what I was doing there? I was getting us from pets back to documents, because that’s kind of at the core of what I want to talk about. You have an emergency of some sort, and to recover from that, you are going to need access to documents. So, the core of the question, and what you’ve been exploring, Rivan, is which documents do you have to physically have with you, which can you scan, and which can you not worry about? So, that’s what I want to get to.

Rivan Stinson: Okay. Well, the easiest answer was that you can scan everything. The issue comes moreso, when do you need an original document versus a scan or a copy? Usually that’s moreso going to deal with your birth certificate. States, and any type of government agency, just does not like a copy of your birth certificate, in terms of the scan. They want that original piece to say what hospital you were born in, who is your mother, who is your father, everything like that. For that, you want to store it somewhere that will not get destroyed. Nine times out of 10, that is going to be a safe deposit box, or if you have a fireproof safe. You need to get it out of the house, put it in a Ziploc bag so nothing floods. But in everything else, digitize it. You should keep your Social Security card with your birth certificate as well. But when was the last time you pulled out your Social Security card? I rarely do, I just write my number down.

David Muhlbaum: Rivan, for someone concerned about a natural disaster at their doorstep, they know they need a go bag, packed with what they and their family absolutely must take with them. But the idea of going to the file cabinet, and getting a packet of critical documents and cramming that in there, you’re saying that’s obsolete?

Rivan Stinson: Yes. Because nine times out of 10, you probably have everything on your computer, on your phone already.

David Muhlbaum: You should.

Rivan Stinson: Or you should. Because let me take that back, my father does not, but he does have a safety deposit box, and I know where the key is at. In those types of situations, you can also probably grab your license. That is the first thing.

Sandy Block: Your driver’s license?

Rivan Stinson: Your driver’s license. First line of defense, in terms of identifying who you are to do things. These other documents, let’s think insurance policies, maybe a healthcare directive, you have a copy somewhere in the internet ether, and that’s because it’s a login account.

But now with technology also comes other issues of just remembering your 50 million passwords to get into all of these places. For that, it’s more so where are your passwords? Again, if you are old school like my dad and writes all his things down, you keep that list of passwords and your safety deposit box. Or if you’re a little more tech savvy, you can share it with a trusted friend or family member. You need to have a backup to make sure you can log back into your accounts.

Sandy Block: For a lot of people, Rivan, this might sound like a lot of work. I know one of the things we’ve talked about is, for example, doing an inventory of everything you own for purposes of filing for insurance. But hasn’t technology made that a little easier now?

Rivan Stinson: Yes. It’s literally as simple as downloading an app on your smartphone, either yours or your kid’s. Or if you happen to have a newer printer, which I do, that has a scanner, and it’s Bluetooth, put them right in there and do it. It’s moreso taking the time out t actually do that. But if you can snap a picture on your phone, you can create an inventory. You can keep your documents.

David Muhlbaum: How about doing video?

Sandy Block: Oh yeah.

Rivan Stinson: Video is also important, particularly when it comes to your home, because it’s hard to really describe in words what your home things are worth. But a photo it’s easier to see and maybe it will jog your memory in terms of, "Oh yeah, that was my great-grandmother’s cabinet. It was made of 100-year-old oak," and whatever the appraisal would be for that. But writing that down, you may forget some of those details. It’s just easier. It’s another way to record, on top of keeping maybe a Google doc that is the home inventory connected to that video. The video is just the easiest thing for you to do.

Sandy Block: Rivan, something else that you’ve written about, that for some reason, always generates a lot of reader mail, is not only where to store your documents, but how long you need to keep them. That particularly comes up with respect to tax records. Since we’re not that far away from tax day, if you could run through what you can keep, and which ones you could actually safely shred at some point?

Rivan Stinson: Okay. In general you want to keep all your tax documents about a three- to four-year rolling basis, and that’s because the IRS has about three years to audit you. You want to make sure you have the documentation to claim all the deductions, if you itemize and things like that. However, things get a little more complicated if you have a broker account, maybe you have some IRA contributions. For the broker example, you want to keep those things for 10 years, only because if IRS thinks you’ve underreported, they have a longer time period to audit you. Same with some IRA contributions.

Rivan Stinson: But in general, if your life is pretty simple and you have a W2 form, you just want to keep them for about three, four years. It also gets a little complicated if you’re a homeowner. You want to keep all of your documents until the day you sell your home, plus three years. That’s because you are going to have to prove your cost basis for your house, or your primary residence.

Rivan Stinson: That gets into, what was a home upgrade, what was this? That is all for the CPA to figure out, what is your tax?

David Muhlbaum: Yeah, because the crux of that is this exclusion in the capital gains on the sale of a house.

Rivan Stinson: Correct.

David Muhlbaum: Now, those values are, what are they, $250 for single?

Rivan Stinson: $250,000 for single, $500,000 for a married couple. That is how much of a sale you can exclude-

David Muhlbaum: From a capital gains tax level, right.

Rivan Stinson: Yes.

David Muhlbaum: So, let’s run some numbers here. What’s bringing that capital gain exclusion to the fore is in part the run up in home prices. The $250,000 and $500,000 exclusion, that hasn’t changed, but home prices sure have, and have gone up. Rivan, you had in your piece, and you actually used a sample with dollar values. I want to walk through it because I think it’s a good example of how this actually works. What you said is, you had a scenario where, let say you and your spouse bought a house 20 years ago for $200,000. Today you sell it for $800,000. So, that’s a profit of $600,000.

Now, in theory, you would have $600,000 in capital gains and only $500,000 of exclusion, so you’d owe capital gains tax on that $100,000 dollars. But if you had done renovations, you had remodeled the kitchen, the bathroom, replaced the garage door, whatever, and those all totaled up to, and were using round numbers here, $100,000, then boom, even-Steven, no tax.

Rivan Stinson: Correct.

David Muhlbaum: But to do that you need those documents.

Rivan Stinson: Correct. Because things like home maintenance such as painting and your general repairs does not count for that. So, to say on the safe side, you might as well keep everything that’s big. It just makes the CPA’s job easier.

David Muhlbaum: But this could be literally that file folder full of like, "This is the tile samples, and here are the five punch list things." Right?

Rivan Stinson: Correct.

David Muhlbaum: Digitize.

Rivan Stinson: Yes.

David Muhlbaum: Don’t take it with you.

Rivan Stinson: This is the fancy faucet that I bought for my remodeled kitchen. You got to know that.

David Muhlbaum: Right.

Sandy Block: I think either scan, or just keep receipts for all of that work that you had done. Because you don’t want to be calling up your contractor on April 14th saying, "I need all these receipts for roofs and fences and upgrades."

David Muhlbaum: That is the most fictional thing I think I’ve ever heard. You’re going to reach a contractor from 20 years ago to give you details about the job that you both left in a huff. Yeah, that’s just not going to happen.

Rivan Stinson: Yeah. So, my suggestion there if you are really paranoid person, and this will be my mother, she did it both. She does have a box, plastic bin, that has all of her stuff in it. She told me where I can find it, because she did some replacements and all that. I think she’s also scanned it. So, you can do both. It’s more so if the original document gets destroyed, you have a backup to prove everything.

David Muhlbaum: Right. Well, the destruction, which was the theme of your most recent piece about financial emergency in the time of serious natural disasters, we talked about the safe deposit box being where to bring things. But we had situations with the fires in California, and Australia for that matter, where places with safe deposit boxes were burned. It’s unlikely, it’s improbable, but it’s kind of unnerving.

Rivan Stinson: It is. For that, I would ask the bank, how do they protect those safe deposit boxes? This is why it’s important to, at least if you can, grab your driver’s license or passport, because that will be your starting point to rebuild your life. Again, most of these things we’re doing now are on the web, or it’s a scan, you just need to log in.

Maybe you don’t need your birth certificate today, but you do need to get into your bank account. That would be more important. You just got to remember your bank account login. If you don’t remember that, now where are those passwords? Did you back the passwords up with either a friend or family? Do you use a password manager, such as LastPass, which does have an emergency feature to allow others into it if you can’t? Do you use something like a Google drive? Do you keep things in your Apple iCloud? Anything that can make this quicker for you to do.

Rivan Stinson: Even if your iPhone or Mac gets destroyed, as long as you remember your Apple ID and password, you can reset all that stuff. If you are prone to forgetting, I would suggest you share it with someone that is a trusted friend or family, because Apple does not have an emergency access feature.

David Muhlbaum: Yes, I know from personal experience that an Apple ID is a difficult thing to get a reset on, but there are others that are worse. As you mentioned, getting a duplicate birth certificate or a Social Security card, but not impossible.

Sandy Block: Not impossible, and I think that’s why you want to scan all this stuff. Because if worst case, the bank burns down with your safe deposit box and those documents in it, you can track them down. It’s going to take some time, but I have done this, you can get your birth certificate if you know where you were born. You can find these things, but having the originals digitized will speed up the amount of time it takes to track them down.

Rivan Stinson: Correct. If you don’t know what office to go to, I believe the article has where you should go. I think David will list that within this podcast link. But like Sandy said, you can replace your birth certificate. Replacing your Social Security card is easier now, too. Again, you log onto the Social Security Administration website.

Sandy Block: Yeah, I recently replaced my Social Security card. It can be done.

David Muhlbaum: In the end, what it comes down to is doing the work ahead of time. We think of disaster prep as things like ... Well, are the gutters cleaned is kind of basic. But if you live in a fire zone, creating a defensible area, making sure that your roof doesn’t have brush or needles on it. I’m revealing that I don’t live in a fire zone, but I know there are things you should do. But some of that prep work is just sitting down with the computer, with the phone, and doing the administrative work.

Rivan Stinson: Yes. Make it fun. I do all my administrative tasks with a glass of wine, it’s great. Yes, you just have to sit there, and you also have to tell people where they are. I will say I appreciate the fact that every time I come home, my dad tells me exactly where his safe deposit box key is. It’s a little unnerving to keep talking about his impending death, but at least I know where things are.

Sandy Block: Since we’ve been talking so much about safe deposit boxes, I think it’s important, because we got mail on this, to remind or advise people that you should not keep estate documents in there. The reason for that is if you die, and your relatives don’t have access your safe deposit key, they’re not going to be able get to this information that they need to settle your estate.

Sandy Block: Now, in Rivan’s case, her dad tells her where the key is. But unless you have the key, if your name isn’t on the safe deposit box, you can’t get these documents. It will be kept with your lawyer, or with your executor. You could digitize, but don’t leave the original copy of your important healthcare proxy, estate documents, in your safe deposit box, because you could be in a situation where people who need them cannot get them. We get a lot of mail on this, so I think it’s important to point out.

David Muhlbaum: I have a couple more details on the will thing. I believe, in some states at least, this was the case in Virginia, the lawyer was able to essentially file the document with the courthouse, so the document is sort of always there. It’s with a seal at the court.

Rivan Stinson: That’s right. That reminds me of something I learned through research. If you don’t know, ask your financial planner, if you have one. Ask your doctors when it comes to healthcare proxies. Ask people, "Do you have a system to store this in case something happens to me?" Particularly if you don’t have family close to you to get to that.

Sandy Block: One of the things Rivan noted in her story is that if you’re gone and no one has a safe deposit box key, the bank doesn’t keep a master. Someone has to hire a locksmith to bust into your box. It’s not like you can tell the bank, "I lost the key. Let me in." They won’t do that. It’s important that you have some kind of backup, some kind of system. Don’t assume that people can get at documents in your safe deposit box if you’re not around.

David Muhlbaum: Well, to go back to the disasters, that we’ve dragged Rivan into being our disaster professional, we’re recording at the start of what we historically have thought of as, well, disaster season, if you will. Wildfires, hurricanes, of course New Mexico’s already on fire. But I think it would be good, Rivan, if you gave us a reprise, partly from last year, but partly because it’s still an issue, homeowner’s insurance. What it does for you in disasters, and what it doesn’t, and how you fill those gaps?

Rivan Stinson: First off, talk to your insurance agent before disaster happens. If you live in an area that is prone to anything, you need to understand how it works. For example, say you live in Florida. High winds for a hurricane. If damage is done by the winds, that’s a separate deductible. Or if your house is flooded, that is not covered by your standard homeowner’s insurance policy. That is a different policy that you have to buy through to someone else. With a wildfire, nine times out of 10, the insurance will cover the cost of replacement. The issue is you can’t change coverage in the midst of disaster, whether it’s wildfire, floods, a known storm, tornado. You can’t call your insurance and be like, "Hi, I think I need to add some more coverage to my home." They’ll be like, "No, we can’t sell you any more."

Rivan Stinson: They will stop business and restart at a predetermined time. That can be a little bit after even the storm is passed, because they don’t want a spike in claims. You have to do that administrative in-house work months before, just to make sure you’re covered. Again, if you’re not sure if you have enough coverage, talk to your insurance agent. They should have tools to help you estimate things, in terms of if you keep expensive jewelry at your home, if you have expensive tech, considering all of us have been working from home the past two years. If you don’t know, ask.

David Muhlbaum: Mm-hmm.

Sandy Block: One other thing you mentioned in your story, Rivan, is that a lot of people may not have enough coverage because of inflation. Prices have gone up, and the aftermath of a disaster, a lot of times labor and other supplies will cost a lot more. People need to make sure that the coverage they have now is really going to make them whole if they lose their homes, correct?

Rivan Stinson: Correct. For that, you really want to ask about an extended replacement rider. This should help you cover the cost of inflation, and things like that. This is also, it comes back to, remember your home upgrades. If you upgraded your home, but haven’t upgraded your homeowner’s insurance, that is going to take the cost of building your home way up. You need to let them know what kind of materials. You also get discounts. If you put on a new roof, that’s an insurance discount, but they also need to know so that you can be properly insured.

David Muhlbaum: Well, it’s good advice. There’s an undertone here of, "Do the work, people." I’m sorry about that, but in the end, we’ll all be better off. Thanks so much for walking us through it, Rivan, appreciate it.

Rivan Stinson: No problem.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts, or wherever you get your content. When you do, please give us a rating and a review. If you’ve already subscribed, thanks. Please go back and add a rating or review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. If you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• How to File Your Taxes for Free
• 7 Money-Smart Ways to Spend Your Tax Refund
• Earn 7.12% With Series I Bonds
• Amy Domini on the Secrets of Sustainable Investing
• Double Your ESG Impact With Funds Tied to Charities
• 5 'Blue Economy' Stocks and Funds
• Kiplinger ESG 20: Our Favorite Picks for ESG Investors
• EWG Skin Deep® Cosmetics Database

Transcript

David Muhlbaum: Environmental, social and governance investing is hot these days. So much so that we at Kiplinger now have our own editor on the beat. Ellen Kennedy will share her insights about the intersection of investing and activism. Also, how to spend that tax refund wisely, coming up on this episode of Your Money’s Worth.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com’s senior editor, David Muhlbaum, joined by my co-host, Kiplinger senior editor, Sandy Block. How are you doing, Sandy?

Sandy Block: I’m good. Finishing up my taxes right now. Did you file yours yet, David?

David Muhlbaum: Me?

Sandy Block: You said you were going to get them done this year before the deadline.

David Muhlbaum: I think it’s going to be close. I’ve roughed out a version of them. I imagine I’m going to pay what’s owed and get the extension. So at least I won’t be paying penalties for late payment. There may be domestic penalties, but I’d rather not get into that. On the bright side, I did file both of my kids’ tax returns and we, that meaning me and my kids, had a little discussion about how to claim exemption from withholding in the future, so at least someone got a little education. Actually also, I used IRS Free File so I guess I got some education too.

Sandy Block: So tax teachable moments for you and your kids. We certainly pushed IRS Free File here enough, so what did you think? What’s your review?

David Muhlbaum: You’re asking me to review software? You’re the one who reviews tax software. Well, first of all, as you know well, IRS Free File is an expression, it’s a phrase, it’s a marketing term that we and others use to get people to those filing software options that are actually free, so long as you meet the income and other requirements. IRS Free File isn’t a piece of software itself. It’s like a program. So there are many and, of those, I chose TaxSlayer. And I guess I’d say the one thing I noticed that was different from when I’ve used, shall we say, full-pay versions of TurboTax and others in the past, was that the Free File version of TaxSlayer did not offer me the ability to log into brokerage accounts and things like that to get information directly imported electronically. And that meant I had to copy and paste, sometimes even look and retype and, as we know, that’s a way to make mistakes and is tedious.

Sandy Block: Yeah, and actually TaxSlayer has gotten pretty good reviews from us, but I suspect you have to upgrade the premium to get that service, which tells us that you get what you pay for. TurboTax and H&R Block basically dropped out of Free File so the most popular tax software versions aren’t even available there anymore. So on the one hand, you get to file for free. On the other hand, you may not get all the bells and whistles you’re used to if you pay.

David Muhlbaum: Duly noted, and we should probably move on because, well, when this episode drops, it will be after that filing deadline and the only people still mucking around in software will be clowns like me who missed it. But we’re still in the tax season in a way, because now we’re in potentially the happy side of tax season, refund time.

Sandy Block: Well, refund checks or more hopefully and likely, direct deposit. And we certainly understand that this isn’t anything other than getting your own money back because you’ve given an interest-free loan to the government, but people still love their refunds. And a fat refund is probably a sign that you should consider adjusting your withholding, which you do with a W-4 if you’re an employee, but maybe that’s another-

David Muhlbaum: Yes! That’s what I went over with my kids.

Sandy Block: That’s right. Don’t give the government all your money. All right, it’s too late to do that for 2021 so let’s just talk for a minute about what to do with that fat refund. And as we’ve mentioned before, refunds are up in part because of the various stimulus programs like the enhanced child credit. While generally the goal of those was to get money out quickly, depending on how some people access them, some people didn’t really get to claim their full credit until they filed their taxes, which means a bigger refund for them.

David Muhlbaum: Okay, so I’m sure we’ve got some good solid Kiplinger eat your broccoli ideas about what you should do with that refund.

Sandy Block: We sure do, and I guess the takeaway is make your refund work for you. So I think the number one thing would be, if you’ve got any high-interest credit card debt, you want to pay that down. Interest rates are going up. The fed has pretty much put on billboards, “We are raising interest rates.” That’s going to raise the amount you��re paying on a balance on your credit card. Pay off your balance. You get a 15% return or more, you can’t get that anywhere else, so that’s number one. Build up your emergency fund is another one, and you may want to invest it because many brokerage firms will now let you open an account for less than $500 and some have no minimums at all.

David Muhlbaum: A brokerage account, or you could invest directly with Uncle Sam. You could turn that money right back around and go get you... What is the bond-

Sandy Block: The I bond.

David Muhlbaum: The I bond that’s paying 7.12%.

Sandy Block: And it’s going to go up-

David Muhlbaum: For now, for now.

Sandy Block: It’s going to go up above 9%.

David Muhlbaum: Okay, I’m going to get myself one of these. I’m going to do this as a reader service or a listener service. I’m just going to go get myself one and I’ll report back on the process.

Sandy Block: Yeah, we’ve got to talk about this.

David Muhlbaum: Yeah, okay. There are other ways that you can put that refund to use and Sandy’s delineated many more of them in... What’s it called, Sandy, the slideshow?

Sandy Block: This is a Kiplinger special. It is Seven Money-Smart Ways to Spend your Refund.

David Muhlbaum: That’s right. Do not blow it at the racetrack. Coming up next, we’ll be joined by Ellen Kennedy, Kiplinger’s editor for environmental, social and governance investing. She’ll help us decode ESG. Stick around.

Decoding ESG Investing with Ellen Kennedy

David Muhlbaum: Welcome back to Your Money’s Worth. Joining us for our main segment today is Ellen Kennedy, an associate editor for Kiplinger with a long history in the ESG space, as the jargon goes. She was an ESG manager and analyst at Calvert Investments for 15 years covering environment, climate, consumer staples, and she served on the sustainability councils of several Fortune 100 and Fortune 500 companies. She’s filed shareholder proposals on supply chain and issues like that. She served on ESG boards and councils. Real hands-on stuff. And now she’s writing for us here at Kiplinger with articles that do a great job unpacking all these acronyms we find in environmental, social and governance investing. ESG is just one of them and I think you’ll find her articles interesting, whether you’re grappling with what is this ESG stuff about really? Or maybe you’re already deep into the topic and you’d appreciate her interview with Amy Domini of Domini Impact Investments, who is a true pioneer in ESG. So welcome, Ellen.

Ellen Kennedy: Thanks for having me.

David Muhlbaum: And a welcome back also to Kyle Woodley, senior investing editor for kiplinger.com who helped bring Ellen to Kiplinger. He’ll be co-hosting with me today. Sandy Block is going to give ESG a pass.

Kyle Woodley: Hello, hello.

David Muhlbaum: So to move from who Ellen is to what she knows, I’m going to start with a definitional question. The term we’ve headlined this podcast with is ESG, environmental, social and governance investing. But let’s wade a little bit into history. When you started in this field, Ellen, it was called social investing, socially responsible investing. Can you take us back a bit please?

Kyle Woodley: Wait, did he just ask you to define the history of ESG in 30 seconds? Good luck with that.

David Muhlbaum: No, no. You’ve got a whole minute. You’ve got a whole minute.

Ellen Kennedy: Okay. Well, back in the 1980s, religious groups and human rights activists started to realize that capital markets, the stock market, are a powerful tool to bring about change. So a handful of firms, like Amy Domini’s that you just mentioned, dedicated to socially responsible investing or SRI, they set the table for a way investors could avoid industries they found distasteful or unsustainable like tobacco. And they also tried to work with these activists to pressure corporations to change. So SRI investors were asking the question, how can we use investing to maximize positive impact in the world?

David Muhlbaum: So investors, they were part of the fight against big tobacco?

Ellen Kennedy: That’s right, David. And as SRI investors became more and more successful, the mainstream investors sat up and took notice. They realized that some sustainability issues really could affect a company’s bottom line or what we call material, and so environmental, social and governance or ESG investing was born in the mid 2000s. They asked the question, how can we harness sustainable opportunity or risk to improve performance?

David Muhlbaum:

They being investors?

Ellen Kennedy: Yes, the ESG investors. Yes, so nowadays we have this huge mosaic of many, many sustainable investment approaches. ESG has two levers it can pull. If you imagine a box with two up and down vertical levers in front of you, the first one is deciding how much you want to invest to avoid risk versus seize opportunity. So all the way at the top of that lever, your ESG fund will avoid investing in the dirtiest companies. And if you pull that lever chunk like in an old voting booth, it will focus on a theme like renewable energy or investing in industry leaders.

The second lever is how much the fund will try and influence a company through engagement or advocacy. So on one extreme, a fund could do nothing at all to encourage the companies that it holds to be more sustainable. And on the other hand, if you pull that lever all the way, it could meet with corporate leadership or even file shareholder proposals. There are so many combinations of these two continuums, so the mantra is ESG is not a monolith.

David Muhlbaum: Well, thank you. The history is important here, because ESG is not something that came out of nowhere. There was John Wesley, the Methodist minister, he was telling his people in the late 18th century, don’t invest in liquor, don’t invest in gambling, that sort of thing. So I think there’s also a religious component to the history.

Ellen Kennedy: It goes back to the Bible!

David Muhlbaum: We might just have been calling it differently, but language matters. So now that we’ve said, ‘Here’s what it is,’ I guess my first question would be what do you think is the biggest misperception about ESG investing?

Ellen Kennedy: Definitely that you have to sacrifice returns for gains. And most studies have shown, however, that you will do as well as or better than traditional investment approaches. Last year, there was this huge, ginormous — That’s a technical term — study looking at over a thousand other studies on the stock market performance of companies with high ESG scores. It found that a majority, 58% of the time, companies that embraced ESG beat the performance of non-ESG companies. ESG laggards beat the stock performance of ESG-embracing corporations only 8% of the time and the remaining studies showed mixed results. So again, that score was ESG 58%, non-ESG 8%.

Some other really interesting findings that came out of that study were that ESG is more likely to outperform over longer time horizons, and ESG can provide a hedge against economic or social crises. And I’d say we are facing several of those major crises these days.

David Muhlbaum: No doubt. We live in interesting times. So beyond tracking performance trends on the macro scale, Ellen, you also write about new wrinkles in ESG investing, and one that caught my eye were these mutual funds or exchange traded funds that link your investment to a charity. Let’s say you want to support an organization like the National Wildlife Federation, well, you can invest in a fund with their name on it. But here’s my question, it’s not so simple you say, or rather, these funds are not all cut from the same cloth. We don’t have time to rank them all. That’s what your article is for. But what should someone who’s trying to do good and get a good return with one of these linked funds be looking for?

Ellen Kennedy: There are a growing number of funds that donate a portion of their fees to a specific charity, and in some cases they even construct the portfolio to match the goals of the fund. So in a way, you can have your cake and eat it too. For example, the Simplify Healthcare ETF whose ticker is PINK (PINK) is actively managed by Michael Taylor. He’s a really fascinating guy. He’s a virologist who also has deep experience in biotech and also is a highly regarded hedge fund manager. Simplify is donating all of its net profits from managing the fund, or a minimum of $100,000 per year, to the Susan G. Komen Foundation for breast cancer research. The fund is in the top quartile for its category year to date according to Morningstar, so it’s really interesting to look at this.

David Muhlbaum: So to break this down, in this case, in PINK, is the fund invested in companies that are trying to solve breast cancer?

Ellen Kennedy: So remember those two levers I spoke about earlier, this actually doesn’t use an ESG screen per se. It just invests in really solid biotech healthcare stocks. It doesn’t focus on breast cancer or even on women’s health. It just uses Michael Taylor’s knowledge of that sector, which one could argue is a beneficial sector for social good and so that’s the ESG investing slant, but they don’t call themselves an ESG fund per se. And then it has this minimum $100,000 donation as well.

David Muhlbaum: Got it. So he, as a fund manager, is basically taking some of his earnings from being a fund manager and apportioning it to the Susan G. Komen Foundation?

Ellen Kennedy: Yes.

David Muhlbaum: And your returns are what you get from his fund?

Ellen Kennedy: Yes.

David Muhlbaum: Okay, got it. But there are some other funds that where the fund itself is choosing investments based on the charity with which it’s affiliated?

Ellen Kennedy: Sure. So there are a number of funds that try to combine an ESG screen that would favor what a nonprofit is trying to accomplish in the world with a donation as well. So one example that’s really interesting is the Impact Shares NAACP Minority Empowerment ETF. The ticker on that one is NACP.

David Muhlbaum: So like the charity minus one A. Right.

Ellen Kennedy: Minus one A, yes. So they actually have worked with the NAACP to design the fund. The only screen really, as I recall, is for racial equity and they then hired somebody from the NAACP who has a very deep experience in what’s called DEI or diversity, equity and inclusion to work with impact shares to talk with companies and to say, “Hey, we really want you to be in this fund. And it’s a real sign of your commitment to NAACP values to be in this fund, but you’re not quite there yet. Here’s the changes that you need to make.” So they’re really reaching out to companies and actively trying to change their policies and programs to align with those goals.

David Muhlbaum: And backing it up by saying, “Do this and we will buy your shares.”

Ellen Kennedy: Exactly, yes. So these are very attractive funds but before you invest, there’s a few things that you have to look out for as you can imagine. It would be very easy for these kind of funds to just be a marketing ploy. So you have to ask yourself is this fund designed to bring a positive impact to the cause it supports? And the example that I just gave of NACP is an example where they are trying to do that. You can also ask yourself is the company that manages the fund dedicated to sustainability? Does it actively partner with a nonprofit group it benefits to bring about change like I just mentioned? And also does the fund vote shareholder proxies or file shareholder proposals to help the nonprofit’s cause? And most importantly, make sure you’re not investing in these funds just because they donate to the charity you like. That’s just not a good way to focus your donations or your investments.

David Muhlbaum: Well, they make the donation to take the tax deduction as opposed to you. It seems a little odd, yes.

Ellen Kennedy: Exactly. And we are limited now in the amount of tax deductions we can take so this might be a way for people to have more of an impact in terms of their donations.

David Muhlbaum: Oh, that’s a good point.

Ellen Kennedy: But still, this is an investment and you need to treat it as such. You should make absolutely sure that the fund is a solid investment that fits with your own personal portfolio and your investment goals.

David Muhlbaum: Got it. Okay, we’ve talked about PINK, the ticker, and we’ve talked about green because the first word in ESG is environmental so I use that as a proxy for the color. But there’s a new color on the block too and that’s blue. So we had a piece in Kiplinger’s personal finance magazine recently about the blue economy and so, Ellen, what’s the blue economy?

Ellen Kennedy: I see what you did there with those colors. That was very clever.

David Muhlbaum: Thank you.

Ellen Kennedy: So the blue economy refers to all of the dollars spent to improve the economic health and livelihood of oceans and coastal zone ecosystems. So think about everything related to oceans which cover 70% of the world’s surface. They’re huge, but also that section of the earth where the oceans come up to the shore and we interact with them there. So we often just forget about oceans. They’re really critical to our survival and also for healthy economies. We’ve been dumping plastic and toxics in the oceans. We’ve been overfishing and removing coastal plants that help buffer the effects of hurricanes. I’ve experienced that personally because my husband is from New Orleans and the loss of so much of coastal zones in those areas that had been planted or had wild habitat there acted as a buffer to hurricanes. But when those were taken out, Hurricane Katrina, of course was able to exact a real toll on that area.

David Muhlbaum: So blue is not water, but ocean. That’s one of the key distinctions, because there are water funds out there, right?

Ellen Kennedy: That’s right, there’s a ton of water funds out there. I actually used to manage the sustainability side of one of them, but they’re often filled with utilities and water infrastructure companies and they don’t focus as much on the conservation solutions. One interesting company we’ve profiled recently is called Danimer Scientific (DNMR). The ticker is D as in dog, N, Nancy, M-R. It is developing a kind of plastic that is 100% biodegradable and compostable. It’s a small company that IPO’d in 2020 and is still proving that it can turn a profit and scale up, but it has already scored valuable customers like PepsiCo and Walmart.

David Muhlbaum:

Okay, so Danimer Scientific doesn’t handle water or oceans, but because their product is aimed at helping the oceans, that’s how they got on the list. So this screening and thinking, it also governs a much longer list that we have at Kiplinger, the Kiplinger ESG 20. Now, we rolled this out in 2021 and it’s 15 stocks and five funds that do well on meeting environmental, social and corporate governance challenges. Good corporate citizens. So Ellen and Kyle, I was hoping you guys could call out one or two from that list, which we’ll link to, but you know there are 20, so Ellen?

Ellen Kennedy: One of the stocks that I like from the ESG 20 may surprise you, it’s called Clorox.

David Muhlbaum: No, I never heard of that.

Ellen Kennedy: The ticker is C-L-X and most of us think, ‘Oh, gross. It’s bleach. It’s environmentally terrible. Why would Clorox be in the ESG 20?’ Well, first of all, aside from the environmental issues, it’s a really good pick on governance. They’ve done a good job of diversifying their board of directors. 42% of its members are women and four members are people of color. And the board is also independent, which is a great metric for understanding how a company has tried to shape its board in a way that will benefit investors and shareholders. I used to cover the household products and personal care products industries. And I remember the bad old days when Clorox was really a laggard in this area, but they did a lot of work to clean up their act and to get more involved in green chemistry. For example, if you go on a website called the Skin Deep database of the Environmental Working Group-

David Muhlbaum: Skin Deep?

Ellen Kennedy: Yeah, that’s right. Skin Deep. They provide ratings on the toxicity of thousands of different products. And so, for instance, you can find products made by Clorox that score very well because they are, for instance, bleach-free hand sanitizers. They also acquired Burt’s Bees which you may think of as a green company. And overall they’ve really worked to think about the life cycle of those products and ensure that they are just much more environmentally responsible than they used to be from cradle to grave.

David Muhlbaum: Yeah, that’s interesting. Kyle, I think we ought to look to you for a fund.

Kyle Woodley: Yeah, so if you just prefer to buy a bundle of ESG-friendly stocks and let it ride, one ESG 20 option is the Putnam Sustainable Future ETF. That’s ticker P-F-U-T, and this is an actively managed ETF whose companies either make products or provide solutions to sustainability challenges. Top holdings include science and tech from Danaher, that’s ticker D-H-R. There’s Chipotle Mexican Grill, ticker C-M-G, and that’s long been a pioneer in sustainable food sourcing. And it even holds MSCI, ticker M-S-C-I of course, which is the top global provider of ESG indexes, so there you go.

David Muhlbaum: That’s very inside, that they-

Kyle Woodley: There’s a little meta there, isn’t there?

David Muhlbaum: We’ve mentioned Amy Domini’s name a couple of times so far, and we’ve done so in part because you, Ellen, got to interview her recently. So tell us a bit more about who she is, what she’s done.

Ellen Kennedy: So I’m an Amy Domini fan girl, as I think a lot of people who came out of the SRI industry are. She’s someone I’ve admired for years. She pioneered SRI investing way back in the 1980s by founding Domini Impact Investments which is still growing strong. And she did all this as a woman in a field that was very male-dominated back then. What I appreciate most about her is her clarity. She helped develop the concept of triple P investing or investing for people, planet and profit. And she recommends avoiding companies that spell trouble in those three areas. Very simple, invest in triple P, and she’s always looking out for the next sustainability opportunity around the corner. She’s especially bullish these days on healthcare and transportation innovations, so check out my interview with her.

David Muhlbaum: We’ve gone in a number of directions with ESG. There are many more we can go to. We’ve got to keep an eye on the clock, but one of the things that just lurks in the back of my head that I want to ask Ellen before we go is, there’s a phenomenon where writing about/discussing ESG investing generates negative feedback. Is that a fair enough term for it? What is it about ESG that frankly gets some people so riled?

Ellen Kennedy: Well, I think first of all, as I said, ESG is not a monolith. It’s many things, but overall I think there’s a lot of misunderstanding about how ESG has become professionalized. And as we know, it could use more standardization but it’s getting there. And so people often read into ESG, I think, political opinions. It’s to try and find those metrics that will deliver the best return for shareholders and that’s really all there is to it. It just so happens that a lot of the metrics that were ignored by shareholders for many years are these things that lead us to a more sustainable world.

Ellen Kennedy: I actually often think of ESG, I know Kyle is also a nerd, I think of it like a Tardis, like a time machine from Dr. Who, a big red telephone box that you can get into and you can set your course for the future. And if you look at the major trends going on, a lot of them happened to be sustainability trends, climate change, water issues that we’ve talked about, equity issues we’ve also talked about, along with those other thing that investors have considered for many years, like population growth or geopolitical risk. So I really think that when people dig into the way ESG is conducted, they’ll see that it really just makes business sense and that is why so many people are turning to it now and why it’s so popular.

Kyle Woodley: Well, being a fellow nerd, I’m going to have to point out, the Tardis is blue. It is not a big red box. It is a big blue box. And sorry, ladies, I am not available. Sorry.

Ellen Kennedy: I am mortified. I thought it was red. Thank you so much. I stand corrected.

David Muhlbaum: Okay. Well, we’re sure if that’s all we have to worry about, we’re in great shape. Thank you so much for joining us today, Ellen. We really appreciate your insights and all you’ve brought to ESG coverage for Kiplinger. Thanks again.

Ellen Kennedy: Thank you. My pleasure.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you’ve already subscribed, thanks. Please go back and add a rating or review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• SECURE Act 2.0: 14 Ways the Proposed Law Could Change Retirement Savings | Kiplinger
• How the SECURE Act Will Impact Your Retirement Plan | Kiplinger
• Kiplinger's Economic Outlooks: Energy Prices
• Weekly Petroleum Status Report - US Energy Information Administration (EIA)
• Gas-Saving Tips That Actually Work
• Electric Vehicles Take Charge in 2022
• 10 States with the Highest Gas Taxes
• 10 States With the Lowest Gas Taxes

Transcript

David Muhlbaum: Gas prices have shot up and consumers are feeling the pinch at the pump. We’ll talk with Jim Patterson, Managing Editor of the Kiplinger Letter and a long-time energy watcher about what’s behind the surge, when it might ease, and what drivers can do to cope. Also, Congress is fiddling with retirement savings rules. What should we expect? All coming up on this episode of Your Money’s Worth. Stick around.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com senior editor, David Muhlbaum, joined by my cohost, Kiplinger’s senior editor Sandy Block. How are you doing, Sandy?

Sandy Block: I’m good, thanks. Happy April Fool’s Day to you.

David Muhlbaum: Well, thank you. You know what’s another thing we’ve lost working virtually? Office pranks. I used to enjoy those a good bit and April Fool’s Day was a prime opportunity. Okay, well anyway, no joke. Those pranksters in Congress are messing with retirement savings rules again and I’m talking about SECURE Act 2.0 or rather Sandy, I’m going to ask you to talk about SECURE Act 2.0. The listeners have heard me grump about how uncreatively this bit of legislation is named and that’s going to force us to take a step back and explain the SECURE Act first which is going to eat into the time that we have to talk about the SECURE Act 2.0. So look, if your head is starting to spin, please go to the show notes. I’m going to put in an excellent explainer article about the SECURE Act 2.0. And if you’re like, retirement rules, whatever. Well don’t go away just yet because we’re going to come back with a great main segment about fuel prices and who doesn’t care about fuel prices?

David Muhlbaum: So, okay, Sandy. Let’s take a step back with these very inside the beltway terms. We’re talking about the rules that govern how you can save for retirement and then how those savings get treated from a tax perspective like when do you have to start taking money out? What happens if you want all this money to go to your heirs? We’re talking mostly about individual retirement accounts, IRAs, and those hold a ton of money on the aggregate. So people care — or should — about what happens to the rules.

Sandy Block: Right. And so sorry to bring the names back but in late 2019, Congress passed very quickly, in fact so quickly that some of us lost our breath catching up, without a lot of discussion, rules changes called the SECURE Act and that had some significant effects. And we spent a lot of time explaining those, including here on this podcast.

David Muhlbaum: Right. Although, I think that some of that was before my time on Your Money’s Worth. But you had the great Ed Slott on to cover the SECURE Act?

Sandy Block: Yes. And I have a feeling we’ll be having him on again. But we’ll put in the link to that one. So what we’re looking at now is a new set of changes that people have dubbed SECURE Act 2.0. That passed the House last week and there’s a good chance it’ll get passed by the Senate at some point and signed into law.

David Muhlbaum: What’s the elevator speech version of what’s probably a 400-plus page document?

Sandy Block: Oh yeah, yeah. It is a ton of provisions. But these are ... I’m going to just tick off the ones I think have the widest impact for retirees or people who are saving for retirement, kind of based on my mail. And number one is that if this is signed into law, retirees will be able to wait longer before they have to start taking required minimum distributions from their IRAs and other tax-deferred accounts. Currently, retirees are required to take the RMDs at age 72, and that age was actually increased in the SECURE Act. The SECURE 2.0 would increase the age to 73 in 2023, 74 in 2030, and 75 in 2033. And I think the argument for this is that if people got a late start, it gives them more time to build up tax-deferred savings until they have to start taking money out. This will be very popular.

David Muhlbaum: The basis of this scenario is someone who has enough money in retirement from sources outside their IRA that they don’t want to touch the IRA as long as possible?

Sandy Block: Right. Because you have to pay taxes when you take that money out. Now in reality, this is a fairly small group of very passionate people who can afford to wait that long to take money out of their IRAs. Because a whole lot of people have to take money out to live on. But there are people who have built up substantial amounts and they would like to postpone taking money out and, as I said, if you got a late start, maybe you worked until you were 70. Or maybe you’re still working in your 70s. You would rather wait to take that money out. So those people are going to benefit.

Sandy Block: And that leads to my second point which is another provision that will benefit what I would view as late starters. This will allow workers between the ages of 62 and 64 to contribute an additional $10,000 a year to 401(k) or other employer-offered plans. That’s up from the current catch-up contribution for people who are 50 or over of $6,500. So if you got a late start working or you’re just making so much money that you can save it all, you will like this provision because money that you put in your 401(k), eventually it’ll be taxed but it’s not taxed when you’re working. And so it’s a big tax break. So I think, again, I think people who got a late start and are really scrambling to save enough, this will benefit them. The SECURE-

David Muhlbaum: So again, the income profile you need for that is that you weren’t making enough money or you weren’t saving enough money.

Sandy Block: Right. Right, right.

David Muhlbaum: Which is a distinction there. Now you are making enough money and you’re trying to make up for lost time.

Sandy Block: Exactly. And you would have to be making a lot of money because you can already put more than $26,000 in your 401(k). So we’re talking big bucks here. But there are some people who might ... At least it gives the people who have the ability to save that much the option. And the bill would also increase the catch-up contributions to IRAs which have been stuck at $1000 since 2006. They would be indexed to inflation. So gradually, the amount that you can put in an IRA which benefits people who maybe don’t have a 401(k) at work. That would go up, too.

And the final thing I wanted to mention because it’s just very interesting to me is that this bill would create a national, online database to help people track down 401(k) plans that they left with a former employer. There’s apparently billions of dollars in these orphan 401(k)s. Probably small amounts that people changed jobs, left behind, moved on. But it’s still money. It’s still money that you should be saving for retirement. And it might not necessarily even be your fault. Sometimes, maybe you left a company, you left the 401(k) there thinking you’d go back and get it and then it merged or it went out of business or something like that. So I think this is a very useful thing. Young people in particular change jobs a lot and you’re not required to move your money out of your 401(k) when you leave a job so I think there’s some money out there to be had. So I think it would be a very useful tool for people to plug their name in and see if there’s money sitting around that they forgot about.

There’s lots, lots more in this bill that we will be delving into, particularly after it’s signed into law. But those are just a couple things to think about.

David Muhlbaum: Okay, yeah, right. And Sandy, those details, we’ll be talking about them but they’re also going to be in that link that we’re going to put in the show notes. We know there’s a lot in SECURE Act 2.0. Please, check it out. We’ve got the detail right there for you.

David Muhlbaum: Coming up next, fuel prices. We’re going to talk about why they’re high, why they’re going to stay high, and what you can do about it with Jim Patterson from the Kiplinger Letter. Stick around.

High Gas Prices with The Kiplinger Letter’s Jim Patterson

David Muhlbaum: Welcome back to Your Money’s Worth. Joining us today is Jim Patterson, the managing editor of the Kiplinger Letter, who you last heard here over a year ago to tell us his publication’s forecast for the year 2021. And while as managing editor, he has oversight of the Letter and all of its coverage, he also brings subject matter expertise to the table and he has, for almost a decade now, or maybe over a decade now, provided weekly updates on the direction of energy prices for Kiplinger’s Economic Outlooks. And those you can see for free, online.

David Muhlbaum: So Sandy, last episode you and I, we had gas prices on the mind and we wanted to find a qualified guest. Well, we have one right here in-house, that being Jim. So welcome back, Jim. Thanks for joining us and putting your toddler in timeout or whatever you needed to do to find the time.

Jim Patterson: Thank you, guys. Good to be back. And yeah, my son, George, is hurting these days from the high diesel prices we’re seeing these days. He’s going to have to put his toy school buses into storage, I think.

David Muhlbaum: Oof, you’re teaching him the hard lessons early, I see.

Jim Patterson: He better learn sooner rather than later.

David Muhlbaum: Okay, well prices are going to come down?

Jim Patterson: No, the short answer is no, David. I’m afraid we’re not going to see much in terms of relief at the gas pump for consumers. I wish I could say yes, but I don’t think that’s going to be the case.

Sandy Block: Well I guess that’s not surprising but it is definitely depressing because as we’ve discussed gas prices are something that’s front of mind for anybody who’s got a car and maybe even if you ride the bus.

Jim Patterson: Right. Gas prices are maybe the most widely watched price in our entire economy. We literally have them on giant signs on every street corner. So especially when they go up a lot really quickly, everyone’s very aware of them. They know they’re paying more at the pump. They really feel it. They really feel the hit to their spending power. It’s not necessarily the biggest expense for most households, but it’s one everyone is keenly aware of. So it really affects consumer psychology a lot.

David Muhlbaum: And yet, gas prices ... I mean they’ve had a really sharp run up but they’re not a record, right?

Jim Patterson: Right. When you adjust for inflation, the record would actually be about $5.25 in today’s dollars. That took place in the summer of 2008, you may recall, right before the Great Financial Crisis hit. Energy prices skyrocketed.

David Muhlbaum: And then they crashed.

Jim Patterson: And then they crashed, right. Because suddenly, the economy went into a tailspin and demand for fuel went way down so we went from really, really high gas prices to some of the lowest gas prices we’ve seen in recent memory.

David Muhlbaum: Mm-hmm. But, giive us a little more on your near-term forecast, what you’ve got. We’re not seeing a crash this year, right?

Jim Patterson: No, no. We’ve had this tremendous spike; prices had been going up very steadily for over a year now and when Russia invaded Ukraine, that caused a lot of concern in oil markets because Russia’s such a big exporter of petroleum. So gas prices went from rising to skyrocketing, I think is a fair term. So we’re at currently about $4.24 a gallon for regular unleaded for the national average. And granted, state prices vary a lot but just talking about the nation’s average as a whole, we’re at about $4.24. And we’ve been at that level for over a week now, actually staying very close to that $4.24, $4.25 mark. And unfortunately, I don’t see them coming down much, if at all. If anything, prices are probably going to take another leg higher as spring gets here. People are going to start driving, they’re going to go on vacations. That’s the normal seasonal pattern.

David Muhlbaum: The traditional seasonal pattern.

Jim Patterson: Right. Vacation season rolls around, people pack up the car for road trips, demand for fuel goes up. Unfortunately, that will probably add some more to these already very high prices we’re seeing.

Sandy Block: Everything that I’ve seen in red, Jim, suggests that even with prices rising, there’s just so much up-demand and that in turn keeps prices high, right? People aren’t put off by these high prices?

Jim Patterson: Exactly right. It does seem like there’s a lot of evidence for what you’re saying, Sandy, that people want to get out. They want to take the beach trips or whatever that they may have been deferring the past couple of years. I see it in the weekly Department of Energy data that gets released. You can see stats on fuel consumption. And it’s going strong at a time of year where we’re late March, it’s not quite spring or not quite warm travel season yet in a lot of the country. Demand usually isn’t very strong at this time of year but it’s looking pretty good right now. And gas prices at $4, $5-plus dollars per gallon don’t seem to be putting people off right now.

David Muhlbaum: So people complain but they don’t necessarily change their behavior that much. But Lord, they sure do complain. I mean there’s a lot of pressure on politicians and others to "do something."

Jim Patterson: Right, yeah. Of course, there’s a lot of calls for the government to do something, somehow. We’ve seen a lot of what I would call stop-gap solutions. The federal government is releasing crude oil from our strategic petroleum reserve which is a series of underground storage facilities where we have stored a lot of oil in case of some sort of emergency. I don’t know if this really qualifies as an emergency but for politicians it’s an emergency when gas prices go up. So we’re releasing a lot of that stored oil to try to make up for what is being lost from Russia. We’re seeing some states, as Sandy mentioned, instituting gas tax holidays and that might help a little bit but it depends on whether the gas stations actually lower their prices in accordance with that or if they try to pocket some of those savings by keeping prices higher. It’s actually really debated amongst economists what share of state gas taxes are paid for by the motorist versus by the sellers of the fuel. We don’t really know. So in other words, if your state tax gas goes away, don’t expect to see the full amount come off the price at the pump.

Sandy Block: Although, and maybe David, you have some insight on this. In Maryland, are you seeing prices come down since the bill with the gas tax holiday was signed into law?

David Muhlbaum: I did, but the question... I couldn’t tell you because I don’t remember what the price was before. If it was exactly that 36-cent margin. And I think that’s what Jim is getting at, is that there’s a little cushion in there for somebody.

Sandy Block: Well exactly because if demand is still high, they don’t really have a lot of incentive to pass the savings on to consumers, right, Jim?

Jim Patterson: That’s right, yes. And actually, I was just looking at the data for Maryland and the price of gas in Maryland today is actually higher than it was a week ago. So I don’t think we’re seeing too much in the way of savings yet. The reality is there’s not a whole lot, whether it’s the state government or the federal government, there’s not a whole lot anyone can do in the immediate term to really lower prices. But you will see politicians try. There’s talk in California about sending out rebate checks, essentially, to every household with a car. That might sound nice to voters but it’s not really going to change the underlying dynamics of the oil industry.

David Muhlbaum: Will they be sending them out to houses with electric cars?

Jim Patterson: I read that they will be, yes.

Sandy Block: So Jim, basically what you’re telling us is that the options for lowering oil prices are pretty limited. But for people who still have to drive, what options do consumers have?

Jim Patterson: That’s a good question, Sandy but I’m going to turn that one over to David as the resident Kiplinger car guy. David, you just did something on gas mileage right?

David Muhlbaum: Okay. Well the guest is turning the tables on the host. But yeah. Yeah, I wrote something with the title, Gas Saving Tips That Actually Work. You see, I was a wee impressionable one during the gas price crises of the 1970s and 1980s. And so I remember the era when MPG and OPEC were the acronyms on everyone’s lips. Back then, the real price of gas doubled and it stayed high for years. So getting better fuel mileage was a really big thing. And that led to a bunch of gas-saving tips and myths.

So I wanted to make a list of ideas that don’t violate the laws of physics, compromise safety, or insult your intelligence. You know, ideas that work. So hey, I’ll put a link in the show notes, you bet.

Sandy Block: I’m just curious, David, what are some of the myths? Remember, I’m old enough to remember this too and people, if you stayed up late on nighttime TV, they would advertise these devices. Do you remember that?

David Muhlbaum: Yes, the gadgets. Things like magnets for the fuel lines, little fan blades to put above your carburetor and potions to put in the tank. Well those are gone now, thankfully. Oh, here’s a myth that lives on. The idea that you should buy gas in the morning when it’s cooler out because you’ll get more gas if it’s cold and the density is higher. Like most myths, it’s not totally crazy. There’s some physics that make sense in there. But the reality is, the gas you put in your car is coming from a tank way in the ground and the temperature’s going to be close to constant. The air temperature doesn’t matter so that’s one.

Sandy Block: Okay, but you also mentioned electric cars and even though there’s still a small segment of the market, as you pointed out in your story in Kiplinger’s Personal Finance Magazine, there are a lot of automakers are rolling them out. So is this a good time to buy an electric car? Is that one of your tips?

David Muhlbaum: No. Certainly, electric car owners have ever more reason to be smug right now and they’ll let you know that they’re not buying any gas. But yeah, an electric car will save you money on gas. It’s obvious on the face of it. The question is, do they save you money? And that’s way more complicated and I don’t think that for anyone looking to save money on gas, the answer is to go out and buy an electric car. Now, if you’re in the market for a car, sure, obviously gas prices are a major factor in the equations you need to run to figure out if an electric car is a money-saver for you. But it’s not easy and it’s not a sure thing for everyone. Basically, you got to drive a lot of miles to recoup that.

Sandy Block: Right. Well the other thing, and I’m going to turn back to Jim on this one. I’ve been doing a deep dive into state gas taxes and the thing that just really jumps out at anyone who looks at a map of the U.S. is the huge variation in gas prices in the country. And I think a lot of that has to do with gas taxes. Could you talk a little bit about how much a variation there are? I think the reason I’m asking that is if you’re driving cross-country, it does seem like it could save you money to wait until you’re in a lower-price state before you fuel up. But why is there such a huge difference in the price of gas?

Jim Patterson: You hit that nail on the head, Sandy. It’s really largely a tax story. The tax that different states levy on fuel really varies a lot. Some states, it’s really minimal, some states it’s a really big chunk of the whole price that you pay. There’s also some regulatory issues that play a role. Some states, like California, have really strict standards for the formulation of the gas that goes into cars there for air pollution reasons and it can be very difficult for refiners to make that fuel. So there’s maybe not a lot of fuel being imported to a state like California from, say the Gulf of Mexico.

And then there’s issues of where the pipelines are and where they aren’t. Some parts of the country, it’s much easier to move gas around by pipeline or by boat. Other places are more remote, hard to keep supplied. So it’s a combination of taxes and logistics, I would say, and regulation.

Sandy Block: And I’m here to tell you, and David knows this, too, because I think he worked on some stories about the highest and lowest gas taxes in the country. Alaska has the lowest gas tax at $0.15. Unfortunately, that’s probably not going to be worth your while to gas up there because-

Jim Patterson: That’s a long detour, yeah.

Sandy Block: It’s a long detour.

David Muhlbaum: And most of the ... When you see a car in the lower 48 with Alaska tags on it, the funny thing of it is, it probably didn’t even drive here. It came on a boat.

Jim Patterson: Probably.

David Muhlbaum: The pipeline thing, it was almost a year ago that we had this drama when it was Russian hackers, I think. They took down the Colonial Pipeline here on the East Coast. That’s a gasoline supply for a lot of the Southeast and we had real, all-out shortages.

Jim Patterson: Right. That’s a major fuel artery that supplies a lot of the Southeast and the Mid-Atlantic. It was hit by hackers last spring. I personally saw lines forming at gas stations right in my neighborhood. Actually, a lot of the news reports showing pictures of long lines at gas stations were taken on the road that I live on here in Alexandria. There must be a lot of photographers for AP or whoever who live around here. But yes, that was a huge blow to this part of the country’s fuel supply. And it shows just how vulnerable we are if something gets taken offline, even for a few days.

David Muhlbaum: That was the whole people putting gas in plastic bags scenario.

Sandy Block: Yes.

Jim Patterson: That was a little scary. People were putting gas in things they shouldn’t be putting gas in.

David Muhlbaum: Right. The government had to tell you not to put gas in plastic bags. But you know, I don’t let the government tell me what to do with anything, so-

Jim Patterson: I’m going to put my gas where I want to put my gas, darn it.

Sandy Block: I do remember though in the 70s stories and I remember a friend of mine telling never to tell anyone this, that his friend buried gas in their yard. And I always wonder if some of that’s still out there.

David Muhlbaum: Oh my God. Now they live on a Superfund site.

Jim Patterson: Yeah, probably long since seeped into the ground and poisoned the soil.

Sandy Block: Yeah, probably.

David Muhlbaum: Great.

Sandy Block: But that is a question, Jim. I mean, again, referring to the 70s and this speaks to my age, are we at any risk of -- we know gas is costing more -- is there any risk in all of this scenario of shortages?

Jim Patterson: I think there is probably a pretty good chance of at least some limited shortages. And I don’t want to sound alarmist about this. I’m emphasizing the word limited but especially this summer, if we have a lot of people driving, going on vacation, there might be parts of the country where some stations are running low or running out. And it’s not because of a lack of gas itself. Our stockpiles are not that low. We have enough gas in storage and enough crude oil, et cetera. But it can be difficult to get enough truck drivers to drive the tanker trucks to resupply those gas stations when demand is high. There were some instances of that last summer. A source of mine warned me that that would be a problem and it did crop up in a few places. And it’s places you would expect where people are going on vacation or beaches or resort sort of areas. Places where there might not be a whole lot of gas stations. And then suddenly, there’s a lot of demand and maybe there aren’t enough tanker trucks to get out there to fill up those stations again.

So I think that if nothing else, people should be alert for that possibility when they’re going on vacation this summer. If they’re going somewhere that’s a popular destination, a lot of cars on the road, that could happen. I don’t think we’re talking about the 70s where we have gas rationing and things like that, genuine shortages. But there could at least be some, I would call them spot shortages.

Sandy Block: Spot shortages, yeah, okay.

David Muhlbaum: So we’ve been throwing around oil prices and gas prices kind of loosely but as Jim can tell us, that’s hazardous because there are very specific prices for oil depending on what kind, where it’s delivered, that sort of thing, what’s it, West Texas Intermediate is one of the terms, I believe.

Jim Patterson: Right. That’s the one you often see cited for the U.S. That’s considered the U.S. benchmark for crude oil.

David Muhlbaum: But gas prices, well we’ve talked about regional variations and all that but, gas prices are like what I paid for gas. What did it cost to fill up last week. Anyway, what I’m trying to get at is that one of the things that people sometimes fixate on is the lag-time between movement in oil spot price and what they pay at the pump. It’s kind of similar to what we spoke of before when perhaps a state implements a gas tax holiday and then that doesn’t show up. And anyway, so oil prices, they come down from a peak but gas prices stay stubbornly high. And the consumer scratches his chin and says, "Well that ain’t right." What’s happening?

Jim Patterson: That’s a good question, David. I think that to some extent, it’s gas station owners who paid X amount for a delivery of fuel and they’re not going to be rushing to lower their prices even if the spot market price for crude oil comes down. There may also be-

David Muhlbaum: Because they’ve got 2,000 gallons sitting in the front yard.

Jim Patterson: Right, right. And they paid almost as much as you, the consumer, paid. There’s not a big difference between what the station paid to take delivery of that load of fuel and what they’re going to charge you. There’s not a big margin, in other words, they’re not making much of a profit here. Actually, gas stations don’t make very much money from selling gas. They mostly make their money from selling snacks and drinks and things like that that people buy when they stop for gas. So it’s a low margin business. They’re at the mercy of the markets as well. It might be a big loss for them to quickly cut their prices after they paid a lot for, as you said, 2,000 gallons of more expensive fuel. And there’s always some certainty about whether prices are going to keep dropping so they might be hesitant to really lower their prices. Until they see their competitors down the street doing it.

David Muhlbaum: Mm-hmm (affirmative). And I’ve seen some lobbyists, too, for the convenience stores saying, "Hey, we don’t immediately jack up our prices either. We don’t bounce up with the spot price of oil. So cut us some slack on both sides, please."

Jim Patterson: Consumers tend not to complain when prices come down a lot.

Sandy Block: It sounds like what you’re saying is we won’t see gas prices come down until there’s a prolonged drop in overall oil prices.

Jim Patterson: Right. I mean we already had very expensive oil prices before the Russian invasion of Ukraine and then that added what I would call a risk premium to the price of crude oil. And even if peace broke out tomorrow, oil would be unlikely to really drop a lot in price. Global oil market was already very tight. There wasn’t a lot of what’s called spare capacity meaning extra production that could be brought online quickly to meet extra demand. Demand has been coming back faster than supply has been coming back since the pandemic when global oil consumption really cratered. A lot of production was shut down. It’s a slow process to bring oil production back online once it’s shut down. So I think this is a case of supply struggling to keep up with demand already and then we have this tremendous geopolitical shock from the Russian invasion.

So yeah, unfortunately Sandy, I think oil prices are going to stay high. I think that means that we, the consumer, are going to continue to pay high prices at the pump. The question maybe is, how high are we talking about? $4 a gallon or $5 a gallon? As I said earlier, we’re about $4.24 right now. I think there is a real possibility we could see a peak sometime this spring or summer, close to $5 again. And again, I’m talking national average. I know some states are already above that point but if you’re following the national average, I think we could be talking about a number that starts with a five sometime this spring or summer. Because as we’ve talked about, demand is really strong; supply is struggling to keep up. Things could get worse in Ukraine before they get better. We could see more Russian oil being cut off from the global market. So I wouldn’t rule out the possibility that we go a good bit higher sometime this spring or summer.

David Muhlbaum: Well, it’s not good news but it is informed news. And so I think we’ll wrap up there with Jim’s précis of his forecast because you know what? He’s got to write another one because Kiplinger’s Economic Outlook on energy prices is updated weekly. So we’ll put in a link to that. You can check it out online. You could bookmark it. You could keep coming back to see what Jim has forecast for fuel prices, energy prices, looking ahead.

David Muhlbaum: Thanks for joining us, very much, Jim. We appreciate your insights.

Jim Patterson: My pleasure, guys, I enjoyed it.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and review. And if you’ve already subscribed, thanks. Please go back and add a rating and review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episode’s transcripts and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Kiplinger’s Economic Outlooks: Energy Prices
• How Much Will Home Prices Continue to Rise in 2022?
• Home-Sale Prices in the 50 Largest Metro Areas
• Kiplinger’s Economic Outlooks: Inflation
  

Transcript:

David Muhlbaum: Houses are scarce. Home prices are high, and the all-cash offer is king. We’ll talk about buying or selling a house in this market with contributing writer, Daniel Bortz. Also, why do high gas prices hurt so badly? All coming up on this episode of Your Money’s Worth, stick around.

Welcome to Your Money’s Worth. I’m Kiplinger.com senior editor David Muhlbaum, joined by my cohost Kiplinger senior editor Sandy Block. Sandy, how are you doing? Is the car still working?

Sandy Block: It’s hanging in there. I just doubled its book value today by filling up the tank.

David Muhlbaum: That’s an old Yugo joke. Is that a comment on the low value of your Subie or the high price of gas?

Sandy Block: I would say both.

David Muhlbaum: Huh. Okay. Well, I filled up my car today too, which I just discovered was a mistake because Maryland signed a gas tax holiday like today, I think.

Sandy Block: Yeah.

David Muhlbaum: So the price should come down fairly soon. Now the gas tax here is about 36 cents per gallon, but truth be told, I don’t know that I could have held out much longer. I was on vapors.

Sandy Block: Yeah. I was thinking that a car guy like you knows better than to run the car on low.

David Muhlbaum: I should know better. Look, people get weird about gas prices. They seem to have this outside effect on the psyche and politicians are responding like with these gas holidays. Now I would really like to do a full episode on fuel, right? Gas prices, fuel economy, where to buy it, how to save it, all that sort of stuff. We’re kind of still hunting for the guest. But I did have an email exchange with one of my gas sources, John Eichberger, at the Fuels Institute. So basically the question was what I mentioned in the intro, like why do gas prices matter so much? Like they matter beyond the actual percentages.

Sandy Block: Right. It’s not a linear relationship. You don’t get 20% more annoyed by a 20% increase. So what did he say?

David Muhlbaum: Well, yeah, he called gas prices, quote, “the most transparent and advertised consumer price point in the market and a bellwether for consumer sentiment. ” And then he cited what research the organization did. I’m going to quote it again. He said, “during a five-year period in which we, that’s the Fuel Institute, surveyed consumers every month, typically 70 to 80% of consumers said the price of gasoline had a significant effect on their feelings about the economy in general.”

Sandy Block: Right. So I mean, and it makes sense to me because I don’t remember from week to week how much eggs cost, but every time I step out the door, I see how much gas costs. So it’s the visibility, right?

David Muhlbaum: Yeah. Yeah. And the frequency. Like you buy gas probably more often than you buy eggs. I mean, it’s a transaction that people do often.

Sandy Block: Yep. Yeah. And oh, unless you buy an electric car, I guess.

David Muhlbaum: Oh God, Sandy, why do you have to yank my tail? Anyway, if we do come back to gas prices and I do want to get back to this and get on because we have a long segment coming up about housing prices, I promise to talk about whether electric cars actually save money. But yeah, we’re going to talk about another sector with high prices, housing, stick around.

The 2022 Real Estate Market with Daniel Bortz

David Muhlbaum: We’re welcoming you back to Your Money’s Worth. Daniel Bortz, a contributing writer who has covered real estate for Kiplinger for the last few years to talk about the housing market today and what it looks like for sellers and buyers, as well as homeowners with no intention of selling or buying. We’ll get into some of the “do this, don’t do that” specifics of what is probably still the most complex transactions people ever get into. Thank you for joining us, Dan.

Daniel Bortz: Thanks for having me, David.

David Muhlbaum: You know, housing is a big field to cover. I don’t envy your assignment here. I mean, I’m supposed to know something about cars and if my editor, who is your editor, said write an assessment of the car market today, I’d probably have a panic attack. So my congratulations for filing your piece, but Sandy and I, and people who were listening to us last year, well, they know, and we know, that you have a secret weapon, Dan, tell us again what it is.

Daniel Bortz: Well, I’m a licensed real estate agent.

Sandy Block: Okay. Very cool. But do you actually use it and how does that help you in your writing and reporting on this topic?

Daniel Bortz: So probably the other secret is that I’m not an active agent anymore. I sold real estate for five years, and then I changed my license to referral only. So now when I hear of someone looking to buy or sell a home, I refer them to a good buyer or seller agent in their area. But retaining my license does benefit me in the sense that I’ve built relationships over the years with a lot of real estate agents, mortgage lenders, and other industry professionals who I keep in touch with. They let me know what they’re seeing firsthand in their housing markets and what topics I should be covering as a reporter.

David Muhlbaum: Well, here in the journalist world, we think it’s pretty cool that you have a license. I dropped your name past someone here and they’re like, “oh, do you mean the guy who has his real estate license?” Anyway, now we’ve reestablished your bona fides, let’s get to some of the facts that you uncovered about real estate, still hot.

Daniel Bortz: Smoking hot. With record-low mortgage rates, saving accounts that are still plump with stimulus checks, and a healthy increase in wages, millions of home buyers flooded the housing market last year. And that surge in demand paired with the lowest home supply in more than two decades, and sent U.S. home prices to what I would describe as stratospheric highs.

David Muhlbaum: What are some of the numbers? For 2021, I guess?

Daniel Bortz: So median existing-home sale prices rose 14.6% in 2021. Sale prices reached an all-time high of $361,700 by the end of December. And that’s a $46,000 gain compared with the previous year.

David Muhlbaum: So, that’s like a national average price?

Daniel Bortz: Yes, exactly. And then if you look closer to specific metro areas, Austin, Phoenix and Las Vegas saw the biggest home price gains last year among the 50 largest U.S. metro areas.

David Muhlbaum: Yeah. In fact, that reminds me, we have a chart of that data exactly. And I’ll drop in a link to that so you can go check out what your metro did, which people might find interesting.

Daniel Bortz: Yeah. I think that would be really helpful for a lot of people.

Sandy Block: Obviously, seller’s market. How many years are we on this seller’s market? And let’s get to the most interesting thing, does this pressure continue for 2022?

Daniel Bortz: That’s a great question. It’s been an unequivocal sellers market since I would say mid-2020, which is when real estate inventory took a nose dive largely due to the pandemic, as I’m sure you can recall, a lot of people were kind of holed up in their homes and that affected home sellers, too, who were a little hesitant to put their houses on the market. Buyers were hesitant to go look at homes. So we saw a significant drop in inventory. But most real estate economists expect that these rapid home price increases that we saw in 2021 are going to slow down this year.

Danielle Hale, she is realtor.com’s chief economist. I spoke with her for the article and she is predicting that U.S. home prices are going to grow 2.9% this year. So slower than last year, and she attributes that to an expectation of mortgage rates going up this year and higher mortgage rates may change how aggressive buyers can be with their offers on houses.

David Muhlbaum: So, to do a little slicing on the numbers, if we’re looking at roughly 3% for home price increases in 2022, another way of saying is, oh, it’s about a quarter of the price gains of 2021, which – am I overplaying that? I mean, it’s still a gain, but it might be a gain that’s below inflation at large.

Daniel Bortz: That’s a good point. I think you always have to keep inflation in mind and especially right now when inflation recently hit what? A 40-year high.

David Muhlbaum: Yep.

Sandy Block: Yep.

David Muhlbaum: All right. So maybe there’s some hope for the buyers in 2022, but in this environment, it has not been good for first-time buyers, right? I mean, rents continue to soar and the prospect of home ownership, that vaunted smart investment that you’ve heard here and elsewhere, it remains kind of elusive.

Daniel Bortz: I completely agree. In many housing markets, especially where home prices have exploded during the pandemic, first-time buyers, they’re really having a tough time affording a home purchase. Let me give you an example. So Boise, Idaho, the median price for an existing home was about $474,000 in December. And that’s about 10 times higher than the city’s median income. In Phoenix, the median sale price for an existing home hit $446,000 in December. And that was a 26% increase from December 2020. And it’s a challenge there for first-time buyers who earn the city’s median income of $57,500.

Sandy Block: Yeah. That’s really striking. And it’s interesting to me because some people who live across the street from us just sold their house and moved to Boise because in this area $446,000 sounds like a deal, but you’re right, that’s way higher than the median price for people who actually live and work there. Is there a rule of thumb for what’s considered affordable because that could help us compare these cities? Like, where is it better?

Daniel Bortz: Right now, rust belt cities, Columbus, Ohio, Harrisburg, Pennsylvania, and Indianapolis. They offer buyers more affordable homes. The median home sale price in all three of those cities is still less than $275,000. But to answer your question about a rule of thumb, whether you can afford to buy a house largely depends on what’s called your debt to income or DTI ratio. And this is the percentage of your monthly gross income that goes towards paying down your debts. We’re talking credit card debts, student loan payments, and your future mortgage payments. And as a general rule, to qualify for a conventional mortgage, your DTI ratio cannot exceed 36%.

David Muhlbaum: Ah, got it. So that’s interesting. We have these two metrics. We have one, this ratio we’ve talked about of the median sale price and the median income. That’s kind of more for planners, economists, and that sort of thing. When you’re looking to buy the home, we’re looking at the DTI ratio, the debt to income. Got it. Because most purchases are financed. So for the home buyer, first-time or not, who’s looking at these prices and not deterred because they want a house, they need a house, what’s it going to take to get one, to win these bidding wars that we keep hearing about – besides spending a lot of money?

Daniel Bortz: They’re going to need to be flexible. Some things haven’t changed. You still need to get pre-approved for a mortgage, for example. And that’s a key move because it can really be a reality check on what you can afford. So you want to get pre-approved before you even go out and start looking at homes. That way you go in knowing how much house you can buy.

David Muhlbaum: Okay. I understand the preapproval thing, that’s always been a good rule, but there’s so many of these cash offers going around. It’s like up to a quarter of home sales. Actually, can you help us out here? Really, what does all-cash mean? It’s not like people roll up with their trunk full of benjamins. And help me out with why it holds appeal to buyers. I mean, a seller gets paid at closing unless they’re doing some kind of owner financing weirdness. So why exactly do they care about how the buyer raises the money?

Daniel Bortz: All-cash buyers have a big advantage over buyers who need a mortgage because there’s no guarantee that lenders are going to fork over the money. A lot can get in the way of someone qualifying for a mortgage, everything from a subpar credit score to a low home appraisal, there are a number of issues that mortgage borrowers can encounter before they actually get final approvals for their loan. So sellers prefer cash offers because if a mortgage buyer’s financing falls through, it’s back to square one, they have to go out and look for another buyer. Buyers also have to compete right now with investors, and investors are scooping up a ton of real estate these days. Looking at the numbers, investors made up 27% of all single-family home purchases in the first three quarters of 2021. And that’s up from just 17% at the end of 2019.

David Muhlbaum: Sandy, it’s the people who are trying to buy your house!

Sandy Block: Exactly. I got another letter this week and I’m not alone in this, but I keep getting these letters from people saying that... The first one we got was really intriguing because they offered to buy our house for what seemed like a really a large amount of money as-is — you can stay in it for six months; the only thing they didn’t throw in was a gift basket or something. And it was signed by an individual. But what you’re saying is, I’m wondering if that’s the kind of offers that people get from investors.

Daniel Bortz: So I’ve received those letters and offers in the mail as well. You probably received an offer from an iBuyer. An iBuyer is an online home buying company that goes out and purchases, fixes up and then resells properties to make a profit. Opendoor and Offerpad are two of the big players here. But what’s interesting is that for iBuyers, there are some signs that have emerged that this business model may have some major flaws. Let me give you an example. So Zillow was a big player in the iBuying field for about three years, but it pulled out last November.

Daniel Bortz: But they admitted that their iBuying arm lost more than $420 million dollars in the three months ending in September 2021. Now, for context, that’s roughly the same amount of money that the company had earned in total during the prior 12 months. So Zillow’s chief executive, he came out and said the company’s algorithm wasn’t as good at estimating home price values as they thought it was. And then when Zillow stopped its iBuying program, they were, unfortunately for them, left with thousands of houses that were worth less than what they had paid for them.

That’s a crazy story. In a weird way, it’s sort of like they tried putting their money where their mouth was, but then.... I mean, if the algorithm didn’t work for them, it maybe didn’t work for some other people. Anyway, that was quite a doozy. But let’s say if you have a house to sell, you might be listening to us and steepling your fingers and going mwahahaha, but Dan, in your article, you’re suggesting sellers shouldn’t be too cocky. You’ve got guidance for them too.

Daniel Bortz: Even though the market is super-heated right now, sellers have to be careful about how they price their homes. So one agent that I interviewed for the article told me that he’s seen sellers get too ambitious with their list price and then their home just sits on the market for weeks without receiving a single offer. So right now in this market, the best approach is to list your home at market value based on comparable properties. There are some other strategies that we recommend for sellers too.

Sandy Block: I get the sense sometimes that people actually price their home below market in hopes of sparking a bidding war. Does that work?

Daniel Bortz: It does work. There are some pros and cons of doing that. So you’re going to draw a lot of attention to your listing if you put it on the market lower than its market value. But this might seem counterintuitive, one of the challenges of being a home seller right now is getting flooded with a ton of offers. When you’re faced with 30, 40, 50 offers, comparing them side-by-side can be really difficult. I’ve talked to real estate agents, a lot of them use spreadsheets where they write down how much the offer is. But the thing that makes it difficult to compare is that there are also other factors you need to consider when you receive an offer, namely contingencies. Contingencies such as whether the buyer is going to require a home inspection, whether they’re going to require an appraisal. And these are all things that sellers are going to have to consider when they’re weighing tons of different offers.

David Muhlbaum: And yet, the contingencies, of course, matter to the buyers as well. And one of the things you mentioned there is home inspection and the guidance because we touched on this last year, your guidance is now is that a buyer should not waive that, right?

Daniel Bortz: Correct. So it’s a sticking point right now, but here’s the important thing. Buyers should not waive a home inspection. We are seeing some buyers waiving their right to home inspections to make their offers more attractive to sellers but that strategy is very risky. Instead, you should tell the sellers that you won’t make home repair requests unless they exceed a certain amount of money or unless they’ve posed a structural safety or environmental issue. That way you still have protection, but your offer is still attractive to home sellers.

David Muhlbaum: Yeah. It’s almost like you’re writing an insurance deal with a deductible cap. You’re like after this I won’t worry about it. But over that, I have an out.

Daniel Bortz: That’s a good comparison.

Sandy Block: One of the other things you hear a lot about in this very, very hot market. And I know people who have gotten these are love letters where a potential buyer will write to the seller and say you-

David Muhlbaum: You already got one.

Sandy Block: No, no, I need more love than that. Actually, I just want money. But I’ve heard a lot of stories about people writing letters saying we have a dog and two kids and we love your neighborhood and we would cherish your house and live in it forever and I know you’re getting a lot of offers, but please sell to us. What’s wrong with that?

Daniel Bortz: I’m so glad you asked about love letters because this is a topic that we frequently cover every year in the housing market feature. So love letters to sellers can tug on a seller’s heartstrings, but they can also potentially violate fair housing laws. Fair housing laws are the laws that govern discrimination based on race, religion, and other protected classes. And I should mention that Oregon actually banned real estate love letters this year for that very reason. So the advice right now is if you want to write a heartfelt note to a seller, have your agent look it over before you attach it to your offer to make sure that it doesn’t pose any fair housing concerns.

David Muhlbaum: How about as a seller? Should you consider not even opening the envelope?

Daniel Bortz: Depends. I have spoken to some agents who as a point of practice will not even present personal letters to their clients for fear that the client might make a decision that could potentially violate fair housing. I mean, it’s a tricky subject because this is a strategy that buyers have been using for years and a lot of sellers are accustomed to reading these letters. And some people do make emotional decisions when they sell their home and they decide, yeah, this house meant a lot to me, here’s where I raised my family. Let me give this to another couple that’s starting a family, but then of course, like you said, Sandy, some people are just laser-focused on how much money they can get.

David Muhlbaum: And so also if you’re a buyer and before you spend a long night working your prose to the shiniest, maybe you should check with the agents involved to make sure it’s not just going to end up in a burn pile. But you know, one thing that we’ve touched on and I want to come back to is well, is pricing and determining pricing. We touched on the Zillow issue, when they sort of stepped in it when they tried to become an iBuyer, but what are you looking to, and what are you recommending to people for determining that selling price and determining those offer prices? It’s really kind of the crux of the whole thing.

Daniel Bortz: So one thing that I like to track is the National Association of Realtors publishes every month sales data for existing homes. That’s something that you can use to keep your pulse on the market. Realtor.com-

David Muhlbaum: And that’s the one that the economists get into every month. That���s the sort of top number, right?

Daniel Bortz: Yes. That’s the one that tracks here’s what the median, it’s usually a single-family home, is sold for.

David Muhlbaum: And the prices that we’ve been throwing out in this podcast.

Daniel Bortz: Yes, exactly. There are a number of other websites that collect really good data that can be useful to both sellers and buyers. One site that I like is realtor.com. They do a good job of tracking what they consider to be the hot housing markets. They look at major metro areas and they’d see based on their records what homes are selling for, and they use that data to then present to users the average sales pricing in a particular zip code, in a particular city, and that’s all information that you can access just by going onto their website. And otherwise, they collect similar data, Zillow, Trulia, Redfin. These are all good resources.

But if we’re talking about, say, I wanted to sell my house, what I would do to price out my house? Setting aside the fact that I’m a real estate agent, I would lean on whoever I hire as my listing agent to compile the most accurate, most recent comparable properties for me. Those estimates that you get of your house value online Zillow’s estimate and all the other websites, those can be a little tricky because sometimes they’re not updated with the most recent data. They don’t take into consideration intangibles, like, was your kitchen remodeled in the last year? They’re basically using your property's sales history and what it last sold for and what homes are selling nearby to determine your value. But there are a lot of things inside your home related to renovations and improvements that could significantly increase the value of your house and what you should be listing it for.

Sandy Block: Maybe this isn’t fair to ask you this, Dan, because you are a licensed real estate agent, but I could see some people in this hot market where houses are on the market for a day in some neighborhoods thinking, why do I need a real estate agent? Why not do, I believe the term of art is FSBO?

David Muhlbaum: FSBO. First tell us what FSBO stands for.

Sandy Block: FSBO stands for, for sale by owner, I believe.

David Muhlbaum: Right. Got it.

Sandy Block: What’s the downside of doing that?

Daniel Bortz: So like you said, I might be a little biased. A lot of people do try and a lot of people do successfully sell homes on their own without using a real estate agent. I think there are some potential problems with that. I mean, It depends on whether somebody’s sold a home like that in the past, maybe they’ve learned a thing or two about how to navigate the ins and outs of the home selling process, but selling a house isn’t as simple as slapping on a listing price and then accepting an offer from a home buyer and then you skate your way to the closing. There are a lot of nitty-gritty things that a real estate agent can help you navigate. Like I said, one thing earlier, they can help you compare offers. Offers are written using your state’s specific sales contract, and that has a lot of legalese in there that you as an average person probably aren’t familiar with, but this is something that agents are looking at day in and day out.

So they can help you interpret offers. They are there to help you pull the most accurate comps when listing your home. If your home doesn’t appraise for the value that you and the buyer agreed upon, your agent can go to bat for you and negotiate with the buyer. Ideally, the buyer’s going to make up the difference between the sales price and the price that your home appraised for. This is only if we’re talking about a buyer who had an appraisal contingency, which is usually for buyers who are getting a mortgage because those are the ones who... A lender’s not going to lend them more money than the appraised value.

David Muhlbaum: Yeah, we could probably do a podcast on appraisals themselves. I think that point is well taken of the value of an agent, but since everyone’s got an anecdote, I will say that we did once sell a house without an agent. It was a weird situation, which where we basically had an offer we couldn’t refuse thing. But what we did use was a lawyer and he was worth the money. The transaction went well, but the reassurance that the lawyer brought to it helped a lot.

Daniel Bortz: That’s a great point. I mean, you can hire your own real estate attorney and pay them by the hour to help you with all the contracts and make sure you’re doing this transaction 100% correctly, and you’re passing on the ownership of your property to the next buyer. So that is a good strategy, I think, or tip.

David Muhlbaum: We never did it again.

Sandy Block: And I have to say, my anecdote is, when we bought our house at the last minute, the sellers tried to back out because they realized that they were selling it for probably less than they could get and if we hadn’t had a real estate agent, I don’t think we would’ve bought our house because he was able to make it happen. But things come up and I think that it is a very complex transaction often. And I think that’s where either an attorney or experienced real estate agent really does earn the money.

Daniel Bortz: I agree. You also have to keep in mind, I mean, for the average person, this is the largest single asset that they own. So you want an expert, whether it’s a real estate agent or a real estate attorney, you want somebody there by your side to help you through this process.

David Muhlbaum: As I said at the start, real estate is a vast topic, and we are going to wrap up with that – the value of the agent. There are so many great things to talk about and thank you for your insights into all of them, Dan, we appreciate it very much.

Daniel Bortz: My pleasure.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you’ve already subscribed, thanks. Please go back and add a rating or review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links and resources mentioned in this episode:

• IRS Free File: Do your Taxes for Free
• How to File Your Taxes for Free
• IRS Free File fillable forms
• Extending Financial Planning’s Reach
• About CFP Board: History
• CFP Board: Center for Financial Planning
• PODCAST: Why Pay Money to File Your Taxes?
• Child Tax Credit FAQs for Your 2021 Tax Return
• CFP Board: Kamila Elliott bio
• Foundation for Financial Planning
• The Financial Fiduciary Standard Explained

Transcript:

David Muhlbaum: At Kiplinger, we talk to a lot of Certified Financial Planners. They give us guidance on the best practices they’re using for their clients, and other insights into personal finance. But today, we’re going to talk to the woman who is, in a way, in charge of all of them, and how she’s working to make CFPs a more diverse group. Also, ways to file your taxes for free, all on this episode of Your Money’s Worth. Stick around.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com senior editor David Muhlbaum, joined by my cohost, senior editor Sandy Block. How are you doing, Sandy?

Sandy Block: I’m doing great. I’m feeling flush. I just opened a letter from someone who says they’re willing to buy our house as is. And I’m not going to say how much they’re offering, but it was well more than I thought our house was worth, especially given all of the dog hair that is within.

David Muhlbaum: Good for you. But it was an actual someone, like an individual, or an investment fund. Can you tell?

Sandy Block: No, I can’t tell. Actually, it read like a letter from a guy, like a guy named Tom or something. But who knows? Maybe Tom is representing an investment firm. It’s hard to tell who the source is.

David Muhlbaum: That’s interesting for sure. I mean, I get plenty of refi offers, but generally the kind of mail like that, or what you’re talking about, too, it goes right to the recycling bin. So if I got something like that, I probably missed it. But we should get back to this when we talk with contributing writer Daniel Bortz, about home sales, which we’ll do in a couple of weeks. But not right now, because we’re like a month from the April tax filing deadline, so this is probably our last chance to take a swing at taxes. And last year, we did an entire episode on how to file your taxes for free. Good for us. We don’t necessarily have to do that all again, but let’s touch on this question from a 2022 point of view because a few things have changed. Right?

Sandy Block: Right. And the main thing, or one thing, because we really like to encourage people to check out IRS Free File because you really can file for free, your federal taxes, and in some cases, your state taxes too. And this year, in order to use IRS Free File, you need an adjusted gross income of $73,000. That’s up from $72,000 in 2021.

David Muhlbaum: Okay. Well, that’s not exactly keeping up with inflation.

Sandy Block: No. And really, what is? But keep in mind, it’s the adjusted gross income, so it doesn’t mean that you made $73,000 last year, with salary and side hustle or whatever. It’s those things minus things like contributions to an IRA, student loan interest, what we call above the line deductions. But it covers a lot of people.

David Muhlbaum: Okay. I’m going to keep pushing. It’s $73,000 whether you’re single or filing jointly.

Sandy Block: Yes, as far as free file is concerned, the marriage penalty is still in place.

David Muhlbaum: Okay. So it’s $73,000 either way. Okay. Well, all right, and I noticed you were good about the mantra, “IRS Free File” because: those words in that order. I mean, we’re going to link to the IRS Free File site. But Sandy, explain again why say, a conventional web search for filing my taxes for free or something like that, why that’s fraught, what the risks are.

Sandy Block: It’s very fraught because there are a lot of so-called free programs out there from some big names like TurboTax and H&R Block, but they have all these caveats. Even if you think your filing is really simple, just something as simple as making a contribution to a health savings account would bump you up into a paid program. And what really catches people is they’ll start typing in all their numbers thinking they’re going to file for free, and then all of a sudden they find out, no, sorry, you’re going to have to pay 40 bucks.

Sandy Block: IRS Free File, unfortunately, some of the big players have dropped out, but there’s about seven software companies that offer this. They’ll process any return as long as you meet the $73,000 AGI category, no matter how complicated your return is, it will work in free file. So that’s why you really want to go to IRS Free File and not just Google “file my tax for free” because you’ll get all kinds of stuff that way.

David Muhlbaum: Right. And then within that IRS Free File offerings, those offerings you talked about, then there are some differences. Right? Some of them work with, we’ll give you a free state filing, depending. So it pays to look at the details, especially if you are hoping to get a free state filing out of it too.

Sandy Block: Right. You wouldn’t want to go all the way through it thinking you’re getting this great deal and find out it cost you a lot of money to file your state tax return. And the providers that participate are also allowed to define who ... Not everyone can use every program. Some of them will say you have to be a member of the military, or you have to be over 50, or under 50. So you have to sort of do a search and find a program that you qualify for.

David Muhlbaum: Got it. Now there’s another way to slice this. If your income is over that $73,000, there is a way to file for free that’s those free fillable forms on the IRS webpage. That’s like a tongue twister, the free fillable forms. So basically, PDF versions of the various IRS forms, and you could make more than the threshold and file for nothing if you go that route, but you better know what you’re doing.

Sandy Block: Yes. You need to know what you’re doing. All the free file fillable will do is your math. It will do the math for you, but it won’t say, as a typical software program will walk you through and say, “Did you have a home mortgage last year? We think you should take the standard deduction or not.” You’ll get no guidance on free file fillable. It is really just the forms. You fill in the numbers. It does the math. And then you can file electronically when you’re done. But I think this is probably a better option for someone who kind of knows their way around the tax code.

David Muhlbaum: Or there do remain people who, even though you hear from us and from other people time again, file electronically. There are people who simply cannot file electronically, who must file on paper.

Sandy Block: Yes. Most, the majority of tax returns can be filed electronically, but there are some that have to be filed on paper. And I can speak to that personally because when my father passed away last year, I filed a tax return on his behalf. And because I signed it as the executor, obviously he couldn’t, I was required to send it in, to mail it in, paper. That’s the IRS requirement according to the person who prepared the taxes for me. And so, not surprisingly, we still haven’t gotten our refund. Ours is one of the stacks and stacks of tax returns that the IRS hasn’t gotten around to yet.

David Muhlbaum: So how is this filing season shaping up? How are they with electronic or other filings? How’s the IRS doing so far?

Sandy Block: Well, this just in, through February 25th, the IRS says it processed about 44 million individual tax returns. That’s up 11% from the same period last year, so I guess that’s good news. But the really interesting data point I’m writing about for an upcoming issue of Kiplinger’s Personal Finance is that refunds are up. The average tax refund through February 25th was $3,473. That’s up from 15% from the same time last year. Now these comparisons may be imperfect because the tax season got off to a later start last year, and that could affect the numbers. But as you may recall, Congress approved a third round of stimulus checks last year and expanded the child tax credit. So some taxpayers who were eligible for those payments didn’t get them, and they’re able to claim them when they file their tax return, so I think that might be contributing to higher refunds this year. But people are getting more money.

David Muhlbaum: Of their own money back.

Sandy Block: Of their own money back. They’re interest free, and we will discuss this in our upcoming issue as well, why that’s really not a good thing. But no one’s going to turn around, turn away a check from the IRS.

David Muhlbaum: All right. Thank you, Sandy. Coming up in our main segment, we’ll be speaking with the chair of the CFB board about what a Certified Financial Planner actually is, and how she’s working to reshape her organization.

The Future of Certified Financial Planners with Kamila Elliott

David Muhlbaum: Welcome back to Your Money’s Worth. Joining us for our main segment is Kamila Elliott, the chair of the Certified Financial Planner Board of Standards, a nonprofit that establishes and enforces the requirements for the CFP certification. No Board of Standards, no CFPs. No CFPs, well, we’d all probably be a bit worse off when it comes to personal finance. Even if you yourself don’t directly work with a CFP, I think it’s fair to say that their influence is widely felt, and a positive one for people trying to make money, keep their money, and invest their money. So welcome, Kamila, and thank you for joining us.

Kamila Elliott: Hello, and thank you for having me today.

Sandy Block: Thank you, Kamila, for coming on. And listeners should check out my recent Q and A with Kamila in April’s Kiplinger Personal Finance Magazine.

David Muhlbaum: Yeah. We’ll link to your profile, Sandy.

Sandy Block: It wasn’t really a profile. It was more about giving her the chance to talk about her efforts to get more women and minority planners and get more young people into the profession and reach out to more women, minorities, and young people who need financial planning. And she is breaking ground there herself as the first Black CFP board chair.

David Muhlbaum: But not the first woman, right?

Kamila Elliott: Right. I am the first Black woman to serve as chair, but the first woman to hold this role was Donna G. Barwick, from ‘96 to ‘97.

David Muhlbaum: Got it, yeah. In doing a little bit of research for this episode, I looked up some of the history of the CFP board, and I’m going to quote this bit because I saved it. “The financial planning movement experienced a watershed moment on December 12th, 1969 when 13 men gathered in Chicago and outlined the first steps to further the idea that people could benefit from a profession that integrated knowledge and practices across the various areas of financial services industry.” So, that’s like the birth of CFP. But it was kind of striking to look at that and go, “Oh, yeah. 13 men.” That’s what it was. So I guess we have made some progress, or you have.

Kamila Elliott: Yes.

Sandy Block: Industry has.

Kamila Elliott: The industry has, yes.

David Muhlbaum: Well, we do very much want to talk about representation among CFPs and elsewhere. But I want to, as ever, do a bit of definitions first. And I think you’ll welcome this, Kamila, because it will help with the branding. There are a lot of people giving advice about money, and not all of them are Certified Financial Planners. Now I can’t show this in audio, but there’s supposed to be a little registered trademark, you know the R in the circle, after CFP. And we’re expected to capitalize it too, which is the source of some editorial head scratching here from time to time. So, Kamila, what is a CFP?

Kamila Elliott: A CFP professional is an individual who has met the rigorous qualifications for financial planning set by CFP Board. That includes committing to high ethical standards, attain relevant experience, complete the education requirements, and passing the exam.

Sandy Block: And so Kamila, there’s one thing you run into when you’re a writer, financial writer, is that there are tons of acronyms, letters after people’s names, lots and lots of certifications, some hard to get, some I think you just mail away for.

David Muhlbaum: A lot of them start with C.

Sandy Block: So how do you guys sort of distinguish yourself from the many letters and designations that are out there?

Kamila Elliott: So the CFP certification is a standard of excellence for financial planning because CFP professionals have met extensive training and experience requirements, and commit to CFP Board’s ethical standards. Those ethical standards require them to put their clients’ interests first, providing them with confidence today for a more secure tomorrow.

Sandy Block: And just to follow up on that, Kamila, I understand that, I actually know some people and so does David, who have taken the exam to get a CFP. And it’s not easy. I think the pass rate is not great.

David Muhlbaum: 60%, something like that?

Sandy Block: It’s not something you can just take a quick online test and become, correct?

Kamila Elliott: That is correct.

Sandy Block: It’s a difficult certification to obtain.

Kamila Elliott: Yeah. We’re going to discuss this a little bit later. But I spent some time working at a firm that supported RIAs. And when I joined, to your point, there were so many certifications, I couldn’t keep track of them. And at the time, I was a CFP professional, so Sandy, I actually sat one day, I guess I had extra time on my hands, and researched all the certifications and looked into: Is this a certification that requires a two-hour test, and you leave and that’s it? Or is there an education requirement? Is there ongoing continuing education? So a lot of these certifications do vary significantly.

David Muhlbaum: Okay. And about you, so as chair of the Certified Financial Planner Board of Standards, what does the job entail besides talking to us? Are you elected?

Kamila Elliott: I joined the CFP Board on their board of directors in 2019. And to join the board is a self-nominating process. I think the year I applied, there were over 100 nominations and I was lucky to be one of the four that they selected. And then once you join the board, you are then eligible to raise your hand to serve as chair, so I raised my hand to serve as chair in 2020. I was elected by my board of director colleagues to serve, and I began my term in January.

David Muhlbaum: Got it. And you will serve for a year?

Kamila Elliott: Yes. It’s one term.

Sandy Block: So Kamila, in our conversation for the magazine interview, we talked about one of your goals being to increase the number of women and minority planners and attracting more young people to the profession. And I guess my question is: What are you planning to do to try and accomplish that goal?

Kamila Elliott: So one of the things I’m really proud of is that this is not a new goal for the CFP Board. There’s been a lot of focus and attention in this area because we want representation of CFP professionals to mirror the representation or the demographics of the US population. The US population is 13% Black. It is about 16% to 18% Hispanic. And our goal is to ensure that we represent the public in how we serve them and with financial planning. So one of the biggest things that we did was start the Center for Financial Planning in 2015. And part of their role is to focus on the growth of the profession and enhance the level of diversification and support firms to create more inclusion for people of color or those that are historically underrepresented.

Sandy Block: Becoming a CFP isn’t without cost. I think just taking the exam is $1,000. Are some college grads deterred by the cost? And does the board have any plans to address that?

Kamila Elliott: We have multiple scholarships available for CFP certificate education and exams. Just this week, we announced a joint scholarship with the Financial Alliance for Racial Equity, a coalition of leading financial services firms like Nationwide and Morgan Stanley, HBCUs, and leading organizations like DCIIA and the American College of Financial Services. If financing this designation is a challenge, we have a lot of resources available to you.

David Muhlbaum: Yeah. Well, I mean, they’re investing in themselves. I mean, that’s a principle of financial planning right there. But I think perspective matters here. So an amount of money that to a mid-career financial professional, it might sound like a monthly car lease payment, well, that could be the difference between someone entering this career path or not. So, $1,000 can matter.

Kamila Elliott: It does matter. But one thing I’m excited about is that there is demand for financial planners ... or I would say CFP professionals. We expect a 5% growth in this profession from now until 2030. As you probably know, a lot of large firms are specifically asking for CFP professionals to support their clients with holistic investment advice and financial planning. So to your point, David, it is an investment in yourself and it’s an investment in a very rewarding and growing profession.

David Muhlbaum: Yeah. That’s interesting you raised the question of who is employing and where the CFPs are in demand. And this is something I was thinking also, I mean, the ecosystem of financial advice, and I’m speaking broadly here, not just how it applies to CFPs, it’s increasingly tied to big firms and platforms. Kamila, you yourself worked for Vanguard for many years. So I’m thinking often it’s going to be a trading platform or a custodian that provides the gateway to a financial professional. So this is a bit of an inside industry question. But the CFP Board, you have a constituency that includes both individual operators, people with their shingle out, and probably a lot of people who are corporate employees. Can you talk about that dynamic at all?

Kamila Elliott: It is. And David, I have been in all of those. Right? I started working at Vanguard, which is a large retail organization. And then I spent some time working at a broker dealer. And then now I’m the CEO and founder of Collective Wealth Partners, which is an RIA. So working in all those different segments, I really appreciate some of the opportunities that the CFP Board has in helping these organizations support their CFP professionals, support the growth of the profession, and also the innovation that’s continuously happening within the profession. And how do we make sure that our standards and competencies continually address those challenges they have?

Sandy Block: So Kamila, I’d like to switch this conversation to the people who invest and may consult with a financial planner. In the past couple of years, we’ve seen a lot of young people entering the stock market. They’re new investors. You can invest with an app from Robinhood, that sort of thing. And they’re in turn using their existing information channels like Reddit, TikTok, for financial guidance. How do CFPs reach them? And how do you say that maybe relying on information you get on the internet is not necessarily the best way to develop a financial plan?

Kamila Elliott: And all these forums, you don’t see much conversation about short-term and long-term capital gains rates, or you don’t see conversations about whether you have the right estate plan. And we’re happy that people are talking about investing, but they often need professional help. This is true when you’re just talking about or just starting out, and you also want to gain more assets, which adds a level of complexity. But just as you see a doctor so you can have better health, if you’re working with a CFP professional, you’ll have better financial health. It’s a more holistic approach to improving your finances besides just picking or helping you choose a couple of stocks here or there.

Sandy Block: What can the financial planning industry do to reach out to people who need advice but don’t have a lot of money to manage? I’ve seen in my experience, I’ll talk to planners and they seem really great. And friends of mine will ask me for a referral. But a lot of the planners I know won’t even take your business if you have less than $1 million in assets. And that excludes a whole lot of people. So what are you doing to try and reach out to folks who need advice, but don’t have a lot of assets to manage?

Kamila Elliott: That’s a great question. And I would say we’re looking to address it in a couple of ways. One, as the CFB Board, we’re always evaluating pro bono financial planning for those that are underrepresented. The Foundation for Financial Planning was one of our key partners in offering services to those that historically have been excluded from larger firms. But Sandy, to your friends that may not fit the underrepresented, but just they’re in that spot where they’re not quite the ideal client for some firms, is focusing on more innovation and technology. And how can we provide financial advice, or support the delivery of financial advice, to scale, to ensure that these larger firms will welcome these clients and give them the support that they really need to reach their long-term goals?

David Muhlbaum: Kamila, I knew that you’d worked for Vanguard and that you had your own firm now. And you mentioned having worked for a broker-dealer. But can you tell me a little bit more about your path to where you are today and how that informs what you’re trying to do with the CFP Board?

Kamila Elliott: Sure. My path is very untraditional. I grew up in a single parent household where no one in my family had a financial advisor. I did not know what a financial advisor was until I went to college. I just ended up working at a job part-time and learned more about investments and started reading. And to your point, my first job out of undergrad was working at Vanguard, talking to participants in 401(k) plans. And so it wasn’t a concerted effort where, Sandy and David, I woke up at 10 years old, I want to be a financial planner. It really evolved over time. And I’m really proud of that story. It’s because I feel that many people like myself, young, Black women, just don’t have exposure to this industry.

And I think there’s importance in displaying. One of the things I always say is, “This is an industry where you can do good for yourself and do good for others.” And how do we articulate that message for a lot of people that when you’re looking for a career that marries maybe a love of investments, a love of talking to people and helping people? The financial planning career is something you should definitely be looking into.

David Muhlbaum: Just one little curiosity detail because you mentioned having grown up not knowing what a financial advisor was, and then working for Vanguard. Can you explain how those two came together? Because in part because Vanguard is a name that we live and breathe all the time here on the inside of the industry. Were they doing outreach? How did you get to them?

Kamila Elliott: No. So this is a comment that will age myself, David. I am from Philadelphia, and Vanguard is in Malvern, which is outside of Philadelphia.

Sandy Block: Valley Forge.

Kamila Elliott: I was reading the newspaper, and I saw that Vanguard was hiring. I was home for the weekend.

David Muhlbaum: Yay, a traditional media moment.

Kamila Elliott: Exactly, exactly. And I drove to the Malvern office. They had an all-day career fair, where they were interviewing people on the spot. This was during the 2000 tech emergence, and the stock market was doing really, really great. And they were hiring a great deal of new people. And that’s how I ended up at Vanguard. They said, “Do you have an interest in investments? Do you like talking to people?” Yes and yes. Come join us.

David Muhlbaum: That’s great. Well, I think all our Bogleheads will appreciate that.

Kamila Elliott: Yes, they will. Yes, they will.

Sandy Block: Kamila, you talked about the ability to do good for yourself and do good for others. And I think that’s a good segue to asking you about the fiduciary standard. I believe that all CFPs now are required to adhere to the fiduciary standard. And I wondered if you could explain that, and why that’s important.

Kamila Elliott: It is very important that all CFP professionals adhere to the fiduciary standard. When I think about my profession and what we do, people entrust their entire life’s worth and assets with us, and help them reach their long-term goals. And it’s really important that as CFP professionals, when we’re providing recommendations, when we’re sharing different investments, that we put the clients’ interests first, above our interests financially, and that we continuously provide support and resources for CFP professionals to make the right recommendations and to provide holistic planning and support.

One of the things that I ... In our profession, only about a third of all financial advisors are CFP professionals. And unfortunately, many people in the public may not have had the best experience with a financial professional because they were not a fiduciary. Our goal is to ensure that more and more people or CFP professionals adhere to the fiduciary standard and really uphold our profession and make it a very respectable profession because we do hold our individuals to high ethical standards and integrity.

David Muhlbaum: Okay, Kamila, this may be an elusive metric, but are there connections between stock market performance and the number of people seeking guidance from CFPs, for example? On one hand, there is this dynamic where people come to CFPs when they’ve made money. On the other hand, losing money or maybe just greater volatility probably leads to people freaking out, no, no, seeking more professional guidance. Is this a dynamic in the field?

Kamila Elliott: Yeah. People often turn to CFP professionals during pivotal moments, whether it be a global event like the pandemic, or key life moments like having their first child. So CFP professionals establish, we work with clients to help them whether life’s ups and downs, and while we do not have metrics to support the volatility point you made, David, I can share anecdotally that myself and almost every colleague experienced an uptick in inquiries during the pandemic. The uncertainty led to an increased demand for professional advice, and something CFP professionals are uniquely qualified to provide.

Sandy Block: So we’re talking to you at a time when the market is extremely volatile. There’s enormous ... We’re sort of coming out of the pandemic, but now we’ve got geopolitical events, oil prices are rising. My husband commented yesterday-

David Muhlbaum: There’s a war on.

Sandy Block: There’s a war on. Gas prices are soaring. And that makes people nervous. So I guess maybe to wrap up, what’s your advice to people right now who are perhaps spending a lot of time looking at their 401(k) and seeing on a particular day that they’ve lost a lot of money, or spending a lot of time watching the news? What should they do?

Kamila Elliott: One of the things I tell my clients, Sandy, is yes, there’s a lot of things happening. Right? There’s war. There’s increased prices. But I go back to the person. What has changed with you? You changing in terms of maybe your income, your goals, are usually the biggest predictor of making changes to your portfolio or making moves. There’s always going to be an event. Right? I mean, think about the past five years. Right? We also have a global pandemic. We had a lot of racial injustice and protests. I mean, there’s been a litany of events that have happened over the past five years that could make anyone’s head spin, and have created a lot of volatility in the market.

And if you reacted to every single event that happened, you wouldn’t be able to do what you do full-time, focus on your family, and on all of your other priorities. So my advice to people is, if you have any concerns about the market, work with your CFP professional, I hope. Work with your financial advisor. And they can help you understand how these events may impact you, or not impact you. But sometimes I say it’s important to turn the TV off every once in a while, or close that laptop down because all the noise in the markets can really be frightening and alerting for people. But it always is not necessary.

David Muhlbaum: Well, thank you very much. We’re hoping that people will now reach the end of our podcast and have a moment of zen to reflect on all those things. And we wish you lots of luck in your term achieving these goals that you’ve outlined for us. Thank you so much, Kamila.

Kamila Elliott: Thank you so much.

Sandy Block: Thank you.

Kamila Elliott: Thank you for having me.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts, or wherever you get your content. When you do, please give us a rating and review. And if you’ve already subscribed, thanks. Please go back and add a rating and review if you hadn’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links and Resources Mentioned in This Episode:

• Electric Vehicles Take Charge in 2022
• Matt D’Avellla YouTube channel
• Credit Card Interest Rates to Rise, Too
• What Does Your Credit Score Really Mean?
• Think Twice About Applying for Credit
• Consumer Financial Protection Bureau: Credit reports and scores
• Free Credit Score
• Credit Karma
• Annual Credit Report

Transcript

David Muhlbaum: Like it or not, there’s a number, a grade really, that will follow you around most of your life and affect what you pay for a number of things. We’re talking about your credit score here. What is it really? And what can you do about it? We’ll talk to Kiplinger’s credit expert about this number, or maybe it’s numbers. See, it’s complicated. Also, 2022 looks like a promising year for electric cars. All coming up on this episode of Your Money’s Worth. Stick around.

Welcome to Your Money’s Worth. I’m kiplinger.com Senior Editor David Muhlbaum, joined by my co-host, Senior Editor Sandy Block. How are you doing, Sandy?

Sandy Block: I’m doing good, David, but I just put some more money into repairing my 12-year-old Subaru and I keep thinking, I’ve got to replace this car. And I see you got cornered into writing about electric cars again. So my question is, should I buy a Subaru Solterra, which looks pretty cool. Looks pretty promising. 230 miles of range would get me to West Virginia, although maybe not back.

David Muhlbaum: Oh, yeah. Well, this is the sort of electric vehicle talk that I’m happy to do, discussing the prospect of an electric vehicle with people who are kicking the idea around, like you. It’s the political battles between the true believers and, I don’t know, the EV haters, that I try to stay out of. And that ain’t easy. So what I did in my piece is focus on the vehicles themselves. What are they like? How might they affect the market? And yeah, the Subaru Solterra was one of them, so we can get into that. But before we do, I don’t know, maybe for the sake of our listeners, we should take some of that offline.

Sandy Block: Right. And you mentioned your piece, David. You’re talking about the piece that’s going to be running in our upcoming April issue, correct?

David Muhlbaum: Correct.

Sandy Block: Okay. But even ahead of that, the Super Bowl, you probably didn’t watch it, but I did. Kind of a Bengals, Joe Burrow fan and half the ads were about EVs. The other half were about cryptocurrency. And I think both of them people have strong opinions about.

David Muhlbaum: Yeah. Which one is the future? Maybe both. Maybe neither. No, I do think electric vehicles are the future. The big question is always, are they the now? Anyway, we can get into that. But yeah, there were a lot of ads and the amount of ad spending relative to actual vehicle sales, well, that’s kind of weird. Right?

I mean, let’s remember EV sales were a bit over 2% of total vehicle sales last year in the U.S. Now, that’s forecast to about double this year, but that’s still not much. Oh. And you know who doesn’t advertise, right? Tesla, because they don’t need to. They sell all the EVs they can. Yeah. And in fact, in my piece, it’s the Tesla Model Y, the compact crossover SUV, that a lot of these new entrants, like the one you’re looking at, are gunning for. I mean, it’s the benchmark. Ford and VW already have models aimed at it. The Mach-E and ID.4. But your Subaru? Well, your aspirational Subaru.

Sandy Block: My wishful-

David Muhlbaum: Your wishful Subaru Solterra, along with cars from Toyota, Kia and Hyundai, they’re all trying to match the Model Y with features, but undercut it with price.

Sandy Block: Right. And price is key here. Right, David? Because I remember when the original hybrids came out and people did all these calculations about you pay more but you save on gas, you get a tax credit. There’s all this math involved in what you’re paying and what you’re getting. And is it worth it or should you just wait? I mean, I think a big question I have is should we just wait until there’s more of these cars and the price comes down?

David Muhlbaum: Well, and remember that the car market itself is pretty much crazy cakes right now, which I think will have an effect on these EV-or-not-EV decisions in some cases. And I can get into that. But yeah, those equations, frankly, they haven’t gone away. If your goal is to save money with an electric car, that’s getting easier to do. You still have to run the numbers, but it’s getting easier to do for two reasons. One, price of gas is going up. Two, price of electric vehicles is coming down?

Maybe that’s not really the right term. It’s not that they’re coming down necessarily. I think it’s that the gap between EVs and we’ll call them regular cars is in some ways closing and that’s happening in part because of the broad scarcity of vehicles collectively and because these new entrants, for example, that we’re talking about, like your Solterra, they still have that tax credit available from the federal government. It’s worth potentially up to $7,500.

Sandy Block: Right. And that tax credit is confusing because it phases out based, I believe, on the number of cars a particular manufacturer sells.

David Muhlbaum: Right. Which is why Tesla and GM are out. You don’t get-

Sandy Block: No tax credit free out.

David Muhlbaum: No tax credit for those. And when you start looking at the actual listings online about what the MSRP is and does it include the tax credit? Does it not include the tax credit? Some of these listings actually propose a price that includes the potential fuel savings, which is of course nebulous. Anyway, it’s pretty opaque. It takes some open eyes when you go shopping for an EV to know what the playing field is like in terms of the availability of the credit. But, there’s a website for that. I link to it in my story.

The other thing about the credit, which is a weird animal. The other thing about the credit is, we say $7,500 or up to $7,500. It depends in part on what your tax liability is, which to get really arcane, it’s not one of those refundable credits.

Sandy Block: Right.

David Muhlbaum: If you don’t have $7,500 owed in taxes, It’s not like the government’s going to write you a check for the difference.

Sandy Block: Right. Which again, and I remember this with the hybrids. I think it was maybe with the Volt, where they would post the price, including the credit, which is a little misleading because as you said, you may not get the full credit. So I think if there’s anything actionable we want to share it’s that you really have to drill down pretty deep. We didn’t even get into figuring out how you’re going to charge this thing and whether you can charge this thing.

David Muhlbaum: Yeah, especially out in West Virginia.

Sandy Block: Which is a whole other conversation.

David Muhlbaum: Oh God. Yes.

Sandy Block: And range and all this, so it’s very complicated. I think it’s interesting and attractive, and one other thing I wanted to mention in my little five-minute research into Solterra that may benefit EVs is, you can’t just go on a lot and buy a Solterra right now. You have to actually sign up and give them like a $250 or refundable deposit just to look. But, you can’t walk onto a lot and buy any car right now. All cars are scarce. So people are already sort of being programmed to having to wait to get a car. So maybe they’ll think, well, if I’m going to have to wait, I might as well check out the EV.

David Muhlbaum: Yeah, I think that’s exactly it. That’s kind of what I was alluding to in how the scarcity may, to some extent – this has become sort of my pet theory – advantage EVs, because the idea of paying money to sit on a list for a car that’s coming down the road is becoming more common. The old model of hey, go to the dealership, kick a few tires, get annoyed by the salesman and buy the car.

Sandy Block: Drive home.

David Muhlbaum: Yeah, no. Kooky car market. We’re going on a lot. Now I could probably go on more, but we’ll talk more about your Solterra later.

David Muhlbaum: Coming up next on Your Money’s Worth, we dig into credit. What a credit score is, what it means to you, how you could change it, with Lisa Gerstner. Stick around

There’s No Escaping Your Credit Score (So Make It Count)

David Muhlbaum: You probably know you have a credit score and let’s hope you have a reasonable idea of what it is. If you’ve been in the market recently for a house, a car, or maybe even a better credit card deal, you probably have a tighter idea of what it is. And maybe you wish it were higher.

Today, we’re going to dig into credit scores and credit reporting, what they mean and what you can do about them. And to help us with this, we’re joined by Lisa Gerstner, who’s been a contributing editor for Kiplinger’s Personal Finance for quite a few years, been a guest here before and knows this topic cold. Welcome back, Lisa.

Lisa Gerstner: Thanks for having me back.

David Muhlbaum: Well, thank you for joining us today. So, Kiplinger’s Personal Finance ran an interesting, frankly kind of alarming, statistic this month about how a good chunk of people who are carrying a credit card balance don’t know what interest rate they’re paying on it. And it was kind of like, yikes. So how about credit scores? I don’t know if that is fair for me to ask you to do a study on the spot, but do you have any sense of whether people generally know their scores?

Lisa Gerstner: I think depending on which study you look at, it can be something between about 40% to 60% of people don’t know their score. So I mean, that’s a pretty significant chunk. You’re talking roughly half of people don’t know what it is. So, I think there’s a lack of information out there about it, unfortunately.

Sandy Block: So David goes right to the market research shaming hypotheticals, and I’m going to try to be more helpful. Lisa, can you give us like a one or two line explanation of exactly what a credit score is and then maybe a brief history of how we got there, a nutshell history of credit scoring as a thing we all should care about. Fair, Isaac to start.

Lisa Gerstner: Yes. To start, a credit score, it’s a three-digit number that expresses how risky you are to a lender in terms of your credit worthiness. It’s calculated from your credit history, all this information that’s collected about you on your credit reports, and basically the higher that score is the better.

Lisa Gerstner: When it comes to the history of the score, there’s a couple major companies that create these scores. FICO is the big one. The creator of that is Fair, Isaac. They’ve been around for quite a while and your FICO score is the credit score that’s going to be most commonly used by lenders.

Lisa Gerstner: The other major company out there is VantageScore and VantageScore was actually created by the three major credit bureaus, which are Experian, TransUnion and Equifax. So that’s kind of a competing score to FICO. I believe it’s still not quite as prominent in terms of usage by lenders, but it is out there. Some lenders do use it. It’s also pretty commonly the one you find on free credit score websites.

So that’s the basics, two major companies that do it. When it comes to the scores themselves, they both typically operate on a scale of 300 to 850, kind of at that most basic level. There’s a ton of different ways they do it and we’ll get more into that later. For those purposes, it’s usually that scale. I think the bottom line is there are a lot of scores out there and most likely you’re not going to know exactly what version of a score a lender is going to look at, but as long as you’re practicing good credit habits and the scores that you are looking at are on the higher end, you’re in pretty good shape.

David Muhlbaum: Yeah. I heard about Fair, Isaac before I realized there was a comma in the name. You know, Fair Isaac, he’ll make a reasonable judgment whether you get a loan, because he’s fair.

Sandy Block: Uh-uh. No. No dad jokes.

David Muhlbaum: I’m a dad! So since you’re bringing my dad status into here, you know, I like to bounce stuff off my kids for perspective. And so I quizzed my younger daughter a bit about, what is a credit score? Basically the question we just asked Lisa, and she actually had a pretty good idea. Now this is a 17-year-old with no credit card and thankfully, no debt. So I was like, was that your economics class last year? And she was like, no, I got it on YouTube. My hackles went up a little bit, but no, she’d been watching this guy named Matt D’Avella. He’s a documentary filmmaker who also makes short-form stuff about self-help, minimalism, life skills. I mean, I didn’t end up watching it, but what she learned from him was spot on. It was kind of interesting.

Lisa Gerstner: Yeah, that’s great that someone that young knows, because this got me thinking about my first credit card, which I believe I got right out of high school, starting in college. And I think I knew, don’t pay my bill late. As far as I recall, I always paid my bill on time, but that’s about all I knew. I’m not sure I even knew what a credit score was at that point. So, I’ve come a long since then. And I didn’t have YouTube way, way back in the early 2000s, late ’90s, to learn about all this.

Sandy Block: Well, and I think the other problem is that a lot of people don’t become aware of their credit score until they need it, like they want a car loan or a house loan. And that’s kind of too late because you want to know how your credit score works and what you need to do to bring it up before lenders start looking at it. And I think what actually complicates things even more is that Fair, Isaac is now FICO, which isn’t as much fun for David, but it’s one of many names of companies involved in credit scores and credit reporting, which can get confusing. And sometimes I wonder if that’s deliberate because not all these companies are putting the borrower’s best interest first. I guess what I’m getting at is there are plenty of places that will happily charge you to get your credit score, but you don’t have to pay. Right, Lisa?

Lisa Gerstner: That’s right. There are a ton of free places now to get your free credit score. I think, since I’ve been covering this or the past decade or so, it’s just exploded. But to narrow it down for you, I think there are a couple of good websites you can use that cover the three different bureaus and the scores that you would get from those. One of them is called freecreditscore.com. That one is from Experian, and you can look at your FICO score from Experian there, as well as your credit reports. The other website that I like to use is Credit Karma. They cover TransUnion and Equifax with, I believe, your VantageScore credit scores from those two bureaus, as well as your credit reports. So those are kind of two easy places. If you want to get your bases covered, you can do it that way.

Also, your credit card issuer or your bank might offer a free score. Sometimes they have programs where every month say, you’ll be able to see a refreshed credit score based on the score that they are using to judge you because they do occasionally look back and say, okay, is this person still credit worthy for us? So those are some, some great free places. You typically don’t need to pay for your score.

I’ve heard in some cases, maybe if you’re getting a mortgage and you want to see the particular FICO score that a mortgage lender may or may not even be looking at, FICO does sell some of those, but personally, I’ve had three different mortgages now with my moving around and I’ve never had to do that. I just had a pretty good idea. Okay. I know my score is high because of these free websites I’ve been using and then that’s always worked out okay.

David Muhlbaum: You know, that kind of harks back to one of the things that Sandy mentioned about how some people don’t really encounter their credit score until they are buying something big. And probably the way it works is that people who haven’t had to really care about it that much are probably inherently going to have a good score because they’ve had a good credit record. On the other hand, maybe not always. Could you have a situation where if you don’t use credit a lot, then it would hurt you when it does come time for the big buy?

Lisa Gerstner: Yes, that can be a big problem, and I think that’s a good reason to get started as early as you can on using credit. Of course, you want to do that responsibly, but as a young person, once you’re able to say, maybe get your first credit card, it’s a good idea to do that. You know, you can often maybe try to go to your bank that already knows you a little bit, or maybe you can get a secured credit card, just to get started and get that credit history started. Because, say 10 years later, if you want to get a mortgage and you’ve never applied for anything before and you realize, oh, I have no credit history, they have nothing to judge me on, that can be a problem. So we do recommend to build that credit as early as you can, baby steps, and eventually that can pay off for you later.

Sandy Block: Following up on that, Lisa, talking about things that are potentially confusing or mysterious, I think a lot of people don’t know what actually goes into their credit score and to make things worse, talking about companies that aren’t always looking out for your best interest, when I listen to local news radio, I often hear all these ads for places that say they will fix your credit score or repair your credit score, or there’s some magic to it. But I think, as I understand it correctly, the basics of building and keeping a good credit score aren’t all that complicated. Right, Lisa?

Lisa Gerstner: No, they’re really not. There are a few main things you can do to boost your score or to keep it high once you get it up there. The number one always is pay your bills on time, all of your bills, whether it’s your credit cards or loans or utilities, your rent, anything.

David Muhlbaum: They’re not complicated, but they might be hard.

Lisa Gerstner: Yes, exactly. Because that does account for the biggest portion of your credit score. Payment history, that’s number one. So always make sure those bills are paid on time to the best of your ability. Even one late payment can really bring that score down. So that’s important.

The second one is just to try to keep your credit balances fairly low relative to your credit card limit. So we’re talking particularly about credit cards here, because another component of your credit score that’s fairly significant is something known as your credit utilization ratio. So, what the credit scoring companies do here is they take your credit card balance and they divide it by the card limit to come up with a percentage. Say you have a $2,000 balance on your credit card and your card limit is $10,000. Your utilization ratio is 20%. And they do calculate that both on your individual credit cards and in the aggregate across all of your card accounts. So be thinking about that. When you’re using your cards, try not to let the balances get maxed out, not too high, because they don’t like that. Basically, the lower that ratio is the better.

David Muhlbaum: Okay. That’s where I thought you were going to say a magic number, because this is one of the things I was always wondering. Is there really a magic number? And lower is better, higher is bad? What is it? I’ve heard 30%.

Lisa Gerstner: Yeah, the common advice is try to keep it below about 20% to 30%. On the main credit card I use, I actually have a notification comment on my text message where if I’m getting above 20%, I try to think, okay, I should probably keep that down. But that’s the baseline. What I’ve always been told about this directly from the credit scoring companies is the lower that is, the better when it comes to that ratio.

David Muhlbaum: Okay. Now I’m going to ask a real detailed follow up question with personal interest. This question of utilization of your credit availability applies even if you’re the sort of person who likes to run your card to rack up rewards or that sort of thing, and you pay every month. That doesn’t solve it, right?

Lisa Gerstner: Right.

David Muhlbaum: You could still be above that magic 20% to 30% even if you’re paying your credit card and not using a revolving debt.

Lisa Gerstner: That’s right, because it’s kind of a snapshot. So when your credit card lender sends this information to you, the credit bureaus for your credit report, it’s just a snapshot in time. At this time, your balance is 60% of your credit limit. So, that’s where that ratio is going to come in. Even if you pay off the bill and a couple weeks later, it’s down to zero. You don’t necessarily know when that’s going to get sent in, so it’s good to just keep it low all the time if you’re really concerned about keeping that credit score up.

David Muhlbaum: And another question that I think will possibly help, not just me, but the listeners at large.

Sandy Block: Other people in your house?

David Muhlbaum: No. All you good people. If you’re in that situation of pushing up against a balance that you can afford to pay off at the month, you should be also in a situation where you could call or contact your credit card issuer and say, make my limit higher, please, because you’re a proven good risk.

Lisa Gerstner: Yes. That is absolutely an option. If you’ve been a good customer, maybe if your income has gone up... I know sometimes when I log into my credit card account, they’ll ask me, oh, what’s your current income? And they take that into account too when they decide your credit limit, so that could help you get a higher limit. But it certainly never hurts to ask. And especially knowing, during the pandemic, when the recession was happening and there were lots of bad things going on in the economy, a lot of card issuers were pulling back and actually lowering people’s limits. I got one of those notifications myself even though I don’t think I changed anything about my credit habits with that card. So this is a great time to review that too.

Sandy Block: Well, and the other thing, Lisa, I think we’ve advised readers is sometimes people think, well, I never use this credit card and I don’t want to be tempted to use it so I’m going to close it. But that could actually hurt you because that reduces the amount of available credit you have and thus your ratio changes. Is that right?

Lisa Gerstner: That’s right. So sometimes it’s a good idea just to keep a card open, even if you’re not using it anymore, just to benefit from that credit limit. Now, if it’s a case where you’re paying an annual fee and you don’t think it’s worthwhile anymore, it’s probably not worth keeping it open for that reason. Or if you’re just having a hard time managing your spending because you have this credit card tempting you to spend, well, then you probably shouldn’t keep it open, but if it’s just going to sit there in a drawer, not hurting anything, it’s often a good idea to just keep the account open.

David Muhlbaum: I thought you were supposed to freeze it in water and put it in the back of your freezer.

Sandy Block: That’s a strategy. It works. Yeah. I think another thing-

David Muhlbaum: That’s a credit freeze. No, it’s not a credit freeze. We want to talk about credit freezes, but not like that. Sorry. Move on.

Sandy Block: Lisa, the one other thing that I think can ding your score that people may not realize is applying for a lot of credit at the same time. Not necessarily when you’re buying a house, because I think they make exceptions for that, but if there’s still a mall open around you and you go there and you’re getting 10% off for opening a retail credit card. If you do that a lot, can’t that ding your score a bit?

Lisa Gerstner: Yes. So particularly when it comes to credit cards, as you mentioned, that can be a problem. If you apply for several credit cards in a short time, that creates several hard inquiries on your credit report is what they call it. There’s also soft inquiries, which don’t really hurt you. But these hard inquiries can. When they see a lot of those, that indicates risk. The lenders are thinking, okay, this person seems a little desperate for credit. Are they actually going to be able to pay off their bills if we take them on? So that’s why that’s a problem. If you’re going to apply for a credit card, one at a time, space them out a little bit, make sure you leave at least a few months if not more in between card applications.

As you mentioned, Sandy, it’s a little different when it comes to other types of credit. So when you’re looking for a mortgage or a student loan or an auto loan, they don’t want to discourage you from rate shopping and trying to get the best rate that you can. So I know at least with FICO scores, any hard inquiries for those types of loans that are made within 30 days of each other don’t affect your score. And if it’s, I think, something like 45 days with the latest scoring models, if they see similar inquiries, it counts as one. So you don’t have to worry about it so much with that kind of shopping, but credit cards, take it easy.

Sandy Block: So Lisa, as I understand it, your credit score is based on information in your credit report. So could you talk a little bit about what you should be looking for in your credit report that could affect your score and how you can get your credit reports?

Lisa Gerstner: Yes. So your credit and report, it’s basically a list of all the various credit accounts that you have. Mostly, it’s going to be credit cards and loans and detail on how you manage those accounts. So for each one you’re going to see information about your payment history, whether you made those payments on time, the credit line that’s available, your balance due. All of this stuff is being reported again to those three major credit bureaus: TransUnion, Equifax and Experian. They also include any inquiries. I was mentioning those hard inquiries that can show up on your report. Accounts that have gone to collection unpaid. This is all kind of what shows up there.

When it comes to looking at your credit reports, there’s a resource called annualcreditreport.com. And that’s the place where you can get credit reports from each major bureau. Typically, you can only do that once a year, hence annualcreditreport.com, but because of the pandemic they’ve made those reports available weekly. And the plan right now, I believe, is that they’re going to be doing that through the rest of 2022. So you have a great opportunity. For the rest of this year, you can check your reports more frequently. You don’t have to wait just once a year to do that.

When it comes to the reason why you should check your credit reports, there’s a couple things. One is that unfortunately the bureaus are notorious for letting errors slip into credit reports. If you have a similar name to someone else, sometimes they will mix that information up and you may have information coming onto your report from someone who is not you, so you need to make sure that’s not happening. Or perhaps one of your lenders that you do use is reporting something mistakenly, maybe the balance is wrong, or they’re saying that you paid something late when you did not. So those are things you need to look out for.

Lisa Gerstner: Another big point here is fraud. You know, unfortunately data breaches just keep going up and up and up. I think 2021 was another record breaking year in terms of data breaches. So when criminals get ahold of that credit information, sometimes they can actually open accounts in your name. You won’t know that necessarily, unless you go in your credit report and check for any unfamiliar accounts that you don’t know about. Or that could even appear as maybe a debt collection account from a utility, an account that was opened in your name. So basically just get those reports, go through, make sure everything looks okay. These are all accounts that you own. That the information is correct on those. If you do find something wrong, there are processes that you can go through to get that corrected. You can contact the lender in question. You should also contact the credit bureaus and get all of that rectified.

David Muhlbaum: Is there any sort of organization that is an advocate for consumers in those fights or disputes, other than the consumer themself or potentially their lawyer?

Lisa Gerstner: Yeah. Typically, this is something you can do yourself. It can be difficult. I have written entire feature stories about this, because unfortunately it can be a challenge sometimes when your credit is mixed up with someone else, especially. But our advice is usually you can do it yourself. We have information on our website about how you can do that, articles that we’ve written. If it gets really bad at the end and you think you’re in the right, but you can’t get them to correct a problem, you can bring legal expertise into this. Another avenue you can take is to go to the Consumer Financial Protection Bureau. They have a complaint database where you can go in and pick the name of the company that you’re having trouble with. If you’re having trouble with all three credit bureaus, you can file complaints about them. And the CFPB will actually look into that, get back with you in a couple weeks, and then try to resolve the problem. That’s another route you can go.

David Muhlbaum: You know, one of the things I mentioned in my intro is about how the credit report kind of follows you around your whole life. Presumably if you’re doing things right, you can get to a point where it just doesn’t matter that much, right? That you’re heading into retirement, you have assets, you’ve paid down your mortgage. You can move on?

Lisa Gerstner: Well, I think it’s still important just to keep those basics in mind. You don’t want to let your credit score tank just in case maybe you have some unexpected need for credit in the future. I mean, I think there is a case that a lot of retirees think they probably won’t need it, but maybe you’ll want a credit card at some point to rack up lots of great points or something like that. So, I wouldn’t say ignore it. You may not need to wear worry about it quite as much once you get to that point, but I would still keep those basic habits in mind just to keep your score at a decent place.

Sandy Block: Yeah. Because you know, David, you still might want to refinance your mortgage. Older people buy cars. I mean, actually, to Lisa’s earlier point about how young people have a hard time getting credit, sometimes that happens to older people too, because they stop borrowing. They don’t have a credit card and then they decide they want to take out a loan and they have a thin file even though maybe they’re very well off. So I think it’s important to everybody.

David Muhlbaum: Well, yeah, that’s an interesting point. In part, there’s a mentality that it’s both sort of an old-fashioned don’t borrow, save your money, buy cash kind of approach that you’ve heard from Kiplinger over the years. And I think we’ve also heard this concept among a younger generation of avoiding debt, buying with cash, that sort of thing. We’ve talked about how there is a potential downside to that, how you can, by not being part of the credit ecosystem when you ultimately need it, get burned.

Lisa Gerstner: Yes. And I think that goes back to that point of just building some credit early. Even if you don’t necessarily think you’re going to need it down the road, you might be surprised what happens later on in your life. So I think it’s wise to at least maybe just have that one credit card that you use, keep a low balance, put a couple things on it every month just to keep that baseline amount of credit for you.

Sandy Block: Yeah, because just try renting a car without a credit card. It just doesn’t happen.

Lisa Gerstner: Yes.

David Muhlbaum: Exactly. Exactly. Well, maybe someday we’ll revive our credit versus debit smack down piece, even though we don’t have Robert Long anymore.

Lisa Gerstner: In a few years.

Sandy Block: He’s out there using his debit card somewhere.

David Muhlbaum: Right, or maybe it’s Apple Pay and Venmo now. I don’t know. Yeah, payment apps. We’re going to come back to payment apps, totally, in our future. But thank you very much for taking us through credit today, Lisa. We appreciate your time and everyone, go download your reports.

Lisa Gerstner: Thanks for having me.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you’ve already subscribed, thanks, please go back and add a rating or review if you haven’t already.

To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Amazon Raising Annual Fees for Amazon Prime Membership
• 40 Best Amazon Prime Benefits to Use in 2022
• Erin M. Collins, National Taxpayer Advocate, bio page
• Taxpayer Advocate Service qualifier tool
• Where's My Refund? How to Track Your Tax Refund Status
• How to Cut Your 2021 Tax Bill

Transcript

David Muhlbaum: Did you know there’s someone at the IRS whose sole purpose is to help taxpayers deal with the agency? If that sounds like an oxymoron, that’s just because you haven’t met Erin Collins, the current taxpayer advocate. She’ll join us to explain what her office does, how it can help you, and why the IRS is struggling to get refunds out. Also, Amazon is raising prices; what can you do? All coming up on this episode of Your Money’s Worth.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com senior editor David Muhlbaum, joined by my co-host, senior editor Sandy Block. How are you doing, Sandy?

Sandy Block: I’m doing great. Welcome back from whatever wilderness you were in the last few days.

David Muhlbaum: I was in Utah, experiencing the rising cost of rental cars. So yeah, that’s an inflation story, you know. Everyone’s got an inflation story these days. Have you seen the price of milk, gas? Oh my God, whatever. But now we have a price increase for the way we live now, and that is to say by ordering things online.

Sandy Block: You mean Amazon?

David Muhlbaum: Yeah, exactly. That’s a shorthand. I mean, the price of Amazon Prime is going up from $119 to $139. So that’s a 17% increase if you’re paying annually. And that covers a lot of people. I don’t know that it’s more people then who buy milk or gas, but it’s 150 million or so here in the United States. That’s a lot of people who are going to be affected.

Sandy Block: Right. And I mean, I know the headline definitely caught my attention because 17% sounds pretty steep. But since we brought inflation into this, we need to be careful about our statistics. That’s not a year-over-year increase like we talk about with the price of milk or gas, which seem to go up every month or whatever. The last Amazon Prime increase was quite a while ago.

David Muhlbaum: Yeah. Yeah. It was 2018. So our editor Bob Niedt, he knows Amazon backward and forward. And in fact, he forecast this increase a few weeks ago. So, Amazon has operated on a four-year cycle for price increases. And the last one was from $99 to $119. Now, you know on a percentage basis, that was a bigger jump.

Sandy Block: Right. We’ve got our calculators out, but let’s move on from crunching numbers. What are those 150-plus million people supposed to do other than just roll their eyes and suck it up?

David Muhlbaum: Yeah. I imagine most people are going to shrug and pay it. Probably in part because they’re going to get auto renewed at the new rate. And well, there you go.

Sandy Block: Right. And that’s I think what a lot of these subscription services really count on, is inertia. You’re not even paying the bill. You’ve got it on your credit card. It goes on, and they’re just hoping that you’ll just move on, but if you really don’t want to give up free shipping, maybe one way to live with this increase is to go deeper into the Amazon ecosystem and make sure that you’re actually getting what you’re paying for, because there’s a whole lot more to Amazon Prime, as I plan to discover for myself, than just free shipping. There’s videos, there’s music, there’s movies, there’s all kinds of stuff

David Muhlbaum: Yeah. So forth indeed. I mean, that’s just the thing that Bob has written about in his piece on best Amazon Prime Benefits to Use, beyond the entertainment. You mentioned there’s also this try before you buy, which lets you pick up to six items of clothing, shoes, accessories. You can see if they fit or well, look good, and then bring it back for free or send it back for free. And he also gets into how to manage a Prime membership to get the most out of it. Like, you can share benefits with something called Amazon Household. So maybe you don’t need as many accounts, that sort of thing.

Sandy Block: Right. And one of the things that I discovered even before this price increase, I don’t go to Whole Foods all the time, but I did happen to go into one this week. And I used my prime membership. And I saved a couple bucks on some overpriced fish. So that’s the kind of thing you need to be thinking about. But the other alternative is, you could quit. What wasn’t around last time there was an increase was Walmart Plus. They’ll give you free next day or two-day delivery, prescriptions and gasoline discounts, some other perks for $84 a year. So maybe they’ll pick up some disgruntled Amazon people who aren’t into inertia.

David Muhlbaum: Yeah. Well, until they raise their price, maybe? I doubt it. That would not make much sense. But you know who is also likely to raise their membership fee this summer? Costco. That’s another one of Bob’s forecasts.

Sandy Block: Oh no. Well, I don’t go to Costco anymore because I always spent too much when I did; we go to BJ’s. But you are a dedicated Costco customer, aren’t you?

David Muhlbaum: Yeah. Truth. My dogs have been on Nature’s Domain salmon meal and sweet potato dog food for well, as long as I’ve had dogs. So I don’t think they’re going to let me switch.

Sandy Block: Well, maybe your dogs won’t let you switch to Old Roy, but I think these increases in subscription prices present a good opportunity for everyone to review their subscriptions, make sure you’re actually using all of the ones that you signed up for. If there are cheaper alternatives or maybe you can get more out of the subscriptions that you already have, because they really do count on you not doing that when they raise these prices.

David Muhlbaum: Be a conscious shopper. Yes, thank you for the actionable personal finance advice, Sandy.

Sandy Block: That’s what we’re here for.

David Muhlbaum: That’s right. Anyway, coming up on our main segment, we will talk to Erin Collins, the national taxpayer advocate about what her office does, what it can do for you as a taxpayer and how this filing season is shaping up. Stick around.

Meet the National Taxpayer Advocate, Erin Collins

David Muhlbaum: Welcome back to Your Money’s Worth. For our main segment today, we’re joined by Erin Collins, the national taxpayer advocate. Now that’s a pretty cool title, don’t you think? So here’s the history. A law called the Taxpayer Bill of Rights created this job almost 30 years ago. And the advocate has a staff of about 1,600 and a mission to be a voice for taxpayers, as well as report to Congress on what kind of job the IRS is doing. So that’s kind of a policy-wonk description of the taxpayer advocate’s place in the Washington ecosystem. But they have a very real, very tangible role in helping individual taxpayers all over the country. And we definitely want to get into what they can and can’t do for you. So, welcome Erin.

Erin Collins: Thank you so much for having me today.

Sandy Block: I want to thank Erin not for just coming today, but for being a great source for us since she took the job a while back. And you’ve given us a lot of insights on what’s happening in the IRS and what people can expect when people are filing their taxes, which frankly isn’t really good. That’s important to our audience because they come to us for a lot of information about filing their taxes and I think that’s been even more critical in the past couple of years when people have gotten lots of stimulus checks, child tax credits, and other sorts of new wrinkles in the tax system. The other thing we want to talk about is if people need help with their taxes. They have to be careful about who they go to because basically anybody can call themselves a tax preparer in the current system. So, on that note, Erin, can you explain a bit more about how your office, the Taxpayer Advocate Service operates? I think people might find it a little confusing that while it’s technically part of the IRS and funded with taxpayers’ dollars, it’s actually meant to advocate for taxpayers.

Erin Collins: Yeah. We have a unique role that we play in tax administration with respect to assisting taxpayers. So we wear multiple hats. As you indicated, the position was created over 20 years ago. And what we do is we represent individual taxpayers with their unique problems that they have with the IRS. But we also look at what we call systemic issues. Those are issues that impact multiple taxpayers, where we can provide administrative recommendations to the IRS for change as well as proposed legislative recommendations to Congress to change the law on behalf of taxpayers. But I think most people that work with our local TAS offices, they’re working with our case advocates to fix a particular problem.

And I think what a lot of people don’t focus on is what our authority is. We advocate, hence in our name, Taxpayer Advocate Service. So we do not have the delegated authority to actually implement the correction or the change. And that was specifically created so we could be an independent organization. We can give it a fresh or fair new look from what the IRS has previously done. And then we work with our colleagues or our counterparts in the IRS and recommend the correction or the fix.

David Muhlbaum: But there’s not a real equivalent at other federal agencies, is there? I mean, you know some have ombudsmen and that sort of thing, but this is so much more involved and aimed at private citizens, businesses too.

Erin Collins: Yeah. So again, we do. It’s a unique role. I think most people are familiar with what I would call the classic ombudsman. And those are individuals that conduct investigations, make recommendations. We do wear that hat, but we also have the ability to advocate specifically for taxpayers, both systemically across the board for all taxpayers, but again, we can help individuals with a particular challenger problem they’re having with the IRS.

David Muhlbaum: Okay. Let’s dig in a little bit to what that particular problem might be. Which ones you can solve, which ones are not your purview. And I noticed on the website, you have this really cool thing, the TAS Qualifier Tool. And we’ll put a link into that, which is basically, it literally tells you, it answers the question that I’m asking you now: "Does your problem fit?" But since not everyone’s going to go there right away, could you give us some sense of what problems are in your purview and what problems are not.

Erin Collins: Sure. So we have what we call two buckets. One is for financial hardship, and the second bucket is our systemic, when you have an issue with the IRS system. So the first bucket for example, take a situation where collections is knocking at the door and a taxpayer is having issues making ends meets. They can’t pay the rent or they’re having trouble. And what we can do is assist and work with our collection folks to possibly suspend the collection activity, or even possibly get an offer in compromise or installment agreement.

Erin Collins: So we can work with the taxpayer with that specific problem. The other challenge taxpayers are facing right now, and it’s been a very difficult two years for the taxpayers with respect to the filing season is when the system isn’t working as it’s intended. It’s broken. Unfortunately, the filing season with all the additional backlogs, and the challenges, and the delayed of the processing of those claims, we’ve created millions of taxpayers that in essence fit in that second bucket. And as you alluded to, we have typically 1,600, 1,700 employees. We can’t help 2, 3, 4, 5 million taxpayers at a time. So we try and limit what we can do to get the most result. And where’s the best use of our resources? So as you said, if you go into the tool, you’ll see it gives you options as to whether or not your case qualifies to work with us and contact a local taxpayer advocate.

Sandy Block: So I think Erin, from what I understand about what you all do, tthe axpayer advocate office is not there if you have a question about whether you should itemize or not, or whether you’re eligible for the child tax credit, the IRS has a lot of websites for that. But as you alluded to, and this is something we want to dig into, you’re probably not going to have a lot luck calling the IRS for help. Can you talk to us a little bit about what taxpayers can expect during the upcoming tax season? Because last season was pretty awful in terms of customer service. Hardly anybody could get through to the IRS. A lot of refunds were delayed. What should we expect this year?

Erin Collins: Yeah. If we’re talking about the filing season, I do have concerns that the IRS has, as we call it, they’ve dug themselves into a hole from the last two filing seasons. And they still have not dug out of that hole. So it’s going to potentially impact the smooth or quick processing of the current filing season. So we do have concerns. And as you alluded to, Sandy, although we are IRS employees, we’re not really main IRS. So the typical questions and problems, that’s really more in the purview of IRS. Although we do a lot of outreach and lot of education, that’s really not our main role. So again, when the system isn’t working, that’s really where taxpayers should reach out to us. But yes, they should make the effort to try and work with the IRS. But as you pointed out, the level of service on the phone this past year, it was about one in 10 calls were answered, which is just unacceptable.

Erin Collins: So taxpayers are being forced to try and self-help. irs.gov has a lot of useful information, but unfortunately, it’s sometimes difficult to find. And if you’re trying to get specific information on your delays, on your refund, the tool the IRS has, Where’s My Refund, doesn’t answer the question if you have a delay.

Sandy Block: And Erin, following up on that, I know from personal experience that Where’s My Refund does not work very well, but given this situation that the IRS has a huge backlog of returns from last year, from 2020 that they haven’t even processed, what is the most effective way that a taxpayer can avoid a delay or a problem during this tax filing season?

Erin Collins: Yeah. I think, although we realize that there is a percentage of our population for whom filing electronically is not an option, but for those who have the ability, make every effort to file electronically. Paper returns, those are where they have the most delays. Paper is not a friend to the IRS. So number one, you want to file electronically. Number two, if you can request a direct deposit, so provide your bank information. And number three, triple check for errors. Last year, part of the delay that was caused for all taxpayers was individuals that put inconsistent information on the return from IRS records. So for example, you use your last pay stub to put your income, not your W2. And your pay stub may include two or three days from the month of January. So that information may not match the IRS’s records. If you received a stimulus check or the six monthly payments that you receive for the advanced child tax credit, that should match IRS records.

If it doesn’t, it will be pulled out of the system and manually processed. So last year again, we had at least 13 million returns that had to be manually processed, which caused a 35 million backlog at the end of the filing season. So we do not want to have a repeat of that backlog going forward. So if taxpayers can really try and make sure that the correct information is on the return and they file electronically, they should not have a delay and it should be processed within that 21 days that the IRS projects that you’ll get your refund.

Sandy Block: I want to dig a little bit deeper Erin, as to why there was such a backlog last year, you mentioned the stimulus checks. And I also think that the pandemic’s effect on the IRS itself had a role in that. Maybe you could talk a little bit about why some people still haven’t gotten their 2020 refunds yet.

Erin Collins: Yeah. It actually started at the onset of the pandemic. The IRS shut down, basically all the facilities across the country. And think of the volume that the IRS receives. And in essence, it’s over 200 million tax returns every year. So what happened was when the pandemic first started, they got in a hole, and it’s been two years now and they still are not out of the hole. They still have a backlog month after month after month. So if we don’t get through the backlog, we’re never going to get ahead. So this year, absolutely the IRS has to not only be timely with respect to the current filing season, but we’ve got to get that backlog resolved and get the payments to the taxpayers who are still waiting for those refunds from last year.

David Muhlbaum: That gives me an idea for a modest proposal. So, if you don’t pay your taxes or behind you pay, not only, but interest on the amount that’s outstanding. What if the IRS were to pay you interest for a refund they haven’t processed, assuming it’s not your fault?

Erin Collins: You are great on tax administration because golly gee, you can get interest if the checks are delayed.

David Muhlbaum: Oh, this exists?

Erin Collins: So thank you for that recommendation. But yeah. But unfortunately that doesn’t make people happy. The interest rate’s incredibly low. And so, yes, maybe you’ll get an extra $5, but people want the money now. A lot of these returns that were filed or were filed before, possibly April of last year and they still have not received their payment. And again, that’s just unacceptable.

David Muhlbaum: Well, as Sandy knows my own personal tax situation is such that I’ve never been in a position to receive such a reward. I am a little curious though, is the interest rate the same as you pay for owing?

Erin Collins: Now you’ve stumped me. I want to say the answer is yeah.

Sandy Block: I don’t think it is.

Erin Collins: I think when you have... There are exceptions, like if the size of the company. There’s all sorts of different criteria, but they’re close, but again, neither one is anything to write home about.

David Muhlbaum: Right. Right. Got it. Okay. Well, we certainly appreciate your guidance about filing electronically and that’s what more and more people do each year. But there’s a subset who are going to want help filing whether it’s electronically or on paper. That is to say they don’t have a tax problem. Well, not at least yet. They just want someone to do their taxes for them. So assuming someone doesn’t meet the guidelines of... And Sandy, these are the two programs you wrote about the Volunteer Income Tax Assistance Program or the Tax Counseling for Elderly Program. We’ll put some links in to explain what those are about. How do you recommend people go about finding a tax preparer? Like, do you all have guidance on that?

Erin Collins: Yes. And it’s also on irs.gov, but real quick, going back to the VITA and what we call the TCE, that is limited with respect to your income. And I believe it’s $56,000 a year ...

David Muhlbaum: Or your age.

Erin Collins: Right. So if you’re above that amount, unfortunately, you don’t qualify for that. But IRS has on their website, I think it’s https://www.irs.gov/chooseataxpro. And then actually, it’s a very useful tool. It helps you select a qualified or federal tax preparer. So it includes a list of licensed or certified, or folks with credentials. So for example attorney, CPA, enrolled agents, and it also includes a directory of those individuals that take annual CPE and also get certified. And it’s listed by name, city, and the criteria.

Erin Collins: So it’s a great directory and it’s a great tool if you’re looking to find a particular person. But you really should choose that preparer carefully. We read about the scams, the IRS is very well aware. So you know, ask a friend, ask somebody you trust, get referrals, check out their credentials. Some people go into the Better Business Bureau, see if there’s complaints. And then taxpayers also have the ability to what I call self-help. There are a number of companies out there that do tax preparation software which will walk you through as you’re preparing the returns. So there are options for taxpayers out there to get help with respect to preparing their returns.

Sandy Block: And to follow up on that, Erin, you and I have talked about this just when you refer to scams. I know you’ve advocated for some kind of minimum competency requirements for tax preparers. But right now, basically David or I could put a sign on our door and charge people to prepare tax returns, which would not be a good idea, but we could do that. Is that not the case, Erin, is that why you have to be extra careful?

Erin Collins: Yeah. I think, again, there are some good intentioned folks out there that are helping their neighbors or families or loved ones, but they may, no offense, not be familiar with the tax laws. I’m more concerned about those who are unscrupulous, people who are taking advantage of taxpayers. And unfortunately there are many of those individuals out there. There’s something that’s referred to as a PTIN. I think it’s your professional tax identification number is what it stands for. If your return preparer doesn’t have a PTIN that would be a red flag to you because the taxpayer or the preparation folks have to put that on the return, at the bottom of the return if you sign it and also your return preparer signs it. So if the person doesn’t want to sign it, there’s probably a reason and you might want to get up and walk away.

Sandy Block: So Erin, one thing that I’ve reported on through the years. And if anybody stays up late, who watches late night TV will see ads saying, "We can reduce your IRS debt. We can make your IRS tax bill go away." And I think what they’re referring to is a legitimate program called offer in compromise. But, it’s a lot harder to get that than some of these commercials imply. And a lot of these companies, as I understand it, just basically charge you a fee and then never get the offer. Could you talk a little bit about that?

Erin Collins: Yeah. Again, if you are going to use someone to assist you in the offer in compromise program, you want to make sure that they are on the up and up, so to speak. You don’t want people who can over promise pennies on the dollar and under deliver, and then charge you on top of it. So again, these are companies, there are a lot of legitimate folks out there. A lot of firms that do offer in compromise and assist taxpayers. And then there’s the others that we would prefer you not go to. So IRS tries to identify if there’s potential problems. In fact, I know we are currently as an organization or agency looking at that issue across the board so that we can make sure we get useful information out to taxpayers. But yes, you can do it yourself. You can do it with the assistance of TAS or you can get a professional to help you. But be wary of those who make very large promises and have a price tag attached to it.

Sandy Block: I think anytime you hear pennies on the dollar it’s probably a big red flag, right?

Erin Collins: Yeah. And you know I hate to say it, there are some taxpayers who may end up pennies on the dollar based on their financial situation, but it’s not a standard you can apply across the board.

Sandy Block: Right.

Erin Collins: So again, be careful, the old saying, "If it’s too good it to be true, it probably is."

David Muhlbaum: So Erin, this question of trust, who can you trust to help you with your taxes? Do you or your advocates ever, or your staff ever find essentially pushback, because at the end of the day, you’re an IRS employee? And as we discussed, there is this independence built into your office, but, you might have to do some convincing of people, right?

Erin Collins: Well, yes, that’s hence the term advocacy, but I don’t believe we’re advocating for positions that we do not believe are correct. So if a taxpayer comes to us and wants to argue that the moon is purple, we would probably not recommend we take that position with the IRS because A) we think it’s wrong and B) it would not be successful. So we work with the taxpayer to get the best possible facts and position when we work with the IRS. So in essence, I would like to think of us as trusted, sort of, advisors or trusted advocates because really that is what we’re doing for the taxpayers. We’re working with the IRS and pushing what we think is the correct position.

David Muhlbaum: Excellent. Maybe you could put another T in the acronym, you could be "Trusted Taxpayer Advocate Service" because we’re all about acronyms here. On that acronymic, Washington note, I’m curious if since you sometimes deal with things that are systemic problems with the IRS, rather not the problem of the individual taxpayer but a group of taxpayers, do you find yourself being pulled into the policy debates of how taxation should be implemented? That is, when it ends up in congressional testimony, how we all argue about that here.

Erin Collins: Well, it depends how you define that, but we push for administrative change. I lead the policy up to the Hill and Treasury, but I guess we push for policy in the sense of, we want fair treatment of taxpayer and we want the system to be fair and fairly implemented. So in that sense, if that’s a policy, yes, we do push for that. If it’s whether or not the tax rate should be 20% versus 30%, we normally stay out of that debate.

Sandy Block: But on that note, Erin, I know you don’t get involved in what tax rate should be and that sort of thing. But you do advocate for the IRS in terms of funding. You and your predecessor Nina Olson have argued for many years that the IRS is underfunded. Nobody wins votes by saying they want to give money to the IRS, but why is that important? And why is the IRS so underfunded?

Erin Collins: Yeah. I think the challenge is, and I look at not necessarily the IRS, but the impact to taxpayers. So what is the impact of underfunding the IRS with respect to service, with respect to fairly administering the tax laws. And that has been a real challenge for a number of years because the budget that Congress has every year has gone down about 20% over the last 10 years. Unfortunately, that means so have the IRS employees. I mean, you can’t have more employees without more budget. And the challenge is IRS has picked up additional work. So over the years and especially over the last two years, Congress has entrusted the IRS to do three rounds of the stimulus payments. They’ve done the monthly advance child tax credit payments, as well as a number of business benefits that they’ve done.

So they’re overtaxing, so to speak, the IRS’s abilities to process just not only the normal filing season, but all the additional work, with fewer employees and fewer budgets. So unfortunately service and taxpayers are paying the price. And when you think about, if you want to step back and look at the politics of this, the IRS brings in and I think the numbers about and 95% of the entire nation’s budget. So the monies that go through IRS and Treasury is what funds everything else that Congress does. So when you think about how important the IRS is, without a functioning IRS, it’s going to impact the function of our country of what we can do.

Sandy Block: Erin, that’s a great way to wrap up this conversation, and we really want to thank you for coming on to our podcast and for all the things that you do. Thanks again.

Erin Collins: Thank you so much.

David Muhlbaum: Thank you, Erin.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you’ve already subscribed, thanks. Please go back and add a rating and review. If you haven’t already to see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes transcripts and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Take This Job, I'm Retiring
• When Can You File Your Taxes This Year?
• Tax Withholding Adjustments Can Boost Your Paycheck Now and Avoid Penalties Later
• Child Tax Credit FAQs for Your 2021 Tax Return
• Talking With the Taxpayer Advocate: The IRS Is Under Stress
• Pew Research Center: Amid the pandemic, a rising share of older U.S. adults are now retired
• 5 Tips for Retirees Worried about Today’s Market Volatility
• Are You Prepared for Health Care Costs While in Retirement?
• What’s Your Retirement Number?
• Factoring Inflation into Your Retirement Plan

Transcript

David Muhlbaum: We’re sure you’ve heard about the great resignation, about how millions of people are quitting their jobs during the pandemic for a variety of reasons, but the gray, that’s G-R-A-Y, resignation is a thing too. Many people close to retirement age have been moving up the day they’ll leave their regular gig as well. We’ll talk about why and what goes into making that decision wisely. Also, tax season, it’s here. All coming up on this episode of Your Money’s Worth.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com senior editor David Muhlbaum, joined by my co-host, Kiplinger senior editor Sandy Block. Sandy, how are you doing?

Sandy Block: I’m doing great, David.

David Muhlbaum: Good. Well, since we work for the same employer, I’m pretty sure you got the same email last night that I did. It came from ADP, the big payroll firm, and it had that critical tax form attached, the W-2. What that kind of says to me is it’s on! Tax season, that is.

Sandy Block: That’s right. Actually I got my husband’s W-2 in the mail this week. Yes, Monday, January 24th is the first day the IRS will accept a tax return. You could be preparing your return right now, even submitting it through some of the software, but I seem to recall, David, that you are not one to jump on the filing of your taxes.

David Muhlbaum: You’re correct on that, Sandy. But I’m trying. I have promised my wife to do better this year. In fact, that W-2 is already uploaded to a folder, but I still have plenty of work to do with the more elusive drips and drabs, but hopefully this year, no extension. Look, fundamentally, being early to file versus waiting until the deadline, which is April 18th this year for most Americans, that’s a question of whether you have a refund waiting or you owe taxes. If you got a refund waiting for you, well, go get your money. Do you owe? Well, what’s the rush?

Sandy Block: But even if you owe, what I tell readers is, first of all, you can always arrange to have the amount that you owe paid on April 18th so you don’t have to come up with the money now. But I think even if you think you owe, you should do your taxes because that’s not some information you want to have to digest the night before taxes are due. Better to know now how much money you have to hand over.

David Muhlbaum: Right. Also, I mean, and generally speaking, more people have a refund waiting for them. My understanding is that this year they might have an even bigger refund waiting for them than they realized, or than in previous years, because of these various programs that were launched during the pandemic.

Sandy Block: That’s right. Actually even in the past, most people got a refund. We’ve written a lot about how that’s really not a good idea to give a loan to the government. But most people get a refund. This year they could be particularly rich because of some of the stimulus measures that people have not claimed the entire amount of. There was the expanded child tax credit, which some people got last year, but some people have not gotten all of the credit that they’re eligible for.

David Muhlbaum: By got, you mean that the advanced checks that went out?

Sandy Block: They got checks in the mail or direct deposit.

David Muhlbaum: But even those checks, that was only going to get up to half. Right?

Sandy Block: Right. Exactly.

David Muhlbaum: There’s still money out there.

Sandy Block: There’s still some credit out there. There’s still some money out there. Some people, there was a third stimulus and some people didn’t get that yet. When you file your taxes, that’s your opportunity to sort of true up, to reconcile what your actual tax situation was last year versus what you might be due in terms of stimulus money or child tax credits. Yes, refunds could be very generous this year, for a lot of people.

David Muhlbaum: Well, so tax season is on. Is it our favorite season? I don’t know, but we enjoy it and we make a lot of it. We’ll be back talking about taxes, I’m sure, several times in the next few months. In fact, we’re hoping in our next episode to have on the national taxpayer advocate, Erin Collins. She’s the head of this, essentially, service that is designed to, on one hand, help taxpayers with problems with the IRS and in ... Well, Sandy, you know Erin from way back. Why don’t you define what she does?

Sandy Block: Well, I’ve actually interviewed Erin a few times and I interviewed her predecessor, Nina Olson, many times. Basically it’s an office, as you said, that advocates for taxpayers, but they also provide information to the public. They’re sort of a watchdog for the IRS. They put out annual reports, pointing out problems that the IRS has that how they can be resolved. They’re also sort of a place of, you’re not supposed to call them just because you don’t understand something on your tax return, but if you are truly in a situation with the IRS that you can’t resolve, they’re there to sort of step up and help you.

David Muhlbaum: I mean, that’s one of the things I would like to get into with Erin is where they can help and where they can’t help, because I know at least on their website, they do a bit of work of saying like, “Call us, don’t call us.” But yes, we hope to do that. We hope to have her on soon. But Sandy, give us a little preview too, of their report to Congress, because this is a tax season issue right now. It doesn’t look so good.

Sandy Block: It’s very sobering news. Basically what she’s telling people is that the IRS had a huge backlog of tax returns last year that they’re still trying to complete some tax returns from two years ago. Coming into this new tax season, they’ve got a huge backlog, which means that there could be more delays and more waits for people who file their tax returns this year. One of the really distressing things is that hardly anyone who called the IRS last year got through. If someone picked up the phone at the IRS and I know this from personal experience, that’s like winning the lottery. It just doesn’t happen. They’re just so overwhelmed with all of the things that Congress asked them to do with the economic stimulus, staff shortages, COVID, all these things sort of came together to create just a huge blizzard of unprocessed tax returns.

Sandy Block: What Erin is going to say, and I’ll say this now as we’re going in, is file electronically if you can, because what’s really held IRS up is anything that requires manual work. Those are the ones. There’s a pile of tax returns out there that the IRS has just not been able to get to. File electronically and try and resolve ... Use their website, use irs.gov, as much as you can to answer your questions because calling the IRS is going to continue to be a real problem. I think that’s what she’ll talk to us about.

David Muhlbaum: Got it. Lots and lots of tax questions to talk about in the weeks ahead, but coming up next on Your Money’s Worth, we will be joined by Liz Windisch, a certified financial planner about an uptick in early retirement that’s happening during the pandemic. What if you want to punch out early, too? We’ll talk about how to make sure that’s a wise move. Stick around.

The Gray Resignation with Liz Windisch

David Muhlbaum: Welcome back to Your Money’s Worth. For our main segment today, we are joined by Liz Windisch, a certified financial planner from Centennial, Colorado. We found our way to Liz thanks to Sandy, who interviewed her for a piece she wrote for Kiplinger’s Personal Finance magazine with the very catchy title, Take This Job, I’m Retiring, which I think marks the second time we’ve made a country music reference on Your Money’s Worth.

Sandy Block: Yeah, and my West Virginia roots are coming through here loud and clear.

David Muhlbaum: Well, it was Johnny Paycheck who made you can Take This Job and Shove It a big hit. But David Allan Coe wrote that song. Anyway, we’ll leave the country music podcasting to Cocaine and Rhinestones and stick to personal finance ourselves, when we can. Welcome Liz and thank you for joining us.

Liz Windisch: Thank you for having me.

David Muhlbaum: Sandy’s article didn’t just have a catchy title, it also coined a term. The term, the term I mentioned in the introduction, gray resignation. Seriously, Sandy, I think that was an original term. I’ve searched it and I’ve searched it and I’ve searched it. So Sandy, since you created it, tell us what gray resignation means.

Sandy Block: Well, it means, you know, there’s been so much publicity about the great resignation, how all these people are quitting their jobs or changing jobs. But within those numbers is a very large number of older workers. We’re seeing a significant increase of adults age 55 or older retiring. In 2021, it was 50.3% of adults older than 55 up from 48.1% in 2019. This is according to the Pew Research Center and that tracks for other older demographics as well. We’re definitely seeing a lot of people retiring. I think the question I asked you, Liz, in this story was, are you seeing this in your practice?

Liz Windisch: Absolutely. I have seen a number of clients who are really re-prioritizing what they want their life to look like, and that does not include working any longer.

David Muhlbaum: That re-prioritization, we’re seeing that across the board. What is convincing your clients that they can do it now?

Liz Windisch: I think that there are reasons both financial and non-financial. I think the financial reasons are convincing them that they’re able to do it, that being that the market has been really strong the last few years and people have seen their investment portfolios increase significantly. They’ve seen their home values increase significantly. They may have cut down expenses during the pandemic, which just makes them feel a lot more confident in their ability to retire early.

Sandy Block: I think one of the interesting things that some of the analysis of this trend has found is that unlike 2008, which we can talk about in a bit, people are not filing for Social Security early. Does that speak to just the financial security that they don’t feel like they need it, which is actually a good thing probably?

Liz Windisch: It is a good thing. I was really glad to see that. I think certainly everyone is different, but if you are choosing to retire because you’re taking Social Security early, you may want to reconsider if you can actually retire. I think that the increase in everyone’s feeling of security because of their home values and because of the stock market really has made people feel more secure and feel that they don’t even need to take Social Security. They can delay that and retire on what they have now.

Sandy Block: Liz, maybe for folks who don’t dive deep into Social Security like we do, why is that a good thing that they’re not taking it at 62?

Liz Windisch: If you take your Social Security benefit before your full retirement age, that is, the age that the Social Security Administration deems full retirement, your benefit is permanently reduced for each year before your full retirement age. Your benefit is smaller and it stays smaller for the rest of your life.

Sandy Block: I think it’s 25% to 30% smaller than if you wait until full retirement age, I think is what we usually say.

Liz Windisch: That’s about right.

Sandy Block: But pretty serious haircut if you live for a long time.

David Muhlbaum: Liz, we’ve talked about potential retirees looking at their current asset levels and thinking, "Okay, I’m good to go, good to pack it in and retire." But what about risks in the future, like say a big haircut for the stock market?

Liz Windisch: I’m concerned about that as well. I think the market has been doing so well for so long we’ve all forgotten that it’s not always that way. That goes into the sequence of returns of the market. If you have a downturn on the market the first few years of your retirement, that will significantly impact your ability to be successful and not run out of money. Like I said, I think people tend to forget that that very well may happen. Once you retire, if your account values go down, you may also be permanently reducing the income that you can take from those portfolios. I think that people need to take a long, hard look at truly how sustainable their portfolios are, not just based on the value now, but what could potentially happen if we have a significant market downturn in the next few years.

Sandy Block: Which is another reason that we’ll have to revisit 2008 in a minute, but the other big risk I think you and I discussed, Liz, is the cost of healthcare, particularly for people who retire before age 65. Can you talk a little bit about that?

Liz Windisch: 65 is the age that people are eligible for Medicare. Any year before 65 you retire, you would be responsible for paying for your own healthcare, which can be very, very expensive. Even if you’re able to get health insurance on an exchange, those costs can be really significant. I ran a simulation actually. If a 57-year-old woman wants to retire next year, the average cost of her healthcare between now and 65 is about $14,000 a year.

Sandy Block: A year? Wow.

Liz Windisch: A year.

Sandy Block: That’s a big withdrawal from your portfolio or from your savings.

Liz Windisch: It is.

David Muhlbaum: We’ve just been looking head on into the financial consequences of early retirement. But Liz, can you get back to the motivations? What are.... People see high values in their accounts and think, "Okay, I can retire," but what’s going on right now that makes them want to retire more than in the past?

Liz Windisch: I’ve seen a few different reasons. One is that re-prioritization that we spoke of earlier. The last couple years, a lot of people have seen friends and family get COVID, potentially die from COVID, become permanently disabled. That has really made people think about how long they want to spend working and how fragile our health can be. I think people are really burned out. This goes back to 2008. Back in ‘08 and ‘09, a lot of employers laid people off. When the economy turned around, they didn’t necessarily rehire those people back. A lot of people have been doing the job of two or three people for the last dozen or so years, and I think people are really burned out from working.

Sandy Block: Liz, I’m glad you brought up 2008, because one of the things we talk about people feeling very confident because their stock portfolios have done so well. But I think one of the phenomenons we saw, and I assume you were practicing then, was that in the 2008-2009 severe market downturn, a lot of retirees had to take withdrawals from portfolios that were already depressed. Is that a risk that still is out there?

Liz Windisch: Well, it is a risk because like we said, we don’t know what the market’s going to do in the next few years. If you are planning on taking withdrawals from that portfolio, if the market is down 20% or 30% next year and you need to take money out to live off of, you will not have an opportunity to recapture those gains. I think that’s why a lot of people didn’t retire in 2008, even though they may have been close to retirement or may not have wanted to work. They needed to wait for those portfolios to come back up or put more money, save more money for retirement. Because once you take money out, when your values are down, you miss the opportunity to ride those gains back up.

David Muhlbaum: Part of getting ready for retirement isn’t just saving money, putting it aside. It’s how you invest that money in anticipation of some assumed retirement date. Liz, what happens when you have a client who comes in and says, "You know what? I’m done now. I want to take this job and ... retire." They want to move their retirement up a few years from what was originally planned. What can they do? What should they do with their investments and savings to make that happen? What kind of guidance are you giving?

Liz Windisch: That’s a great question. They may need to change some of their assets from that aggressive growth of saving to something more conservative or something income producing. I think there’s two pieces. There’s the immediate needs, your immediate income needs the first years of retirement. Then there’s the portion that you do still need to keep growing that portfolio. Even if you’re retiring, you’re not taking all that money out and spending it right away. You still need to make that money last 30 or 40 years, in which case it will still need to grow. Certainly everyone is different. I think you do need to get a little more of a deep dive restructuring how that portfolio was going to look to switch from growing to spending.

Sandy Block: Liz, and that leads me to another question that was actually the subject of our cover story in February and something that also gets a lot of interest on our website, which is, what’s your number? If you are thinking of retirement either next week or maybe in a couple of years, which maybe is more realistic, how do you help? The big question people has, do I have enough? How do you help clients reach that conclusion that, yes, I have saved enough for retirement or no, I may need to stay on the job a little bit longer because based on these factors, it might be too risky?

Liz Windisch: I get that question often too. How much money do I need? Well, that all depends on how much money you plan on spending. What I do with my clients is run many, many scenarios. We take a lot of inputs on how much you might be spending, but I run different scenarios for that. We have the amount that you think that you might spend, but that may not actually be what happens. We like to make sure that no matter what happens, you’ll have enough money.

David Muhlbaum: You’re using a calculator for this and just showing them, move this and this happens, move that and that happens?

Liz Windisch: Exactly. I have software that I use that allows us to run many different scenarios. I like to do that with my clients. I don’t just say, "Here, I input your numbers. Here’s your plan. You’re good or you’re not good." We’ll sit down together and calculate lots of different scenarios. What if this happened? What if you had significant health concerns 10 years into retirement? Run the numbers. What if the market goes down? What if it goes up? I use a Monte Carlo simulation, but I don’t know if your listeners are familiar with that, but that would run thousands of different scenarios of possible market outturns, excuse me, outcomes.

Sandy Block: Well, Liz, I’m glad you brought up software because one question that’s been coming up a lot in our conversations is when you do those simulations, usually you put input an investment return, an annual investment return. We’ve had some very long, deep conversations when we’ve done this ourselves about what annual investment return to use. In my recent reporting, I’ve talked to some people who have actually notched it down some because they think the market is so overvalued and interest rates are so low that say a 7% annual return, which I think is some people would consider conservative, might actually be a little aggressive. I’m curious about what you recommend in terms of investment returns when you’re running these kinds of programs for people, because that does affect how much you need.

Liz Windisch: Absolutely. That 7% number, is that net of inflation? We don’t know what inflation is going to be, so that number needs to be in there as well. I think I tend to err more on the side of being conservative, certainly because I don’t want my clients to run out of money in retirement. They can’t come live with me, so we need to make sure that they have plenty of money.

I think that’s where running all of 1,000 different scenarios comes in because that will run numbers if the next 10 years we have really poor returns. I think that’s, where having a little bit more sophisticated software comes into play versus just using a simple online calculator where you put in one number that’s an average, let’s say 6%. Even if we use a conservative number, that’s just an average and we know that the market doesn’t return the same number each year. Even if we get that average correct, that’s not how it works.

David Muhlbaum: Well, on that note, when you’re talking about inputting numbers and since you said the I-word first, how are you using inflation in these calculations? Is that a word that’s on the lips of your clients?

Liz Windisch: It sure is. It sure is because that has changed so significantly in the last six to nine months. The software I use will default to the average of the last 40 years, but we can change that. I like to get my clients input on that and use a number that they are comfortable with. Lately we have been dialing that up. I think the average now is 2.4%, but we’ve been using a much higher number just to err on the side of caution if we have the next 10 years of really high inflation, we want to account for that. We update plans as we go too, just because we’re doing this now and deciding if you can retire, this is something that we adjust each year. If we find that inflation hasn’t been that high, we could rerun numbers and maybe you can spend more money. It’s just a snapshot in time.

David Muhlbaum: Right. But there’s a demographic component too because the people who are retiring now, or the people we’re talking about, the late 50s, early 60s, those are people who lived through, and some were aware of the hyperinflation era of the late 1970s, so it’s not foreign to them, even if it hasn’t been seen in a while.

Liz Windisch: That’s right. That’s why I like to have that discussion and make sure that I have their input on the number that we want to use because I would say people that have lived through hyperinflation of the ‘70s are not comfortable using an inflation number that’s 2% or 3%.

Sandy Block: No 2.4% for those folks.

Liz Windisch: That’s right. I mean, they all remember that their first mortgage was 13% or something like that. We want to make sure that we’re using a little bit higher of a number and if we can dial that down in a few years, great. But let’s err on the side of caution, for sure.

Sandy Block: Liz, we’re talking about the gray resignation of people retiring, but one of the other things that I explored in this column that I interviewed you for is that there is a labor shortage. I wonder if very many of your clients, instead of just really walking out the door, reduce their hours or just get a part-time job, because it seems like right now there are more opportunities to do that and do it from home, which wasn’t the case pre-pandemic.

Liz Windisch: Absolutely. I have seen a huge shift over the course of my career in how people view working in retirement. 15-20 years ago, it was I’m this age, I’m leaving my job. I’m never working again. That’s great. People now don’t mind working. It may just be that they want to leave their stressful corporate job. If their company will allow them to work fewer hours or a less stressful job, they’re happy to do that. But a lot of my clients are saying, "I’ll just get a part-time retail job, something to keep me busy, something to bring in a little bit of money," which even if you bring in a small amount of money, it can make a huge difference in your success in retirement. For every dollar that you make, there’s a twofold benefit to that. That’s a dollar that you’re making and potentially saving, but that’s also a dollar that you’re not taking out of your retirement portfolio. Even making a fraction of your former salary can help a lot. I think people are really interested in doing that and staying active and vital.

David Muhlbaum: Well Liz, for all the people who might have been inspired by Sandy’s title, Take This Job, I’m Retiring, I hope you’ve given some insights as well into what you really need to keep in mind as you consider good bye to the working world and an early retirement. Thank you so much for joining us. We appreciate it.

Liz Windisch: Thank you for having me.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple podcasts or wherever you get your content. When you do, please give us a rating and review and if you’ve already subscribed, thanks. Please go back and add a rating review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. If you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Listen now:

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Kiplinger’s Economic Outlook: GDP
• Kiplinger’s Economic Outlook: Inflation
• Kiplinger’s Economic Outlook: Jobs
• Kiplinger’s Economic Outlook: Interest rates
• Kiplinger on tiktok

Transcript:

David Muhlbaum: 2022. Yes, it's already underway, but we've got more than 11 months to go. Forecasting what might actually happen in that time is what the Kiplinger Letter does. John Miley, a senior associate editor for the Kiplinger Letter joins us to talk about his team's top 10 forecasts. Also, the Theranos trial. Are you fascinated by the tale of Elizabeth Holmes? That's all coming up in this episode of Your Money's Worth. Stick around.

Welcome to Your Money's Worth. I'm kiplinger.com senior editor David Muhlbaum, joined by Kiplinger Senior Editor Sandy Block. How are you doing, Sandy?

Sandy Block: I'm good, David.

David Muhlbaum: Great. Well, our guest today is John Miley from the Kiplinger Letter. And I know you were following the Theranos trial very closely, and that story is one that John was intrigued by. So what we're going to do is bring him into the opener right here, right now. But before I turn the two of you loose on your thoughts about Elizabeth Holmes, I want to try to apply the Your Money's Worth principle: Is there some actionable personal finance advice in this tale?

Sandy Block: Well, probably not, or it would be a stretch, but what we do see are some total failures of due diligence by investors. And that should give people pause about the judgment of the smart money we often look to for guidance, and is it is not always right? And I think there is some relevance. What we saw in the past year was how easy it is now to take a flyer on a stock with apps, such as Robinhood, you can do it for free. And while I don't think Theranos was ever available widely to the public, there are plenty of flashy stocks that are. And just because they're getting a lot of buzz, does not mean that you should put your money there.

David Muhlbaum: Got it. All right. I'm curious what John has to say as well, but maybe John, first off, you can give us the Theranos story in 30 seconds?

John Miley: Well, Elizabeth Holmes, as a 19-year-old Stanford... well, she didn't finish Stanford. She came up with the idea for a device that could take a pinprick of blood and come up with all these results. And it's something that the conventional testing couldn't do. They would have to take vials of blood, and the devices were huge and expensive. And she was able to convince a lot of investors to pour in hundreds of millions of dollars into this company. And it lasted for years. She convinced military people. She convinced George Schultz, former secretary of state, and among other things, to buy into this and be on the board. And basically what happened is the thing was covered a lot in the technology world, and it ended up being largely a scam throughout all the years. And she covered up that it didn't really work. And what surprises me most is how long it lasted. But yeah, I don't know if I left anything out Sandy, but that's how I see it.

Sandy Block: Yeah. I think the thing that I was fascinated by was the suggestion that what she did wasn't all that unusual in Silicon Valley, that whole fake-it-till-you-make-it, that exaggerating what you've invented or what you're selling is how it's done, and that maybe she exaggerated things a bit, but it wasn't all that bad. But I think what separated this from the others was that it was a healthcare device. It wasn't pets.com. It wasn't something that will deliver a new type of video to you. It was something where people could die if they got the wrong information from a blood test. And I think that's what really sort of sealed the deal for her, that she wasn't playing around with some cool tech device. She was playing around with people's health and people's lives. And that really made this to me so much more disturbing, I guess.

David Muhlbaum: And in terms of the Silicon Valley culture, the flip side, it seems to me of the culture of fake-it-till-you-make-it, is the people, the board members, the sort of the smart money, if you will, who are supposed to be investing decisions on behalf of their funds, they're supposed to do the due diligence that breaks through the fake-it-till-you-make-it. So they abdicated some responsibility, too. And it was Theranos and Holmes who were called to the carpet. But I would've imagine... I don't know... What are the repercussions for people who lost other people's money in this? Is there any accounting for them?

John Miley: Some of the investors were individuals, Rupert Murdoch, for example, invested over a hundred million dollars. So she did embrace Silicon Valley culture, idolized Steve Jobs, but some of the venture capital was not conventional traditional Silicon Valley venture-type people. But yeah, I do think they jumped in and didn't do that type of due diligence to see, "Does this work?" or they were in over their heads and swept up by sort of, "Oh, we can fix it in software. This is like an app." And I couldn't agree more with Sandy that, with this healthcare thing, not only is there a lot of regulatory things going on, but it's also incredibly challenging to do some of these things more so than building an app and then fixing it when there are bugs in it.

Sandy Block: And I think one other thing I will add, David, too, I wonder... And I'm not an attorney and I wouldn't even be able to channel one, but what is the board's culpability here? I mean, what was their responsibility to do their own due diligence? As I said, one of the reasons that people were so eager to invest in this company is because she had this incredibly prestigious board, but what is the responsibility of those individuals to go beyond the hype and see what's working and what's not working. I imagine they're going to argue they got scammed along with everybody else. And she was really good at covering her tracks, I think, for a long, long time. But that will be something interesting to see. There's going to be a lot of private litigation long after.

David Muhlbaum: That's what I was wondering about.

Sandy Block: Tons of private litigation is going to go on.

David Muhlbaum: Like, who's suing who, right? How come it hasn't happened already, or has it?

Sandy Block: Again, I'm not a lawyer, but I think if I were intending to sue Theranos, I would wait until after the trial, because that gives you more ammunition in your loss, in your civil-

David Muhlbaum: Yes. Okay. I see. That makes perfect legal sense to this other non-lawyer, okay. Again, trying to come away with... I mean, it's a great tale. I'm not as obsessed with it as you guys are, but lord knows my wife sure is. What are the going-forward lessons?

John Miley: For me, it's always considering that biotechnology is really hard, and there is a regulatory part of this. And sort of these hyped-up things that seem amazing merit a lot of scrutiny. But in general, on the technology front, whether it's a new term like metaverse or something like that, I think these require some investigation if it seems too good to be true. I mean, that's something that comes away, for me. Especially if it's in fields that are over a lot of people's heads, and they don't really sort of know what's going on, but they just see money flowing into it, and they see partnerships happening and things of that nature. But she was very good at hiding that this thing didn't work. It's actually amazing if you read the book. There's so many layers, it's almost hard to talk about what seemed to be happening, at least according to the Bad Blood book.

Sandy Block: Yeah. And I guess just going back to our earlier point, David, I think it's just a real wake-up call for individual investors. Now, in this case, we couldn't buy Theranos on the Robinhood app.

David Muhlbaum: Or at all.

Sandy Block: I think you had to be a sophisticated investor to get in. But this just goes to show that even high-income sophisticated investors can get scammed. And that's a takeaway for the rest of us.

John Miley: She also did try to use her technology during the Ebola crisis. So it's kind of a... I mean, I don't know how much it reflects today, but during a pandemic, during a crisis, there are companies that will come in and say, in her case, "We can test for this. I want to do a government contract. We can do this." Again, like you said, her company wasn't public, and I'm sure public companies have other incentives not to do things like that, but people can take advantage of a crisis.

David Muhlbaum: Perhaps we can breathe a sigh of relief that she and Theranos weren't really operating once coronavirus hit.

Sandy Block: She would've said she could fix it.

David Muhlbaum: Yeah. All right. Well, we are going to come back to some of the things John touched on, like massive inflows of money into uncertain new fields. When we talk about 10 forecasts for the year ahead.

The Kiplinger Letter’s 10 Forecasts for the Year Ahead

Welcome back to Your Money's Worth. For our main segment today, we're going to dig into the Kiplinger Washington Letter's 10 forecasts for 2022. Now forecasting is what the letter does 52 weeks a year, but they have a tradition about a decade old now of doing 10 forecasts for the year ahead at the start of the year. So we're going to continue on with John Miley, senior associate editor for the letter, and ask him about these. Which is his real day job when he's not following the literal trials and tribulations of Theranos.

John Miley: Thanks, David. Great to be here.

David Muhlbaum: If we're reading our history right, this forecast for the year ahead thing, got its start as 11 forecasts for 2011. Now, I bet you're glad we didn't stick with adding one each year.

John Miley: I think it was good to ratchet down to 10 and stay with that.

David Muhlbaum: Well that said, I do see a few other things in this letter that are also forecasts for the year ahead. So, well, we might have a few curve balls for you, but let's get started. As makes perfect sense, your forecasts start out with the economy. Economic forecasting is at the core of the Kiplinger Letter and well, the economy is at the core of all sorts of things. But since the economic forecast makes a reference to the COVID pandemic, I would actually like to ask you about that first, maybe in part so that we can get it out of the way. Haha. We're coming up on this end of the second year of the pandemic. So let me just ask flat out: Does the pandemic end in 2022?

John Miley: We are saying that there is a turning point here, which we're calling Learning to Live with COVID. So we think there is a more normal state of affairs. So I do think that marks something optimistic and positive with what we were thinking. And we have a few reasons for that. And I know right now it seems like the pandemic has dragged on, and omicron cases are surging, but we are looking for the surge to likely suddenly, which would sort of be one of the smaller turning points for the year.

David Muhlbaum: Got it. So “learning to live with COVID” is kind of your term. Pandemic, we'll leave that to the WHO, who came up with it anyway.

Sandy Block:

But John, isn't one of the reasons for optimism is that you're saying that omicron, as bad as it seems now, is basically going to edge out the more serious delta strain, and that's how we sort of become able to live with the pandemic?

John Miley: Yeah, that's right. And then other virus variants, though they'll definitely emerge, they're likely to be less dangerous. And I mean, it's the idea of becoming endemic, which was talked about at the beginning, by some of the smart public health people, that the idea that this could be like a flu-season thing, but this year being the year that it starts to be thought of as that, with vaccines widely available, more drugs coming available that can help, hopefully rapid tests becoming available. We mentioned that too, as being a big part of this, having the ability to test yourself, to figure out, are you infectious? Do you have it? Do you need to stay home? Do you want to see family? So part of that too, because during the holidays, people had a hard time getting testing, which it's a tool in a toolbox. It's not everything, but all those things.

And then the other thing would be just so many people having it, just general, more people having antibodies and immunity or some levels of that. And then vaccinations continuing with children and more people. So those are the positive signs. What that means is that eventually consumer confidence comes back. Where infections go down, people see that, more in-person activities. Because now the supply-chain crunch, it's people buying lots of goods. They're not going out as much. So that's restaurants, movie theaters, bars, and, it's varied across the country, of course, but we're looking at the macro picture of the country, if those can come back up. I mean, that's part of what we think of as coming back to normal. I've also forecasted the movie theater industry this year could return to a more normal state of things as it was pre-pandemic. So in terms of box office revenue, people actually going to the theaters, that's one example of this.

Sandy Block: Ooh, I would like that because I'd like to go to see West Side Story, so that's good to hear.

David Muhlbaum:

So, in terms of that viewpoint of what the pandemic will look like and how it'll affect the economy and consumer confidence, let's go to the hard numbers. Let's talk about the economic forecast itself now that we have a sense of how the pandemic fits into it. What is the letter forecasting for GDP growth in 2022?

John Miley: So 4.0%. And when we say a rapid 4.0%, that's slower than '21, which is 5.6%, but that's still rapid growth. Though we do say, it's going to start the year slow because we're having the surge happening and people being nervous, and that's reflected in how they spend and things like that. But we think it will speed up as the pandemic recedes. And like I said, that's going to show up the most in that service sector, the restaurants, the movie theaters. Although, we also think manufacturers will keep going strong. Some of the things that matter to that are the computer chip shortage could ease. That's really important with car manufacturers that just can't find, computer chips for their cars. The cheap computer chips are holding up their expensive cars that they can't sell. So those are some of the factors going into that.

David Muhlbaum: That rebound for the restaurant and service sector depends in part on finding people to work in it. So I would ask the next thing would be like, what is going to happen with unemployment and job creation?

John Miley: That will stay tight. We say unemployment at a 3.2% level or below by year end.

David Muhlbaum: That's 3.2%. We haven't seen that since... Well, I don't know when we haven't seen it.

Sandy Block: Ever.

David Muhlbaum: Ever! Right. Record low unemployment is what we're talking about here.

John Miley: And then that's going to push up wages once again, not quite as much, we don't say as the 5% wage rise in 2021, but we're saying for 4% wage rise. So it's going to require businesses forking over more money to get these workers. Because I mean, one thing we keep writing about is shortages in all sorts of industries and how hard it is to get, to find, and keep workers.

Sandy Block: Which leads to the other big number we want to ask you about, John, is what is going to happen to inflation in 2022? 90% of my mail these days is about price increases. It's top of mind for everybody. What are you all seeing happening in light of what you just said about a tight employment market and higher wages, what are we going to see?

John Miley: I was looking what it actually ended up last year to remind myself and I think it was 6.9%. So yeah, it's pretty clear why it's really on people's minds. We say starting the year high, falling below 3% by year end. So people looking at this, I mean, not good that it starts high if you're worried about inflation, but the idea that it will be falling down is good news for lots of people in businesses.

Sandy Block: And what factors do you see causing inflation to sort of ease off?

John Miley: Part of that is some good news on the supply-chain issues. We do expect major improvements, though there'll still be issues throughout the year. So as that gets smoothed out, that could tamp down inflation in some areas. And then the other thing like we've and talking about, is that people shifting gears back into the service sector. So they're not just buying all sorts of goods, they're going into things that aren't quite as affected by a supply-chain crunch. Whether you go to the movies, the restaurants, those things aren't impacted by ports in LA being clogged and trying to get containers off ships and truck them to places. So that will level out spending and that could ease in other areas. So that's a big part of it, I think.

David Muhlbaum: When we talk about inflation, we tend to talk about interest rates, the other I-word. And when we talk about that, we're looking to the Federal Reserve to take action, to potentially save us from this inflation. What is the Federal Reserve interest rate outlook for the year ahead?

John Miley: We're saying four short-term interest-rate hikes.

David Muhlbaum: Four?

John Miley: Four, and likely in March, June, September, December. And this is even though the Fed still thinks that inflation's going to cool off, but they're worried about the self-fulfilling prophecy of consumers beginning to continue to expect it and paying higher prices and workers continuing to expect ever increasing wages. So I mean, that is on their mind. And I also think that the omicron surge throws a wrench into that too into their thinking, but that's what we're saying. So that's definitely a change of things for the Fed.

David Muhlbaum: It's been a long time since we've had a real sort of series of interest rate hikes, I guess they call it a cycle? I mean, I'm asking a lot of wonky Fed detail, but do you know when the last time they did four in a row?

John Miley: That's a good question. I'm not sure. I know that the major focus has been looking at this unemployment rate and clearly things have changed for them.

Sandy Block: So we don't usually talk about politics on this podcast because we're scared...

David Muhlbaum: We don't like hate mail!

Sandy Block: We're scared, but that is on your forecast list. And obviously who is ever in charge of things does affect the economy and pocketbooks and things like that. So, John, can you talk about what you're seeing in terms of the midterm elections, which are going to be here soon.

John Miley: Sure, yeah. 10 months away, and we're talking about as things stand now and we always know that everything can get shaken up by something big and things can change, but we're looking Republicans to take the House. Democrats have the house now. We're saying Republicans take at least a 10-seat lead in the Youse after the November elections. So, that would flip the Democrat's current slim nine-seat advantage. And we just think that Democrats face a lot of obstacles. Redistricting has helped Republicans and President Biden's polling numbers are not looking good right now. And we also look at the history of what happens in a midterm election in this type of scenario. We also think about what the Democrats are trying to do in Congress and that some of their voters may be frustrated that they're not getting all the campaign promises done. I know the Democrats still have some time and they're still working on the Build Back Better, which we're writing about a lot, but there's still frustrations among their voters.

Sandy Block: So we’ve got a bunch of Democrats retiring and also some redistricting, and that could also play a role in the upcoming election, correct?

John Miley: Yeah. And it's also a sign that Democrats see that they could potentially lose or they feel like they could lose. Some of them, their maps have been redrawn, so it's tougher for them to win. Others are just saying like, "Look, I might not want to be here if we lose the House." It's not as, I guess fun, for lack of a better word, if we're in the minority party.

David Muhlbaum: And the big name that would retire if the Democrats lose the house is... John?

John Miley: House Speaker Nancy Pelosi.

David Muhlbaum: So that would mean, based on the forecast, the next House speaker would be...

John Miley: Kevin McCarthy.

David Muhlbaum: Kevin McCarthy. Okay. But, and again, sticking with the forecast, but okay, who would take Nancy Pelosi's place that is now as minority leader?

John Miley: The best bet is Hakeem Jeffries of New York. So basically he would be holding the minority position under the GOP control.

David Muhlbaum: All right. So that's the House picture, and the Senate?

John Miley: Right now, it's 50/50 with Kamala Harris, the tiebreaker, but we think the edge goes to the Republicans, though we think this is a closer call. So from 50/50, we're thinking that they're going to take a slight one to three seat advantage in the Senate. So basically, obviously now you have Republicans taking over both chambers.

David Muhlbaum: Right.

John Miley: And Biden left in the White House, dealing with a Congress that's Republican led.

David Muhlbaum: And okay. And even before that... We can imagine what that's going to look like legislatively just on the face of it. But remember, we're talking about the year ahead here. So let's talk about what Congress will, or maybe won't do in 2022. They're all kind of looking ahead at the election, what's the legislative outlook in that kind of year?

John Miley: We're thinking more gridlock as a lot of politicians turn to the elections. Election year, sometimes by summer, they stop focusing on major bills. And there's some smaller things that we're thinking about such as, maybe something on a COVID-type package, there's talk.

David Muhlbaum: More relief?

John Miley: More relief for the restaurant industry. Right now, that's talk, but that I know that's something that our political reporter continues to follow, but for the most part, lots of bickering and partisan fighting. And we don't see many major things, major agreements, major things getting done the year ahead.

Sandy Block: John, I want to switch to something that's a little bit more in our area, and that is cryptocurrencies. I get about as many emails about that as I do about inflation, and I wonder what your forecast is with respect to that very interesting segment of the market.

John Miley: A lot more scrutiny is in the cards this yea. I mean, it's been scrutinized, but we think it's going to kick into higher gear. We talked about last year, lots of rise in crypto. As someone who covers technology myself, it's cryptocurrency beyond just the investment and speculation, it's just filling up everything about the tech field. But we think more enforcement action, not from just the U.S. But from global regulators. And we also mentioned that stablecoins, which attempt to offer price stability. Although I wouldn't even be surprised if one of you might know more about stablecoins than me at this point.

Sandy Block: No.

David Muhlbaum: No.

John Miley: Some additional. Those are among the top targets. I know some senators have talked about those.

David Muhlbaum: Well, in terms of the regulatory environment, I mean, one thing we have talked about or seen in the past year is that there are tax consequences to trading cryptocurrencies, and that individuals who hold them and trade them are facing a tax-reporting requirement of capital gains and losses. And when you say in the letter that U.S. Lawmakers are eyeing tax regs, such as restrictions on capital loss deductions, does that mean specifically for Joe Bitcoin, that he might not be able to deduct a loss if bitcoin crashes in the next year?

John Miley: That's what I believe, although I'm not 100% certain on that.

Sandy Block: I'll just throw in here, because I'm working on our tax coverage already, because April 18th this year is going to be here before you know it, that the IRS is definitely paying a lot more attention to cryptocurrency transactions and reminding people, including putting a line on Form 1040, that you are supposed to report your capital gains in cryptocurrency, that it is treated just like any other asset. Even if you use it to buy a car, you still have to pay taxes on any gains. And there are a lot of people sitting on a whole lot of gains. And I guess some platforms are now even sending people 1099s or some form, but that doesn't get you off the hook if you don't get one. I think at the very least, it seems to me like on the enforcement side, the regulatory side, there's going to be a lot more scrutiny because there's a whole lot more money out there that people could be paying taxes on.

John Miley: Sandy, this might be an apocryphal Reddit thread, but I've also seen that some crypto investors get the gains, spend them all and don't realize they may have to pay taxes.

Sandy Block: Exactly, and there's a lot of confusion about this because Bitcoin and other cryptocurrencies, while they are currencies, they are also considered assets for purposes of taxes. So even if you say you bought some Bitcoin a long time ago and you spend it, people may think, "Well, that's just like a dollar. You don't pay taxes on... You know, if you got money in your mattress and you take it out and you spend it, you don't pay taxes on that." But cryptocurrency and Bitcoin is an asset and you do have to pay taxes on the gains, no matter what you did with the money. And I think that's what there's a lot of confusion about, especially now. And this is what I learned in my reporting for our tax cover is we have a lot of newbies. A lot of people bought Bitcoin for the first time last year or cryptocurrency or one of them. And they don't understand that these do have tax consequences.

David Muhlbaum: Since we've been talking bitcoin and since John said Reddit, I'm going to ask about the social media platform that got into the letter and that is TikTok. And this one just frankly, it makes me feel old because I'm on almost everything but this one. And this one, it seems to me, I'm just leaving to my children. John, are you on TikTok?

John Miley: I'm not on TikTok, and this is not on TikTok either, right?

Sandy Block: Not yet.

David Muhlbaum: No, this is not yet on TikTok. Although Kiplinger, we do have a TikTok presence. Big creds to our summer intern from last summer for getting us going there. Okay. So grumble as we will, it's growing fast, right? It's growing faster than its competitors. John, what's the outlook for TikTok, and broadly, what's the outlook for social media regulation because there were hearings, there was plenty of chat about that in 2021. Is anything going to happen in 2022?

John Miley: In a lot of ways, TikTok is going to lead the way in important metrics of growth this year once again. And it's pretty incredible how big they've gotten in the U.S. I was looking and last I saw they had 80 million users, I think in October. That's monthly users in the U.S., Which was approaching Instagram levels of 119 million users. Facebook has 180 million. Anyways, TikTok is big. They've come to be a real competitor against Facebook, Facebook-owned Instagram, the two big ones, and then Twitter and Snapchat, those ones. They have a billion users worldwide. And so it's pretty incredible how fast they've grown. They show that it's not a market that doesn't change. People can enter and compete because people like it. Young users especially love this photo-sharing app, short clips backed with music. Infectious, when you look at it, you can't stop scrolling.

I've talked to our young interns and they say, "Oh yeah, TikTok's better. It just is." And then they'll give me good reasons, but they just think it is better than Facebook or Instagram or YouTube that tries to copy different features of TikTok. And it's a big deal because they're going to start making... I mean, they're competing for ad dollars, e-commerce. They're making lots of money. Facebook is getting worried about this because they're growing with the ever-important young market and they're growing faster. But one thing that none of these companies have to worry too much about, I don't think, is major federal regulation that would crack down on them this year, that would really hinder their business. I don't see that this year in, like we've talked about, Congress may not get many big things done. There's plenty of ideas out there and they're arguing about it, but I don't see them coming up with something that they agree on and they pass that does a big crackdown on the industry.

Sandy Block: But I think you mentioned in the letter that maybe some states will do some things around the edges there?

John Miley: Yeah. Some states are targeting. Florida has targeted, Texas has targeted social media companies, whether it's for censorship or... So in other words, trying to get them not to censor things.

David Muhlbaum: Isn't that just going straight to the courts? That just seems like a federal, state regulatory nonstarter.

John Miley: Yeah. I've basically written that a lot of these face, just the First Amendment. They're going to run into that, which allows these businesses the ability to sort of regulate. I mean, there are other things you could do, you can think about privacy regulations. States are suppressing more privacy regulations.

Sandy Block: Which California did, I believe.

John Miley: Right. You could pass maybe transparency regulations or something along those lines. I'm sure they're thinking about different things. So I would expect more state laws to take effect, but I do think some of those are going to go to court.

Sandy Block: Anything affecting content seems really difficult to get passed.

John Miley: Yeah, for sure.

David Muhlbaum: John, a word that you said a few times up till now has been semiconductors, chips. And in 2020 and 2021, we experienced, certainly in the car industry as you mentioned, the impact of expensive vehicles not being able to come to market because of inexpensive chips. So is that going to get fixed, and if so, how?

Sandy Block: Yeah, when can we buy a car? That's the big question.

David Muhlbaum: At a reasonable price.

Sandy Block: I need a car!

John Miley: I was going to ask David the same thing. Yeah. I mean, we've called for it to ease. I mean, one thing amid this chip shortage that we've looked at for this top 10 is money, just venture capitalists are pouring money into startups that design chips. So they don't build the plants that manufacture them, but they develop new designs. And one of the things that's happening in the chip industry generally, is there's not a one-size-fits-all chip. There's more specialized, different type of chips. So there's a lot of room for innovation. And I do think to your point, it may not be as quick as car buyers want, but I do think some of this money in these promising startups are going to focus on analog chips that would go into cars. How long that takes, I'm not sure, but that would be promising if you take a longer view, I guess for the years ahead.

Sandy Block: I don't have that much more time on my car.

David Muhlbaum: And I think I'm going to try to explain this one because when I first heard the term, I kind of said, "a what?" But an analog chip is the fundamental idea of taking something that's analog, like you talking to your car and turning that into digital information that it can do something with, right?

John Miley: Yeah, sensing something from the real world.

David Muhlbaum: Right. Okay.

John Miley: And like you said, for cars, those are very, very cheap. So I guess they didn't really prioritize them in certain different ways and then sales shot down for cars during the pandemic, and then they just found themselves without these chips and huge backlogs now.

David Muhlbaum: Right. So the chip itself is not a feature of innovation. Making a lot of them at a good price, the fabrication is the issue.

John Miley: That's a big part of it. Although, I mean, I do want to point out that there is very interesting and exciting research in analog chips too, whether they're low-powered sensors or things that could be related to either electric cars or self-driving cars. That could be interesting, innovative features.

David Muhlbaum: Okay, John, we don't want to go through every single forecast because, of course, we would like people to subscribe to your wonderful product and read it online or on paper. But! At the end of the letter, outside the top 10 forecast, you have another one. And that is about the ongoing legalization of marijuana at a state level. What states do we see taking action — and what — in 2022?

John Miley: So we're pointing to four states as the best bets, Delaware, Maryland, Rhode Island, South Dakota, to legalize recreational pot use for adults this year.

David Muhlbaum: South Dakota? Wow.

Sandy Block: Make your vacation plans now folks.

David Muhlbaum: Yeah, I was not expecting that one, but you know-

Sandy Block: Yeah, it's an odd assortment.

David Muhlbaum: Well, the Northwest has had a sort of interesting record. You have Washington and Idaho, couldn't be more different and they share a border.

John Miley: I think one thing... I don't have the stats with me, but the amount of tax revenue some of the states can make.

Sandy Block:

That's what I was going to say. All of a sudden, people who are totally against legalizing pot start seeing some of the money coming in and that changes. So I think taxes definitely drive this conversation.

David Muhlbaum: Interesting.

John Miley: It's very surprising. If anyone wants to look, states can make a lot more money than you might think, if you haven't checked it out lately on revenue on marijuana sales.

David Muhlbaum: And if you want to know what your state or the neighboring state is actually charging, you can check out the Kiplinger tax map because that is one of the metrics in there. Freshly updated. Thank you so much, John. We look forward to the year, we look forward to your forecast, and we look forward to reading more of the Kiplinger Letter. Thanks for joining us.

John Miley: Happy New Year. Thanks for having me.

Sandy Block: Happy New Year.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you've already subscribed, thanks. Please go back and add a rating or review, if you haven't already. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Listen now:

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Meet the Architect of the 401(k) Plan
• Kiplinger’s 2022 Investing Outlook
• PODCAST: Investing for Income with Jeffrey Kosnett
• James K. Glassman’s 10 Stock Market Picks for 2022
• The 22 Best Stocks to Buy for 2022
• 5 Stocks to Sell for 2022

Transcript:

David Muhlbaum: No doubt stocks in 2022 are going to have a tough time topping 2021’s stellar performance, but rise they will, Kiplinger is forecasting. We’ll dig into the year ahead with investing editors Anne Smith and James K Glassman and see what individual equities they’re recommending as well. Also, what the architect to the modern day 401(k) plan thinks of his idea today. All coming up on this episode of Your Money’s Worth. Stick around.

Welcome to Your Money’s Worth. I’m kiplinger.com Senior Editor David Muhlbaum, joined by my co-host, Kiplinger Senior Editor Sandy Block. Sandy, how are you doing? How is Detroit?

Sandy Block: Cold, David, very cold, but otherwise just fine.

David Muhlbaum: Good, good. You interviewed somebody this month, somebody who seemed to me like one of the unsung heroes of personal finance. I know there are probably people outside the benefits world who have heard of him, but I’m guessing not that many. I’m talking about Ted Benna here. Am I overstating or understating his celebrity by calling him an unsung hero?

Sandy Block: Well, not really if you are someone who makes your living writing about the importance of saving for retirement. I think that Ted does deserve that honor.

David Muhlbaum: Which is, the father of the 401(k) plan. I am willing to bet a tiny, tiny, tiny bit of my 401(k) savings that the vast majority of our listeners have, or had a 401(k), but I doubt the vast majority know how this massively popular savings plan got its start. So tell us about Ted Benna’s role.

Sandy Block: Well, I think the best way to explain it is to say that Ted figured out how to turn an obscure provision in the IRS code, that was originally used, I think, by senior executives to pad their pensions, into a savings plan for the masses. And what he came up with are things that seem very routine now, but weren’t 40 years ago. One was payroll deduction, which means that your contributions are taken out of your paycheck. You can’t spend money that you don’t have, and that’s a huge thing. And the second is matching contributions, which is the way that you encourage people to sign up. If you know your employer’s going to kick in some money, you are more likely to put in some of your own.

David Muhlbaum: And that was the sweetener that he had to add to get it off the ground when he was conceiving how to implement the 401(k).

Sandy Block: Right. I think that was something that made it worthwhile for people to do. And I think it also coincided with the disappearance of traditional pensions. So we needed something for people to save for retirement because they could no longer count on a traditional pension. But it’s still hard to get people to save and I think those are the innovations that we really give Ted a lot of credit for.

David Muhlbaum: So 40 years on, how does the father of the 401(k) plan think it’s going?

Sandy Block: Well, he basically thinks that the biggest... There are a couple problems he sees. One is, in some cases, expenses are too high and it’s too hard to figure out how much you’re paying. I think that’s not the case for very large companies, but it can be a problem for small companies. And on that-

David Muhlbaum: Those are the expenses that a firm incurs to have a 401(k) administered for it?

Sandy Block: Right. The expenses the firm incurs which is sometimes passes on to employees. And also, the expense of the funds themselves. If you work for a really big company that has a sophisticated HR department, they will probably negotiate with Fidelity or Vanguard or T. Rowe Price and get you some really low cost, great funds. But if you work for a company with 50 people and the CEO is also the guy who decides which funds to put in your 401(k) plan, he might just go with funds he heard about from a pal, or something like that. And in fairness too, may not have the amount of assets to get the lowest fees available. So I think that’s really where the problem is. I think for people who work for big companies, fees aren’t a problem. For people who work for small companies, it can be.

David Muhlbaum: And at the individual level, Benna is still gung ho on the idea of the young investor or the young employee getting in on it?

Sandy Block: Right. Yeah. And he does some pretty smart math elsewhere in the story that I wrote for the February issue, which has this interview with Ted. He says, "It’s never too early to start investing even if it’s only 1% of your pay." And one point he made I thought was really interesting in the story is, if you start very young, even if you invest only a small amount in your 401(k) contribution, by the time you retire, the majority of the money in your account will probably be from investment gains, not the money you put in. But if you start, say, in your forties, the majority of money in your account when you retire is going to be money that you contributed, which means you have to contribute a whole lot more to get to the same place.

So, he really encourages people who are just starting out, even if it’s a small amount to get started, because they really are in a position to benefit. And the other thing, he sort of discourages people from taking loans from their 401(k) plans, even though they may look very attractive. They do slow you down because you’re taking money out and reducing the amount of compounding while that money’s not in your plan.

David Muhlbaum: So 401(k)s today, huge industry, trillions of dollars of money in them collectively, where does Benna think it still needs to go, what could get better?

Sandy Block: What he says needs to make it better is more opportunities for people to participate. Because if you work for a major company, this is not an issue. Even if you work for a mid-size company, it’s probably not an issue. But if you work for a company with 10 employees, 20 employees, for those companies or those employers offering a 401(k) is just too much work. The administration, the implementation is just very hard for them. His recommendation is that small employers that don’t have a 401(k) plan should be required to offer a savings plan for their employees that offers payroll deduction and auto enrollment as well. It doesn’t have to be a full-fledged 401(k) plan, but it should be some kind of savings plan. And I think he has a model IRA that does this, that offers the things that encourage most people to participate, which is payroll deduction-

David Muhlbaum: And pre-tax.

Sandy Block: Yeah, pre-tax, payroll deduction and auto enrollment. Because one thing we’ve learned fairly recently is that if you require people to opt out, instead of opting in, if when you take a job you’re automatically enrolled in a 401(k) plan, even if you have the option of opting out, most people don’t. It’s a huge incentive. And there’s just been a huge increase in people participating in these plans, if they’re auto enrolled. So he would like to see a model savings plan for small employers that is low cost, maybe doesn’t offer all the bells and whistles of a 401(k), but does offer payroll deduction and auto enrollment. And he thinks we’ll see a lot more people saving for retirement if we have something like that.

David Muhlbaum: Do you think he ever regrets not trying to trademark this? I mean, it could have… We have the Roth. We have the Roth. We could have the Benna-fit.

Sandy Block: The Benna?

David Muhlbaum: The Benna-fit!

Sandy Block: No, I think the Roth was created. And I think the 401(k) was…

David Muhlbaum: Was interpreted…

Sandy Block: Engineered, reverse engineered.

David Muhlbaum: Yeah. Implemented or yes, well. Well, we still can give him our thanks for putting a lot of Americans on a safer road to retirement with their 401(k) savings. Thank you, Mr. Benna. Coming up next, the year ahead in investing.

The 2022 Stock-Market Outlook with Anne Smith and James K. Glassman

David Muhlbaum: Welcome back to Your Money’s Worth. You can’t talk about investing without talking about time. How did a stock or fund perform over the last year, five years, 10 years. And then there’s your personal timing as well. How soon might you need to cash out your investment? Well, there’s another timeframe, the good old calendar year. And that’s how Kiplinger, like other prognosticators, likes to look at investing trends. How did stocks do in 2021? How will they do in 2022? And then, of course, there’s breaking that down. How will sectors or even individual stocks fare in the year ahead?

David Muhlbaum: And we’re joined today by two people whose specialty that is. One is Anne Kates Smith, the executive editor of Kiplinger’s Personal Finance who coordinates that publication’s investing coverage. The other is James K. Glassman, who’s been a columnist for us since 2004, which is, of course, just one of his gigs. He’s been a newspaper and magazine publisher and undersecretary of state, which means we could, and maybe should, call him Ambassador Glassman. He’s written a number of books as well. The most recent being Safety Net, The Strategy for De-risking Your Investments in a Time of Turbulence. Welcome to you both.

James K. Glassman: Thank you.

Anne Kates Smith: Happy to be here.

David Muhlbaum:

Great. So going from 2020 into 2021, everybody kind of knew the story, "Good riddance to the great dumpster fire of 2020. Hello, fresh start." And that was the broad theme, not an investing-specific one, and 2021 didn’t necessarily live up to expectations. I think most people were hoping to have seen the end of the pandemic, but no. However, in terms of stock investing, 2021 was, well, is so far, just spectacular. Before we move on to 2022’s forecast, Anne, can you give us a recap of 2021?

Anne Kates Smith: Yeah. It was a crazy year for stocks, it was such a juggernaut. The S&P 500, which is everybody’s favorite broad market measure, has returned 26% so far this year as the small cap, Russell 2000, is up only about 10%. The aggregate bond market index is down about 1.5% as interest rates started to creep a little bit higher.

Sandy Block: Okay. I think, at this point, we have to point out that there’s two trading weeks left to go, so let’s not jinx things. Right?

David Muhlbaum: Right, yeah. Stock market is off December 24th, but a full trading day on December 31st. I guess I got to clear all the year-end stuff.

Sandy Block: Right. So 2022 forecasting, David did all his disclaimers about calendar years being a somewhat arbitrary approach to investing horizons. But, you know, it is what it is. If 2021 was so red hot, Anne, what’s the story for 2022?

Anne Kates Smith: Well, we might have been a little too cautious in our prior year outlook. For 2021, we told people they needed to moderate their expectations and that was a big mistake. But sticking with that game plan because, hopefully, and I say this with a little bit of caution because of the Omicron variant that’s spreading, but you can only reopen an economy once. I’m really keeping my fingers crossed on that. So there was explosive growth by almost any measure in 2021 that you just can’t replicate again. So, for instance, in 2022, we’re looking for, Kiplinger is looking for, about 4% percent economic growth. That’s down from what we think will be 5.6% this year. Earnings growth, which is really the driver of the stock market, we’re looking at 50% almost in corporate earnings growth for this year.

Anne Kates Smith: That’s not going to happen again in 2022. In fact, analysts think that it’s going to revert back to more, the long term average, which is about 7 to 8%. So given those more modest parameters, we are telling people to moderate their expectations for the stock market. You can’t expect 60+ all time highs in another year. So we’re looking for high single digits, which again, is about an average return for the stock market, maybe a little bit lower even. But we’re looking about price returns of 7 to 8% and maybe between another one to two points, percentage points, from dividends.

David Muhlbaum: And I want to give you props for getting Omicron right. For those of you who heard me pronounce it wrong a couple of weeks ago, cut me a little slack. The term was like an hour old then and I guess maybe my classical Greek isn’t so hot.

Anne Kates Smith: I studied classical Greek in college.

David Muhlbaum: Well, there you go.

Sandy Block: After that interesting opening, I think the people are interested in specific stocks to buy or sell, and yes, we have recommendations, Jim too, we haven’t forgotten about you. But before we move into ticker specifics, Anne, I want to ask about what you so aptly called, "The elephant in the room," inflation. We just got the November consumer price index numbers. The annual inflation rate in the U.S. accelerated to 6.8% in November of 2021, the highest since June of 1982, which is when I was just out of college. Is that going to continue and how can the bulls stand up to this beast?

David Muhlbaum: Ooh, the animal metaphors are flying.

James K. Glassman: Well, Kiplinger’s inflation forecast for 2022 is quite a bit lower at about 2.8%. I think the thinking on Wall Street is that inflation is going to run hotter than it has for years, which is 2% and below. But it’s going to be right around that 3% mark, which is, again, the long term, going back to 1926, the historical average. So higher and sticky and more persistent, but not 1970s levels at all. But that said, you’ve got to be thinking in your portfolio about protecting yourself from inflation. And if you bought tips earlier this year, good for you. Congratulations, they’re very expensive now. But the good news is that stocks in general, because of their growth component, are very good inflation hedges. Stocks over time will generally, not all the time, but over the long haul will keep up with inflation so that the stocks are a good place to be.

David Muhlbaum: I’m glad you mentioned TIPS, treasury inflation-protected securities, because we actually did a segment with Jeff Kosnett a couple weeks ago. And I’m going to put a link into it because, frankly, today we’re just going to blast right past fixed-income investments and stick with stocks. So as you said, Anne, stocks are a good investment for an inflationary environment. Are there some that are better than others? What stocks, if you will, are inflation ready?

Anne Kates Smith: Yes. You definitely want the inflation fighters. And those are companies that can keep their costs low. They have a handle on costs so they’re not suffering by paying more for rising input costs. They’re companies that can raise their prices because they enjoy such strong demand or because their market share’s expanding so strongly that they can go ahead and raise prices. And I’m thinking of companies like Netflix (NFLX), the streaming giant, they raise their prices and people keep paying them. Farm equipment maker Deere (DE), is another one with a strong market share. We also recommended AmerisourceBergen (ABC), which is a healthcare distributor. They enjoy very low labor costs per employee. So they have a handle on costs.

Sandy Block: So Jim, in your column, in your January column, you said that you like PepsiCo (PEP) because it stands to benefit from general inflation, from aggressive price increases. And you also mentioned, I love this example that you like Public Storage (PSA) because they can raise their prices and people are not going to go take all their stuff out, which I think is a really good point. Any other thoughts on, maybe you can expand a little on the types of stocks that you think benefit in this environment and maybe some that don’t.

James K. Glassman: Well, Sandy, I agree with what Anne said. I think that growth stocks benefit more than value stocks. And I also think that there are a lot of extremely profitable technology companies that have not done a lot of price raising, and I think of Amazon (AMZN) being one of them. And I also think, maybe not so much Apple (AAPL), but I also think Microsoft (MSFT) can raise its subscription fees fairly easily. These companies have been basically sitting on very close to the same kinds of fees for a long time. So I don’t think they have a hard time raising their prices. Also, I mentioned, my pick for 2022 is Starbucks (SBUX), although Starbucks, I believe, already has been raising prices because coffee prices have gone up, I think they’re also in a position where they can raise prices.

I don’t have a great fear of inflation. I also agree, as far as stocks are concerned in general, unless inflation obviously leads to the Fed doing enormous amount of tightening and that causes the economy to go down. And also, I generally agree with what Anne was saying. I don’t really see inflation being, certainly not being, over 3% next year. So I’m not sure how much the Fed is actually going to tighten, to tell you the truth. But I think in general, look, investors are always choosing between stocks and bonds. And for the past 10 years or so, bonds have just not been a choice at all, unless you want to get one or 2% on your money. And so that could change and I think that will change. So that could have a depressive effect in general on the market.

David Muhlbaum: Well, since you brought the Fed up, Jim, you and Anne are both pretty bullish on financial sector stocks. I was wondering, do you feel like last week’s announcement by the Federal Reserve, the Bank of England, does that confirm your expectations that the sector will do well in 2022?

James K. Glassman: Yeah. I think the issue is whether this is already kind of baked into the cake because financial stocks have been rising, but I don’t think it has been completely. I mean, the problem for banks, let’s say, normal commercial, large commercial banks, like Bank of America (BOFA), which is one of our picks, one of our 10 picks for the year ahead, is that there hasn’t been much of a gap between what the bank pays for deposits and what it gets when it lends that money out. And as interest rates rise, that gap increases and they make more money. And again, unless rates rise in an extreme way and really harm the economy, banks will benefit from higher interest rates and these rates have been anticipated for a long time. So I think it’s one of the reasons that stock prices have gone up for banks like Bank of America. But I think there’s still room to grow.

Anne Kates Smith: Yeah. One of the ways we like to play financials is with Invesco S&P 500 Equal Weight Financial. That’s an ETF, symbol RYF. And why we like it, is that it gives as much weight to the smaller regional banks as it does to the big money center giants. And we think it’s nice to have exposure to those Main Street banks that will do well as the economy improves and things pick up again. So that’s one way to play financials that we like.

James K. Glassman: And Anne, I’m a big fan... I’m sorry, Sandy. I just want to say, I’m a big fan of Main Street banks. I cut my teeth on Main Street banks and I should be doing a column on that subject soon.

Sandy Block: Okay.

James K. Glassman: If you’ll permit-

Sandy Block: Put a pin in it.

Anne Kates Smith: Check.

Sandy Block: Anne and Jim, we’ve been talking about domestic stocks, but China did not have a great year last year. And some of the news coming out of there, I think was concerning. Are you still long-term bullish, Jim, on China? Do you think it has a place in investors’ portfolios?

James K. Glassman:

So my answer to that is yes and yes, but I also warn investors that China’s very risky. But I see China, at least as far as what they’ve done with some of their larger companies, eventually coming to the party, eventually coming to its senses. But I just want to say that the worst performer on the 2021 list, on our 2021 list, was in fact Alibaba Group Holding (BABA), which fell by nearly half. So that’s not good, but on the other hand, it’s not easy to find bargains. And I think China is a place to do it, but you just have to understand that there’s risk. So for this year’s list, 2022, I’m not giving up. And we’ve got on our list is Tencent Holdings (TCEHY), which has also been clobbered. But for that reason, it’s good value.

Anne Kates Smith: We also put Alibaba on a list of stocks to buy for '22, but reiterate the comments about risk there.

David Muhlbaum: And to explain a little bit about the list that Jim is referring to, every year since, oh gosh, we figured out last year, since like 2006 or so, for Kiplinger, he’s put together a list of 10 stocks for the year ahead, but can you explain a little bit more about how you go about making that list, and FYI for everyone listening, I’m going to put in a link to it because we’re probably not going to get to every stock. But Jim, tell us a little bit about the process if you would.

James K. Glassman: Sure. David, and actually this list goes back to pre-Kiplinger days when I used to write a column for The Washington Post. So I guess it’s well over 25 years at this point. So what I do is, I look at people that I trust, so either managers of any kind of fund, but certainly a mutual fund or probably less likely than an exchange traded fund, but look at managers of mutual funds. Look at analysts. I’ve been using Terry Tillman for a number of years now. It’s like eight years in a row, the guy has beaten the S&P 500, he’s a software analyst. And compile a list which are really my choices, but they’re picked from the choices of others. And then I also add a stock of my own, which, by the way, in 2021 was the best performing stock. That’s not always true on my list at all.

David Muhlbaum: What was the 2021?

James K. Glassman: Well, that’s a stock that I like to call ONEOK, and other people call it ONEOK (OKE). I actually don’t even know how to pronounce it. But it’s a gas pipeline company, it is a fabulous company. It’s a really good way to play energy certainly at lower volatility than buying an exploration and production company. But its price does rise as the price of gas and energy, petroleum rises.

David Muhlbaum: And for 2022?

James K. Glassman: But it’s a really good company, it’s over 100 years old. It’s based in Oklahoma. And you know, they’re not building a lot of pipelines anymore. Maybe we should be, but we aren’t. And so, they have a wonderful market.

David Muhlbaum: And for 2022, it was, as you mentioned, Starbucks. So I guess we get to find out if people are going to need their caffeine as much as they need their energy.

James K. Glassman: Yeah, good point. Yeah, so Starbucks, I just think if you look at Starbucks, and I’m a long time owner of Starbucks, actually like Netflix, things will happen and it scares investors off and the stock will drop, maybe drops 10%, or something like that. I’m not necessarily a buy on the dips person, but I think with certain stocks, you can see this pattern quite often. And this is what’s happened with Starbucks, mainly because of China, to tell you the truth. I mean, they got a lock on their market and they actually have benefited from COVID because a lot of smaller coffee houses that have been competing with them are out of business and they’re still going strong. Now they may have a union problem. I kind of doubt that. I mean, there’ve been some Starbucks stores in the Buffalo area that have unionized, but Starbucks really does take very good care of its employees. And I don’t see that as a big problem.

David Muhlbaum: Yeah. They’ve been famous for their healthcare benefits. It’s time to throw a few companies under the bus, I’m afraid. I’m talking about the sell calls here, which are, as you mentioned, Anne, they’re harder to make than buys. But buy and hold doesn’t mean buy and hold forever. So can you give us a highlight or two for five stocks to sell for 2022, and a bit about why?

Anne Kates Smith: Okay. Well, I hate to answer this question. This is-

David Muhlbaum: Nobody wants to be negative. I understand.

Anne Kates Smith: No, it’s not that. I love being negative. The problem is, this is the hardest call to get correct. Stocks go up over time, so just in general, it’s hard to find stocks to sell.

David Muhlbaum: Well, how about-

Anne Kates Smith: When I tally up our record every year, this is not the one I like to promote.

David Muhlbaum: Well, can you talk about Nike (NKE), for example, because I thought that was such an interesting example.

Anne Kates Smith: Well, yeah, there’s two on here. There’s a couple of different reasons to sell a stock and Jim has written about this very articulately in the past. One is if the business model has changed, or the management has changed, and something that you liked about the stock is no longer present. We’ve got two stocks on this sell list. One is Nike, as you mentioned, the other is TPI Composites (TPIC). They’re not bad stocks, they’re just badly priced.

David Muhlbaum: And TPI Composites, we’ve talked a lot about that. We were talking about that one last summer.

Anne Kates Smith: That’s a green stock. They make components for the wind industry. So they’ve got a long runway for growth as does Nike, but here’s the other thing. In a market that is up so strongly this year, you might want to trim some of your winners. When you sell a stock, it doesn’t always mean jettison every single share. It might just mean trim some of your winners in the normal course of rebalancing. Well, which ones do you want to trim, maybe these two.

David Muhlbaum: Right. And maybe that’s why the traders are working all the way until the end of the day on December 31st is those last-minute adjustments.

Sandy Block: Last-minute trims.

Anne Kates Smith: Yes. The old window dressing as they call it.

David Muhlbaum: Yes. Well, don’t forget the wash-sale rule, people.

James K. Glassman: I just want to say that I agree with Anne. I think I once wrote a column about this, about just how hard, I mean, I’ve written columns about when to sell, but I think I wrote a column about stocks, actually about how hard it is to pick stocks that you should sell. It’s very, very difficult. And my hat’s off to anybody who tries it. I think I tried it once.

Anne Kates Smith: This is a much harder call to make. It can also be a lot more fluid.

David Muhlbaum: Well, as I’ve said to Anne before, thank you for sticking your neck out. And I think we might have a return conversation here too, to talk about that psychology of when to say, "Sell."

Sandy Block: When to break up with your stocks. We’ve done that, yeah.

Anne Kates Smith: I’ll tell you a call I feel much more comfortable with, is our call to buy dividend stocks. Dividends historically have been responsible for about a third of your stock returns, but dividend growth has lagged way behind earnings growth. And I think there’s a number of reasons for that to turn around and catch up. One is that demographics as we age and retire, demand goes up for dividends. There’s a lot of scrutiny on companies that spend their money buying back stock and a potential tax on buybacks. That’s going to make dividends on the margin slightly more attractive for companies. We think dividends are going to potentially be a much bigger component of your total return as price returns start to moderate in 2022. So I feel a lot more confident about that call.

David Muhlbaum: Is any of that a hangover from 2020 when some firms cut dividends or suspended, and they just have resisted a return?

Anne Kates Smith: Yeah. Those dividends are coming back for sure, so that’s part of it. But also just going forward in a more moderate price return environment you’re going to be looking for, or you should be looking for, that dividend component to give you more of your total return.

David Muhlbaum: Excellent. Well, thank you both very much for joining us. And I’m wishing everyone a prosperous end to 2021 with what little of it remains. Get those trades in. And we’ll talk to you again in 2022. Thanks so much.

Sandy Block: Thank you both.

Anne Kates Smith: Alrighty. My pleasure.

James K. Glassman: Thank you.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you’ve already subscribed, thanks. Please go back and add a rating or review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. And if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly podcasts@kiplinger.com. Thanks for listening.

Listen now:

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Resist the Impulse to Buy These 14 Holiday Gifts
• “Investing for Income,” Kiplinger’s Personal Finance magazine column
• Kiplinger’s Investing for Income newsletter
• Don’t Overlook Preferred Stocks
• Stay Above the Interest Rate Fray

Transcript:

David Muhlbaum: Everyone wants to make money on their investments, but some of us are a bit more focused on income. Does whatever we buy pay us back regularly with interest and dividends? You know, cash, not just paper gains. That's investing for income, and we'll talk today with Jeffrey Kosnett, who has covered this sector for decades.

David Muhlbaum: Welcome to Your Money's Worth. I'm Kiplinger.com Senior Online Editor David Muhlbaum, joined by my co-host, Senior Editor Sandy Block. How are you doing Sandy? Did you have a good Thanksgiving?

Sandy Block: Sure did. Got together with some family for the first time in a couple of years, so it was very special.

David Muhlbaum: Good, good. For a number of reasons, we have delayed ours to today, Friday. We just needed a little extra time to get everyone here and get ready, and it turns out you can just do that. I mean, I guess I'm violating the sanctity of Black Friday or something.

Sandy Block: Well, you're also working on a day off. We're both working on a day off.

David Muhlbaum: Well, yes. I mean, notably Friday, Black Friday, is not a day off for the stock market. They have a short day to trade and, my, they took full advantage of it. The market sold off like crazy over these fears about a new COVID variant. I think it already has a name: omicron.

Sandy Block: Oh, joy.

David Muhlbaum: Yeah. Red Friday? The stock market was only open for four and a half hours and it still managed to lose 2.5% to close at 34,899. That was its worst day of the year.

Anyway, a few quick thoughts about Black Friday, and a holiday shopping season that's still unfolding, before we get to our main segment, which is about income investing, and kind of long.

Sandy Block: But worth it. And Black Friday will be over by the time anyone hears this.

David Muhlbaum: Well yeah, that's true. But the reality is, Black Friday began before today too. Come on, the whole thing is an artifice. And obviously, every year retailers spend a lot of time and money on consultants, trying to figure out when to introduce discounts, how much those will be, and then when they're going to roll them out. And then we, as journalists, or something close, try to figure out how to translate those into the most savings for the customer. That's the guidance. And what comes out of that are these lists and slide shows and all sorts of other fun things that we post online, that I'm not going to recite here, other than to say, "Well, we got them." But the main takeaway that I can pass on is that the watchword in this year's holiday shopping season seems to be scarcity.

Sandy Block: Right. Supply chain problems.

David Muhlbaum: Yeah. Those are three words. I mean, we've heard that phrase a thousand times by now, but when it comes to actually fulfilling people's holiday wish lists, it's going to matter.

Sandy Block: So the idea of waiting for a better price is riskier than usual this year.

David Muhlbaum: Yeah. In short, yeah. I mean, I think the best advice is to do your research. Not just whether whatever items you're thinking about are going to be in short supply or not, but to check with your recipient, how much they really want this or that. And maybe you'll go ahead and buy this right now at full price, whatever, and you'll wait on buying that to see what happens. It kind of depends on how much they really want it.

Sandy Block: Which works pretty well. But what if your recipient thinks all presents come from Santa Claus? You're going to have to make up a story about Santa having a shortage of container ships.

David Muhlbaum: Yeah. I hadn't even thought about that. It's been a long time since my kids believed in Santa, the Easter Bunny, or the Grinch. Yeah. Anyway, let's move on to our main segment: income investing with Jeff Kosnett. We'll be right back.

Investing for Income with Jeffrey Kosnett

David Muhlbaum: Welcome back to Your Money's Worth. For our main segment, we're joined by Kiplinger Contributing Editor Jeffrey Kosnett, who is going to give us some insights into income investments. That's a topic we haven't given a whole lot of attention to here on Your Money's Worth, but it's a huge investing sector and one that Jeff has deep experience with. So welcome, Jeff.

Jeff Kosnett: Hi, thank you for inviting me.

David Muhlbaum: Yeah. Well, Sandy and I have a lot to learn. I mean, I know it will be educational for the two of us, and I hope the listeners will benefit in the process. Now, to clarify a bit about what Jeff does and what Jeff knows, we're going to need to talk about a phrase that I'm sure we're going to repeat a lot today, and that is the three words: Investing for Income.

Now, since you can't see capitalization or italics in podcast-land, I'm going to try to explain that investing for income means three things to us.

First of all, it means the behavior: buying bonds, certificates of deposit, and yeah, some stocks, with the goal of steady and hopefully generous payouts.

David Muhlbaum: Second of all, “Investing for Income” is the name of a column that Jeff writes for Kiplinger's Personal Finance every month. I'll put in a link.

Thirdly, and this is the big one, both for Jeff and his audience, is Investing for Income, the newsletter. And this is a monthly deep dive into all things fixed-income. Has a massively loyal following, strong subscriber base. Yes, that Income for Investing costs money to read. And I know Jeff isn't the only one who'd say it's worth every penny. So, how long have you been with Kiplinger, Jeff?

Jeff Kosnett: 40 years. I started at the end of 1981, and I think that really makes me a unicorn to have spent basically my whole life with one organization, and I'm very proud that I have.

Sandy Block: Well, and we're real lucky to have you, Jeff. And I think the fact that your experience shows so often in your column in your newsletter, in that very often, when you say something is going to happen with interest rates or bond yields or anything like that, you're usually right.

Jeff Kosnett: Well, thank you very kindly. I appreciate hearing that.

David Muhlbaum: Yeah, and I like unicorn. I, who have been with Kiplinger for quite a while too, generally refer to myself as a dinosaur. But you win in terms of years. So! And when did you launch Kiplinger's Investing for Income, the newsletter?

Jeff Kosnett: Okay. It first appeared in the world in August of 2012. So we have now completed, what, it looks like 10 full years of publishing. I prefer to say that we have now done 113 monthly issues, and many more to come.

David Muhlbaum: Not that we're counting. Okay. And about how many subscribers do you have?

Jeff Kosnett: Don't hold me to this exactly, but it fluctuates between 15,000 and 17,000. And we're always hard at work trying to get more.

David Muhlbaum: Yeah. And they ask you lots of questions, right?

Jeff Kosnett: They do. I have a very long and deep inbox of email questions. I get about two of them a day. And I get a few more than that when the newsletter reaches the subscribers and they read it and then they immediately have questions or observations related to what they just saw.

Sometimes it's as simple as saying, "Well, I'm glad that you like this strategy or this fund or whatever because I've owned it for a long time, and now I have a second opinion." Other times they say, "Have you thought about this idea? Or why have you overlooked this fund? Or why won't you suggest that people do this?"

And then I will reply. And oftentimes, it's because it's too risky or it's untimely. And I make every effort to treat everybody with total respect. And I think that Kiplinger, as a company, has always put a priority on reader service and I'm proud to continue that.

Sandy Block: Yeah, it's very old school. And Jeff, as someone who used to sit on the other side of the wall from you when we were in the office, I am well aware of how much time and patience you spent with your readers. It was always very impressive. And as you said, treating with respect because, as we know, calls we get aren't always respectful. But you were always extremely respectful and patient, and loud, because some of your readers didn't hear too good.

Jeff Kosnett: Yeah. Thank you. One thing about Investing for Income is it does appeal to an older audience.

Sandy Block: Yes.

Jeff Kosnett: So I have readers who are literally in their 90s and yet they want to talk about long-term investment strategies. And I have had people 95 years old who say, I want to buy a 30-year bond. Good for them. I hope they're around to see it mature.

David Muhlbaum: That is optimism. Yeah. And on a note about the old-school communications, I'd like to remind people that we take questions too. The email is podcast@kiplinger.com. And we will repeat that and tell you more ways to stay in touch with us at the end of the show, in case you have questions.

Jeff, you've touched on the question of the demographics of your audience being a little bit older. But the reality is that a lot more people have fixed-income investments than are maybe even aware of it. And so, while the profile of the fixed-income investor is somewhat true to the stereotype of the pensioner, a lot of younger people have these fixed-income investments through a 401(k) or another retirement plan.

Now, maybe they own bond funds in those 401(k)s. And maybe those bond funds are themselves in a target-date fund, which that's a product we've talked about here. And so the ultimate owner, they're really distanced from the actual individual security. It's like the bond is somehow in a bunch of shells, like some sort of matryoshka doll. But in some way, right, that 401(k) investor is in some distant way tied to some bond issued by Lake County, Illinois, that pays 1.5% or whatever.

Jeff Kosnett: That is true. And through a mutual fund or through a 401(k) or through a pension fund, everybody is invested in bonds. But I would like to clarify that when we talked about Investing for Income, which, as you said, was the title of our newsletter as well as my column, we're not only talking about bonds, we're talking about many other kinds of investments, from oil wells to dividend-paying stocks, to preferred stocks, to financial intermediaries, mortgage companies who pass through a lot of interest income or dividend income. And that income is not fixed. You are not locked into collecting 1.5% for 30 years. You may get a growing dividend from a growing real estate company that is every bit as much of an equity investment as it is an income investment.

So the categories that we cover span a really wide range, and that appeals to people and investors and savers of all ages, not just your 90-year-old retirees or your 65-year-old who is wondering whether or not he has enough money to step down from his job, this sort of thing. So our field is extremely varied and highly interesting.

David Muhlbaum: That's a good point about the shorthand we should be using. I guess probably we should not be using the shorthand, fixed-income. We should be using the shorthand, as we talked about it at the beginning, investing for income, to reflect that range of asset classes involved.

But let's be frank. You say it's really interesting. And a lot of people do find it really interesting. And some people, I know some of them because I work with some of them, find it boring.

Jeff Kosnett: Yes.

David Muhlbaum: They just want to talk about stocks.

Sandy Block: GameStop.

David Muhlbaum: Yeah, a little bit GameStop. But what's going on there? What is up with that? Why do people tend to think of this as boring?

Jeff Kosnett: Well, first of all, bond math is just boring. It's finance, it's numbers, it's formulas. It's the net present value of a future stream of income, which translated means if you make an investment today and you know you're going to collect a thousand dollars in interest over the next 10 years, what's that really going to be worth? So, that is dull.

However, there are many, many people I have met for my 40 years in this business who find that the challenge of finding an unexpectedly good value somewhere in this field or finding a preferred stock that is priced to yield 8% when the company's paying only a 2% dividend, is really, really, not only challenging, but when it works, boy, you feel really good. And while everybody and their brother and their sister and their kids and their grandfather is trying to find these hot stocks, very, very fewer people are out there trying to find some of what I look for, and that's an advantage today.

David Muhlbaum: So Jeff, you brought in a term there; you brought in preferred stocks. So as I mentally promised, let's talk about what each of these things is as we bring them up. So can you give us a quick explainer: What the heck is a preferred stock?

Jeff Kosnett: A preferred stock is a combination equity and debt instrument that banks, real estate companies, and occasionally utilities or industrial companies issue. And it is sort of a bond in that there's a coupon rate, and it's usually a fixed rate, like 6% or 7%, that you get every year.

But it's also an equity because you are not guaranteed that you are going to collect this money if the company runs into trouble. So it's kind of in the middle. It's not quite as risky as a common stock, it generally pays more, but you are behind the bond holders when it comes to the pecking order of creditors, if indeed the company runs into trouble.

David Muhlbaum: Got it. It's the right bowl of porridge in Goldilocks' scenario. But it, on the face of it, 6 or 7 percent’s, pretty good. No?

Jeff Kosnett: Yes, it's really good. And especially when you have not only low interest rates on bank deposits, but with the possibility of higher inflation. And we're now talking about hyperinflation or 1973-style inflation. But if inflation settles in at 3 or 4%, a 6% coupon bond or a preferred stock or anything is going to be something that more and more people are going to want to own.

And the economy's doing well. Nobody's worried about companies en masse going bankrupt. Many of these preferred stocks have good credit ratings, investment grade, and they are highly prized by a lot of people. And a lot of money is entering the handful of mutual funds that invest in them, so right now they're in their moment.

Sandy Block: So Jeff, I mean, I think to me what's very interesting about your column and your newsletter is that a lot of people do think bonds and they think buying a 10-year treasury or maybe... David, I think, the other day found a certificate for a Russian bond in his basement. An actual bond. But I think what you recommend is that people in general shouldn't actually buy a bond. And maybe this refers to preferred stocks, too. You can clarify. They're better off getting a fund? Can you talk about that?

Jeff Kosnett: Yeah. I think people should have some of both, and it varies for many reasons. First of all, if you're just starting out or if you're building a position over time and you don't have a lot of cash to put in, obviously, you can send $3,000 off to Vanguard and buy a total bond market fund, and then you don't have to worry about the minimum it takes, generally, to buy a bond from a broker, which is going to be $5,000 or $10,000.

But there are certain classifications of bonds that are very difficult to understand and to manage, such as high yield bonds. Preferred stocks are sort of are in realm, international bonds for sure, where you really do need the expertise of a professional management team, as well as a trading desk. Mutual funds are a partnership between a manager and a trader and some analysts, and they're out there looking for good bonds to buy at good prices.

So when it comes to anything other than a plain vanilla, like your local school bond, which is certainly safe to buy, I like active management of bonds through either funds or sometimes through ETFs, which are exchange traded funds, or closed-end funds, which is another variety of investment company.

Jeff Kosnett: But for somebody who is really experienced in this and is willing to hold the bonds for a long time, it is a good idea to own some individual bonds` for this reason: When interest rates are rising or inflation is a worry, and remember that it doesn't matter what the actual inflation numbers are, it matters what the psychology of the markets is, a bond fund may lose value, whereas your ordinary bond, it may lose value on paper, but you know that when that bond is ready to mature in 5 or 10 or 20 years, you can get back your original principal. So it really doesn't matter what the bond market does.

And meanwhile, you get paid your semi-annual or quarterly interest payment. So holding a bond itself kind of shelters you from the day to day volatility in the financial markets, and that's why a lot of people like to own individual bonds.

Sandy Block: So Jeff, you mentioned inflation, and that's all you hear about now. The inflation rate is expected to top 6% for this year. Based on my knowledge of the bond market, isn't inflation the Darth Vader for fixed-income investors? And what should they do about it?

Jeff Kosnett: Well, you're right. Inflation is public enemy number one or Darth Vader or whatever of fixed income investors, to the point that if you own a long term, say a treasury bond, that is going to give you a yield of one and a half percent, and inflation runs 6% during the life of that bond, obviously you have lost a lot of purchasing power. The humiliation is, in addition to that, you have to pay taxes on that interest income, so you're really going to get hit.

However, in my way of thinking, and I've written this and I've said it on television, there are several ways to look at inflation; and one is consumer inflation and the other is what I call bond-trader inflation. And that explains why, despite the fact that you're seeing all these headlines and you're going to get bombarded with how much it costs to buy a turkey and things like that, interest rates have stayed low and most bonds have either held their value this year or even gained in value. It's because the financial markets don't think this is a long term reality and a terrible risk.

Jeff Kosnett: And I kind of agree with that. I have been reading, since the end of the 2008 recession, that interest rates were supposed to, quote, and I use a little bit of jargon here, "normalize," which means get back to the levels that we all remember when we were kids: 4%, 6%. And also that you were supposed to go back to the world where, if the inflation rate was 2%, a bond would always pay 3 or 4 percentage points more, instead of the reverse of that.

Well, those days have changed. That ship has sailed. We have a doctrine called lower for longer, and I am still convinced that by this time next year or even sooner than that, everything will be back to roughly where it was before the pandemic and that this current burst of inflation hysteria will ease. People, of course, who get socked with it in their gas pump don't believe it, but it's true.

David Muhlbaum: Okay. That is a bold prediction and I think what we now know is that we're going to invite Jeff back here next year and see, "How'd it hold up?"

Jeff Kosnett: That's right. Yes. I've said this before, and I've been right for many years. And I could be wrong, but there's been a lot of inflation scares for a long time and nearly all the time they go away.

Sandy Block: So Jeff, does that mean, and I hope I don't get in too much jargon here, but there's been a lot of talk about investing in fixed-income investments that offer protection against inflation, such as treasury inflation-protected securities, or even I bonds. Are you saying that maybe people don't necessarily need to go there?

Jeff Kosnett: No. And right now they're a good deal, especially those I bonds. Because of the quirks of the way that the government sets the rates on some of these things, you can get, I think, 7.2% for the next three or four months on an inflation-linked savings bond.

And my observation on that would be: the government limits us to, I think, $10,000 a person. And that's a good thing because if the whole world, which owns 20 trillion or whatever it is of American debt, were to sell all their 1% bonds and buy these 7% bonds, well, I think you know where I'm going with that.

Sandy Block: We'd go broke.

David Muhlbaum: Yeah, I think we'd basically be subsidizing it at that point.

Jeff Kosnett: Yeah. Yeah. But there are other investments besides government securities that have some of these protections. One of my very, very favorite places to put savings is something called a floating-rate bank loan fund. This is a municipal or a taxable fund that owns participations in bank loans to corporations and other borrowers where the interest rate on these loans resets constantly, sometimes even overnight, but usually every quarter or every year.

So this is like a variable rate fund. It's generally going to pay you 3 or 4 or 5% as it is, and if inflation were to drive interest rates higher, these rates would float upwards. So this is a good way to protect your savings against what Sandy was just describing.

David Muhlbaum: Jeff, I want to check in about some of the operational approaches to investing for income. And we talked about a 401(k) investor having essentially exposure to this kind of security because they probably own a bond fund. And I would imagine the next step up for them would be to, well, start paying some closer attention to which bond funds and which ones you're recommending. Because they usually have a choice within their 401(k), they could start being a little bit more proactive about that.

But just the idea of buying an individual bond, as you posited, in a world where I can buy and trade stocks from my phone on Robinhood, how do I actually go and buy that Lake County, Illinois bond? I mean, where would I start?

Jeff Kosnett: It's not that hard. If you have an account with a brokerage firm like Fidelity or Charles Schwab or any of the other big ones, they will have a bond desk, just like they have a stock desk. And you click through the various places where it says products or whatever, and in addition to seeing stocks and CDs and mutual funds, you will see bonds.

And Schwab is a good example because they oftentimes participate in the same new individual bond issues as your Morgan Stanleys and Bank of Americas do for institutional investors. So one of the things is, let's say that you live in a high tax state like California, New Jersey, where it would benefit you to buy a state tax-exempt bond and therefore not have to worry about the taxes you pay on the interest, as well as, of course, saving the federal taxes.

Well, just go into one of these brokerage platforms, click in New Jersey, what bond rating you want, A or better. I trust that many of you know that there are bond ratings from... AAA is the best, and some bonds don't even have a rating. And see what's there, and it will tell you all the basics, like the yield, the current yield, the yield at maturity, the rating. It'll give you access to other documents relating to this bond and it will ask you how much you want to buy. And if you buy $5,000 dollars worth of bonds, you will see $5,000 worth of this bond land in your balance, just like if you went out and bought 500 shares of IBM stock.

David Muhlbaum: And then just to double check: those face values, the amount you have to buy, the minimums are 5 or 10 because that's the value of the product?

Jeff Kosnett: Yeah. It's usually 5 or 10, because the way that bonds are traded as a practical matter is even if the school board borrows $172 million, let's say, they break that up into $1,000 chunks. So there's an expression, a bond: a bond is a thousand bucks. So if somebody were to say, I'm going to buy five bonds, they're buying $5,000 of this massive issue. And that means you will get... Let's say if the interest rate is 3% on your $5,000, what does that add up to? About $150 a year, and there you have it.

David Muhlbaum: Yeah. There are a lot of terms out there in bond land.

Jeff Kosnett: Oh, yeah.

David Muhlbaum: And I was just thinking we actually... Earlier, I think I used the expression, on the face of it, and I just used that as the conversational metaphor. But then I thought, "Hey, wait a minute. Is that a reference to the face value of a bond?"

Jeff Kosnett: It could be. There's probably as many bond jargons as there are baseball terms used in investing. And let me tell you this: the men and women I know who have spent their life in bonds and similar, in real estate and preferred stocks and other sort of interest and dividend-driven investment strategies, it's a lot harder than with stocks.

Sandy Block: Oh, yes.

Jeff Kosnett: If you're just talking about a common stock, you interview the CEO, you follow the industry, you read the financial statements, you monitor what's going on with the... you try and learn what you can about what the company's new products are about and whether or not Apple is better than Samsung at something. But there are so many different bonds. There are millions upon millions of different bond issues, all priced differently, all maturing at different dates. It's hard.

David Muhlbaum: Yes. Well that's, I guess, why we have you-

Sandy Block: That's right.

David Muhlbaum: -and your column and your newsletter. But that's also, I think, kind of touches on a little of the question of what I was saying before, about how people tend to view stocks as interesting and bonds as boring. I'm oversimplifying. But is because the stocks, the companies have those stories and they have the people and they have that narrative that generates all kinds of coverage from lots of people, including us. And bonds, it's a little harder to write about what each bond's personality is.

Jeff Kosnett: That's true. I know. Everybody will joke about finding the next Microsoft stock or the next Apple stock. Nobody's going to say, "Boy, those 6.2% Walmart bonds of 2049. They just don't make them like that anymore." Which is true, that right now they're not.

David Muhlbaum: But as you mentioned earlier, the person who finds that overlooked security that is paying a high percentage and has a good risk, they're going to be like, "I did it. I got it."

Jeff Kosnett: I wish Kiplinger's Investing for Income had been around about three years before it started, when we were just coming off the financial crisis and the credit crunch and the recession of 2008 and 2009. What happened then was that the only bonds that really held their value and the only interest rates that stayed low were those guaranteed by the US government.

So you had Treasury bonds paying very low rates. You had cash savings accounts, CDs, that kind of stuff, because it's guarantee paying very low rates. But really great corporations, really the cream of the crop of American business, American Express and Walmart and Illinois Tool Works and all the AA- and AAA-type companies, they were going back into the bond market and they were having to pay very high interest rates: 6%, 7%, 8%.

Jeff Kosnett: I remember buying for myself, but also hopefully I recommended it for the Kiplinger's readers, an American Express 10-year bond, back in like 2009, 8.125%, eight and an eighth percent. Now that American Express bond, you would get 8% when the dividends in their stock maybe were one. The interest rate on a savings account was maybe two.

And of course, you know what that meant. One, if you sold that bond a few years down the road, you got a huge capital gain. Or if you kept it until it matured, you were collecting 8% on a very low risk investment when the bank was paying you one. So that's the advantage of buying individual bonds sometimes.

David Muhlbaum: As long as we're checking in on history, can we go back a few years ago when there was a lot of bonds, including lending by governments, paying 0%. Why that was, why it continued, and why anyone would buy a 0% bond?

Jeff Kosnett: Well, that's still the reality in a lot of the world, like Europe and Japan. An individual investor or saver who would buy a bond with a negative interest rate... In other words, I'm paying the government of Germany a half a percent a year, so they can use my money. It makes no sense. And you or I or any of the readers of Kiplingers would know better and would not do this. You would be better off, in theory, just carrying a wad of cash in your wallet or putting it in a drawer in your house.

David Muhlbaum: Under the mattress!

Jeff Kosnett: Under the mattress.

Sandy Block: Coffee can. Coffee can.

Jeff Kosnett: Right. However, there are two reasons why these bonds exist. One is that there was worry about deflation for a while. And if you're going to have deflation and you have a negative 1% bond, but everything deflates by 3%, you're better off. And in some of the world where the economy was really hurting for a long time, and still is, there was serious worry about that.

A second reason is that many government bonds, and this is true in the United States as well, the people that own them are not you and me: they are banks, they are pension funds, they are other governments. They're pretty much required to buy these bonds because of the government guarantee. The expression we all know as "full faith and credit."

So a German bank doesn't have much choice. They have to buy these German government bonds. And the government knows this and so they keep the interest rate to the point where even they profit from this. So these are not securities that are aimed at or are even suitable for individual savers and investors. It's more of a political and institutional type of a situation.

David Muhlbaum: Okay. I understand that those bonds are not for you and me as the retail investor, but again, going back to my idea of the 401(k) investor who holds bond funds in their 401(k) and that those bond funds then own individual securities. It's possible that those bond funds could have some of those very low-paying Treasuries because those bond funds, in turn, are structured so that they're supposed to invest in that kind of stuff. Is it possible?

Jeff Kosnett: That is correct. If you have a fund that is organized and structured as, say, a total bond market fund, it has to own bonds in proportion to what's out there, and that means a heavy dose of government bonds because, as we know, the government is the biggest bond issuer in the world.

However, there are many funds that do not have to do this. They are much more flexible, much more variable, much more able to focus on corporate bonds, on municipals, on credit instruments, on participating in loans, on buying packages of mortgages. All that stuff yields considerably more than the US Treasury right now. And the risk is minimal in terms of the credit.

Jeff Kosnett: I mean, once again, if we were having a economic downturn, where real estate borrowers were defaulting and corporations were going out of business and banks were folding like they did back in 2008, you are right, this stuff would be toxic. But we're not having that right now. Banks are in much better shape than they've ever probably been in this country, other than for the short time in 2008, maybe since the Second World War.

Corporations have so much cash they don't know what to do with it. You're going to get paid. You own a bond, you own shares of a dividend-paying company, you own part of a real estate trust: you are going to get paid. And if you're going to get paid several points more than the US government pays its borrowers from the Treasury, go for it. This has worked great for the whole time that we have published this newsletter. And if you have one bad year after 10 good ones, you're still way ahead, so go for it.

Sandy Block: All right. I think that's a good note to wrap up on because Jeff is telling us we're going to get paid.

David Muhlbaum: Yeah, and I think Jeff has also conclusively disproved the idea that bonds are boring. So thank you very much for joining us. We look forward to having you on again, if not in a year to talk about the inflation forecast, then maybe even sooner. Thanks again.

Jeff Kosnett: Thank you.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you've already subscribed, thanks. Please go back and add a rating or review, if you haven't already.

To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date.

And if you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Listen now:

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links and sources mentioned in this episode:

• When Savings Bonds Make Sense
• What Grandparents Need to Know About Using Savings Bonds for a Grandchild’s Education
• Flood Insurance May Cost You More
• How to Protect Your Home from Natural Disasters with the Right Insurance
• FEMA Flood Maps

Transcript:

David Muhlbaum: Flood insurance. Maybe you have it, maybe you don’t. Maybe you thought you didn’t need it, but mother nature told you otherwise this year. The National Flood Insurance Program is in for a revamp, so we brought on an expert guest to help explain what that means to people already covered or in the market for a policy. Also, a bond that pays over 7%? Yeah, there’s a catch. All coming up in this episode of Your Money’s Worth. Stick around.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com Senior Online Editor David Muhlbaum, joined by my co-host, Senior Editor Sandy Block. How are you doing Sandy?

Sandy Block: I’m great. I understand you want to talk about bonds? Bonds, just bonds.

David Muhlbaum: Bonds. I want to talk a little bit about bonds. In part, because in the near future, possibly our next episode, we’re going to have on Mr. Fixed Income himself, Jeffrey Kosnett, the editor of Kiplinger’s Investing for Income newsletter. And so we’re going to be going deep into rates and all that, but this is just a taste, but it’s one with a pretty eye-popping number. So let’s start there and then you can give me all the yeah-buts. You say you’ve got an investment opportunity for me that’s paying 7.12% and as safe as a US Treasury bill?

Sandy Block: Yes, siree! I know that’s a big number, and it’s as safe as a Treasury because it is a Treasury. This product is a United States Savings Bond Series I.

David Muhlbaum: I, like Igor?

Sandy Block: Igor like the letter before J.

David Muhlbaum: Okay. And it’s 7.12%. Well, savings accounts and even five-year CDs are paying a quarter percent. I mean, the 10-year Treasury that everyone’s been getting so wound up about, it’s yielding 1.58% or so. So, what gives?

Sandy Block: Well, yeah, and I guess the question is why isn’t everyone running out and buying I Bonds right now? Well, there are several pretty big caveats. For one thing, the 7.12% is for I Bonds bought between November and May. At that point, the rate will be adjusted again.

David Muhlbaum: Okay, well, you still have time.

Sandy Block: You still... Okay. But here’s another big caveat. The I Bond consists of two components, an inflation-adjusted component and a fixed rate. And the fixed rate is zero, so if the inflation goes down next year, as many people expect, you are not going to get 7.12% going forward.

David Muhlbaum: Ah, your bond next year will... I see. So, it’s only going to pay 7.12% until the next adjustment?

Sandy Block: Right. And if inflation stays high, I suppose it could pay that again, but that kind of seems unlikely. The other reason I can’t get our investing folks really excited about I Bonds, because I was pretty excited. I mean, I write for people who are very risk averse, and this is as safe as it gets. There are a couple other problems with savings bonds. One is that there’s a limit to how much you can put in one. You can invest no more than $10,000 in an electronic savings bond and $5,000 in a paper bond out of your tax refund. So you can’t put everything in an I Bond. That’s one problem. You can’t take anything out for a year. So this isn’t money that you need... You don’t want to invest money in an I Bond that you might need next month.

David Muhlbaum: Period. Like it’s not early-penalty kind of stuff?

Sandy Block: Nope. Nope. You cannot. You cannot take.

David Muhlbaum: Just goodbye?

Sandy Block: I mean, I’m not sure what the penalty, they just won’t give it to you. Sorry. Now if you take it out after the first year up to five years, then you take a penalty similar to if you cash out like a five-year CD in four years or three years. You will give up some interest. Now, frankly, right now this interest rate is so good that I don’t see that as a huge risk. You could give up some interest and still come out ahead, but it’s something to be aware of. So those are the big problems with I Bonds is you can’t invest a whole lot of money. You can’t take it out in less than a year, and if you take it out in less than five years, you’ll give up some interest.

Sandy Block: But you know, I think a good way that it was explained to me when I was writing about this is if you were looking, say you’ve got your emergency savings in an online savings account that you can get at at any time, but is earning nothing. If you wanted to supplement that with money that maybe you’d want, you need in a couple of years for I’m thinking like a down payment on a house, car, something like that — this is a pretty good bet. You’re only going to earn this great rate until it’s adjusted, but it’s unlikely... Say it’s adjusted to 3%, you’re still going to get a pretty good rate as long as inflation is up, and a lot of people think that even next year, our folks are predicting that it won’t be 6% next year, but it’s going to be higher than average. I think an I Bond is a pretty good bet.

David Muhlbaum: Hmm. Yeah, and I think there’s also I Bonds, another reason for them is for paying for college because I think it’s the I Bonds that have a special arrangement where the interest you can... There’s an income-qualified special exemption for the interest earned.

Sandy Block: Yes, but this is really complicated, and people always mess this up. If you buy the I Bond, you, the parent.

David Muhlbaum: Yeah?

Sandy Block: And when your child reaches college age and you meet certain income eligibility thresholds, then you get a tax break on when you cash out your I Bonds to pay for college, you get a tax break.

David Muhlbaum: That’s a lot of needles to thread which I imagine why-

Sandy Block: It’s a lot of needles to thread, and where people mess this up is they buy I Bonds for their kids thinking, "Well, my kid is going to be going to college." But if I Bond is in your kid’s name, it doesn’t work. But there is a special tax break. I’ll look for something to put in the show notes so people can delve into it, but there is a tax break for college. And the other good thing about I Bonds is they’re exempt from state and local taxes. So if you live in a high-tax state, that’s kind of a nice break too.

David Muhlbaum: Like all Federal Treasuries?

Sandy Block: Yes, yes.

David Muhlbaum: Right.

Sandy Block: Exactly.

David Muhlbaum: Okay. So maybe a little money, a little upside in Series I, but don’t get too excited, a little excited. Coming up next, we are going to talk about flood insurance with an expert in the field. And I don’t just mean Sandy, who’s been studying flood insurance backward and forward. We’re going to be joined by Laura Lightbody from the Pew Charitable Trusts.

Changes Coming to Flood Insurance with Laura Lightbody

David Muhlbaum: Welcome back to Your Money’s Worth. For our main segment, we’re going to return to the topic of disaster insurance. Something the past year has given us plenty of reason to discuss, but we are going to focus on flood insurance which Sandy has just written about for the December issue of Kiplinger’s Personal Finance. And since she wrote about it, I’ll let her introduce our guest, Laura Lightbody.

Sandy Block: Right. We asked Laura to join us today because she’s the director of the Pew Charitable Trust Flood Preparation Initiative, which is aimed at reducing the impact of flood-related disasters on taxpayers, communities, and the environment. She knows the flood insurance system backward and forward. We’ll also dig into some of the nuts and bolts of flood insurance for homeowners, what you’ll pay, how you get it, and why you might need it, even if you don’t already have it. Welcome, Laura.

Laura Lightbody: Thank you. Thanks for having me.

Sandy Block: Laura, one of the reasons we wanted to have you on today is because millions of homeowners are going to see the amount they pay for federal flood insurance go up, while others will see their rates decline. Can you tell us what’s behind this change?

Laura Lightbody: Sure. As you noted briefly, flood disasters are becoming all too common. They are the most common and costly natural disaster that impacts all 50 states, every single community around the country. And back in the 60s, the federal government recognizing this problem created what is now called today the National Flood Insurance Program. It provides federally backed flood insurance to nearly 5 million policyholders across the country.

Laura Lightbody: That program is outdated and has really not been updated since the 60s. The way that it sets insurance premiums to provide that insurance has not been updated. It’s about 40 years old, and recently the Federal Emergency Management Agency, which is FEMA, that provides this insurance to policy holders said, "We’re going to update this methodology so that it is up to date with current flood risk and kind of enter into the 21st Century." As a result of that, insurance rates are going to change for 5 million policyholders. But in fact, 1.2 million policyholders are going to see their rates decrease.

Sandy Block: Right? So Laura, let’s dig into that, go into that a little bit. Where will homeowners likely see a decline in premiums and who are the ones who are likely to see them go up?

Laura Lightbody: So what we know about flood insurance rates based on the data that is out there provided by FEMA is that 1.2 million policyholders are going to see their rates decrease. And that is across all 50 states. In some states, Michigan, Maryland, for example, the majority of policyholders are going to see rate decreases. If this program never went into effect, it’s called Risk Rating 2.0: Equity in Action, every single 5 million policyholders would see their rates increase this year. And it’s really dispersed across the country. What we know about the old system, the old way of doing things for flood insurance is that it tended to have a bias against lower value, lower risk homes, which were over paying for flood insurance and higher risk, higher value homes were not paying their fair share. So Risk Rating 2.0, this new flood insurance rate-setting system really aims to fix that imbalance, so that individual properties are paying their fair share for flood insurance.

Sandy Block: Can we take from that, Laura, that it’s folks with expensive beachfront properties who might be the ones who are going to see their rates going up?

Laura Lightbody: That is an assumption one can make. It’s hard to know exactly. FEMA is protected by the privacy act, which ensures that we don’t see addresses, right? So I don’t know your exact flood risk, but we do know sort of on an area basis where rates are going to go up and where rates are going to go down. What’s interesting about sort of expensive beach houses is that flood insurance only covers $250,000. And if you own your home outright, for example, you’re not federally required to carry flood insurance. And so, it doesn’t always tell the full picture about these second homes or kind of beach house homes that we think of in the outer banks or on the Eastern shore in New Jersey.

Sandy Block: One thing that occurred to me, Laura, is that given these rapid changes, how long are these changes going to be good? I mean, how frequently are communities going to need to update their flood maps to reflect what’s going on?

Laura Lightbody: The way that the flood insurance set premiums right now is on an annual basis. So just like your car insurance or your homeowner’s insurance, the rates are set annually to sort of reflect the methodology that exists. Now what FEMA is trying to do with this system, but also its maps and its floodplain management, and the way that really overall the way that the nation provides disaster recovery and relief is to look forward. This whole program and many of our other disaster relief programs that are provided to flood victims have been really designed based on old data and looking in their rear-view mirror. And so the maps, the insurance rates, really floodplain management, which is the way that communities really incorporate flood risk are trying to incorporate things like sea level rise, change in flood events. It simply rains more and it’s more costly, and so all of these factors are now starting to be incorporated into price, into maps, and into community development so that ultimately communities are more insulated and safer when it does flood.

David Muhlbaum: Laura, in terms of how the changes and rates are determined and considering the inputs that determine the rate changes, is actual loss history involved? Like we know that this property flooded, so now you’re going to pay more?

Laura Lightbody: The old system of setting rates was mostly based on maps that essentially said you’re either in a flood risk area or you’re out and national averages about rebuilding. That was the data that was available, and so this new system Risk Rating 2.0, incorporates a lot more data that is available than it was 40, 50 years ago, right? So it now incorporates things like catastrophic modeling. It doesn’t use this national average system that created this kind of like staircase, right? So if we were all in this big zone, we all paid the exact same amount in flood insurance. It’s going to be much more granular now because it will incorporate things like a homes’ proximity to a river, heavier precipitation events, catastrophic modeling; it’s going to use industry data. So there’s just a lot more inputs that make it a more sophisticated system, but also provide a homeowner with a truer price to represent flood risk.

David Muhlbaum: So how do homeowners find out where they fit in? That is to say, what’s happening with their rates or what if they don’t have flood insurance and are thinking about getting it?

Laura Lightbody: So homeowners are able to now. This new methodology pricing system went into effect starting October 1, and homeowners can call their flood agents and say, "Is my flood insurance going to go up or down under this new system?" You could also call an agent if you don’t have flood insurance to inquire about flood insurance. Anyone in the country can get flood insurance. You do not have to live in this kind of predetermined mapped area by the federal government to have flood insurance.

Sandy Block: Okay, Laura, that’s a really good segue into a question I wanted to ask you. After Ida, a lot of people who do not consider themselves living in flood zones were devastated by flooding. And I guess the question is, do more people need flood insurance, and what should you do if you think you might want to have it?

Laura Lightbody: What we can tell you is that where it rains, it can flood. And so flood insurance really is the first line of defense when it comes to protecting yourself, particularly financially, from the burden of flooding. About 40% of insurance claims actually happen outside of this high risk flood area, which is where homeowners are required to have flood insurance. And so what that tells us and what other data tells us is that indeed a lot of flood events happen outside of this high flood risk area.

So flood insurance is that first line of defense. What a lot of people don’t know is that the insurance program really does aim to make flood victims whole. There are a lot of other federal resources for recovery and rebuilding provided through FEMA, the housing department, the Small Business Administration, but those programs do not make flood victims whole. If you look at data from 2017, the average disaster assistance grant, so capturing some of these small business loans, housing department was less than $9,000. But the average for a flood insurance claim was about $90,000. That is a huge difference when it comes to recovering from a major event that may have destroyed parts or all of your home, which is your largest and often the largest investment you’ve made in your life.

David Muhlbaum: So we’ve established that everyone can buy flood insurance, and it sounds to me like we’ve got three kinds of customers. We’ve got the people who already have flood insurance or are required to have flood insurance, we’ll call them traditional customers, and they’re the ones worrying about rates. Then we have people who have come to realize that they need flood insurance because while they didn’t think they’d get flooded, they did. Maybe it was Hurricane Ida, maybe a nor’easter. And then we have people who might well need flood insurance, but they haven’t yet had a flooding event to prove the point, yet. And I wonder if we should give them a little guidance of where do you start, and I’m hearing where you start is with an insurance agent?

Laura Lightbody: One of the places to start is with an insurance agent. So you could call your homeowner’s insurance agent, for example, and say, "Can you give me an estimate for flood insurance?" FEMA has maps where you can type in your address. They’re a little hard on the eyes. They’re not super, super easy to understand, but you can put in your address. There are also some other resources, so realtor.com, Redfin, Zillow. The kind of home buyer resources are now incorporating some data about flood risk into homes that are for sale. So that’s a resource for sort of the folks on the home buyer side. But the reality is that if you’re in a area that is not of super high flood risk, your flood insurance is going to be pretty low, right? Because price is a clear indicator of risk and the higher your risk, the higher your flood insurance is going to be. Again, just like your health insurance or your car insurance. And we connect those things very closely, but when it comes to flood risk, there tends to be this kind of skepticism and reservation about connecting actual risk with price.

Sandy Block: That leads me to another question, Laura. And my understanding is the reason we have federal flood insurance in the first place is because private insurers would not provide it. And the other thing I’ve learned in researching this is even with the increase, most people aren’t going to pay more than an additional 10 or $20 a month. Is there a moral hazard here? Does federal flood insurance encourage people to build in places or stay in places that, given climate change, they should not be living?

Laura Lightbody: It’s very hard to connect the dots between this exact program and what has occurred in development, in terms of homes and assets, a lot of federal assets, low income housing located in floodplains, but it is clear that over time more development has occurred in flood-prone areas. If you look back to when this program was created under the Lyndon Johnson presidency, it was created after a series of catastrophic events happened. And as you said, the private insurers were not providing insurance. And so the federal government felt, based on sort of a moral position, to provide flood victims with something. At the time, it was estimated that there were about 5,000 communities that were flood prone. That was in the 60s. Today, there are 25,000 communities that participate in the national flood insurance program, which tells us that A. The data’s getting better because we’re able to capture and assess risk, but that there are simply more assets and communities in flood prone areas.

Again, going back to price, price is kind of one of those great indicators of risk. And I wish I could sort of connect the dots more clearly be, but because it’s such a, sort of a large, abstract program, it’s very hard to say because of the National Flood Insurance Program, X, Y, and Z has happened, but it is very clear that over time more development has occurred. More homes are located in high risk areas.

Laura Lightbody: And the question for, not just the federal government, but community leaders becomes, at what point do we stop? Not only at what point do we stop subsidizing flood insurance, because even under this new system, there will be subsidies that exist. At what point do we, local mayor, local city planners say we are not going to build in that area again? We’re not going to rebuild that community, or we’re going to use the data that we have today that tells us, sea level rise is coming, and we’re not going to allow development to occur in a certain area. And that is the question that politicians and elected officials are faced with today. And they can no longer fall back on the fact that the data doesn’t exist because the data is there to tell us where the risk is and what risk is going to look like in the future.

David Muhlbaum: So these changes to maps and rates, how do they reflect efforts by communities to mitigate risk? You know, while saying, "Don’t build there," seems like a step many places are reluctant to take, either there are other things in play. I’m thinking about physical structures like levees, drainage, that sort of thing. Do those end up paying off through rate relief?

Laura Lightbody: So the maps and the rates are connected, but they’re not the exact same thing. So under the insurance program, FEMA supports communities in developing flood rate maps, essentially. They go into a community and they use engineers and modelers and they design a map that is kind of the highest flood risk area of that community. And within those bounds is where the federal government says, "Everyone in this area has to have flood insurance."

The rate methodology uses those maps as sort of one factor in determining how the rates are going to be set and what your rate is going to be. But other factors are incorporated, so the elevation of your home is incorporated. Communities will now be rewarded for certain mitigation activities, which was not the case. And mitigation is a really important driver of one, earning some decreases in premiums, actually.

So if communities or individuals undertake certain mitigation activities, so elevation is one. Community level mitigation like enhanced stormwater management is another that can actually bring rate relief to that entire community. And that’s really important because it’s very hard to take existing communities and their flood risk and sort of retrofit, right? That’s what we’re doing with mitigation. We’re saying the flooding in this community is simply overwhelming the capacity of our roads, it’s overwhelming our storm water systems, right? The rivers have nowhere to go because we have either built around them or we have moved them, right? We have spent decades moving and straightening rivers and then building along them.

Sandy Block: It’s interesting because it sort of sounds analogous to what’s going on out west where people’s ability to get insurance at all or pay certain rates is being determined by their mitigation efforts, what they’re doing around their homes. And it seems like there’s more and more data that sort of allows insurers and private insurers to get very granular in terms of who they want to insure and who they don’t. So I think that’s an interesting trend we’re seeing in all kinds of natural disasters.

Laura Lightbody: Flooding is sort of the biggie because the federal government has a program around it. And so it’s subsidized by taxpayers and so it is highly scrutinized. There is regular review of it. There is a small private market, too, for flood insurance. It’s roughly 3% of the market. In some places, it’s more robust like in Florida. And then you have the analogy of what is happening, sort of with fire, right? And a lot of the solution sets are the same. Insurance is one, but the other is really about development decisions and economic growth decisions because communities are running up against fire just like they are running into water.

David Muhlbaum: So, okay. And then to come back to the idea of community-based mitigation, individuals can do some things, but they can’t do everything. Well, sometimes they don’t do anything. Well, what’s the sort of model action for communities to take to reduce risk? You know, it’s that man versus nature thing where maybe we were straightening the river before, but now we’re going to think more intelligently about the management. But again, there has to be political will for that to happen.

Laura Lightbody: That is the case for flood. And I think the hard part about flooding is that the greater they, or we, tend to blame kind of individuals, you know, "Why did you buy that house? You knew it was in a flood area." And to some degree, that is a problem, right? There are what are called repeatedly flooded properties, homes that just flood over and over. They’ve made multiple-

Sandy Block: Barrier islands!

Laura Lightbody: Yeah, they’ve made multiple claims against the program, and they’re not moving. And they’ve been offered buyouts and they’re not moving, right? Those are for the most part kind of outlier properties. But a lot of these decisions are being made by developers, city planners, elected officials, and a lot of it comes down to local land use decision. And so your point about making very hard choices is right, because a lot of times you are making a decision about economic growth or future risk. And you have some communities who are able to do it, right? So Brevard, North Carolina, Fort Collins, Colorado, both have rivers run through them, have taken a stand and said, "We are making strong regulation around this river where you cannot build certain things." And that’s very hard for elected officials to do because they are saying in certain areas, we are not welcoming economic growth to this area. But it’s a long-term decision that is about risk, and actually ultimately will end up saving that community because Fort Collins is one that has already been through a great flood and they don’t want to do that again because it ends up being way more costly in the long run.

Sandy Block: This has been a really interesting conversation, and we’ve written about homeowners insurance in general and flood insurance in particular, so we’ll post that in show notes. But thank you so much for joining us, Laura. And I think this will really help people understand if their rates go up or down or if they need to get flood insurance at all. So thank you.

David Muhlbaum: Yes, Laura, thank you very much for your insights.

Laura Lightbody: Thank you.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you’ve already subscribed, thanks, please go back and add a rating or review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you’re still here, because as you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Listen now:

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Billed for a COVID-19 Vaccine? Don't Pay
• A Champion’s Mindset: Failure is Not an Option
• Brandon Copeland Cope’ing with Money features
• Who is Brandon Copeland | Money Music Culture (YouTube)

Transcript:

David Muhlbaum: Brandon Copeland wears a lot of hats in addition to his Atlanta Falcons helmet. Yes, he's a professional football player, but also a real estate investor and personal finance educator. He's pursued that last mission in a number of places, including his alma mater, the University of Pennsylvania. But for the last year or so, we've been honored to have him join us as a contributing editor. We'll catch up with Professor Cope, also what to do if you get a bill for your COVID jab.

Welcome to Your Money's Worth. I'm Senior Online Editor David Muhlbaum. I'm joined by my co-host, Sandy Block. How are you doing, Sandy?

Sandy Block: Feeling great. I'm getting my COVID booster shot on Monday.

David Muhlbaum: Lucky you. I mean that. I'm not even being my usual sarcastic self. Well, was it hard to come by?

Sandy Block: No, actually I called up... I got the J&J, which means I'm eligible right away and I called up the CVS in a Target near my house and got an appointment. And that's great because I can maybe buy some bath towels while I'm there.

David Muhlbaum: Okay.

Sandy Block: But one thing did jump out at me and gave me some concern because when I made the appointment... I think when I got my first shot, I just went to a health care community center in Arlington. When I made the appointment with the CVS, they asked me for a ton of information about my insurance, my number, my group number. And I thought, "Does that mean I'm going to have to pay? Will my insurance company... Will I get a copay?" And a lot of people have that same question. This came up with the first round of vaccinations and I suspect it will come up again. Nearly a third of unvaccinated adults say they're concerned about out-of-pocket costs, according to the Kaiser Family Foundation, and those aren't-

David Muhlbaum: Out-of-pocket costs for a COVID shot?

Sandy Block: Yeah. That they'll get a copay. That they'll get a bill. And some people actually have been billed and frankly, given the state of our healthcare system, when was the last thing you got anything for free? I mean, usually there's something.

David Muhlbaum: Yeah. It seems like an anomaly.

Sandy Block: Yeah. It's definitely an anomaly that there's no copay, there's no... Oh, the other thing is people, so many of us now have high deductible insurance policies and people think, "Well, maybe I won't get billed, but it'll count against my... I will get billed later because I haven't met my deductible." So people are skeptical about this. We're not used to getting anything for free.

David Muhlbaum: Well, I have not gotten my flu shot yet and I'm meaning to, and maybe I should just mosey over there. But one of the things that does strike me is I see the signs that say, "Free flu shots." I mean-

Sandy Block: Right.

David Muhlbaum: ... is that new?

Sandy Block: No. I think that's just to get you in the door. It is... I believe that-

David Muhlbaum: And buy some towels.

Sandy Block: Yeah. Buy some towels. Well, I think that's a little disingenuous. I mean, under the ACA preventive care is -- insurance can't charge you for preventive care, but I suspect if you walk into one of those places and say, "I don't have any insurance," maybe that free would go away.

David Muhlbaum: Okay. But let's be clear with the COVID shot-

Sandy Block:With the COVID shot, it is absolutely free. Insurance-

David Muhlbaum: So if you just said, "I don't have any-"

Sandy Block: No, you get your shot.

David Muhlbaum: ... it shouldn't be a problem.

Sandy Block: You get the shot. And that's because, I'm just thinking about how I was going to express this. You've already paid for it. Taxpayers paid for the vaccination. So you have paid for your shot already. These Moderna and Pfizer and J&J are not giving these shots away out of the goodness of their hearts. They're subsidized by us, by the taxpayers.

David Muhlbaum: Okay. But the person sitting there in... Were you going to Target?

Sandy Block: Mm-hmm. Yes, I am going to Target.

David Muhlbaum: You're going to Target. The person sitting there in Target, who's paying for them?

Sandy Block: I think that... Well, that's a good question. I don't know. I don't know. I'll ask on Monday.

David Muhlbaum: But because maybe that has to do with why essentially somebody's going to get billed, right? They're not supposed... They're not giving it. Everyone's giving it away for free.

Sandy Block: Right. And I think that's why they ask for your insurance information. But the takeaway here is the fact that they've asked for your insurance information does not mean that your insurance company can charge you a copay or say that your deductible didn't cover this. Now, given the complications in our system, some people have been billed, which leads to this concern and that may happen because the providers bill them directly instead of their insurers, or somebody just made a medical billing mistake, which happens a lot.

But if that happens, don't pay it, because you don't have to. You should call your provider directly and dispute the charges. You could also call your insurance company and they'll help you to get the bill waived, because this is something that... There's not a whole lot that's clear these days, but this is clear. The vaccination is free.

David Muhlbaum: Good. Okay. Go out if you can and get your booster. Sounds good.

Sandy Block: Or your first one, if you haven't gotten it.

David Muhlbaum: Or your first one. Yes. Good grief. Coming up next, we will get to talk to Brandon Copeland, NFL linebacker and Kiplinger contributor, stick around.

Brandon Copeland on Reaching Financial Freedom

David Muhlbaum: Today, we're welcoming back to Your Money's Worth Brandon Copeland, a man who plenty of people know as a professional football player currently signed to the Atlanta Falcons, where he's a linebacker. But at Kiplinger, we also know him as a contributing editor, and those are just two of the many jobs he holds down.

We hope you've seen the content he's been creating for us over the past year, videos about all sorts of topics, real nuts and bolts stuff about the, not so obvious cost of ownership, as well as a fascinating sit down with a WNBA player and now team owner, Renee Montgomery. Yeah. We're going to put in the links -- Brandon's got his own page on our site. So welcome back, Brandon, and also joining us for this segment is Kyle Woodley, our senior investing editor, and a guy who knows football better than me and we'll have some questions about Brandon's day job as well. So welcome, Brandon.

Brandon Copeland: Hello. Hello. Hello. I'm excited to be back. The difference in a year... Last year at this time, we couldn't even go outside.

David Muhlbaum: That's right.

Brandon Copeland: Now we can go outside a little bit.

David Muhlbaum: Yeah. Well, when we spoke last year, you were in a hotel lobby outside the New England Patriots practice facility up in Foxborough, Massachusetts, and today it's the middle of the regular season and, well, you're playing for the Atlanta Falcons. So I've got two questions. Where are you right now? And where do you call home? Like, where is your house?

Brandon Copeland: Yeah. No, I'm actually literally in the Atlanta Falcons players' lounge right now, and my home... So, in-season, we have an apartment five minutes away from here. I try to live as close to the facility as possible, but my home is Florida now. It used to be New Jersey, but now it's Florida. Like most people, trying to make some tax moves. Smart moves.

David Muhlbaum: Yeah. You just hit on a Kiplinger classic right there.

Sandy Block: That's my lane.

David Muhlbaum: Now why, everybody? Because Florida doesn't have a...

Brandon Copeland: State tax.

Sandy Block: State income tax.

David Muhlbaum: Okay. But Brandon is literally exposed to what is known as the jock tax. Sandy, you're going to explain the jock tax to us?

Sandy Block: Oh, no. I bet Brandon can explain it better than I can because he actually has to pay it. Right, Brandon?

Brandon Copeland: Yeah. 100% Sandy. Yeah, no. Pretty much. Actually it's funny. I started my own podcast, Money Music Culture and this week we were talking about it because literally it's similar. Every week, depending on where we play, we get taxed. So whether we're playing in New York, we're getting taxed at the New York rate. And if we play in California, we get taxed at the California rate.

Brandon Copeland: We play in London, we have to pay London tax. We have to pay UK tax, right? And so whenever I look at my schedule and I see we play the Miami Dolphins, great, Tampa Bay, great, Texans, great, right? It's a little extra money in that check that week. And that's always a good thing for me personally.

Sandy Block: And just to add to that, it isn't really just an issue for jocks, although you probably pay more. This is something we wrote about quite a bit right after the pandemic, because a lot of people lived in a lot of different places and depending on the state, you could work in a... It's all over the map in terms of rules, but you could work in a state for just a couple of days and have to file income taxes in that state. It really varies. And obviously, you guys are very public, so it's hard for... If I worked in California for three days, they might not notice, but if you're playing there, they know you're there.

Brandon Copeland: Yeah. No, it definitely hurts that 13% or so gone out of your check. You're like, "Man, I wish we could play this on the state borderline. Can't we play this in Washington?"

Sandy Block: Nevada. That's right.

David Muhlbaum: Yeah. Right. That's California. I can tell by the number. Kyle. Well, that's where one of his houses is.

Kyle Woodley: I was going to say that's where one of them is, but when Brandon's not busy onto the Dolphins' woeful season, he's elbow deep in the real estate biz. I mean, do you mind telling the listeners a little bit about where you've been buying up houses? Why you chose the locations you did? And any other little gems you've discovered about this crazy real estate market?

Brandon Copeland: Yeah. So started real estate in 2016, started studying, started going and viewing places in 2017. Finally got the gumption and the courage to actually buy my first home in Detroit. I bought a home in Detroit because I was playing with the Lions so that I could watch the entire process. It was a co-investment with a former Detroit Lion.

And from that process, I was able to figure out what my own process wouldl be where I could start investing on my own. And so since then, we've done a number of flips in Detroit and we've also started transitioning, doing things in New Jersey, Baltimore, my hometown. And I think what I have done and what I am doing is I'm always looking at the process and not being lazy, but just trying to figure out how can I do this smarter or more efficient?

How can I require less of my own time to do this? And so we're graduating as a business and we're starting to do larger multi-unit developments. We have a 66-unit, a 37-unit, a 16- and a 12-unit, all affordable housing coming in downtown Newark, New Jersey, all of them starting to break ground.

Brandon Copeland: One should hopefully break ground before 2022, and the rest should start breaking in spring of 2022, which we're excited about. But then, a lot of people will be happy with that, but I'm also trying to figure out how can we do this simpler? So now I'm starting to look in the storage units and parking lots. I haven't made that first initial investment yet, but that is the next graduation for me.

I want to be able to turn keys over to my son and future sons. We have another baby boy on the way and I want to be able to tell them, "Hey, this is really, really difficult. Just repaint the white lines on these parking spaces every 50 years. Don't mess this up." That's where we're going next, hopefully.

Sandy Block: Well, having just cleaned out a house, I can certainly see why the demand for storage units will continue to rise. There is just way, way, way too much stuff in this world right now.

Brandon Copeland: Yeah. And, I mean, to also answer what you mentioned about the market as well, Kyle, this is one of the hottest markets of all time as we all very much know, right? For those people who were sitting on the sidelines and thinking, wondering if they would sell their houses five to 10 years from now, a lot of them have sped that up and said, "Hey, let me go ahead and get it while the getting is hot."

Obviously the historically low interest rates and stimulus checks and things like that have helped amplify or helped put this market on a fast track. And I think what we'll see is the Fed starts to allow interest rates to raise, right, as we see interest rates rising.Instead of you seeing people pull back from the market initially, I think what we'll see, is an initial pour into the real estate market again, because people will be afraid that as these interest rates rise, this is my last time to get in before it just continues to skyrocket, right? So I do think we still have a little bit of time for this market to stay hot.

It's cooling off just a tad bit right now, but that could also just be because it's the holidays, it's getting colder in certain areas and things like that. But I do think we will see this market continue to rise for at least the next year or so.

Sandy Block: Brandon, I've been around long enough, although here where we live in the DC area, we haven't seen much in the way of down markets, but I remember back in the early '90s that we did have one and certainly in other parts of the country 2008, 2009, there were huge declines. What are you thinking in terms of how you protect yourself, your investments against... If people say this is a bubble, what are you doing to protect yourself against that?

Brandon Copeland: Yeah. Great question. We all heard when we were kids, what goes up must come down at some point, right? And so you'd be foolish not to be protecting yourself. What I try to do is I'm trying to build a moat, first and foremost, of all my assets, right? There are certain different asset classes, so that hopefully when real estate does cool off, we are still cranking in other areas per se, right?

But with the real estate portfolio itself, one of the reasons why I am trying to diversify into the storage units is to get out of some of those asset classes that are heavily dependent on tenants and those tenants having jobs. Trying to find more recession-proof, pandemic-proof investments, and who would have ever thought that that would be a term, right? A pandemic-proof investment.

But I mean, let's face it. We have been able to look at this and those who've been able to live through this and look at this, right? We are able to look at it and take notes on things that we know will be strong investments regardless of what type of shape the world is in, right? When you see people storming local Walmarts and grocery stores to get waters and toilet paper. Well, we know those places aren't going anywhere.

Brandon Copeland: Another thing that I'm trying to do, I didn't even mention it before, I'm trying to find commercial assets. We're working on developing land for triple net leases where our tenants are no longer individuals like myself, but now we have 25-year leases from Amazon and Chipotle and BPs, right?

So again, these things are... One of my favorite rappers, his name is Meek Mill, he talks about there's levels to this. And as, I guess, the biggest thing that someone may be able to take away from me, because I know what a lot of people are listening and thinking, "Oh, you're an NFL player and so it's easy for you to talk about these assets and all that type of stuff."

I am learning. I am a student of life and it is easy for me to just play football and focus on football and make that money and go home and sit down and relax. But it is actually what I am on this earth for, it's what we are on this earth for is to keep learning and to elevate and to find ways to do these things, not just on a bigger and better level, but on an easier level. That's what I'm really looking for.

I'm really at the point where I'm trying to buy my time back so that I can hang out with my son more. That's what I'm thinking about. I'm thinking about five, 10 years from now. I don't want to have to do certain things. So I want to be able to put those or sow those seeds today. And so those are the types of things I'm thinking about. And I hope that those commercial investments will be recession-proof, pandemic-proof.

David Muhlbaum: I mean, the thrust of what you've done with us, as you've done with others, is personal finance education. I like to think it works well for all of us, but I'm kind of wondering now that you're one year in, and I'm asking this in part because you were just talking about this ongoing education. What did you learn from the process that you didn't know before? From working with us?

Brandon Copeland: Yeah. So the process is everything. That's where the education happens, right? And so stepping away from the Kiplinger features that we've done, but just thinking about football and then bringing it back to Kiplinger's, right? Like this week we're playing... Who are we playing? The Panthers, right? The process is Monday, Tuesday, Wednesday, Thursday, Friday, Saturday, the routine, the massage, the playbooks, the new plays, just to beat the Panthers, the research, the discovery period, right?

Not only discovering new ways for me to be a better player on Sunday, but also for me to understand this new team this week and that same process, that same energy is what it takes to really do a good feature because there's research involved to learn the details and the intricacies, not to just regurgitate something that you read, but to really break it down in a way that makes sense to everyone.

Brandon Copeland: I think that that's the only reason why I'm here personally, is we have had a lot of, not just in our lives in general. That's one of the reasons why I love what we do together at Kiplinger, right? There are so many people who love to make what they do seem extremely hard and seem like rocket science so that they can be the coolest person at the party and they can make all their friends like, "Wow, I don't know how he understands investing."

But what we do is we try to take something that others may see as super complicated, and we try to break it down and let everyone know that, "Hey, we can all do this. We can all accomplish this." So for me, I think that's been the biggest thing that I've taken from the past year is not just what makes sense, so that I can understand it, but what makes... How do I teach this concept in a way that anyone can understand it? Right?

Kyle Woodley: So Brandon's actually really in a pretty unique position and he gets to do this, be a money mentor to people in a much different financial situation than your average Joe, that is young NFL players. And I think that's really interesting because, believe it or not, that covers a wide range of wealth.

In first rounders, we're looking at $2 million to $6 million yearly salaries to start, not to mention eight figure signing bonuses. Seventh rounders aren't exactly broke. I think it's mid $600,000 salaries to start, signing bonuses are close to $100,000 and then undrafted free agents, I mean, they're looking at mid $400,000, no signing bonus, and it's all better money than most of us make.

But those are really huge differences as far as managing their money is concerned. And as Brandon has talked about with Kiplinger before, they might not see all of the money in that contract. So Brandon, what is it like talking to people that are suddenly coming into life-altering sums of money? And does your advice when you're talking to these young players tend to differ depending on where in the salary pool they're swimming?

Brandon Copeland: Yeah. 100% that the advice differs depending on exactly where they are within the salary pool. But I think one of the biggest things that I emphasize first and foremost, which we all can agree, is that the money isn't promised, and that's one thing that I am a huge believer in.

I've seen players, I've seen some of my teammates sign a big new contract and believe the money was dang, they're guaranteed. And then they go out two weeks later and have a big, bad injury. And so they just signed a four year deal, but they will never see year three or four of that deal.

Brandon Copeland: So, first and foremost, I like to make sure that people understand... Personally, I only count the net income. I don't count the gross number. It sounds really, really good to say to your friends, but if you're budgeting off of your gross number, then you've already set yourself up for failure.

Then after that, especially for us as a lot of athletes have never had a job because most of the time in college, especially if you go to the big schools, your job is football or whatever sport you play. You don't have time for a summer internship like I did at Penn. We were the Alabama of the Ivy League, don't get me wrong -- people did not want to play us, but I had time to go ahead and take those internships in the summer.

Brandon Copeland: But I like to make sure people understand as well that I personally don't count money until it actually hits my bank account. That is something that can help people avoid a lot of pitfalls and traps, especially for us as athletes. The money is so variable that it's easy to start thinking, "Hey, here in week eight of the NFL season, I'm going to start planning what I'm going to do in December with that money." Well, again, you twist your ankle this weekend, you might not ever see that money. So don't spend it too fast. Again, the advice differs for people, but I think that that's the fun part about what we do, is it's not cookie-cutter advice. That was one of the biggest things that I was quoted saying in my first year teaching the course at Penn is...

I remember sitting and doing... This big TV network wanted me to sit down and say a couple of clips or pickups for them. "Hey, can you say something like, save 50% of your money, live off of 30% and invest 20?" And I was like, "No." Some people can't do that. That's cookie-cutter, right?

Some people would look at that and hear that and be like, "Save 50%? I can't keep the lights on if I did that." And then they don't listen to anything else. So I think that that's reason why I love what we do is, regardless of what your financial situation is, you can find something on kiplinger.com that can help you.

David Muhlbaum: One of the things we've published at Kiplinger is how do you find a financial advisor you can trust. I assume it's a bit different in the NFL.

Brandon Copeland: The thing that I always find ironic is that most of us don't tend to just trust new people generally, right? People that you just met for a week, two weeks, a month, et cetera. And now we come to the NFL or we get drafted, and not only are you trusting a new agent, which is great, it's part of the process, you always have to let your guard down to a certain extent. But now this money that you've worked your entire life for, you're going to hand over to a financial advisor you just met in January, right? You got drafted in late March, early April, and so literally you've known this person for three to four months, and you're going to hand over your entire livelihood to them and you're not going to do some work on your end to educate yourself, to be able to monitor them or check on them, right? And I thought that it was always ironic.

So me, one of the pieces of advice I've given to a lot of players is I would talk to a bunch of different financial advisors that first year. If I had no financial understanding, I'd almost consider not putting my money to work for me and just making multiple financial advisors fight for my business. Because from that simple technique alone, you'll see a lot of those people drop out of the race themselves.

Brandon Copeland: "Oh, you're not worth it, oh..." Tell you bad things about yourself, right? "Oh, no. I don't... This is a waste of my time." Things like that. Cool, you're not the person for me, because you're clearly only here for my platform. When it comes to my money, I need somebody who's going to be with me long beyond my playing years.

And that is one of the relationships that I don't think us as players cherish that much. Because, again, most of the time you meet an agent, that agent has people and referrals and friends that he or she has worked with in the past and that's who they're introducing you to. And a lot of times we just blindly have faith in these new people in our lives.

Brandon Copeland: So when it comes to picking a financial advisor, the first thing anyone has to do is they have to work for my business. You have to earn my business and you have to get multiple opinions. One of the things my accountant says that I really love is, knock on wood, if I had to go get knee surgery, would I just take one opinion and go get it? Or would I get multiple opinions? If I needed something, why would I not get a second opinion on my finances as well?

He was like, "Most of the most important decisions in your life, you get multiple opinions on, why not with your finances?" So why not have multiple people, not just working for your business and competing, but also evaluating each other. One of the new things I've started to do with my finances is I have brought different people onto the team to evaluate the current team, because it's easy after a certain amount of time to just get comfortable and just take your job for granted.

Brandon Copeland: That's one of the things we do in the NFL. I promise you, I literally just saw somebody going to their locker with a trash bag, meaning they just got released. They just got fired. They're going home. And I saw a new person coming in, actually one of my former teammates when I was with the Patriots. So, that was pretty cool. It's cool to see that, but you also understand somebody's career is potentially ending as well.

And I always have that fire and that reminder on me personally in my primary job and profession, but we need to do it in not a super stressful way like we do in the locker room, but we need to do it for our financial advisors or our financial team as well, because we're trying to build something that lasts, again, long beyond our playing years. And I hope that guys are starting to get that more. It just takes a little more patience than most of us have. We like immediate results.

Sandy Block: Oh, yeah. We don't want to do the work too. It's easier just to hand it over to someone else and then go on and do something that's really fun, as opposed to looking at spreadsheets or something like that.

Kyle Woodley: So here's the part where we're going to talk about your day job a little bit. So three burning questions for you. I promise these are not hard. These are just nice softball questions I'll throw your way, hopefully. We can translate this into a little bit of media time for you, hopefully NFL Network or something like that. Or if you just want to do something local work with the Atlanta Radio guys but...

Number one, I always just wonder about what personally motivates people, just what they get amped for. I mean, is there a team from your entire time in the league or just now that you're a Falcon where you just really get up to the play against? Anyone on this year's schedule where you're waking up before your alarm, you're showing up to the game early, you're just dying to be a part of that particular win?

Brandon Copeland: Yeah. Every former team, that unfortunately...

Kyle Woodley: The revenge tour.

Brandon Copeland: Yeah. I was going to say fortunately, or unfortunately at this point I've played for six teams in the NFL. So dang, there almost every other week is a former team of mine at this point. But yeah, no, every former team, I mean, you have a natural inclination to think, "Hey, these people said no to me or these people didn't think I was good enough to be on their team anymore," right?

"I'm the treasure that they lost," that's what I look in the mirror every morning and tell myself the day before the game. But yeah, every former team, they have to get the best version of Brandon Copeland that they can get because it's not only... You're also talking to former teammates, right? You take out the personal vendetta or revenge. It's not necessarily against the players, right? It's more against the front office and the GMs and things like that because those are the decision makers, right? It's also good to go up against your former teammates to make them walk back in the building the next day and be like, "What were we thinking getting rid of him? He was literally on our team and you just let him whoop on us."

Brandon Copeland: So those are the types of things. And I think that that's it. I do personally... What I've realized is you got to create your own motivation week to week. I think early as a young player, it's easy to come in every single week and be ecstatic about just being in the NFL and just grateful to be there, and that's great.

You're living your dream, but once you get to year 5, 6, 7, 8, 9, it's like, "All right, well, I've done this before." It's like, LeBron James, he's done the NBA thing right and done it at the highest level, but what's his new motivation, is it personal goals? Is it personal records? What is that next thing that is going to keep him wanting to be the best? And so I try to find different motivations, not week to week, but different things that push me when I feel a little lethargic. When you feel like, "Hey, I didn't wake up with loads of energy this morning, but I got to go out and whoop up on a 330-pound man who flew here and he's coming here with the same mission in mind, right? He's trying to embarrass me. I got to embarrass him.

Brandon Copeland: So what can I do to mentally take myself there this beautiful Sunday afternoon. And I think that that's some of the things that you hone in on as you continue to mature in the NFL. And for me, I've been fortunate enough to have the opportunity to take that motivation and use it in relation to my off-the-field work as well. And so it will continue to motivate me.

Kyle Woodley: And I feel that's where bulletin board material actually really comes into play. People just think, "Ah, they're a pro. Who cares what somebody says on Twitter or whatever?" But, no, if you get to that point where you actually need something to feed you, I mean, you almost start to look forward to hearing someone say something very stupid about you so that you can go and look at that for the entire week and that's the thing that's going to make you lift harder and go out and hit people harder when you're out in the field. I mean, you're almost inviting that in a way. You want that because that's the thing that's going to get you through that particular week.

Brandon Copeland: Yeah. 100%. I know there are times I didn't... I never talked trash. Literally, I never talked trash, in high school, college. I would always try to avoid talking trash because I felt like football is such a dangerous sport, that if you really talk trash and hit a nerve, someone can take you out. Somebody can dive for your knee or do something extra and it's just not worth that.

However, if you talk trash to me, it's on the rest of the game. I'm a different human being. I'm a different player at that point because now it's super personal. And I think, I can't remember... I was in Detroit for sure. And it might have been my second or third year in Detroit when I started to realize and understand why certain players talk trash.

Brandon Copeland: Because I remember there was a couple games and I was just like, I'm waking up super sore without not really feeling like playing, to be honest with you. And I was like, "What can I do to get into this game?" And for me, I was like, I need to talk trash. I need them to say something. I got to say something to you.

I'd literally be having fun. I'd do something and run around. Like, "Man, that's all you've got? Dang, this weak? That's kind of weak." And as soon as they said something back, I'm into the game. Let's go. Now, it doesn't matter how I feel, it doesn't matter what bruises I have.

Now, it's just about me and you and I got to win this match up because I can't let you talk trash to me and beat me. That's just, you know, what are we doing here? So those are the little mental tricks and cues that you develop as a veteran, I think, and just as a player to just make sure that you find that upper hand and win.

David Muhlbaum: Since you're talking about speaking your mind, I want to take you back to a little clip from your talk with Renee Montgomery, which I really enjoyed. Now you got... You were focusing on Renee because it was a podcast to feature her. But I want to ask a little question about a Brandon thing that came up. So I'm going to play you a clip from that:

Brandon Copeland: I remember coming into the NFL and it was like, I don't want people to think that I'm too smart as it makes me feel like a coward saying that. I actually got fired from the job, I think, because I voiced my opinion in a little boisterous way. In terms of, I'm happy being who I am. I have more opportunities. I literally told a head coach, "I'm here because I want to be here. Not because I have to be here," right?

Renee Montgomery: Oh, Lord. Brandon, you can't say that.

Brandon Copeland: Well, I was a little tripping.

Renee Montgomery: You're not supposed to say that.

Brandon Copeland: He tried my school though. He was like, "Why would you choose a school like Penn?" Right? Like, "Hold up bro. Hold up man. I'm here too. Hold up now." I mean there's a lot of opportunities, but I mean, you know me. I'm here because I want to be here, not because I had to be here. Two weeks later-

Renee Montgomery: The audacity.

Brandon Copeland: Two weeks later, I'm at the Greyhound stop like, "Goddamn. What was I thinking?"

Renee Montgomery: But you got that off your chest. At least you said it with your chest.

Brandon Copeland: Yeah. It was good. After that it got deflated though. I was like, "All right, let me go ahead and just shut up and tackle. You know what I'm saying?

Renee Montgomery: "Shut up and tackle!"

David Muhlbaum: That was probably some time ago so maybe you can name names, but that's not really my question. My question is, you actually got fired for speaking up? Can you tell us some more? And how do you feel about that situation in retrospect?

Brandon Copeland: Yeah. Yeah. I mean you never know. Maybe in their mind they might have fired me for personnel reasons. I know at the time they needed safety and the weird thing about the NFL, they might need a certain position that has nothing to do with you, but it's a numbers game. It's a zero-sum game. So they got to bring somebody in, they got to release somebody. But at that time it did...

David Muhlbaum: It had to do with Penn?

Brandon Copeland: Well, no, at that time it hurt, but it made me understand, hey, sometimes you can't shine as bright in front of everybody. I think one of the pieces of advice that I got was somebody told me, "Hey, you're trying to stand in right now. Stand out.” And at a certain point in time, even if you're a peacock, so to speak, you got to dull your feathers a little bit, because not everyone's going to understand who you are or your dreams or the bigger aspiration.And I think sometimes in this business, in this profession, there are some coaches who still have that old school mentality, that old school mantra where they want football to be your one and only thing. And they know if they have your one and only thing, you'd be willing to run through a brick wall right now for them because you don't have anything else.

And I don't think that... I'm not willing to run through a brick wall. Clearly I've done it for nine years, but I do. I am proud of myself that I don't have to run through the brick wall unless you tell me why, right? I get to choose whether or not I want to run through that brick wall today or not, right? It's not the only way that I can eat so to speak. And unfortunately for a lot of my peers, that is their truth. That is the case.

And again, different coaches have different reasons and different mentalities and players and character traits that they look forward to build the culture of their locker room and their team. Ultimately, maybe I wasn't the right one for or the right fit for that culture.

David Muhlbaum: I see.

Sandy Block: Actually I see a personal finance analogy there, Brandon, because it seems to me that the point of saving and investing and living on less than you make is the freedom that it gives you. Most people don't have to worry about running into a brick wall, but if you hate your job, you have to move, you get divorced.

Having a financial cushion gives you so many more options than living from paycheck to paycheck. So I do think that that is something that doesn't just apply to football players and you really are in an enviable position that, you're right, you don't have to play football for the rest of your life or do something you don't want to do because you have a backup, a really good backup it sounds like.

David Muhlbaum: That was the plan all along.

Sandy Block: Yeah.

Brandon Copeland: Yeah. 100%. I mean, football has always been a means to an end and for me, with or without football I want to say and my whole entire heart and soul really wants to believe that with or without football, I would be able to sit here and do this, for example, be able to still do something special for this world without the platform and the biggest reason why is because my biggest fear growing up was having to do something I did not love because it's the only way I could put food on the table, right?

Like you are saying, Sandy, by budgeting, by saving, by investing, if you're starting today, next week you might not be able to have that freedom of choice, but eventually you may be able to. And for me, that is the most important thing that I want to have in my lifetime. And now it's not just about me. I want my sons to have that as well. I want my wife to have that as well.

Brandon Copeland: I remember, as a young player in the NFL, a very true story, as a young player in the NFL, my wife works, not every professional athlete's wife works. So I'm extremely proud of my wife and her own dreams and her own passions and things like that and it's awesome to see her do her thing. Before she had this job that she currently has, currently she's at Google. I'll go ahead and shout them out because they treat her very well and she loves her role there.

But before she had this job, she had another job and she literally hated it. It wasn't that -- she was a manager of people and the way that the job wanted her to manage her people, some of which who were older than her, it put her in an extremely uncomfortable place. She had to be someone she wasn't, she had to ridicule things that she wouldn't typically ridicule.

And I remember one day in the off-season dropping her off to work and she got out and she was super down. At first, I thought, "Everybody's going to act like they hate their job," but she really was like, "Oh, I got to do this again." And I was like, "I can't let that be our reality." I can never see my wife have to go into a place that she doesn't love because she feels like she has to put food on the table or bills or whatever, right?"

Brandon Copeland: And for me, that's why we do all the different things that we do, is because we want other people to also have the opportunity to create that financial freedom for themselves. It doesn't mean everything that you're going to do, you're going to love, right? There's things that I got to do to play football that I hate. It's part of the process though, right? It's part of the journey.

But I want to make sure that in the grand scheme of things, when we look at the entire, quote unquote, timeline of my life, I can look at more spots where I was extremely happy and proud of the way that I was doing things and the life that I was able to live, as opposed to the things that I did just to get by, so to speak. That's what we're pushing right here, right?

David Muhlbaum: Since you brought your wife into this, Taylor. I know she's featured a number of times in the content you've created for us. And she's a participant in your projects, activities, investments in addition to, full-time job.

Brandon Copeland: Mother of my kids.

David Muhlbaum: So she... Yeah.

Brandon Copeland: My baby mama. Yeah. No, I don't know how she does it.

David Muhlbaum: Very impressive. Well, congratulations to you on number two-

Sandy Block: On the way?

Brandon Copeland: Yes. Number two on the way.

Sandy Block: That's great.

Brandon Copeland: Yeah.

David Muhlbaum: And that's going to keep you busier than you are already.

Brandon Copeland: Little less sleep. Little less sleep, but yeah, like you said, we're excited. And I think also as you become a parent, for those out there, it's funny because just now I talked to other guys in the locker room who are about to have children. I'm telling them all the things that other people who were parents before me told me, "Oh, it's going to be amazing. It's going to be tiring. It's going to be this," right?

And it's cool to see that transition. But as you become a parent, you also start to realize that there are a lot of things that you have to be doing that are bigger than you, bigger than yourself, right? And financially, I hope that people use...

Brandon Copeland: If you're having a child or if you have children, if you need to use that as your motivation, the same way, sometimes I got to talk trash on Sunday, if you need to use your children as motivation for you to get your money in order, for you to get your wills and your estate planning in order, that's the greatest excuse in the world. That's the greatest motivating factor in the world.

So again, I would encourage everyone out there because I am also guilty of it as well. I would encourage everyone out there to use your children as motivation to go ahead and get those things that you want done financially taken care of. Get those things in order because they are depending on you to do it and they can't do it themselves for you.

David Muhlbaum: Thanks again for joining us, Brandon.

Sandy Block: Thank you Brandon. You're great.

Brandon Copeland: Thank y'all.

Kyle Woodley: Yeah. Thanks for coming on, man.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you've already subscribed, thanks. Please go back and add a rating or review if you haven't already.

To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. And if you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links and resources mentioned in this episode:

• Inheriting an Annuity? Here’s a Little-Known Way to Stretch Its Tax Benefits
• Retirement Ready Radio Show (Tony Drake podcast)
• Is a Target Date Fund Right for You?
• ICI.org: Target Date Funds Remain Popular Investment in 401(k) Plans
• The Disturbing Conflicts of Interest in Target Date Funds
• FINRA Fund Analyzer

Transcript:

David Muhlbaum: The idea of an investment vehicle that you can put money into and then cash out for your retirement or to pay for your kid's college has long been appealing. Target date funds, which aim to fit that niche, have been growing in popularity. But set and forget, well, it has its pitfalls. Certified financial planner Tony Drake has a few cautions about target date funds. Also, we'll field some listener questions on Roth IRAs and annuities. All coming up on this episode of Your Money’s Worth. Stick around.

David Muhlbaum: Welcome to Your Money’s Worth. I'm Kiplinger.com Senior Online Editor David Muhlbaum, joined by my co-host, Senior Editor Sandy Block. How are you doing, Sandy?

Sandy Block: Doing great, David.

David Muhlbaum: Cool. So, we have gotten some emails, and we love listener mail – when it's nice. Now for the first one, I'm not going to use her name. Not only because it wasn't 100% clear from the email address, but also because the question they posed had real dollar values attached to it and maybe ... well, I'll call her Jane Doe. Maybe Jane wouldn't want us hashing over how much she has in her emergency fund in Roth IRA or how old she is, but we'll need those facts.

Sandy Block: I'm sure Jane will appreciate your discretion, and I sure would. So what does she want to know? Was this related to our chat with Ed Slott about IRAs?

David Muhlbaum: Yeah, bingo. Well, Jane said she liked it, but she wanted to know basically if she could use her Roth IRA as a savings account of sorts. A place to stash money she might need access to in the relatively near term.

Sandy Block: So we're talking about an emergency fund here?

David Muhlbaum: Sort of. Now, she said she already has $10,000 in a credit union savings account as her emergency fund, and she said she directs anything above that to a mutual fund portfolio, which sounds fine and well. But she, and I'm quoting here, "Didn't realize the benefits of Roth accounts until recently, and I only have about $4,000 in it."

Sandy Block: I don't understand how Ed Slott, who thinks everyone should have a Roth IRA, failed to reach her.

David Muhlbaum: Yeah, I know, right? Anyway, so I can only presume that the amount in her Roth IRA is relatively low relative to the other things. Not only because she only recently discovered the miracle of the Roth IRA, but also, as we've discussed, money going into a Roth is after tax. So if you're converting a conventional IRA into a Roth or even making contributions, you've got taxes to cover, and it's a good idea to do these conversions a bit at a time. Now we're guessing at Jane's strategy, but also again, that also seems fine and well.

Sandy Block: Right, and she may just not have converted anything. She might just be contributing and there's a limit on how much you can contribute every year. So what's her question?

David Muhlbaum: Right. Well, it seems rather specific, but since it illustrates how a Roth works for everyone, here goes. Basically, she wants to know she can take contributions and earnings from her Roth IRA out without any tax consequences. I thought this was noteworthy in part because when we talked with Ed Slott, we all went on about how the beauty of the Roth IRA is that money you earn in it won't be taxed ever.

Sandy Block: Which is true, but there are some caveats. How old did she say she is?

David Muhlbaum: 61. She said she's 61.

Sandy Block: She also said she'd only discovered the benefits of a Roth recently. How recently? Was she specific?

David Muhlbaum: Yeah. She said she'd had it more than five years.

Sandy Block: Okay, so it's no accident she said more than five. The reason I'm going all detective ... I love detective novels, I'm reading them right now, on these numbers is because of the fine print. Most people know you have to be over 59 and a half to take earnings out of a Roth IRA without penalty with some exceptions, but she's got that covered because she's 61. The other point is more subtle and has to do with what's called the five-year rule. Basically, you have to wait five years after, if you've opened a Roth, before you can take your earnings out tax-free, assuming you're over 59 and a half, but she's done that.

David Muhlbaum: So even if she puts in more money now, and that was part of her question, it's not like she has to wait five more years to expire on that, to take the earnings back out. She cleared five years. That's it. Done. One single deadline, not a rolling one?

Sandy Block: Right, and that's something that Ed Slott often points out, is that it is not ... The five-year doesn't start every time you contribute to a Roth. The five year starts when you open the Roth. So in Jane's example, yes, she could. She's cleared that barrier. She could put more money in and she could take it out tax-free, and we can talk about whether that's a good idea, but she could do it.

David Muhlbaum: Okay, Jane, I think we have your answer. But by the way, Sandy, shouldn't we be adding some kind of disclaimer here, I mean, that people should go and check with their financial planner or something? Because many of our guests get pretty wary about handing out advice, and maybe we shouldn't be quite so bold. I mean, the only certification I hold is wilderness first aid.

Sandy Block: Which is a good certification to have if you're in the woods and-

David Muhlbaum: If you're spouting blood, but yeah.

Sandy Block: Oh yeah, if you get attacked by ... If I get attacked by a bear, you're the first person I'm going to call. But yeah, I think she should talk to a planner. I guess my ... the other comment I would just make is we have recommended ... One thing is she can always take out the amount that she puts in. You can always take out your contributions tax-free, penalty free at any time. That's is going to be the bulk of the money that you have in IRA. So we have suggested in a pinch, a Roth does make a good source of emergency funds, but we don't recommend it as in practice because that's not really what a Roth is supposed to do. It's supposed to be for your retirement, and when you take money out, you're taking away the biggest advantage, which is you get years and years of tax-free growth. So I'll stop there, but that's just something a financial planner would probably tell her, too.

David Muhlbaum: Very well. Okay, so we had two more questions in, and these were about our very recent episode with Tim Steffen talking about the potential problems of inheriting assets. One was very short. It just said, "What about annuities?"

Sandy Block: Oh no, what about them?

David Muhlbaum: Yeah, exactly. They're complicated! Now with my super special internet skills, I could tell that this person was commenting from the transcript of our conversation with Tim. I knew it was about that episode. So I feel safe extrapolating a bit and guessing that the full question was, "Aren't annuities taxable to the person inheriting them?" And I'm guessing again, that they're probably talking about income tax.

Sandy Block: Right, and yes, it is possible to be on the hook for income taxes on an annuity you inherit as an heir. Now, like anything with annuities, it's complicated. It depends on a whole bunch of things like, are you a spouse? Are you someone else? Was the annuity in a tax deferred account? All that stuff.

David Muhlbaum: All right. So what's the worst-case scenario? How could you basically be on, "what about annuities?" How could it be bad?

Sandy Block: I think it would be ... I think, assuming that the annuity is in a tax deferred account, and I think that's the case with a lot of annuities, most annuities probably, and you inherited it and then you cashed it out, it would be the equivalent of inheriting an IRA and cashing that out. You would owe income tax on all of the earnings and potentially the principal, if that was also tax deferred. So the worst-case scenario is you inherit an annuity. You say, "Oh, boy." You cash it out, and then you get a very big tax bill.

David Muhlbaum: Okay. I see. Well, all right, dear writer. I hope you're not in that situation. I'm going to pop a link into our show notes by one of our Building Wealth contributors. His name is Ken Nuss, and he goes way deep into how heirs can minimize taxes on annuities. It's called an annuity stretch and well, I'm not going into it. You can read it. The last note was from Stan Hardy. He signed his name, so I'll use it. Thanks for listening, Stan, and we're sorry if we alarmed you.

Sandy Block: How did we alarm Stan?

David Muhlbaum: Okay, well, you remember how we went on about how the Secure Act means that heirs who aren't spouses now have to empty out an IRA in 10 years? They can't stretch it out for decades anymore.

Sandy Block: Yeah, we discussed that at length.

David Muhlbaum: Yeah, with Tim, but what we probably didn't make clear enough is that this only applies when it's for someone who has died on January 1st of 2020, or from that point on. It is not retroactive.

Sandy Block: That is right. The Secure Act annoyed enough estate planners as it was; retroactive would have been really unfair. So if you inherited an IRA before January 1st, 2020, the old rules apply. You can still stretch it out, take distributions based on your lifespan, your life expectancy and not worry about a big tax bill or worry about having to take it all out in 10 years.

David Muhlbaum: Got it. All right. Thanks for writing, Stan. We hope that clears things up. In our main segment, we'll talk to a financial planner about target date funds, their strengths, their weaknesses, and whether they're right for you.

The Pros and Cons of Target Date Funds with Tony Drake

David Muhlbaum: Welcome back to Your Money’s Worth. For our main segment today, we're going to dig into a popular investment option, target date funds. There's a good chance you might have some money in one of these, perhaps through a 401(k) plan or in a college savings account. Their simplicity is very appealing and that's a big reason for their rapid growth, particularly among younger investors. Joining us today to discuss them is Tony Drake, who is a certified financial planner from Milwaukee, Wisconsin. He has contributed articles to Kiplinger's Building Wealth channel, and frankly, that's how we found him, although you may have heard him on all sorts of other media, including the live radio show about retirement he hosts on WTMJ AM 630. Of course, that's available online these days as a podcast. We'll put in a link. Thanks for joining us, Tony. You're clearly no stranger to headphones.

Tony Drake: Yeah. I feel like when I started in the industry, everything was face to face. Now it's Zooms and headphones and podcasts, and you have to be comfortable with it. That's for sure.

David Muhlbaum: Yeah. It's funny that Zoom has actually made a lot of people more comfortable with coming on and talking to us this way, as opposed to the old pick up the telephone and patch them in scenario. But on the other hand, I still am astonished sometimes that we have people who don't seem to own a set of headphones in the house. Anyway, Tony, before we get into exactly how target date funds work, I want to ask something kind of blunt. You run a team of advisors and you have a lot of clients. Do you ever recommend target date funds to them?

Tony Drake: Generally, when we're working with the client directly. Most of our clients are in retirement or rapidly approaching retirement, and we don't tend to use the funds in our portfolios directly. Occasionally, we're helping them maybe pick some funds in their own 401(k). Sometimes those are the best options, but in our own portfolios, we don't tend to use them. There can be some inefficiencies, but we oftentimes do in their 401(k)s.

David Muhlbaum: Got it. Okay. Yeah, I just wanted to touch on the idea. We're going to do cons and pros today, as you did in your piece for Kiplinger. So back to definitions, what is a target date fund?

Tony Drake: It's pretty simple. As you could imagine, we're in 2021 here, and imagine you're retiring in 30 years. You would pick a target date fund for 2050 or 2051, and that would get safer as you got closer to retirement. So it's going to be a little bit more aggressive now that we have a long,

30-year runway ahead of us. As we get closer, that fund manager should rebalance that so it gets safer and safer as we get closer to that target retirement date.

Sandy Block: So Tony, we certainly appreciate the simplicity of that idea, but already there's a big choice that people have to make, which is picking the date they expect to retire. I'm not all that young myself, and I really have no idea when I'm going to retire. So what if someone signs up for a target date fund, like you said, with a 30-year runway, and then they change their mind. They decide to retire early at 62 instead of 65, or maybe they decide I'm never going to retire. Can you pick a new date?

Tony Drake: Yeah, you certainly can rebalance your portfolios and pick a new date. I think that question is easy though, Sandy. Let's retire tomorrow, right and enjoy ourselves, right? But no, to your point, you bring up a great point that many of us, at least earlier in our working careers sometimes have no idea when we're going to retire. So as you get closer to that date, if you decide for some reason, you're going to retire five years earlier, you're going to extend it for 5 or 10 years, it's pretty easy to rebalance your 401(k) and pick a new target date fund that's closer to that retirement date that you're dreaming about.

David Muhlbaum: Generally, if that person were making those changes in a 401(k), for example, a traditional 401(k), they can move them around willy-nilly without tax consequences. They could-

Tony Drake: That's one of the beauties, right, of those retirement accounts. You can rebalance that, not incur any of the tax consequences until you start to take that money out in retirement. That's when we get the tax consequences.

David Muhlbaum: Got it. So target date funds date back to the early 1990s. I think you had 1994 in your article. I'm wondering why did it take that long for the idea to come around? It wasn't a change in law regulation. How did this even come up?

Tony Drake: Yeah, I think it's something as consumers got more involved, we had this really seismic shift, if you will, from pension plans to 401(k)s. That really changed the game for investors. Before, your employer was responsible to make those investment choices, and there's lots of testing. If they didn't invest right, they'd have to put more money in. Really that onus was on them to do it properly. When this 401(k) revolution happened in the United States, that burden now falls on the investors. So I think investors were always hungry for more and more options. Generally speaking, if we look at data, retail investors don't do quite as well on their 401(k)s if they don't have help. This was an idea that came along to just say, hey, here's a simple way that you can just pick that target date. A money manager is going to rebalance that over time so you're not stuck. Maybe one year from retirement, a big market correction happens and your portfolio drops more than you hoped.

David Muhlbaum: Yeah. The pension-

Sandy Block: Right-

David Muhlbaum: Sorry, Sandy. I was just going to say the pension plan analogy is very on point. The idea of essentially someone knows when you're going to need the money, and they are going to manage it over that term with the idea that you're going to need it then. As opposed to the more self-directed 401(k) investor, who's into funds and picking and choosing. But Sandy, you had a question.

Sandy Block: Well no, I was just going to comment that I remember early on in, when I first started investing in a 401(k), and you had a lot of choices, and it turned out that people didn't really like that very much, or they managed it badly. I can't remember how many of my colleagues, if we had 10 funds in our 401(k), they would just put one-tenth of their savings in each of those funds. So I think that target date funds solved that problem for a lot of people, because they didn't have to make a lot of choices. We dug into some numbers from the Investment Company Institute, which found that for 2018, which is the most recent year they studied, 27% of all assets were invested in target date funds, and more than half of 401(k) participants in the database held target date funds. That adds up to a lot of money, billions or trillions of dollars, right Tony?

Tony Drake: Huge amounts of money, right, and so many folks are utilizing these target date funds. I think they're a fantastic option for someone that's managing their own money and maybe doesn't really know what to do. I think you brought up a great point, Sandy. Just dividing it by one-tenth in all 10 of the funds isn't always the answer we want to do. Sometimes we see investors that will look back and say, "Well, which one did well last year? I'll put my money in that one." Well, we know the future doesn't always repeat the past, right? So these target date funds were really a great way that folks could do that. When we think a little bit about the huge boost they got around 2006, remember the Pension Protection Act was passed. Then 401(k) administrators had to offer auto enrollment and different investment alternatives. There were some more liability and responsibility that they were looking at the plan and making sure it was responsible. So you saw a big boost there, and to your point, lots and lots of dollars in these funds today.

David Muhlbaum: So yeah, that change in the law, I mean, it helped ... to some extent, it helped the plan providers because it gave them options and gave them some legal protection. I think it's an open question how much it helped the individual investor. I mean, Sandy used the word, the idea that the target date fund solved things. But as we're going to talk about, they created some problems of their own. We'll get into that. But I guess the net result of that was that a lot of people who weren't necessarily contributing to their retirement, well, now they were. Now they're doing something. They're auto-enrolled and putting some money away. I guess that's good from a macroeconomic perspective, but that doesn't mean that target date funds are right for everyone. So yeah, maybe let's get to those cons. What are the downsides of target date funds?

Tony Drake: Like any investment, we're going to have some pros and cons, right? There's things that work great and there's things we need to think about. The limitations on the target date funds is they're just not individualized to your scenario. It's that same investment pool, those same rebalances that happen at certain time periods till the end of the target date that happen for everybody. They treat every person who retired at a certain time period the same, and we know we're not all the same, right? We all have different income needs, certainly different lifestyles, resources. Big thing, we all have very different risk tolerances, right?

Maybe one of us is really aggressive and we want to see massive gains in good years. Those years like 2008 where the market cuts in half, we're not happy, but we know it's part of the big picture, and we'll ride it out. Where other people lose 20%, 25%, 30%, they panic. They sell it the worst point possible at the bottom. Then they're sitting there with their hands in their pockets, wondering when do I get back in? So if you want a more individualized plan, you really run into some limitations, because the target date funds just don't give you that option.

Sandy Block: But Tony, what about fees? Because these are something we're obsessed with it at Kiplinger. Now there's been an argument that fees for target date funds could maybe deserve to be somewhat higher because someone is trading the funds and stocks to change your allocations over time, or at least telling an algorithm to do so. But I guess we've seen that various fees vary between target date funds too, and I just wonder if this is something that investors should be concerned about.

Tony Drake: 100%. I mean, we know fees, especially over a 20, 30, 40 year working career can make a massive difference in the outcome of your portfolio. A great part, Sandy, there's so many options out there nowadays. We know some of the fund families have much lower internal costs than others. So making that part of your buying or your shopping process is really important. The great part, if we think back maybe 10 or 20 years ago, you had to sort through these prospectuses that were written by attorneys. They were difficult to read, maybe on purpose, right, and really hard to find out what you were paying. Nowadays, there's great resources. There's some tools at finra.org, Yahoo Finance, where you can type in the fund, really see exactly what the internal cost is, compare that to other similar funds. So really, in this information age, all that data is right at our fingertips. So we can really make much more educated choices when it comes to fees.

David Muhlbaum: So Tony, you've been a contributor to our Building Wealth channel. One piece that ran earlier this year was called The Disturbing Conflicts of Interest in Target Date Funds. Now that's a provocative title -- it was basically a short version of a study by three finance professors. And I'm going to link to that from the show notes because it's interesting … and quite long … and hard to boil down here today. But we were wondering if you'd heard about this. Here's what sounded like the bottom line to me, and I'm going to quote it: "Many investors in retirement accounts end up holding these target date funds without paying attention to the direct and indirect costs associated with them. This results in a cumulative return loss of 21% for an average investor holding the fund for 50 years."

Twenty-one percent, wow, okay, that's quite a haircut. So, why? And again, I'm trying to describe a huge, footnoted study in a couple of lines, but the authors contend that the fund families who run the target date funds, well, they take advantage of all cash coming into the target date funds to balance volatility within their family of underlying funds, basically juggling the money. Then there's the fact that a target date fund, inherently, it charges fees on top of whatever fees the underlying funds do. I get the feeling that these are known problems in the industry, but the nature of the situation is that the people who often end up in target date funds are the ones who ... they're not paying attention.

Tony Drake: Yeah. There's some pretty amazing studies out there that your retail investor, your person investing in a 401(k) tends to have very little idea what they're paying. That is one of our contentions with the target date funds. Their fees can be large when you start to stack those various internal fees from the funds they're using and the fund fees themselves. That takes a big bite out of your retirement long-term. We also find that some of them can be a little bit inefficient. Oftentimes, portfolios that are more individualized to your needs are going to take advantage of different sectors in the economy that might be doing better under different cyclical cycles or maybe different political regimes, if you will. These target date funds often don't take advantage of that, so they tend to under perform.

David Muhlbaum: Yeah, they seem like in some ways they're a blunt instrument. You used that metaphor going in about the runway of retirement, like reaching the runway. The metaphor I hear in target date funds too, is also the glide path, essentially again, using an airline thing or aircraft thing, flying into that ... flying this theoretical straight line into a smooth landing. But that's all kind of idealized and yeah, as you suggest, may not be the solution for everyone.

Sandy Block: Well, and the other thing Tony, I'd like to ask you about, and I remember this being an issue after the market crash in 2008, 2009, is you mentioned risk tolerance. I don't know if this has changed, but what we found then was that there were huge differences in the asset allocations of some of these different target date funds. Some people were very close to retirement and found out that they had a much higher allocation in equities in their target date funds than they were comfortable with. Is that still a situation, and is it something that people who invest in these funds should be aware of?

Tony Drake: Yeah, that's the limitation, right, I mean, I think for your retail investor that just wants to set it and forget it, doesn't want to think about it at all. I like your idea, David, of the blunt instrument. It can be a great blunt instrument to just at least have something that's rebalancing at some point throughout your decades of working if you just don't want to look at it. But a lot of investors, to your point, Sandy, do have different risk tolerances. Some of these bonds look at, hey, they have different philosophies, right? Just like any money manager, they're going to have a different philosophy on what you should be invested five years out from retirement, for example, and you want to make sure that your philosophy is aligned with that money manager.

Most investors aren't willing to do the research and to dig into that. That's where a good fiduciary advisor might be able to help really come up with a more customized portfolio. Today there's pretty incredible tools where I can have a family come in. They still have their money in the 401(k). Through all these great technologies, I can go and help them rebalance and make sure we're taking advantage of different opportunities. So sometimes that could be better, but if you're a self-trader, want to handle it yourself, they can be a great way to just set it and forget it.

David Muhlbaum: We've been talking about target date funds as a vehicle for retirement, but they're also a popular option in 529 plans, saving for college. For that, instead of picking a date for retirement, we're anticipating, we hope, that there's a year that our kid or kids will be going to college, and choosing a fund that will be stable, mostly cash when it's time to pay those tuition bills. I think there are situations where people who are otherwise more active investors, maybe with individual stocks and mutual funds in their portfolio, they just say, "Whatever. I hope the kid's going in 2024. I'll just stick that money in a target date fund." I know at least one person who fits that profile because it's me, so judge me. Was that a mistake?

Tony Drake: I don't know that it was mistake. Again, if you want to take that attitude that, maybe the kids will go to school sometime around 2024, might be a simple way to stick money into a fund, not have to think about it, not have to worry about it. Again, as we've been talking about it with the target date funds as it pertains to retirement, we want to watch those fees, right? Those can really stack up. We want to look for efficiencies in a portfolio and make sure that that's getting safer as those children get through high school and they're getting closer to needing that money. We may not want the equity exposure. As Sandy mentioned, in 2008, one fund may not have been as conservative as another and they took a lot bigger beating if they weren't invested properly.

David Muhlbaum: That raises a question also about the choices available within each 529 fund. There are a lot of 529 funds out there, but the funds that each of them offer and the families of funds that they offer can vary as well, so that really ... it adds a layer of complexity.

Tony Drake: It certainly can be complex. That's one of the things we want to look at, whether it's a 529, we run into the same issues with 401(k)s or 403(b)s or whatever type of retirement account you have. Some of them offer a lot ... wide range of funds and investment options, and you can really dive into the fees and the costs and make sure you're being efficient there. Some of them give us a pretty limited menu of choices and we're stuck with what we have. One of the philosophies probably behind in-service distributions, as we get closer to retirement, of course, that's the ability for a retiree to say I want to take some of my money out of my 401(k), put it into a self-directed IRA. So now the world is my oyster with as many different options. Now that might not make sense for everybody. Sometimes you're better off leaving in a 401(k). That's probably a more involved conversation, but lots of these prions, whether it's 529 or retirement accounts, some are just better when it comes to the menu of investment options than others.

Sandy Block: Tony, you raise a really interesting point and probably something we could do a whole ‘nother podcast on, which is the pros and cons of rolling over your 401(k) into an IRA. As you said, oftentimes, that does ... once you put money in an IRA, you are in control and you get many choices, but that's not always a good option for people. So I think that's something that we might've wanted to talk about later. But it sounds like what it really comes down to is know thyself. If you really just want to put your 401(k) on autopilot, a target date fund is a good idea for you. But it sounds to me like you shouldn't just assume that it's always the only option that you should explore.

Tony Drake: Great way to look at it. Knowing yourself is really the answer. If you're just going to not look at your investments and not pay attention, that could be a disaster if you're picking specific funds in certain sectors. So that target date fund can really help there. It reminds me, I'm going to age myself here. You guys probably remember that whole deal where you buy term and invest the difference. It was this whole philosophy on not buying whole life insurance or cash value insurance.

Sandy Block: Oh yeah.

Tony Drake: The problem is a lot of people bought term and didn't invest the difference. They spent the difference, right? So again, knowing yourself. If you're a diligent investor, you're going to look at your portfolio, make adjustments as the economy changes. Target date funds may be less efficient and not the best option, but they can be a really simple choice for folks that are just sticking money in every payroll.

David Muhlbaum: Well, thanks for joining us, Tony. We really appreciate your insights and we're going to listen more to your show too, because it sounds like we could chat some more.

Tony Drake: I appreciate it. Now I'll have three listeners, you guys and my mom.

David Muhlbaum: That will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. If you've already subscribed, thanks. Please go back and add a rating or a review if you haven't already. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. If you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Listen now:

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links and resources mentioned in this episode:

• 18 States With Scary Death Taxes
• PODCAST: Estate-Planning Your Stuff with T. Eric Reich

David Muhlbaum: People usually get sympathy when someone close to them dies. If that someone named them in the will, they also get, well, curiosity, sometimes maybe even envy. They don't usually get more sympathy, but maybe, just maybe, they should, because being an heir isn't always that easy. Tax expert Tim Steffen joins us to talk about the real nuts and bolts of settling estates. Also, it's October. Are we due for a market freak-out? Coming up on this episode of Your Money's Worth. Stick around.

David Muhlbaum: Welcome to Your Money's Worth. I'm kiplinger.com senior editor David Muhlbaum, joined by my co-host, senior editor Sandy Block. How are you doing, Sandy?

Sandy Block: Doing great, David.

David Muhlbaum: Well, good. Did you say rabbit-rabbit first thing this morning?

Sandy Block: I don't know where that comes from. That's not part of my heritage.

David Muhlbaum: I learned it from my wife. Well, it brings good luck, apparently, if those words or something like that are the very first thing you say on the first day of the month. It's a superstition. Now, we atheists love to cling to superstitions, you know. Anyway, I don't always remember, but I did manage to pull it off here on October 1st. I'm glad I did, because October, at least for those of us of a certain age, is a month to be concerned about if you're a stock investor.

Sandy Block: But, you've got diamond hands on your index funds, dude.

David Muhlbaum: That's a good one. No, I am a stay-the-course kind of guy, but I think that's more laziness and inertia more than discipline, and I get scared too. Look, a friend of mine on Facebook, he put up a post the other day and listed the closing values of the Dow, NASDAQ and S&P 500 on September 29th. Then he forecast what it would be on October 29th of this year. Obviously, a forecast. He gave stocks just this massive haircut.

David Muhlbaum: Now, this guy's not a trader or a market savant. There's no reason I should pay attention to his prognostications any more than you should pay attention to mine. I don't make them, by the way. Frankly, the point he was trying to make was political. The rest of the post was about the market risks of a debt ceiling default, but it did have the effect of reminding me that a drop like that, well, it could happen, and that drops and bad stuff like that do tend to happen in October.

Sandy Block: Right, bad stuff being big market crashes. I mean, at the risk of making myself sound really old, I'm old enough to have covered the October 1987 market crash, Black Monday, October 17th, a 22% single-day drop in the Dow. Of course, well before that, which I am not old enough to talk about, remember, was the Great Crash of 1929. More recently, more your era, David, was the 2008 collapse that kicked off the Great Recession. The Dow posted its worst weekly performance then, losing 18%, and I'll agree: That bad stuff, it leaves a mark on you, even if in the long run it doesn't necessarily mean the ruination of investors.

David Muhlbaum: Well, it's enough to make a month seem cursed even if it isn't, necessarily.

Sandy Block: Right. October has Halloween. That should be enough fright for any month, and provide plenty of cliches for people who have to cover the markets.

David Muhlbaum: Oh, we'll milk those. We will.

Sandy Block: Oh, you bet. You bet. As is so often the case with the market, though, it depends on how you look at it. The worst month historically for the stock market is September. October's reputation is because of those historically big crashes, or maybe it's just a hangover effect because September is actually the bad month.

David Muhlbaum: Like if you measure performance on a monthly basis, September's the laggard, right?

Sandy Block: That's what our investment experts tell us.

David Muhlbaum: Right, okay. Well, I'll buy that, because certainly this September was a bummer. I have these numbers because I was editing our Closing Bell newsletter yesterday. Hang on. Here's the copy. "For September, the Dow was down 4.3%, its worst month since October 2020. The S&P 500 was off 4.8%, snapping its seven-month winning streak and marking its biggest monthly loss since March 2020, and the NASDAQ shed 5.3%." There you go.

Sandy Block: So, rabbit-rabbit, September's over, yay. Look, there's even a school of thought that October's tendency to dips is nothing more than a buying opportunity. If there's a swoon, the easy advice is don't panic. The better advice is to look for bargains. Dave, you can just sit there like a bump on a log.

David Muhlbaum: Oh. Well, I'm going to make a little confession then, Sandy. Remember my alarmist friend's post? I'm embarrassed to say that it worked, a little. I did put in a sell order yesterday. We've got a tuition payment to make and, well, we need some cash. I would've been selling soon anyway, but the idea of that money that I need losing 20% in value just before I need it, well, that scared me just a bit.

Sandy Block: Well, that's one weird way of financing college you got going there. It's not what we recommend, though.

David Muhlbaum: Yeah. Well, I know. Don't get me started. Just because I know what I'm supposed to do doesn't mean I do it enough. Give me a hard time some other time. I wish everyone a prosperous and crash-free October and, well, if it does crash, be brave. Buy. Coming up next, we will dig into the many reasons why inheriting money isn't necessarily the great stroke of luck it might sound like.

The Perils of Inheritance with Tim Steffen

David Muhlbaum: Welcome back to Your Money's Worth. Today we're going to talk about the downsides of inheritances, the perhaps unforeseen problems that come with finding yourself an heir. And because there's only so much that a lucky or unlucky recipient can do about their situation, we'll also have some advice for people who are in the position to structure an estate to make it, well, easier on the people they're trying to take care of. Joining Sandy and me for this topic to provide some professional guidance is Tim Steffen, a certified financial planner who's director of tax planning for Baird, a wealth management firm in Milwaukee. Thanks for joining us, Tim.

Tim Steffen: Good morning.

David Muhlbaum: As Sandy knows but you don't, Tim, I'm not a big fan of country music, but a few years ago, some friends of mine got a song by a guy named Chris Janson totally stuck in my head. It's called "Buy Me A Boat." Here's the line that I want to quote. In fact, I'm just going to play it for you.

Audio Clip from "Buy Me a Boat": "I ain't rich, but I damn sure want to be. Working like a dog all day ain't working for me. I wish I had a rich uncle who would kick the bucket and I'd be sitting on a pile like Warren Buffett."

David Muhlbaum: First of all, how many country songs have name-checked Warren Buffett? I guess you've got to rhyme with something. I mean, that's great on its own, but the part I thought that was relevant to the conversation we want to hold today is the premise that if someone puts you in their will, well, everything's going to be great.

Sandy Block: Right. Maybe you could buy a boat.

David Muhlbaum: Yeah, and a Yeti 110 iced down with some Silver Bullets. You know this song?

Sandy Block: Oh, yeah.

David Muhlbaum: Okay. Well, like I said, I have my doubts, and not just about his choice of beer, but the premise of that line, the rich uncle who would kick the bucket. Because one thing that we've come across in the year or so that you and I have been doing this podcast, which is also the year in which your father died, is that being on the receiving end of an estate can be, well, complicated, and not everything people get is necessarily even welcome.

Sandy Block: Right. Things rather than liquid assets are often a definite problem, because you have to figure out who gets what and clean out the house. I've learned a lot by dealing with my father's estate. Since we dragged Tim into our little discussion and our country music interlude ... thanks again, Tim ... I want to throw him a question that will get to some of the things that I've encountered. And that is: What's usually the biggest mistake or misconception heirs have when they inherit some money?

Tim Steffen: Yeah. Thanks, Sandy. It's an interesting one. It actually works in their favor once they get the answer, and that is we have people who think that by receiving an inheritance, they have to pay tax on whatever they inherited. There are certainly certain types of assets that you can inherit that come with a tax liability, but the inheritance in and of itself is not income to you. If you inherit a savings account or a checking account or a house or a car, something like those, the value of that is not necessarily income to you for income tax purposes. You just receive the asset. If you inherit other types of assets like a retirement plan, an IRA, a 401(k), that does come with a tax liability, but only when you take the dollars out, not right up front. Actually, the big misconception for some people is they don't have to pay a tax liability the day they get an inheritance, so that's actually good news for them.

David Muhlbaum: Yeah, Tim, you mentioned IRAs, and I know Sandy is itching to ask some questions about those. But with the question of tax. There's no income-tax liability to the heirs, at least not immediately, but there can be taxes involved -- the estate tax, the inheritance tax -- sometimes those get lumped together under the moniker "death tax." If you think of it from the question of, "what am I going to get," taxes could take a bite.

Tim Steffen: Completely true, yeah. Whether you want to call it an estate tax, an inheritance tax, a death tax, at the end of the day, it's all going to reduce what goes to the beneficiary. Now, the good news is that, at least at the federal level, the inheritance tax is something that ... or I should say the estate tax, there's no inheritance tax at the federal level ... the estate tax really doesn't affect very many people anymore. Now, that may change, because there's a lot of possibilities out there. We know something is likely to happen at some point in the future, and might even happen sooner than that,, but the estate tax is not a thing that affects a lot of people.

Tim Steffen: Now, there are certain states that have estate taxes that reach down to much lower levels of net worth. There are other states that have what they call an inheritance tax that, depending on your relationship to the person who died, you may end up having to pay a tax on what you received, but those are relatively infrequent and uncommon. Most people don't have to worry about those.

David Muhlbaum: Because we are unafraid to scare people a little bit ourselves, I'm going to put in a link to our list of States with Scary Estate Taxes, which is something we try to trot out at Halloween. People can click on the link and actually see which states tax what, or what their estate tax levels are. Moving back to a question about the idea of what you might want to get and what you might not want to get as an heir, or how that might create a burden or not for you, obviously liquid assets have an advantage.

David Muhlbaum: One of the things that we've also talked about here is the question of stuff, things, collectibles. One of the things I'd forgotten about, frankly, was that collectibles enjoy the same step-up in basis that say a stock or another market asset ... that's not quite the right term ... have at the time of death. Can you talk a little bit about what that phenomenon is and what that break is, and how it actually benefits, again, the heir?

Tim Steffen: Well, to your earlier point about what's the best kind of inheritance, just like in the business world, cash is king. Beneficiaries want to inherit that cash if they can, but that's not always what people have to leave behind, or they leave specific bequests behind, physical assets or that. One of the provisions of the estate tax, and really more so the income tax law, is that when you inherit something, you get a basis adjustment. Your basis in that asset going forward is equal to whatever it was worth on the date that person died.

That's not something, coincidentally, that happens if they gift it to you during their lifetime. If you receive a gift from an individual, you get what's called carryover basis. The reward for somebody who keeps it in their estate up until the point they die is that, yeah, you might get hit with an estate tax, but the upside is you get a basis adjustment on that. Any gains that are built into that asset at the time you inherit it kind of go away.

Sandy Block: Right. Can I jump in here? The example that we often use when we write about the step-up is, is if your dad was smart enough to buy Apple stock at 12, and you inherit it and it's worth whatever Apple stock is trading for right now, $300 or whatever, your basis is $300. All of those gains in between don't get taxed. If you turn around and sell Apple, basically you get that money tax-free. It's a really nice benefit. I know the Biden administration has looked at eliminating it for rich people, because it does provide years and years and years of tax-free gains that heirs basically just get. Isn't that right, Tim?

Tim Steffen: That's absolutely right. The other piece of that that people sometimes forget is that when you inherit it, it doesn't matter how much longer you hold it after that. Any subsequent gain is always taxed as a long-term gain.

Sandy Block: Wow.

Tim Steffen: Anything you inherit is automatically considered long-term. The owner might buy it today, die tomorrow, you inherit it and sell the next day. Any gain is a long-term gain at that point.

David Muhlbaum: Okay. Let's apply that principle. Let's just check in on how that might work for the physical, the tangible, the collectible that I had in mind.

Tim Steffen: Sure.

David Muhlbaum: I mean, one of the complications there would be valuing that asset, right?

Tim Steffen: That's a great point. You know, you inherit a house. You get a property tax bill every year that has a valuation of some kind on it, some sort of a value which may not totally reflect market value, especially in these crazy times with home values going up every day. At least you've got something, but that vintage record collection you've got in your basement or the baseball cards that are on your shelf or the bottles of wine in your cellar, there's not always a readily ascertainable market value for those things, so it can be a little tricky. The point is still true that those assets do get a step-up in basis, just like your financial assets do. Yes, if you've got that, if you've got that vintage baseball card that's worth a million bucks, like one just sold for recently, that gain can go away.

Sandy Block: I think the point Tim made about houses is really important, because if you inherit your parents' house, and given the way that home prices have just skyrocketed around the country, that's also a huge benefit to you as well. Because again, as I understand it, the value of that house is stepped up to the value on the day that the parent died. That could be a huge tax break for you, in that you will not have to pay taxes on all those gains.

Tim Steffen: That's exactly right, Sandy. For that beneficiary, that gain goes away. Because remember, the home sale exclusion you get for your personal residence won't apply. That half million dollars you can exclude when you sell your own home doesn't apply to the one you inherit. It's not your personal residence, but the good news is there's probably not much of a gain on it anyway, because it all went away via the step-up when you inherited it.

That's an important one between spouses. I know we're talking about next-generation beneficiaries, but even with two spouses, when one spouse dies, that home gets a step-up in value for the surviving spouse, at least the half that was owned by the decedent. If you're in a community property state, you get a 100% step-up on that. That's a great benefit for homeowners.

David Muhlbaum: Getting in deep here, but a spousal heir who might already have the protection of the ... what was that term?

Tim Steffen: The gain exclusion.

David Muhlbaum: Yeah, might already have the protection of the gain exclusion, but that might not cover how much the house is appreciated in value, they stand to benefit as well.

Tim Steffen: Correct, because that basis step-up chews up at least half of the gain. Again, if you're in a community property state, 100% of the gain goes away, even if it goes to a spouse.

Sandy Block: I want to drill down to the nuts and bolts of inheriting an IRA, and not just because I'm writing about it, but because I did inherit an IRA and I'm not a spouse. I guess the question is, as a non-spouse heir of a traditional IRA, what has changed that could increase the taxes that I'm going to owe on that money?

Tim Steffen: This is a big one that a lot of people missed, because the law change happened right at the end of 2019. Everybody was focused on it in January, and then in February we all learned this term, COVID, and that kind of blocked everything else out of the news sites. We forgot about this law change, but it's a big one. It used to be that when you inherited a retirement account from somebody, you were allowed to take distributions out of the account over the rest of your life. If you're a 40- or 50-year-old beneficiary of your parents' retirement account, you had the rest of your life expectancy to take small pieces out of that account. Well, this thing called the Secure Act changed all of that.

For most beneficiaries of retirement accounts, when you inherit that now, you have what's called a 10-year rule that you have to follow, meaning you have a 10-year period during which you have to liquidate that account. It actually works out to about 11 calendar years. You get the year that the owner died, plus the next 10 years after that. You have really an 11-year tax period during which you can take withdrawals out of that account. You can do it at whatever rate you want.

There was some confusion about that earlier this year. There was some accidental guidance provided by the IRS that made us think maybe that rule wasn't quite the way it was, but that all got straightened out. We're back to the rule being what we thought it was, and that is, at any point over that 10-year period, you can take whatever you want out of the account. As long as by December 31st of that 10th year, that account is empty, you're fine.

Sandy Block: Follow-up questions to that, Tim, because you mentioned somebody in their forties and fifties. They could be in their peak earnings years when they have to take this money out. Since you have that flexibility to take it out any time during those 10 years, what should you be thinking about in terms of taking withdrawals so you don't get hit with a huge tax bill?

Tim Steffen: I think we'll break it into two types of accounts. Let's take the easy one first. Let's say you inherit a Roth account.

Sandy Block: Yay.

Tim Steffen: It's a totally tax-free account. Even when you inherit it, when the dollars come out, it's still going to be completely tax-free. You have the entire 10-year period during which you could take that withdrawal. You might celebrate New Year's Eve on that 10th year by liquidating your Roth IRA, and it still comes out completely tax-free. You don't have to take it out any sooner, and why would you? Let it grow tax-free as long as you can.

The more complicated one is the traditional IRA, the 401(k), the 403(b), all those other taxable retirement accounts. There, you're going to be very tax sensitive, obviously. The easy thing is you say, "Well, I'm just going to wait until the end, not pay any taxes on it until the very last year, and then I'll take it all out." The problem is you've got a big income hit there, and you might find yourself in a much higher bracket on some of those dollars than you otherwise would've been. The opposite of that would be maybe we do some more even withdrawals. Every year we take an equal amount out, to try and spread that tax liability out over the 10- or 11-year period. That makes a lot of sense for a lot of people.

You take that one step further. You can be even more tax strategic. You look at your own income level. Am I in a high-income year this year or a low-income year? I might fluctuate my distributions on an annual basis to match the rest of my income for that year. Hard to do for some who's just a W-2 employee, but if you're a business owner whose income maybe fluctuates a lot from year to year, you might have more flexibility in timing those distributions to match up with what makes sense from a tax standpoint.

Sandy Block: Tim, I want to clarify one thing. What we were just talking about is adult children, non-spouses. There are different rules for if you're a spouse who inherits an IRA, correct?

Tim Steffen: Correct, yes. This 10-year rule that we're talking about applies to ... it's a new term that they came up with called non-qualified designated beneficiaries. There's this group of people who are not subject to this 10-year rule, and it's about five or six different groups of people. Spouses are one of those. Spouses can continue to take distributions just however they would have in the past. Typically, they roll the account into their own name. Husband dies, wife inherits the IRA. She rolls the IRA into her name, takes distributions over her life expectancy, just like she always would have.

There are other exceptions for minor children, those who are disabled or chronic health issues, or those who are within a certain age, 10 years or closer to the age of the decedent. They are not subject to this 10-year rule, but it's a relatively small subset. Your traditional "mom and dad leave the retirement account to their adult children," they are the ones dealing with the 10-year rule.

David Muhlbaum: Okay. We've really gone through the details of how you would deal with an inherited IRA if you're the recipient. I wonder if we can step back for a second and, knowing how we have this significant variation between the Roth and the traditional, as well as how it's treated for spouses and, well, the others, can we take a moment to talk about what someone who's structuring their estate could do to make it easier on the recipient when it comes to IRAs?

Tim Steffen: Yeah. It depends on how far you want to go as an owner of these accounts. As the person who's going to be leaving the inheritance, how far do you want to go? Because what these new rules mean is basically that your beneficiaries are going to have to pay tax on those accounts sooner than they otherwise would have, no later than 10 years, where it used to be their entire lifetime. They're going to pay tax sooner. They're probably going to pay more tax, because the distributions are going to be larger. They can't take small amounts for the rest of their lifetime, they've got to take larger amounts. The impact is your beneficiaries are going to pay more tax, which means they walk away with less money overall.

What do you as an owner want to do about that? Some owners might say, "You know what? Tax laws are what they are. I'm leaving you this inheritance. You figure out the tax implications of that. I'm not going to bend over backwards to make a bunch of changes to my estate plan to accommodate tax laws that might change again in the future anyways." Some owners will just say, "That's for the beneficiaries. They're still getting a nice inheritance. If they pay a little extra tax, they'll worry about that." Other owners might go to the extreme and they say, "What can I do to possibly mitigate that tax cost and to reduce the impact of these new laws?"

Tim Steffen: A lot of things people have been trying to do. You hear people talking about maybe you do a Roth conversion, convert all those dollars out of the traditional IRA into a Roth. Mom and Dad pay all the tax on the account so that when the kids inherit it, they just get a tax-free asset. That can really pay off, especially when Mom and Dad are at a very low income tax bracket and the kids who inherit it are at a very high bracket. There's a real opportunity there. When the brackets are more equal, the Roth conversion may not be the best strategy, because you're really accelerating a tax liability then.

Other things people have talked about is maybe leaving the IRA to a charitable remainder trust, because that can allow for tax-deferred growth within the account and structure the distributions to the beneficiary a little differently. That can work as well, but you do give up a lot of control. The beneficiary doesn't get the IRA like they used to, they just get a piece of it. There is no silver bullet for solving this new issue beneficiaries have. There's things you can do to maybe lessen the impact, but you're not going to be able to just solve it and go back to the old ways.

Sandy Block: Right. One other thing I've heard people consider is leaving more in the IRAs to the spouse and leaving the taxable accounts to the kids, since the spouse still has a lot more flexibility in what they can do with the IRA.

Tim Steffen: For sure, yeah. The surviving spouse always has the most flexibility. They can inherit the account and roll it into their name and treat it as if it had always been theirs. Yes, when you're married, you've got more flexibility. It's the surviving spouse, that single person. That's where the tax issues come into play.

Sandy Block: Right, and that's where things get complicated. My experience writing this story is that inheriting as a spouse is a lot less complicated than inheriting as a child, because as an adult child, in addition to this issue, you have to sell the house. You usually have to get rid of everything. It's just a lot harder after the second spouse dies to manage the estate.

Tim Steffen: Very true.

Sandy Block: This is one of the things that they have to deal with.

Tim Steffen: The one solution I've found that I think works well for a lot of people in that case, if you really want to try and replace those taxes that are being lost under these new rules, life insurance.

Sandy Block: Oh, yeah.

Tim Steffen: It's not the same as an IRA. In some respects it's better, because it's tax-free. Now, not everybody can get life insurance, but that's a solution I think can work in a lot of those cases and mitigate this extra tax cost.

David Muhlbaum: Can you explain a little bit more of the tax parameters of life insurance there?

Tim Steffen: Sure.

David Muhlbaum: Because frankly, I don't know.

Tim Steffen: A death benefit ... so we're talking strictly death benefit, not taking loans out of a policy ... Mom or dad purchases a life insurance policy. One of them passes away, the beneficiaries are the kids. The kids inherit those dollars income tax-free. That's not considered income to the recipient. It goes back to the question we talked about at the very beginning, where that's an inheritance but it's not taxable income to you. It's just a tax-free inheritance.

Frankly, it's a great way to provide liquidity to an estate when there's not a lot of liquid assets. Think about the business owner who only has one asset. It's a business, and you can't sell off a piece of the business to pay an estate tax liability. You purchase life insurance. That provides the liquidity that's needed to pay the taxes, and allows you to keep those physical assets intact.

David Muhlbaum: That reminds me of something I wanted to ask, which is about liabilities. It's pretty hard to inherit debt, right, but there are, I presume, some exceptions.

Tim Steffen: Debt is typically an obligation of the estate. When an individual passes away, that's one of the roles of the executor of an estate, is to make sure any liabilities are taken care of. Before the beneficiary even gets their first payment, they want to make sure the mortgage is paid off, the credit cards are paid off. Are there any invoices outstanding for work that was done at your house? All those things have to be paid off before the beneficiaries actually get their assets. No, you're not typically passing debt onto the next generation. Now, from spouse to spouse, yes. From parents to kids, not really.

Sandy Block: There's another story I'm working on, but we won't task Tim with this, but the debts can certainly reduce the amount that you're going to get, right?

Tim Steffen: Absolutely.

Sandy Block: Because they come off the top.

David Muhlbaum: Right, but it cannot go below zero. You don't get stuck with the bill. We are drifting into the question a little bit here of how you actually administer an estate. That job usually falls to the person who is named executor. Furthermore, it's not uncommon that the executor named in the estate is one of the people who's going to get the money at the end of the day. Is that a good idea?

Tim Steffen: It can be, if that person is qualified to handle it. Sometimes people don't put enough thought into what the responsibilities of an executor are. If you're just passing on a few bank accounts and an IRA to a single beneficiary, the executor's role is pretty simple. If you've got physical assets that have to be divided, you've got a business, you've got real estate, for example, and you've got multiple beneficiaries inheriting it that you have to assign these assets to in a sense, then the executor's role can get very complicated. If there are assets that are maybe titled a little uniquely, the executor's role can get pretty complicated.

You need to make sure that whoever is named the executor of your estate is able to do it, and frankly is willing to do it. Too often, people just default to the oldest child or their estate attorney, who may be 10 or 15 years older than they are, may be long retired by the time this role even comes into play. We see that happen sometimes. Put some thought into who your executor is, who the trustees are going to be. Don't just pick somebody at random. Make sure they know that you've tasked them with this future responsibility, because they may not want anything to do with it, and then you need to think of somebody else.

Sandy Block: If you inherit an estate, particularly if it's complicated and maybe you are the executor, what's your team? Who do you need to get help from? Because I think a lot of folks think they can do this on their own.

Tim Steffen: Yeah. I agree, and that's a big mistake. You're probably going to at least have to consult an estate attorney. Whether you fully engage them or not to handle all the probate and other distribution issues is another situation. You have to decide that, but you want to at least consult with somebody, so you understand what you have to do and what some of the risks are, because there are scenarios where an executor can be held liable for expenses of an estate that weren't maybe paid out of estate dollars. The executor passes all the cash out to everybody, and ignores the contractor who just put a new roof on your house and hasn't been paid yet. That executor maybe could be held liable for that bill because they passed all the assets out, they ignored that liability. It's important to understand just what your responsibilities are.

You start with the estate person. Perhaps you get an accountant involved if you've got some tax work that has to be done. You may need an appraiser if you've got hard-to-value assets. You've got real estate, you've got the collectibles we talked about, so you may need somebody who's good at appraisal work. Those would probably be the three you would start with. You may not need all of them. You may not need any of them, but I would start with at least consulting an estate attorney.

Tim Steffen: One other thing on the executor issue that I think that you were alluding to a little bit too, Sandy, is what if you have four kids and you name them all beneficiaries, but you name one of them as the executor? That can create some issues too, where the other three say, "Well, why is that person making all the decisions?" You can go the other extreme and have all four of them named the executor, and you can do it in a way that says nothing gets done unless all four agree. Well, you can imagine what kind of problems that can create.

Think through who's in charge of things, who you're going to leave it to to handle those, and make sure they understand it so that everybody knows what it is you want to accomplish, what your plan is here and they're all on board with it, rather than springing it on them at a time when they're already struggling because they just lost a parent. You don't want them to have to deal with all these uncertainties at that point then too.

David Muhlbaum: You know, the equity question between siblings, I know of a case where the parents will specify that one of the kids, as executor, should bill the estate for essentially the cost of their doing the work, at whatever their hourly rate was at the time. There you go. You are now the heir and making money.

Tim Steffen: Yeah. The more you take, the less is available to go to your siblings. You may have to pay tax on some of that income that you pay yourself. There's other considerations there.

David Muhlbaum: Yeah. It could be a good time at Thanksgiving. Well, thanks very much for your insights, Tim. We have been wandering around the world of inheritance in the past year, and we definitely appreciate your professional insights.

Tim Steffen: Happy to do it, and would love to chat again sometime.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you liked what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. If you've already subscribed, thanks. Please go back and add a rating or review if you haven't already. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. If you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links and resources mentioned in this episode:

• iSeeCars: Best Leased Cars to Buy Back and Sell for Profit
• ETFs vs. Mutual Funds: Why Investors Who Hate Fees Should Love ETFs
• The 21 Best ETFs to Buy for a Prosperous 2021
• PODCAST: Investing in Space, with Andrew Chanin

Transcript:

David Muhlbaum: Mutual funds or exchange traded funds? Which one's better for you as an investor? It's probably no surprise that there's no easy answer, but it's a decision you'll want or need to make. Fund expert Todd Rosenbluth joins us to talk about these two investment vehicles. Also, got a leased car? You might have yourself a little gold mine there. We'll tell you how to cash in.

Welcome to Your Money's Worth. I'm Kiplinger senior online editor David Muhlbaum, and I am not joined this week by my regular co-host Sandy Block. At least not for our opening discussion, as she is off on vacation swimming with sharks or something. I asked the editor of Kiplinger's Personal Finance magazine, Mark Solheim, to take her place, in part because I want to talk about cars and car leasing, and that's something that he and I do. Thanks for joining us, Mark.

Mark Solheim: You're welcome, David. It's great to be back, even though we're talking about leasing.

David Muhlbaum: Yes. Leasing. We last had you on when we had Karl Brauer of iSeeCars as a guest to help us sort out the craziness that is today's car market, and that craziness, I guess, we can sum it up in two words, high prices. In fact, it was a study from Karl Brauer's outfit that got me wanting to drag you back here. It was a list basically of, okay, here's the title, “The Best Leased Cars to Buy Back and Sell for Profit.” It seems like some consumers are in a position to take advantage of high car prices, and that's like a man bites dog story because usually, it's not good out there.

Mark Solheim: Yeah, that's true. Yeah, this might be a bit of a niche story. I may be jumping ahead a bit here, but it sounds like it's a story about the residual value. Usually at Kiplinger, our advice has been whether to lease or buy and that's not what we're talking about now. The problem with leasing of course is it's this argot, this jargon that a lot of people don't understand. Capitalized cost for the vehicle price-

David Muhlbaum: Residual value. Terminology.

Mark Solheim: Yeah, residual value. Money factor for the interest rate. But this one sounds like a pretty good story. Let us explore it.

David Muhlbaum: Okay. That lease versus buy thing. I always felt like we talk about almost two camps. It's like a partisan divide. There are the leasers and there are the buyers, and nary the two shall meet, even though there really are valid reasons to consider one or the other. What this is about is kind of telling people who are leasing a car to buy one. The car they have right now, not their next one, the car they have right now, because basically it's worth more than expected. There are several things you need to make this work. You got to be in a lease, you've got to be willing and able to purchase the car that you already have, and you have to be sort of conceptually willing to switch teams, maybe this once. But there could be a lot of money on the line.

Mark Solheim: Okay. How much money? What's a lot? Thousands?

David Muhlbaum: Yeah. How much? Well, it turns on the question of what the car's buyout value was when you leased it. It's sort of the residual value. That price was set three years ago. Before this COVID microchip-driven car shortage that we and everyone has talked so much about. The equation is what is the car worth now versus what did the leasing company three years ago think it would be worth? What's the difference? What's the delta? Okay. From the iSeeCars study, for a Dodge Charger, that is almost $12,000.

Mark Solheim: Holy mackerel.

David Muhlbaum: On average, per the iSeeCars study, the difference across all three-year-old cars is about $7,000.

Mark Solheim: Right. This assumes, of course, that you're in a three-year lease, which is the most typical term and $7,000 on average. Wow. That's a lot, and certainly worth exploring. But how do you get it? You and I both know that leasing is full of — you know, there's a contract and there are fees and lots of things that you really have to read the fine print to know about. So, what's your next step, or your first step?

David Muhlbaum: Yeah. Yeah, no one said it would be easy, but step one is knowledge. You’ve got to know that your leased car is worth more than everyone thought it would be. But you know, the world of car valuation tools, well, they're out there online. You know, KBB, Edmunds, CarGurus, others. Anyway, there's probably a good chance that some sales representative has already been calling or emailing you saying, "Hey, why don't you come down, turn in that lease early? We'll get you something good on the next one." Because the car dealerships are desperate for inventory, and they know that they can resell your car for a big profit.

Mark Solheim: Yeah. That's pretty interesting. I'm not getting any of those emails because our main car is a 2007. They don't want it. But one of the issues with changes in car pricing, even like the ones that we're talking about now, is that most people who decide to sell a car replace it with another one. You got to trade in, trade up, just kind of like buying a house. You still have to drive something, you still have to live somewhere.

David Muhlbaum: Yeah. Yeah. Right. So, the advantage of having a higher price for your old car doesn't make that much difference when you have to pay X more for your new car. But this is kind of a special case. There can often be a difference between residual value and market value at the end of the lease, and sometimes it's the leasing company that gets holding the short end of the stick. But now because of the run-up in car prices, that difference is big, four, five figures big.

Mark Solheim: Okay. Explain. How much? How do you get this seven grand?

David Muhlbaum: Right. Well, yeah, in a paper bag? No. So I talked this over with Karl and I poked around a bit. As things involving leasing tend to be, you know, it's complicated. We've said that already. And it also depends on your own financial situation, including your credit score and how you approach your car, because this gets back to the whole leasing versus buying camp. But let's assume you have one of these leases that's coming due and you plan to replace that car. If you just hand it in and take on a new lease, well, that's not a particularly wise choice because the cost of your new car will likely be higher and you're not capitalizing on the increased value of your old one.

So, conversely, the most straightforward way to get that value would be to buy out your lease. You can buy the car you've been driving at the low value in your lease contract. Then you can do one of two things. You can keep it, assuming you can make the payments on your new loan, because now you're an owner, or you could sell it to any of those zillion places who are begging to sell them your car. Then go out into the leasing market with some portion of that $7,000 in your pocket.

Mark Solheim: Okay. I noticed you did some fine print language there.

David Muhlbaum: (Mocking garbled words)

Mark Solheim: You said some portion of the $7,000. Okay? Explain what's eating away at that number.

David Muhlbaum: Okay. Well, I won't even talk really fast. No. First of all, the $7,000 was just the average from the study, but that's a very good point to make. Basically, fees and costs are a factor that anyone trying this route needs to consider. Any lease is riddled with fees. There's a fee to buy the car, there's a fee not to buy the car. And then sales tax becomes a real consideration, because if you're becoming a car owner, you're now going to pay sales tax on the entire cost of the car, what it's worth now when you register it. Excuse me. Not when it's ... Well, that's an interesting question. Actually, I hadn't thought this through. What if you buy your car below market value and you show up at the DMV and they go, "Yeah, it's worth more than that?" Well, I have to explore that.

Mark Solheim: Yeah. This is not easy. It's complicated. But yeah, I know. That's the sort of arbitrage that the leasing crowd generally isn't into. They like to make it simple. Here's my monthly nut, I get the car for three years, turn it in, get a new one. Hello, goodbye, thank you.

David Muhlbaum: Right. Right. No, I'm not going to argue with you there. I have a cousin-in-law who follows this model. She has what she thinks is a very good relationship with her dealership. She feels well treated as she rotates through leases every three years. Is she overpaying? Maybe. But she's happy with the situation. But still, and this is one of the things I discussed with Karl, even someone who's taking that approach should absolutely do the research to understand what their car is worth, what its buyout value is, and what the difference is. Because once you recognize that, you can use it as a bargaining chip with your good friend at the dealership. If they know that you know that you have options, they might cut you a deal on your next lease, even if you don't have any intention of actually buying it out. Yeah, sure. It's a bluff, but you can bluff very politely.

Mark Solheim: Right, right, right. You've got to ask to get your cash. Okay. I get it.

David Muhlbaum: Yeah. You got to ask. I'll put in a link to the iSeeCars study so you can see what some of the cars with the most paper profit are. Mark, I probably should do a drive time column on this. I'll put in a link to that as well, though it might not get there by the time this airs. But that's the beauty of the internet. I can go back and tweak our files. Thanks for joining us.

Mark Solheim: Oh, you're welcome. It's a pleasure.

David Muhlbaum: Coming up next, our main segment is a conversation with a fund specialist, Todd Rosenbluth, on the differences between mutual funds and exchange traded funds, and which is best for you. And Sandy will be back for that one.

ETFs and Mutual Funds with Todd Rosenbluth

David Muhlbaum: Welcome back to Your Money's Worth. For our main segment today, we're joined by Todd Rosenbluth, the head of ETF and mutual fund research at the research firm CFRA. Now see, I already went and used an acronym, so let me take a quick step back. The ETF in Todd's title stands for exchange traded fund, and I'm going on about this because the fact that there are two main types of funds — we'll probably call them investment products — mutual funds and exchange traded funds. But it's right there in Todd's title. What we want to talk about today is how they're similar but different, and when and why the individual investor might want to choose one instead of the other. And also, a little bit more about the future of each broadly. And so, it should be pretty clear that Todd is the perfect guy for this. He knows both of them backwards and forwards. Exchange traded funds and mutual funds. Country and western. So, thank you for joining us today, Todd.

Todd Rosenbluth: My pleasure. Great introduction of me.

Sandy Block: Yeah. Thanks, Todd. David, when you said country and western, it reminded me of that scene in the Blues Brothers movie where they say, "We play both kinds of music, country and western."

David Muhlbaum: That's exactly where I was pulling from.

Sandy Block: But here on the podcast, we've sometimes had fun in the past with little smackdowns, credit card versus debit card. That was one. There's definitely a temptation to try to do that with exchange traded funds versus mutual funds. But I don't know.

David Muhlbaum: We figured out pretty quickly that wasn’t going to work.

Sandy Block: Too divisive.

David Muhlbaum: Yeah. Frankly, it didn't make sense. There's just too much nuance. Some of that nuance we hope to get into today. Instead of a pitched battle, we're going to have you help us out. One man, two fund types!

A couple more notes as I meander my way to our first question, and one is that we believe based on previous traffic to Your Money's Worth that our audience is fairly knowledgeable about fund investing. The other is that in previous episodes, we have spent some time talking about specific funds, like with the ticker symbol and everything as potential investments. This one, not that one, that sort of thing. I don't think this is going to be that kind of show.It's going to be a bit more general, more about the vehicles themselves, the products, how they work, the fees they charge, that sort of thing.

But if you want ticker-specific, "buy-this-fund" kind of information, I promise you, we have it in spades. If you just search Kiplinger and ETFs or Kiplinger and funds. Lots and lots. Okay. All right. Todd, I just said our listeners are pretty fund savvy, but we've still got to do definitions. Please, I know it's a basic question and a lot of people know the answer or they think they do, but can you outline the main differences between mutual funds and exchange traded funds?

Todd Rosenbluth: Sure. Let's start with a mutual fund. That's probably what people are most familiar with and they might have within their portfolio, and they think that it's the same as everything else. A mutual fund is a pooled investment. You will hold a combination of a range of different stocks or a range of different bonds or a combination of stocks and bonds together within the same portfolio. It's going to be managed by somebody else, so you don't have to do the work yourself in terms of choosing the securities, trading them, moving in and out of the respective aspects of the portfolio. It tends to be diversified. You pay a fee for that management of the product, and then you often may pay a fee in order to trade that product, in order to buy into it or to be able to exit that product.

So, the other investment product that we're talking about is an ETF, an exchange traded fund, and those first two words is what highlights the difference between this ETF and a mutual fund. It trades on an exchange. Just like you would buy a stock, you put in an order to buy this and you're often buying it from another seller, not directly from a fund company, and it's traded. You can only buy this during market hours. You pay a trading cost for that, whether it's even — Often it's commission free, but there is a cost in terms of what you pay, and you pay a price that is different than the net asset value of the portfolio.

A little bit more complicated in how it's set up. But a couple of the other key differences between an ETF and a mutual fund. Most ETFs charge a lower fee than a mutual fund does. Most ETFs track an index as opposed to having a portfolio manager or manager team that are selecting individual stocks or bonds. The exchange traded fund is tracking an index like the S&P 500, the Russell 1000, the Bloomberg Aggregate Index, but they work just the same. You get a similar level of diversification. You just — It's set up differently. Those are some of the main differences between an ETF and a mutual fund. An ETF tends to be cheap, it tends to be managed by an index provider and you buy and sell trading with somebody else as opposed to putting new money into a fund.

David Muhlbaum: Thank you. I just want to note for anyone listening along, Todd's in New York City. You can probably tell. That's life. The ambulances will go by. But thank you for that. It's very broad. I hope to find a resource because you shared with us a few slides ahead of time that delineated very well some of these differences. They're extensive and significant, and I'm hoping we're going to find a resource online that we can pop in the show notes that will break those down so people who want to come back to it can come back to it. But looking at some of the points that you brought — one of the main things you mentioned is that many ETFs are not actively managed, are index funds that follow an index.

And so, well, you know, so are some mutual funds. I kind of want to jump to the individual investor who is going to be looking at, who might have that very straightforward choice of investing in, let's say, the good old S&P 500, right? Well, you know, even looking, and we'll narrow it down further. Let's just look at Vanguard. Someone who is going to, wants to invest in an index fund tracking S&P 500, at Vanguard, they could pick an ETF of it, VOO, or the mutual fund, VFINX. What and why would guide their decision? I mean, obviously you told us a lot about the fee structure and that sort of thing. But for the individual investor, which one do they pick?

Todd Rosenbluth: Well, the fees are going to be quite similar. There are either three basis points or four basis points or five basis points depending upon the different version of the Vanguard 500 Index Fund that you have. And so you're not really going to make much of a difference in terms of performance in terms of those fees. So it matters perhaps what type of an investor you are. So in an ETF, the fact that you can make that trade, you have liquidity throughout the day, you can choose to rebalance it and do so in a more seamless manner, that may be an advantage to you as an investor. Whereas with a mutual fund, it's easier to do something like dollar-cost averaging and build into a position and schedule those changes.

You might also find that you might not be making this choice yourself. It might be within a 401(k) plan or a retirement program that you have. And so, in that case, mutual funds are almost always the choice that you have. ETFs are extremely rare to find within a 401(k) plan, just because some of the advantages that come with an ETF don't make sense. You're not making that intraday trading and the fees tend to be lower because the institutional share classes are set up. So, if you're making the choice yourself, there's probably no good or bad choice between the Vanguard 500 Index Mutual Fund and the Vanguard 500 ETF. They're owning the exact same securities, they're charging almost the exact same cost.

Sandy Block: I'm going to pick up on that, Todd, because David and I were discussing the whole 401(k) issue, and the fact that if you have most of your money in a 401(k) plan or all of your money in a 401(k) plan, pretty much I don't think you can invest in ETFs unless you take advantage of a brokerage window, which is something I'm writing about right now. But very few investors do. Is there any chance that that's changing? The reason I ask that question is we have a lot of stories in our magazine and our website about people looking to ETFs for very specialized indexes. They are attractive to people, and I just wonder, is this going to change or is there just something institutional in 401(k) plans that make ETFs not really sustainable?

Todd Rosenbluth: It's more, I think, inertia. The providers for 401(k) plans just are not encouraged to make the change. They haven't done the back office to make this possible. It will happen, but I think I've been saying it for the last 10 years that it will happen, and I probably may be still saying it for the next 10 years that it will happen at some point. But you make an excellent comment that with index-based ETFs, there's just many more choices. So an investor that likes a lower cost structure can get many more granular and either more targeted exposure towards either lower risk stocks, dividend paying stocks, more thematic long-term approach towards some of the themes like cybersecurity or clean energy that are increasingly popular.

There aren't mutual fund choices that exist that track these indices the same way that they do in ETF. So I hope that we're going to see change, but I've been hoping that for a while. The ETF structure makes more sense for our long term investor because the fees tend to be cheaper. So if we can get index-based mutual funds, then perhaps, but the index-based mutual fund world tends to be pretty broad S&P 500-like in nature.

David Muhlbaum: Yeah. You mentioned the specificity of funds. We, in fact, had pretty much an entire podcast about just a handful of funds, technically one, about space investing. That was a classic case of where you had this extreme focus on one section of the industry, and they structured as an ETF. To jump back, because I cued on the word, you talked about inertia, that there's inertia in this industry. To some extent it, it's also inertia and a small “c” conservatism. Things just don't change that quickly. I was hoping you could give us a bit of just the general history of mutual funds, which are something that, you know, in our lifetimes, just have always been around, and then ETFs, which are the relative newcomer. Can you just give us a quick history of how this whole idea of pooling things even came about and where it stands?

Todd Rosenbluth: Sure. So the mutual fund is almost 100 years old, at least based on the history that I have. In 1924, I believe, it was the Massachusetts Investment Trust, which is I think the longest lasting fund. It's still around for investors —

David Muhlbaum: I think Vanguard Wellington also makes a claim, I saw.

Todd Rosenbluth: Yeah. Perhaps that's been...

David Muhlbaum: Right. They can fight it out.

Todd Rosenbluth: Yeah. Well, we should celebrate the history of the 100-year mark for the mutual fund, nonetheless. And that's the way it was, you know, for decades. And in fact, mutual funds were actively managed up until Vanguard launched the first of the Vanguard, what it became, the Vanguard 500 Index Mutual Fund, I believe, in the '70s. Again, Jack Bogle, who was, you mentioned, was at Wellington, set up Vanguard and helped to pioneer index-based investing in the mutual fund wrapper. We have to fast forward to 1993 when the first ETF, which also was tracking the S&P 500, came to market. That was from State Street. The ticker is SPY. So that is now 28 years old.

And we've seen just an evolution in terms of the number of products that have come out. Both we've seen now more index-based mutual funds. We're actually now seeing actively managed ETFs. The ETF industry in the United States is almost $7 trillion dollars, $6.7 trillion in total assets currently as it stands today, but is still far smaller than the mutual fund industry. Most folks are still choosing or still hold mutual funds. And perhaps, you know, you've pinged off of my comment of inertia. Some of that has to do with perhaps inertia. If you held a mutual fund for decades, there's no reason to make the change just because there's a newfangled ETF that's come around in the last two decades. Good products are still good products.

David Muhlbaum: Right, and there could be significant tax consequences depending on how they're holding onto it. Why would you change just for the type? But one scenario where I was thinking,where someone who was not used to ETFs could all of a sudden essentially have the opportunity to invest in them, and perhaps, if I've got this right, do it without those tax consequences, is on a 401(k) to IRA rollover. I'm waiting for one of you to jump and go, "It doesn't work that way." But-

Sandy Block: No, it does. I think it does because in the story that I'm just working on, pretty much, and Todd can back me up on this, I think once you move money into an IRA, you can invest in just about anything, but like collectibles. I assume that means the ETF world is open to you then, right? Is that right, Todd?

Todd Rosenbluth: I believe that's the case. So, you can buy an ETF in any of your IRA programs. I'm less versed in the conversion into an IRA, but yes, the advantages you'd have. Now, some of the advantages of using an ETF in the IRA get muted. The tax, we didn't touch on as much. But ETFs tend to be more tax efficient because when I want to sell shares of my ETF, I'm selling it to one of you as opposed to dealing with the fund company. So, Sandy, if I sell my shares of SPY and you buy it, it only affects the two of us. It doesn't affect any of the other investors. Whereas in the mutual fund, if I redeem my shares, it does cause or could cause a tax implication for the broader shareholder base. So, if you're in a tax protected account, there's less of the benefits, but still benefits.

David Muhlbaum: The impact of that trading shows up in the end of the year when you get your capital gain distributions in your mutual fund, which are either taxable or not, but they’ve got to be thought about. But so, in my little theoretical, someone who had a 401(k) that perhaps held VFINX, the Vanguard S&P 500, they could — once they've rolled over their 401(k) assets — they could sell VFINX and buy the ETF, VOO. It's theoretically possible. Is there an argument for it?

Todd Rosenbluth: Well, I think the reason to do so is if you're using other ETFs. So, it's just easier to have a portfolio if you're gravitating towards ETFs in general and you want to build your portfolio using the S&P 500 as your core. But you want to increase exposure to a certain sector or focus more on a lower volatility product. Vanguard offers some of those in a mutual fund structure, but many of them, they don't. They offer now ETFs that they don't have a mutual fund for, assuming you want to stick with just Vanguard as opposed to diversifying your asset managers. So, it helps you because ETFs in a pool of investments is easier to track than some ETFs and some mutual funds. But I don't know that you'd necessarily want to swap the exact same product, to just go from mutual fund to ETF.

Sandy Block: No. I mean, it sounds like picking up on what we discussed earlier, Todd, if you did a rollover into an IRA, the ETF world offers you an opportunity to either be a more active or more specialized investor than maybe you could have been in your 401(k).

David Muhlbaum: You mentioned the relative amount of money that is in mutual funds versus ETFs, and that mutual funds are still larger. But my understanding is there's a directional flow happening in the market. Essentially money is leaving mutual funds and heading towards ETFs in a sort of broad approach. So, on one hand, we have this question, what should the individual investor do? What do I do with this? But we can also measure, what are all the investors doing, right? And they are increasingly picking ETFs.

Todd Rosenbluth: That's correct. So, in the United States, we saw record inflows into ETFs in 2020, $504 billion — we've blown that away. As we're recording this today, we are about $600 billion of net inflows through the end of August. Already passing the record. Most of the money has gone into equity ETFs, particularly index-based ETFs. Investors are still comfortable and using actively managed fixed income mutual funds. We've seen money continue to go into those products. Even though we had record inflows into fixed-income ETFs in 2020 and we might actually break that record again in 2021.

So with fixed income, we're seeing investors use both those products. Increasingly, investors are choosing an equity ETF over an equity mutual fund, but that doesn't mean people should do so; they should stick with the products that make sense. If I can add two quick additional bigger picture things that's happening. One is that we've started to see actively managed mutual funds actually convert into ETFs this year. So we’ve seen, we saw a relatively small firm, Guinness Atkinson, do that. We saw a much larger firm, Dimensional Fund, do so. With about $30 billion, they converted existing mutual funds that were low cost and lightly active management. And now J.P Morgan has announced they plan to do so in early 2022. We're likely to see more of this, and that's just money directly moving from a mutual fund into the ETF structure. Then the second thing is that we're seeing more firms that previously only offered actively managed mutual funds offer actively managed ETFs.

So, Fidelity has offered ETF versions of some existing mutual funds. T. Rowe Price has done so. Where now the big elephant in the mutual space, Capital Group, that runs American Funds, plans to launch ETF strategies using the same management team, but different names and there'll be nuanced differences between the products. Now investors are going to have a true choice between whether or not they want an ETF or a mutual fund, as opposed to only sticking with active mutual funds or index-based ETFs, and then we'll see. You'll have that battle you wanted to have between the debit card and the credit card. Investors are going to vote with their wallets.

Sandy Block: So, Todd, let me just drill down on that a little bit, because you said you should choose the one that's right for you. Any thoughts on how to make that choice — given, you know, all things considered, you're not just talking about a 401(k) plan where you really don't have — If you have the option, what you should be thinking about, mutual funds versus ETFs?

Todd Rosenbluth: It probably matters a few things, your time horizons for investing and your patience in doing so, and then whether or not there's choices available for you to achieve the goals that you want. I'll try to tick those off if we can. If you're a buy-and-hold investor that doesn't need the advantages of liquidity to be able to trade and to rebalance it yourself, but you want somebody else to do that for you, you can certainly build a couple of, have a couple of mutual funds or even just have, make it simple and have an asset allocation or target date mutual fund to achieve those goals for you. You pay perhaps a little bit more than you would in an ETF, but someone's doing that work for you.

If you want to keep it simple and you want index management, there's simple index-based products — Vanguard and Schwab among them — that offer those products. Whereas if you want to have a more tailored portfolio, you want to be able to focus and , overweight certain sectors or overweight certain styles, you have more confidence in your ability or your advisor that you may be working with’s ability to allocate towards those respective areas. Or you want to invest in index-based products that have longer-term themes. You touched on space investing. That's one of them. There's a whole range of those products that don't exist in the mutual fund world. So, we at CFRA have clients that are only using mutual funds. We have some that are using only ETFs. We have some folks that have had mutual funds that have continued to build ETFs into their portfolio. It really comes down to a personal choice and we want to provide the research tools. I know you at Kiplinger want to write articles that help people to sort through those various choices and make sense for them.

David Muhlbaum: Coming back to something you talked about earlier, I was aware of the concept, you know, of fund companies offering essentially a ETF versus mutual fund version of the same fund. But you talked about these direct conversions where a company that was offering a mutual fund changes it to an ETF. And I just want to try to figure out what this means to the individual investor who already owns shares of, well, we'll call it the predecessor mutual fund. Do they get liquidated and converted to ETF shares?

Todd Rosenbluth: It was a non-taxable event that took place. One day they owned a mutual fund, the next day it became an ETF. They had to do nothing. It just converted it for them. Then they had the liquidity if they were unhappy. If despite hearing all of this, they don't want to own an ETF, they don't believe in it or it's too complicated, they could choose to sell. That would be a taxable event. But this was done behind the scenes and seamlessly.

But we're going to see some more of this, in my opinion, but I don't think we're going to see a lot more of it. And partially why is that with mutual funds there’s often multiple share classes. There's an advisor share class and there's a retail share class and an institutional share class, and converting all of those together, pulling that back together and then making that conversion and getting all of those shareholders to be comfortable with that and those changes is probably harder to do. Which, in part, why we're seeing Fidelity launch Fidelity Magellan ETF. They continued to have Fidelity Magellan, the mutual fund, because they wanted to give investors the choice instead of making the choice for them.

David Muhlbaum: Yes, that was the one that was rolling around the back of my head, the Magellan. Well, Todd, we're planning another podcast soon about target date funds, which are another slice of the market altogether, and I'm generalizing here, kind of the opposite of what the active trader using ETFs is likely to favor. But I know there are people out there who own both. They're deep into trading, but they might also have their kid's college money in a target date fund. Anyway, the point here is not to go too deep into target date funds, because Lord knows we're going to do that someday. But to ask you,Todd, how the mutual fund versus ETF question plays into those. Since a target date fund is a fund of funds, their managers get to pick which kind, which are they picking?

Todd Rosenbluth: So, they're picking what their fund company offers. So, there are some ETFs that exist within these target date mutual funds. I believe, for example, that BlackRock, which offers target date funds or fund of funds, they may not be target date funds, but certainly fund of funds, they are using ETFs alongside mutual funds to round it out. It makes sense when it's their own products, and so target date funds tend to use the home cooking that's provided. But then also you can just bring the cost down by often using the index-based ETF instead of in a large cap core. So they might own — I don't know if they do — for example, they might own the S&P 500 through IVV, which is iShares S&P 500 ETF and then have some active management in other asset classes to build around it. And so, they're doing so. But many of the firms either don't have an ETF structure, or if they do have an ETF structure, they're relatively new, relatively or they're less liquid right now. But it perhaps is something that we could see: T. Rowe Price or Fidelity beginning to use their own ETFs within it and improve the liquidity all around.

David Muhlbaum: To go back to my, to go back to our 401(k) investor who, at least for the most part, doesn't have access to ETFs. Sandy, we'll get to the brokerage window one of these days. But doesn't have access to ETFs. But if they owned a target date fund in their 401(k), they could indirectly own ETFs. They may not even know it, but at least it's theoretically possible.

Todd Rosenbluth: It certainly is possible that they have it, and I'll hit on the key point, to me, of what you said, is that they may not know it. And that's part of what we're doing here, what you're doing of trying to educate investors. If you own a target date fund, it's probably worth knowing what's inside it, understanding the allocation, the same way that you would if you were building a portfolio yourself using individual stocks just because it's easy to own a target date mutual fund. Doesn't mean you should stop the homework there. You can understand it and make sure it's the right one for you. But there are no target date ETFs that exist. There are some asset allocation, so they own other ETFs within it. BlackRock, among others, run some of these products where they'll do the work for you. It will rebalance so that you'll get back to having a 60/40 split or a 70/30 split between equity and fixed income over time so that you don't have to do that. But that's the disadvantage or one of the disadvantages to using an ETF is you have to do the work to rebalance it yourself.

Sandy Block: So, Todd, you mentioned earlier on that, one of the advantages of ETFs is that they are cheaper. Now we have written and I've followed for years about how mutual fund expenses have gone down a lot, especially if you stick with index funds. But how much less expensive are ETFs and how relevant is that? Are we putting too much on fees here?

Todd Rosenbluth: So, let me cover that. I'll do the second half of that first. We're spending too much time collectively focusing on fees. Now, you want to pay as little as possible, but you don't want to just buy the cheapest product that's around because often the cheapest product, it offers you much different exposure and what's inside-

Sandy Block: You get what you pay for sometimes.

Todd Rosenbluth: You get what you pay for and what's inside the portfolio, the stocks or the bonds are what is going to drive the fund higher relative to its peers and keeping up with the broader market much more than the fee savings you might get. You certainly shouldn't be selling out of something just because something cheaper came around. You wouldn't sell your house just because something else came on the market down the block for a little bit less money. It's probably a different house.

Now, fees are important though. ETFs tend to be much cheaper. Because they’re, often because they're index-based and in part because of the competition that's happening within this space. There's dozens of index-based ETFs covering equity and fixed income investment styles that charge less than 10 basis points. There's actually two different fund families that offer ETFs where there is no fee at all. You pay a 0% fee and that's not for a limited time offer. They're charging you nothing for the product, and what they're hoping is that you'll buy other things within the fund family and build products around that. That doesn't mean you should buy the cheapest product around. The Vanguard 500 index-based ETF charges three basis points, and it's got hundreds of billions of dollars in assets. People are not moving out of it.

With mutual funds, the fee tends to be closer to 100 basis points if it's actively managed, and then there's gray areas in the middle. So your actively managed ETF will probably charge 65 basis points, maybe even lower, 50 basis points. Your index-based mutual fund will be closer to the fee of the ETF. There's a long answer to this. There's a wide range of different choices. The fees keep coming down because money is chasing and going after the lower cost products. But investors shouldn't just buy the cheapest product around it. The free products are good, but they may not be better at all than what you have today, and you would cause a taxable event by selling out of Vanguard 500 to buy the Bank of New York Mellon large cap ETF, BKLC to save three basis points. You'd actually lose money as a result of that, in all likelihood.

David Muhlbaum: Yeah. That inertia we spoke of, it's not. Inertia sometimes, I think, has a negative connotation like, "Oh, I'll get around to that." But actually it also reflects wise choices about the entire tax strategy of how you manage your investments and not just jumping for what looks like a marginal savings and forgetting the big picture. That's an important nuance you brought up, Todd. I think it's something we can use thinking about from time to time, because a lot of us, including here at Kiplinger, can get pretty obsessed about fees. But, you know, as we've said, you’ve got to think about what you're paying for here.

Todd Rosenbluth: Indeed. It should be one of the metrics that you focus on when choosing the fund in addition to performance, in addition to the exposure that you're getting, in addition if it is an actively managed fund is to how long that manager has been in place. Fees matter, but they're not the only thing that matters.

David Muhlbaum: Excellent. Just to come back to the idea of the smackdown, I am just curious, do you get essentially the cocktail party question like, well, which is better?

Todd Rosenbluth: I get asked which is better, and then I get asked for, okay, well, then if you choose that-

Sandy Block: Which one?

Todd Rosenbluth: ... which one and which one would you buy and what the reasons are.

Sandy Block: That's the cab driver question.

David Muhlbaum: They want specifics. They want specifics.

Sandy Block: Yeah. That's the cab driver, the Uber driver. Yes, right?

Todd Rosenbluth: They want specifics. But more, I mean, I think it's in part, people are increasingly gravitating towards ETFs, so they might own a mutual fund and have questions about an ETF and what makes it different than what they know, because mutual funds are just what most people have or people my generation have grown up with. The younger generation and my kids won't know, won't have thought much about a mutual fund because ETFs are more of what they know. I think that we're seeing that in survey studies as well in terms of ETFs are increasingly being used by a younger generation of investors. But, you know, everybody I think is getting more comfortable with it. The greater comfort, the better, because ETFs benefit from the liquidity and the buying and selling of other people.

You want to know that somebody's going to buy what you're looking to sell and that there's inventory and vice versa on it. So, I think we're at an inflection point where we're going to see more and more focus on ETFs and less perhaps on mutual funds. But anyone that owns a mutual fund, again, I'll reiterate, should not make a change just because there's something relatively new that's come around.

David Muhlbaum: That is a great summation of the dynamics of the market today. Both the broad, what's happening on the big level, and what the individual faces in choosing, well, A or B, B or A — "I've had A, should I get B?" I hope that in what we've covered today, we've given people some of the tools to guide those decisions. Thank you very much for joining us today, Todd. Really appreciate it.

Todd Rosenbluth: No, it's been my pleasure. It's a great conversation and happy to work with you guys.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. If you've already subscribed, thanks. Please go back and add a rating or review if you haven't already. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. If you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Listen now:

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links and resources mentioned in this episode:

• SECURE Act 2.0: 10 Ways the Proposed Law Could Change Retirement Savings
• Ed Slott & Co. LLC (irahelp.com)
• Roth IRA Basics: 11 Things You Must Know

Transcript:

David Muhlbaum: Individual retirement accounts. Lots of people have one, but are they getting the most from them? We talked to a master of strategy, Ed Slott, about the ins and outs of IRAs. Speaking of retirement savings, Congress has got its eye on making changes again. We'll check in on what's new.

David Muhlbaum: Welcome to Your Money's Worth. I'm Kiplinger.com senior online editor David Muhlbaum, joined by my co-host, senior editor Sandy Block. How are you doing, Sandy?

Sandy Block: I'm doing great, David.

David Muhlbaum: Well good. So in our main segment today, we're going to get way deep into individual retirement accounts. And if you think that sounds a bit dull, well, you haven't met our guest, Ed Slott.

Sandy Block: As you said, Ed is the consummate professional, and he's also very entertaining. He will make IRAs and Roth IRAs a lot of fun. So I'm really looking forward to that-

David Muhlbaum: Even a Henny Youngman joke.

Sandy Block: I know, I know he's got the shtick, that's all I can say.

David Muhlbaum: But retirement savings, it's a big, broad subject and we do narrow in on IRAs when we talk to Ed. And so I think for that reason, we should probably touch on the news in retirement savings more broadly, which is the Secure Act 2.0.

Sandy Block: Right. This is a follow-up to legislation Congress enacted a couple of years ago and it makes a bunch of tweaks and protections of benefits, mostly benefits, I would say, to retirement savings and specifically the way you save for retirement through your employer. Basically it's designed to encourage, make it easier for people to save and there's a bunch of provisions in it that also include when you take the money out. But I think we're going to narrow in on a couple of them today.

David Muhlbaum: Why couldn't they come up with a new name?

Sandy Block: I don't know. I've been at this for a long time. Secure Act 2.0 is not exactly good, but one of the things, and we actually have a story about this upcoming issue. One of the things that Congress wants to create, which to me makes a lot of sense, is a national database where you could go looking for a lost or orphaned 401(k) plan, or maybe a pension plan if you've lost track of it. Well, it sounds really surprising that anybody would lose track of money they're saving for retirement. There's a company called Capitalized that estimates there's more than a $1 trillion dollars in assets in these forgotten 401(k) accounts. And typically what happens is someone changes jobs and they just don't get around to taking their 401(k) with them. And maybe if it was a small amount, they forgot about it. And maybe the company that they worked for no longer exists. Maybe it merged or got acquired or something like that.

Sandy Block: So, this money is just sitting around and you hope people will go get it, but it's really not good money management. You know, the investments in your old 401(k) may not really reflect your age and risk tolerance. You should be keeping track of this money because someday you're going to need it. So Congress wants to create a national lost and found database where you could go actually search for your lost 401(k). And once you get it, you can make smart decisions about what to do with it.

David Muhlbaum: What was the sum value you said is lost?

Sandy Block: Well, this company, all right, this is a company called Capitalize and they estimate that there's over $1.35 trillion in assets in these forgotten 401(k) plans. Now we don't know if they're really forgotten. Some people may just have their 401(k) with their former employer and they're fine with that. It's a good plan. They're going to go get it eventually.

David Muhlbaum: Right. They chose not to roll it over. They chose to let it be. But there are other people who probably have five figures or more essentially under the couch cushions here.

Sandy Block: Oh yeah. Yeah. And I think a lot of these are small accounts. I mean, think about how often people change jobs these days. You might have a couple of thousand dollars saved and you're three jobs in and you've forgotten about it, but it's still sitting there and it should be with you. You should know what's in it. You should be making smart decisions on how to invest it. And if you change jobs a lot, you can have a lot of plans all over the place. And I don't think that's really the best way to manage your retirement savings.

David Muhlbaum: Right. And even if the value, even if the amounts are relatively large, because it's retirement money, it's often not front of mind. You're like, eh, I'll get around to that

Sandy Block: Right. You're not spending it. Exactly. Yeah, yeah, yeah.

David Muhlbaum: Hmm. Okay. What else has it got in Secure Act 2.0 that we should be paying attention to?

Sandy Block: There are a couple of other provisions that are interesting. One would allow your employer to give you extra incentives to contribute to your plan. Right now they're prohibited from providing financial incentives aside from matching funds, which are valuable-

David Muhlbaum: Right, which is a financial incentive.

Sandy Block: It's a huge financial incentive. As we say, it's free lunch. So matching funds, if you get a match, you should be contributing to your plan. But if this law would say, if your employer also wanted to throw in maybe a gift card, maybe to get you to sign up. They could do that.

David Muhlbaum: A trip to the amusement park?

Sandy Block: Yeah. I don't know. I don't know. That's a good-

David Muhlbaum: ... that's maybe not financial enough, not financial enough, but yeah, it is a little odd.

Sandy Block: A gift card. And yet they went in this direction more relevant is that it would make it easier to contribute to a Roth 401(k), which is a 401(k) that you fund with after tax money versus the traditional 401(k) that you fund with pre-tax money. And what the law would say is that if you wanted to put your money in a Roth, 401(k), your employer's matching contributions could go there too. Now, even if you want to put your entire contribution in a Roth 401(k), the matching money goes into a tax deferred account. So you're going to end up with you-

David Muhlbaum: .. so you end up with two accounts.

Sandy Block: You're going to end up with two accounts, whether you want it or not.

David Muhlbaum: Two accounts to lose, but sorry.

Sandy Block: Yeah, that's right. Two accounts that are somewhere in your past job. Although if you're thinking this hard about it, you're probably taking your 401(k)s with you when you go. But yeah, I think it would make Roth 401(k)s more attractive and people who really want to load up on this after-tax version of 401(k)s would be able to put their matching money there, too. So I think that's kind of an interesting provision that we'll be keeping an eye on.

David Muhlbaum: And I'm glad you brought that up because if anyone's sitting there going, what the heck is Roth, well, that's just the distinction that Ed Slott is going to help us sort out in our main segment. So please stick around. We'll get onto that.

Ins and Outs of IRAs with Ed Slott

David Muhlbaum: Welcome back to Your Money's Worth. For our main segment, we're talking with Ed Slott, who's joined us here before to discuss individual retirement accounts, IRAs, and how to make the most of these tax-advantaged savings plans. We're going to hope you're all saving, somehow, for that time when you can't work anymore or don't want to and so long as we're making assumptions, for purposes of what we're going to talk about here, we're also going to assume that you've got an individual retirement account. Now that's not a 401(k), which is a similar type of program, but one run by your employer. But there is a connection. The way lots of people end up with IRAs is because they leave a job and they either have to, or want to, roll over their 401(k) to an IRA. Then within IRAs, there are key differences between the two main types, the traditional IRA and the Roth IRA, which is named after the U.S. senator who cooked up the latter, William Victor Roth. I like to make sure he gets credit.

Now, Bill Roth couldn't join us today, being dead and all, but I think it's safe to say that Ed Slott knows as much about IRAs as the late Senator. Maybe more. His bio is long. He's an author, consultant and of course, a certified public accountant. His website is called irahelp.com and well, that's what we're hoping to extract today: some IRA help. Thanks for joining us, Ed.

Ed Slott: Great to be here.

Sandy Block: So, as you can tell by David's intro, Your Money's Worth shoots for a pretty broad audience, but when it comes to IRAs, we at Kiplinger often go deep because people want specific guidance. And Ed has really helped us deliver that. He's a regular source of mine, and this is all online, folks, in droves. Your best bet if at any point we lose you is to search Kiplinger IRA basics. You'll get our frequently asked questions for those for both traditional and Roth IRAs. But Ed, before we get into why you'd have one or the other, or why you convert from one to the other, please give everyone a short explainer of the difference in how they work.

Ed Slott: This is a great point you bring out because most people miss this. There's a huge difference between IRAs and Roth IRAs. So now one huge difference comes down to one little three letter word, and that word is yet Y-E-T. IRAs are tax deferred as opposed to tax free. Tax deferred means you won't pay taxes on that money yet, but you will at some future time at some future date, maybe at a higher rate, maybe at a higher value, as opposed to tax free which is what a Roth is, which means you'll never pay taxes on that money. So that's why there's so much interest in Roths. Two words, tax free. People want a tax-free retirement, generally.

David Muhlbaum: Right. But the flip is it means a tax now, to use another three letter word. They're going to have to pay tax now.

Ed Slott: Now versus yet. Yeah. Same kind of thing. Now means yet. You have to pay now, but with the other way, it's just growing. And if you're worried about that, you got to think long term, if you're thinking retirement or even beyond for estate planning, or wealth transfer to your beneficiaries. Remember, every day that goes by that you're holding an IRA, part of that is a debt owed right back to Uncle Sam, which — that's up to you. You don't have to pay that debt. It's not even like... I don't know if you know this., but he's not even your real uncle. So there's no requirement to keep him as your beneficiary.

Sandy Block: Well, I guess, this is one thing that we wanted to talk about maybe later, but I'll bring it up now. Does that mean that if you're really worried about tax rates going up in the future — and tax rates are as low now as they've ever been. We're running up very, very large deficits and the current administration is talking about raising taxes. Is that an argument for Roth over traditional IRA?

Ed Slott: Yes, absolutely. The Roth versus IRA is a straight play on the tax rates. Some people call it tax-rate arbitrage, like with stocks. There's a saying in stocks, buy low and sell high. It's the same thing here. It's all about the tax rates. The best explanation I ever heard, and this is from a comedian in the fifties that didn't know from IRAs or Roths, Henny Youngman. He said, "I'm putting all my money in taxes, the only thing sure to go up." He was right. That's the whole game with the Roth. You're betting, you're investing. You're buying the tax rate now while it's low, the foundational principle of all good tax planning, meaning keeping more of your hard-earned money sheltered from taxes is to always pay taxes at the lowest rates. And that may be right now. Right now, historically we have the lowest rates most people will ever see in their lifetime.

Ed Slott: Just to give you an idea how low they are, going back in history, the years people like me, maybe even Sandy, not you, Dave, you look too young, but the baby boomers, I'm talking about, the people born like me between 1946 and 1964. The top federal tax rate for every one of those years, just as a frame of reference to today, exceeded 90. 9-0. The top rate exceeded 90% for every one of those years except for the last year, 1964. That's because that's the year the Beatles came to America and everybody was so happy that they lowered the top federal rate all the way down to only 77%. So we can see that looking at our deficit and debt levels. I heard them talking just yesterday. One of the congressmen on a news show said, "We're increasing this deficit." I don't know if it's right. It sounded too bizarre, "by $4 billion a day."

So somebody's got to pay that bill and you don't want to be stuck there holding the bag with this IRA that's loaded and growing and compounding with taxes. So that's the case for the Roth IRA.

David Muhlbaum: But given all that Ed, why do we even still have a traditional IRA? Why wouldn't everyone just go with the Roth? Is it the income limits on contributing?

Ed Slott: No, it's not the income limits because that's easily worked around with backdoor Roths, but it's the tax deduction, the allure of the tax deduction upfront. But to me every time, not just to me, this is just a fact, every time you take a tax deduction, it sounds good for the moment. Just like eating candy and ice cream and everything else. It sounds good for the moment, but every time you take a deduction, what a tax deduction is, in reference to an IRA, for example, is really just a loan. You're just taking a loan from the government that has to be paid back, plus whatever it earns and then some, because at some point that money must, by law, come out by your required beginning date, generally after age 72 now under the Secure Act. So you will be forced to pay all of those benefits back, but some people just look at... They're short-sighted and they look only at what am I getting now: "Look, I'm getting a bigger tax refund now."

It might pay to give up that deduction. Remember we're in low rates, like I said. Deductions are worth more at higher rates, not at lower rates. When rates are lower, deductions are worth less, not worthless, worth less, so you may want to look at foregoing that deduction to have your account build tax free. So all the earnings accumulating and accruing in your Roth IRA accrue 100% for you. So you never have to worry about the uncertainty of what future higher taxes could do to your standard of living in retirement.

Sandy Block: But Ed, I want to maybe get you to elaborate on what you just referred to because there are income limits on who can contribute to a Roth. And you don't have to be super rich to be ruled out. But as you mentioned, there's a way around that. Maybe you could talk about the income limits and how people can avoid them. Because I actually think from talking to David this morning, he may be in a position to do that.

Ed Slott: Oh, okay. Well, first of all, let me make it clear to listeners, there's two flavors of Roth, like ice cream, chocolate and vanilla. There's two flavors. The big money is in the conversions. We're talking about contributions here, which are limited by income and the amount you can contribute, which is nutty in the tax code. For example, you're limited to a maximum contribution each year, $6,000 or that's for '21. It changes a little each year. $6,000 per year or another thousand, if you're 50 or over. So $7,000 altogether, and only if you're under these income limits Sandy talked about, and I'll give you the limits. I happen to have them. I knew you would ask. So I happen to have them.

David Muhlbaum: Thank you.

Ed Slott: I keep my little handy lists. We make up our little lists here just for this. All right. So for 2021, if you're married, joint, your income exceeds $208,000. So that's a pretty high limit. But if you're over that you cannot contribute to a Roth. If you're single, it's $140,000. If you're over that, you cannot contribute to a Roth, but there's ways around that. There are no income limits like that if you want to contribute to an IRA, but now you're going to say, "But Ed, you just said, don't take the deduction." Right. You contribute to a non-deductible IRA and then that can be converted to a Roth. So you're back in the same place, but you got there a different way. So that's why it hits me that having a... This is just a comment and opinion, having income limits, like these limits to who can have a Roth for the lousy $6,000 or $7,000 seems ridiculous, when if you wanted to, you could convert a billion dollars to a Roth IRA.

There's no income limit on that. And no dollar limit. There's nothing. You can convert hundreds of millions or billions. But if you want to contribute $6,000, then bam, we're going to put off with down here, have some limits. So it doesn't even make sense.

David Muhlbaum: Oh, Sandy, I know what you've got to ask about now. Our friend Peter-

Sandy Block: Right.

Ed Slott: I gave you the tee up there by using the word billions twice.

Sandy Block: So, Ed speaking of people with billions of dollars in a Roth IRA, there's been a lot of news about Peter Thiel, the founder of PayPal. I think he has something like $5 billion in a-

David Muhlbaum: Billion, billion.

Sandy Block: Billion with a B.

Ed Slott: With a B like Bill Gates.

Sandy Block: In a Roth IRA that is apparently completely tax-free. It got a lot of play. Congress made a lot of noise. So I have two questions. One is, is that legal? And two is how can the rest of us put $5 billion in a Roth IRA that will never be taxed?

Ed Slott: All right. It's like the question, how do you become a billionaire? All right, first have a billion dollars. But he didn't do it that way. First, what he did was legal. I know that several senators are all up in arms about it. They released a data report, came out last week about people with $25 million or more in Roth IRAs and IRAs. But that's a very slim portion. That's like saying, look at all these lottery winners that have hundreds of millions of dollars. That's one out of millions and millions of people. But you hear about that one. You don't hear about all the people that may have taken risks and lost that money. So what he did back in 1999, he didn't make that much. The story, and I'm going from as everybody else is, the ProPublica report, because that's where we got a lot of that information from. The story is he only earned about seventy-odd thousand that year.

So he was under the limit to have a Roth contribution that year. And the most you could contribute that year was $2,000, which he did in 1999 and contributed the max. He was allowed to in 2000. And in 1999, the amount was $2,000. He contributed the maximum he was allowed to contribute for 1999, which was $2,000 that year. And it's interesting. That's the only money he ever contributed to his Roth IRA, $2,000. That year he took $1,700 of that $2,000 and invested in the startup PayPal. And he got the stock at 1/10th of 1 cent per share. So he bought 1.7 million shares and the rest, as we say, is history. It took off. Totally legal. Now, if you can find a stock like that and use the money in your Roth IRA, have at it. The key is finding that stock. So many people may have speculated and lost money and you never heard about them.

I don't know if speculating that much with your retirement savings is a good idea for most people. It worked out for him, but he's not out of the woods yet. People might say, "$5 billion." Sandy, you just said it and I said it earlier. That's growing tax free and is Roth IRA, $5 billion tax free. But not yet. Like I used to say on PBS, or they had me say, "But wait, there's more." All right, first, he can't touch that money until he's 59 and a half, because I think he's only in his early fifties, I think I saw 53 or 54 years old, something like that. So he can take his $2,000 out, no problem. But the other $5 billion of earnings, he'd have to wait until he's 59 and a half. But even if he does, because let's assume he has other money, hopefully somewhere, maybe they'll start a GoFundMe page for something to live on until he hits 59 and a half.

All right. So now he's in his sixties and the $5 billion may be worth #$10 billion by then. Who knows? Because remember, it's not just PayPal. He invested in other things all through that account, knowing anything he earns in there will be tax free for him forever, but here's the kicker so to speak. It's not going to be tax-free forever. There's something called an estate tax and Roth IRAs are... you can't get them out of your estate, even though they're tax free for income tax. So everybody is saying tax-free. Income tax free. Who knows what the estate tax will be on a $10 billion Roth IRA that's included in the estate? And that's... I said maybe at 60. Let's hope he lives a long and healthy life. Maybe by 80, it'll be $30 billion. I don't know what the estate tax at that point may be, but between estate tax and now maybe state estate tax, a lot of that could go right back to the government.

Now I know somebody when I mentioned that on another program, somebody said, "Well, they think he moved to New Zealand for tax purposes," Or something like that. That's between him and himself. I don't know about that. But the point is, Roth IRAs, even though they're income tax free, are also included in your estate if you have an estate high enough to be subject to a state tax.

Sandy Block: That's a good point.

David Muhlbaum: So Peter Thiel was pushing the limits of Bill Roth's little savings invention, it seems. Maybe he should make a donation in Roth's name? Just a thought, but it wasn't so long ago that many more people looking to convert to a Roth were doing some tax strategy of their own. And what I'm talking about here is what was called Roth do-overs. The idea was you could convert to a Roth and then in the same tax year, change your mind. People could undo some or a part of it, depending on what was best for taxes based usually on what stock prices were doing that year. This was complicated but popular, but that's gone now, right, because of the Tax Reform Act of 2017. So now, what happens to someone who converts to a Roth and then they can't pay the tax bill for it? They're just stuck?

Ed Slott: Yeah. You're stuck. There's no question. That was a major change and we used to do that strategy. We used to tell people, "Convert everything," and then when we have the numbers in, we'll show you how much to unconvert, or the word was "recharacterized," to undo it. There's no second chances, no do over. So what you have to know about Roth conversions is first, do an accurate projection of the income tax so you know what the bill is going to be. Once you convert, the tax is going to be owed even if the market crashes. So convert what you can. Maybe a better strategy for most people is to do a series of smaller annual conversions over time to smooth it out, almost like dollar-cost averaging into a Roth IRA and use up the lower tax brackets. That's probably a better long-term plan.

Sandy Block: And maybe we could just talk briefly, Ed, about why Roth is a good thing to leave to your kids or your spouse. Why is Roth a good thing to inherit?

Ed Slott: Oh, because it's tax free again. The last thing you want to worry about, especially as a surviving spouse who's now filing single at higher rates, it's great to have a source of tax-free income in retirement so it doesn't boost their tax brackets and in turn cause them to have a higher tax, more taxes, eating into maybe limited income. Having that income from a Roth IRA... And remember a spouse is exempt from all the changes in the Secure Act, limiting the stretch IRA and all that. So the spouse could do a roll over and treat that Roth as his or her own. And one of the great things we didn't talk about yet about a Roth IRA, there are no required minimum distributions during your lifetime.

Ed Slott: So let's say that wife, we were talking about, the widow, let's say, if she doesn't need money, she doesn't have to take, but whatever she takes will likely be tax free, not increasing her rate, not increasing her Medicare charges or her Social Security taxation, or all the other things that are affected if she had inherited a traditional IRA and been subject to required minimum distribution.

David Muhlbaum: Ah, there it is. Those three words: required minimum distribution. So just to back up one step, can you go through the distinction of how those are treated by Roth versus traditional? You invoked that, but I'd like to make it explicit.

Ed Slott: Right. Well, the tax code lets people have a break. Even with an IRA you can defer and defer and defer. But as I said before, we made our deal with the devil with that. We took the tax deduction upfront and as with any deal with the devil, there's a day of reckoning and they have a name for that date. It's called your required beginning date. In essence, that's the date Congress decided, we're sick and tired of waiting for you to drop dead and we want our money back. That's at age 72. A technically April 1st after you reach age 72, where it has to start going back the other way and taking your money out, and those are called required minimum distributions, based on your age.

David Muhlbaum: To use your metaphor from earlier, it's like the loan is coming due.

Ed Slott: That's exactly right.

David Muhlbaum: ... We're at the end of the term.

Ed Slott: Dave's kicking into high gear now, That's exactly right. Where Roths don't have lifetime required distributions during your life. That's a big difference. Beneficiaries do. Most beneficiaries will be subject to this new 10-year rule, except for a spouse.

David Muhlbaum: But they won't have to pay any taxes on that. So if you want to leave your kids the right kind of legacy, prepay the taxes. Make it a Roth.

Ed Slott: Right. You know what? I've had clients that I've done this with. I can think of many people and even some older people who may say, "I'm in my seventies. Should I pay tax on a Roth conversion?" I said, "If you're doing it for yourself, no. The cost versus the limited benefit, given your shorter life expectancy, it's not worth it. But if you're doing it for the next generation, children or grandchildren, even if they only have 10 years past the time of your death, what you're doing in essence is giving them a gift. But it doesn't count as a gift for tax purposes. You're paying a bill in essence that they would have had to pay if you didn't convert and they had to take it all out in 10 years, bunching all that income into 10 years."

David Muhlbaum: That brings us to another layer of estate planning. Sorry, Sandy.

Sandy Block: I think I have a good wrap-up question because this is a question I get about once a month and I bet you get it all the time-

Ed Slott: Okay, because you tipped us off it's a wrap-up question. Whenever we're running out of time at a seminar, I say, "This'll be the last question," but I find the last question is usually the best. Let's see.

Sandy Block: Oh my God, the pressure.

David Muhlbaum: No pressure.

Ed Slott: All right. Well, okay. I don't know if this is the best, but I get this question from readers and I am sure you get it all the time when you extol all the benefits of a Roth IRA, someone comes to you and says, "There's deficits climbing," as you said, "$4 billion a day or whatever. I'm afraid if I put all this money in a Roth that Congress is going to turn around and say, 'I have to pay taxes on it anyway.'" What do you tell people when they don't trust that the Roth that they're investing in today will be the Roth that they will be able to take tax-free income from tomorrow?

Ed Slott: I'd like to say right now, bam, that's the question! That is the best question. You know why? I do lots of consumer programs. Over the last year and a half, of course, we've been doing them all virtually, but for years I've been doing that exactly as Sandy says. I extol the virtues. I love tax-free. You'll love tax-free. The Roth is great. And somebody will always stand up, not as nicely as Sandy, but they will say up, "Yeah, but can you trust the government to keep their word that Roth IRAs will always be tax free?" And here's my answer, "Of course not. You can't trust these guys as far as you could throw them. Look what they did with the Secure Act. They upended 30 years of tax law that we relied on, the stretch IRA, the estate plan, lots of other rules, but it's here now. But I'm going to tell you the secret why it won't be touched, my opinion.

Secretly — now don't spread this around, I'll say it low — secretly, Congress loves Roth IRAs. If you look at all the legislation that's happened in the last 10 or 15 years, it's all been pro-Roth. It started in 2010. I don't know if you remember. Before 2010, if you wanted to convert big money, you couldn't. If your income exceeded a hundred thousand dollars. They removed that income limit and they were awash in money. The money just poured in. The floodgates opened and they said, "This is a good deal. We can use this to fill budget gaps." So ever since then, they've been adding things like the Roth 401(k), expanding that. Back under the Obama administration and even with the Trump administration and even now there was this term that was bandied around by Congress, called Rothification. They wanted everybody to Rothify because — here's Congress' thinking and lucky for us, the people in Congress are the worst financial planners in the world because they're such short term thinkers.

They say, "This Roth thing, it brings in money up front because the only money you can get into a Roth is already tax money." And they realized that if more people went to Roths, they would get less tax deductions and the government would get more money. Short term! But if everybody on earth or in America did Roth IRAs, they'd all be tax-free millionaires and the government would get nothing when people cashed in at retirement or even for beneficiaries. But they don't think long-term. They only think in short budget cycles. So they secretly love the Roth. And I'll give you another example. The new bill, Secure 2.0 is also pending. It has lots of this Rothification, expanding Roth access in company plans, but where they put the Roth provisions, the expanded Roth provision is at the end of the bill.

You know what's at the end of every tax bill? How to pay for it. It's called revenue provisions. And that's where they put the Roth. They know it's the golden goose. So they're not going to break it, my opinion, because they think it brings in tons of money, which it does. They wanted, under Rothification, in case somebody doesn't know what I mean by that, that was something Congress came up with. They wanted to take people's deductions away. They didn't want any more 401(k)s. They wanted people doing Roth 401(k)s so they wouldn't take deductions, ergo, the government would get more tax money upfront. That's how they think. But I would tell you this. They might find a way to trim around the edges. In other words, they're not going to double tax people because that would kill the golden goose, but they might say, "Yes, it's tax free, but we're going to treat that like tax free, for example, municipal bond interest," something like that.

Ed Slott: If you take a certain amount of that down, maybe we'll make more of other income taxable, like the 3.8% tax on net investment income. Those other things like what we call stealth taxes, tied to a level of adjusted gross income where you start to lose deductions, credits, exemptions, or other benefits. So they might trim around the edges there, but I don't think they can go too far or they're going to lose their golden goose that's providing them all this money with people going heavier into the Roth IRA. But it is the question that everybody asks. I'm telling you: It's here now, take advantage of it. We don't know what the future is going to bring, but the answer to Sandy's and everybody's question is, no, you cannot trust Congress and CPA, accountants always had this saying, "Tax laws are written in pencil."

Sandy Block: David, did you have anything else? You can't beat that.

David Muhlbaum: No, you can't beat that. A great question. A great answer. Both of you. Thank you so much for joining us today, Ed.

Sandy Block: Ed, that was great. Thanks.

Ed Slott: Okay.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and review and if you've already subscribed, thanks, please go back and add a rating or a review, if you haven't already. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. And if you're still here because you want give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Listen now:

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links and resources mentioned in this episode:

• Shield Your Portfolio From Inflation
• Procure Space ETF (UFO)
• How to Cash In on the Final Frontier

Transcript

There's a ton of enthusiasm for space — visiting it, commercializing it, investing in it. A pioneering fund manager in, well, space joins us today to talk about where there's money to be made. Also, inflation is here, maybe to stay. How should you change up your investing strategy? All coming up in this episode of Your Money's Worth.

David Muhlbaum: Welcome to Your Money's Worth. I'm Kiplinger senior editor David Muhlbaum, joined by my co-host, senior editor Sandy Block.

David Muhlbaum: How are you doing, Sandy?

Sandy Block: Doing great, David.

David Muhlbaum: Well, good. So another month, another Consumer Price Index report, and here we are again, talking about inflation.

Sandy Block: Well, we do it because we have to, or we do it because we care, or because everybody's talking about it, I'm not sure.

David Muhlbaum: If I have reluctance to talk about inflation it's because, like many big trends, there's not a whole lot you and I can do about it. And like any economic condition, it's ... temporary?

Sandy Block: Well, it's temporary until it isn't, until it goes on for a while, like the '70s.

David Muhlbaum: Well, a while is a pretty squashy term, no? Look, like many people, I keep seeing the headline, "Inflation is here to stay." And I think, "Well, how long is that? It's not forever."

Sandy Block: No, but it could be years and that could make a real difference in people's situations, their investments. And particularly, I'm hearing a lot from retirees, if you live on a fixed income, inflation is a real, real problem.

David Muhlbaum: Yes, investments, you said that. We're getting to the point where inflation concerns are driving people to reevaluate those. And investing is a place where, I guess, you can do something about inflation, or at least its impact on you. And, hey, get this, I can do something about telling the listeners what they can do.

Sandy Block: Okay, you're being a bit cryptic here, David.

David Muhlbaum: Sorry. Here's the thing, the next issue of Kiplinger's Personal Finance has an article about this very thing, it's called Shield Your Portfolio From Inflation. Now, of course, if you all were subscribers, you'd have that in hand already, but we do eventually share a lot of that magazine content online. But just for you, lucky listeners, I'm going to move that article's online publication up so I can stick it in the show notes.

Sandy Block: All right, then. Well, give the people a little bit more here. Give us something we can use?

David Muhlbaum: Well, okay. It's long and comprehensive and the introduction talks a lot about what's going on, how long inflation might last, the scary stuff. But this right here, this is the counsel from the writer, Adam Shell, "The best inflation strategy is to hope for the best, but plan for the worst." Okay, so let's put that into action: What to buy? One classic investment is Treasury Inflation-Protected Securities, or TIPS. You can buy these directly from the Treasury Department or through exchange traded funds like Schwab U.S. TIPS ETF, the symbol is SCHP. Now, how exactly these work, I'm not going to explain. But basically, they do better when inflation is high. But Adam has plenty of other options for people who don't want to mess with TIPS, or other bonds, or maybe find them a bit dull. And you could change your stock allocations, for example. Some sectors are going to do better in inflationary times, usually energy, industrials, building products, aerospace firms.

Sandy Block: And David, you mentioned TIPS as a classic inflation hedge, but another classic inflation hedge that people often talk about at times like this is gold, gold in them thar hills, the Treasure of Sierra Madre gold.

David Muhlbaum: Well, yes, gold. I mean, gold has always had its fans. And in inflation, you're right, it's always been a big argument for gold. But the track record though, isn't so clear, at least per Adam. Gold tends to perform best during bouts of extreme inflation, such as in the 1970s, which we mentioned earlier, when oil prices skyrocketed, but it doesn't do quite as well during more muted inflationary periods, which is what we're expecting.

Sandy Block: Right. And gold seems more like a lifestyle choice, like if you're the kind of person who doesn't mind putting some bars under your bed, or something like that. You're either a gold buyer or you're not.

David Muhlbaum: I'd agree. And the people who already have it, they might buy more. But get this, how about Bitcoin for an inflation hedge instead?

Sandy Block: Oh, come on.

David Muhlbaum: Well, when you're talking cryptocurrency, you have to include the warnings, and Adam does. So I won't repeat them all here, but yes, one of the fundamental ideas for Bitcoin is that it's an inflation hedge, since there is a firm limit on how much of it can ever be made. It's not a fiat currency, and all that jazz.

Sandy Block: You're right, but what I've been looking at from Bitcoin... And we're working on a story about that now for an upcoming issue... is you need a strong stomach to invest in that area.

David Muhlbaum: Well, yes, we've established that. But you're going to need a strong stomach for this inflationary run too. So hang in there, people. When we return, we'll talk to a top fund manager about investing in space. Stick around.

David Muhlbaum: Welcome back to Your Money's Worth. Joining us for our main segment today is Andrew Chanin, co-founder and CEO of ProcureAM, which oversees the Procure Space ETF, ticker UFO, the first pure-play space themed exchange-traded fund. So in short, we're going to be talking about stocks in space, which is a Muppets reference I've been dying to make ever since Kyle Woodley, our senior investing editor, suggested we do a segment about, well, stocks in space. Kyle, in fact, will be joining us today to pepper Andrew with questions.

David Muhlbaum: Thank you both for joining us.

Andrew Chanin: Thank you for having me.

Kyle Woodley: Hello, hello.

David Muhlbaum: Now, Kyle knows ETFs cold and he's a space fan as well. But before I turn over to him, I want to ask a few sort of establishing questions for people who might be less familiar with the field, or frankly, with you, Andrew. So as we said, you're the co-founder and CEO of ProcureAM, which oversees the Procure Space ETF. Does that mean I can call you a fund manager, or are there people working for you who do that part?

Andrew Chanin: Sure. So we do work with an outsourced portfolio manager that does the actual trading, but we are the fund advisor, and issuer. And sponsor. So we cover a whole bunch of roles for our Procure Space ETF.

David Muhlbaum: Got it. And again, I know Kyle's going to want to talk about some of the individual stocks that are in this sector and in Procure Space ETF, but let's just explain how they get there. If I read this right, you guys track the S-Network Space Index, so what's that — and how does that drive what stocks are in UFO, your ETF?

Andrew Chanin: So S-Network had licensed us their space index to utilize for our ETF. So the goal of our portfolio manager is to try to replicate that index, before fees and expenses. And by doing so, you're having fairly similar weightings in the fund representative to the index holdings themselves. And the way that the index was built was, it was actually co-developed with a former director of research at the Space Foundation. And you may know them for the Space Report, which is a report that comes out every year, also with quarterly installments that looks at the space economy, the space industries, and the revenues that come from there.

Andrew Chanin: And Micah, the individual that works with S-Network on this index was actually part of the team that actually helped define what the space economy actually is. This was something that hadn't really been quantified until the Space Report and the Space Foundation had gone out and done the research to actually figure out what our space companies, where are the revenues coming from, and actually being able to publish that on a fairly regular basis. And so having someone with an extremely in-depth knowledge and understanding of the space industry was extremely important for us. He also has a background in astrophysics as well as space policy, so a really incredible background and understanding that you don't get with most people that are just looking at the space industry. And-

David Muhlbaum: Will you give us his last name too? Micah...

Andrew Chanin: Micah Walter-Range.

David Muhlbaum: Okay, Micah Walter-Range.

Andrew Chanin: And so when you build an index, you have to build out the methodology, so kind of what makes it tick? Well, certainly defining space industries, so: ground equipment manufacturing dependent upon satellite systems, rocket and satellite manufacturing and operations, satellite-based telecommunications, radio and television broadcasting, space industry segments such as space-based imagery, and intelligence services, as well as space technology and hardware. And those were the five original categories that comprise the index. However, since time has gone on, the index provider also recognized that there could be some other emerging space industries, which they categorize as space tourism, like transportation, hospitality. Space-based military and defense systems, space resource exploration and extraction. Space colonization and infrastructure, as well as some other potential industries that could come down the line.

And actually, since UFO launched over two years ago, at least two of those emerging space industries have already found their ways into the fund, and those are with companies like Virgin Galactic, representing space tourism, and then some of the more diversified aerospace and defense names that you'll also see in the fund from the space-based military and defense side. So, as you can see, this is a living, breathing, constantly evolving index that's looking at current industries as well as what's possibly coming down the road. And it looks for companies with over a hundred million in market cap, and it tries to have at least 80% of the index, at rebalance, focused on companies that are pure-play space companies, meaning that a majority of their revenues come from space.

But also understanding that some of the more diversified aerospace and defense names are also major players in space, but not necessarily wanting companies that aren't purely focused on space to really be driving a ton of the movement of the fund. There's up to 20% of the index that can be in these more diversified aerospace and defense names, meeting the qualifications if they have over 20%, but less than 50% of their revenues coming from space, or over 500 million in annual revenues from space.

David Muhlbaum: Got it. I know this is a little weird coming in the wake of your having explained very precisely what's in the fund, but I want to ask about something that's not in the fund. A couple of the big space names that get a lot of press, they aren't in there, SpaceX, Blue Origin. And that's because, well, they're private. They're not publicly traded. And I'm wondering if that's going to continue to be the case in the space sector, a lot of firms looking to stay private? And what that would mean for you, running an ETF, and what it would mean for people who want to invest in space?

Andrew Chanin: So, the two companies that you had mentioned are, they're very large players in the space industry and they're actually affecting companies that are in our fund. And how they're doing that is by... Certainly on SpaceX's front... they're helping to lower the cost of sending things into outer space. So you look at a company like Maxar, and that's in the fund, and they're helping to develop satellites. Well, if it's cheaper to send satellites into outer space, maybe there's more potential customers that can then utilize those satellites. Not only that, but because they're using reusable rockets, it also can help speed up the time in between launches. Whereas, typically, you have to rebuild an entire rocket when you want to send something into outer space, that's no longer the case.

Andrew Chanin: And then you look at how that's also freeing up budgets. So NASA, now able to use SpaceX to send astronauts to the space station or elsewhere, is saving a considerable amount of money. Because before we actually started using SpaceX to send NASA astronauts to the ISS, we were utilizing the Russians and it was costing north of $80 million per astronaut, per seat, to send them into outer space. Whereas, it's closer to $45 million per seat. So if you think about the amount of budget that that can free up for an organization such as NASA, it really is incredible.

Andrew Chanin: So there's a lot of things that these private companies do that are actually helping to benefit the public side of the markets as well. But you just have to realize how those connections fit into place.

Andrew Chanin: That said, Elon Musk has teased that he might sell off his satellite business at some point, and maybe he would spin that off into a publicly traded entity prior to taking SpaceX public. And he's also teased that he wouldn't bring SpaceX public until possibly sending people to Mars. So it is potentially in their flight plan in the future maybe to offer themselves to the public markets. But right now they really haven't needed to because they've been able to access so much capital from their private raises. So, it's really going to come down on a case-by-case basis. When you look at companies that may have major contracts from governments or militaries, for some it might be in their best interest to go public. For others, that might cause them to lose some contracts. So every company is going to need to make the best decision for them. But certainly those that are looking to access capital, may want to look at the public markets for those needs.

Kyle Woodley: So piggybacking on what you said about cutting costs, it feels like getting cost down is one of the biggest barriers to, say, success/differentiators in the space industry. So recycling rockets, finding fuel advantages, is there any particular recent innovation on this front where you look at it and you're like, "This thing right here, this is what really gets the next leg of the space industry going."

Andrew Chanin: Yeah. So we're seeing it, we're literally living in it right now. Over a year ago, one of the heads of NASA had basically kind of coined the term that space is open for business. And what they meant is that NASA doesn't need to go out and say, "We want to do this, so we're going to just start building it." They've shown tremendous success contracting out various things to third parties to help them accomplish their goal. And that entire mindset change is something that is really opening opportunities for companies, entrepreneurs, individuals, technologies that can actually help them achieve those goals. So we're seeing this former hesitancy of working with companies to help achieve these goals has vanished. And now, with rocket costs being lower, with sending things in outer space... You look at satellites and they're getting smaller as well, and they can do more than just one function, like their early predecessors.

But really, it's not a technology that I see driving space forward immediately. It is that space has become an absolute necessity. Before, the U.S. used to be able to claim that we were the dominant country in outer space, and that dominance lead is diminishing by the day. And we're seeing what the Chinese are doing, and the Russians, and even the ESA over in Europe, and their ability to figure out what they want to do and achieve those goals is becoming apparent. China wants to build a permanent research base on the moon by 2028, and Russia has signed on board with it. So what we're seeing is, I think, the space race is not the technology, it's the need to own or dominate space, that is really this upcoming driving factor that I see on the immediate horizon.

Kyle Woodley: And that governmental spending part of it seems to be a major part of the equation that you have to factor in. I mean, space investing clearly has some overlap with the defense industry. And I mean that literally of course in that you have a bunch of defense contractors that are involved with satellites and rockets-based communication components, and so on. But I also mean, it seems that while some aspects of space investing are going to be heavily private sectors, such as tourism, the fate of other aspects is at least somewhat determined by government spending here — and certainly abroad — on national space programs. So how much is this a factor when investors are thinking about the space? And in addition to what you've mentioned with China and Russia, what do international space program spending trends look like nowadays?

Yes, so space has become a must-spend for many countries. Many countries now have the ability to send satellites into outer space to own or operate their own satellite networks. But for many private companies for years, the difference between success and failure for them was their ability to get government contracts. So, like you said, in the early days of the space program, the '50s, '60s, space spending was almost 100% from government. Now, the commercialization of space has increased dramatically where although space and governments and military contracts are extremely important, they only represent about 20% of the overall space economy. So, business has really stepped up and helped fill that void.

So governments giving you a contract isn't necessarily the only lifeblood, but it truly depends on the type of company that you're creating. If you're trying to create secure communications or military surveillance types of satellites, well, there might not be a ton of other use cases outside of the military, at least in that company's early stages until it learns how to utilize that technology and pivot and find other customers.

But space is now something that so many companies are trying to expand into and space is something that touches almost every single publicly traded company around the world today, whether it's communications, whether it's how it surveys, or does GPS tracking of its own assets. Almost everyone that uses a computer that's connected to the internet is relying upon space from some use case. So space has become something that... Like technology in the early days was something that... You're a technology company, well, now every company is essentially a technology company in some aspect. There's many that believe that space is also going to become one of those next jumps as well. And every company is going to need to figure out what the best way for them to raise capital is, and some have chosen the public markets, SPACs and other types of vehicles, in order to access that capital.

David Muhlbaum: You said the word space tourism a couple of times, and I believe you said the term, space hospitality. Is that right? Because those are two words I had not expected to hear in close proximity. But it does bring me to something I know that Kyle wants to talk about, which is the idea of everyday citizens, maybe Kyle, engaging in space tourism, like going there, so-

Kyle Woodley: Nope. So let's get something straight right now, like I'm not getting into a rocket and going into outer space. My wife would be game, my mom would be game, but I love gravity. It's for me. But I am interested in what space tourism's runway looks like as a business. Virgin Galactic is selling tickets for, I think it's like a quarter million a pop. So you're going to see oodles of demand from the world's elite right off the bat. But what happens next? What's the next line of progression here and what does it take to get to the next steps where if I wanted to like, I could go into space?

David Muhlbaum: So wait, you want a five-figure ticket? A four-figure ticket?.

Kyle Woodley: I mean, for me, it would take a three-figure ticket, because I don't want to go up there! But I mean, it's something where I could see, think about how much say a family of four spends to go to Disney world, if you're actually going with the all-inclusive package. So something around those lines where you're getting it to say, I don't know, upper middle-class. But there's still a big difference there between, again, $250,000 for a ticket to $50,000 a ticket. I'm curious what does that bridge look like?

Andrew Chanin: Yeah. So I think one of the great things that could help drive down those prices is that we're seeing competition. This competition is extremely healthy because one of the biggest risks is not being successful in sending someone into outer space, from my perspective. Maybe not necessarily for each company or individual, but for me, if you want to build a business off of sending people to outer space, safety comes first. It's not, who's first to market. First you look at safety and if everyone can do that equally, then you look at, "Okay, well, let's look at the experience. What am I actually getting for my money?" The first ticket to be sold for Blue Origin's flight with the Bezos brothers went for roughly $28 million. So between $250,000 and $28 million, certainly there's some great, probably, media PR that you might be able to get by saying I was the first and I got to spend some time with Jeff and his brother on this lovely vacation, but-

David Muhlbaum: For 30 minutes.

Andrew Chanin: Exactly. But it is a short trip. Certainly they try to make you a couple of days out of the experience where you do your astronaut training, and experiencing, and trying to figure out what you will experience once you're up there, so you can utilize that time and you'll maximize that enjoyment. But really when you're talking about significant amounts of money, what's the differentiation between these two? Is one a better trip? Do I get better pictures? Is there better internet connectivity? What's the differentiator? But certainly they're going to be competing on price. And as they do that, and they build out more technology... I mean Virgin Galactic is already working on your next--gen crafts and whatnot to help build out their business models.

So these are things where I think this extreme competition to drive down costs is what will potentially help to open up the playing field for other people that want to experience this? Will we ever see a $1,000 flight become the regular ticket to go to outer space? It will take a lot of time. It's taken a ton of time to get the cost of launching things in outer space down, why would it be any different sending people on this trip? But certainly, as more competitors come to market, if someone can create a better technology that's safer, faster, and is a better experience, and they're able to do it for cheaper, there's room for those companies. But it is going to be very competitive because what's the next slightly better trip? And is that going to be worth paying up a little bit more? It re.

Kyle Woodley: I love that you mentioned the internet connectivity thing because you're right, like whoever's going up to space, whoever's ponying up that level of money to go up into space, they're not doing it to keep it to themselves. So, of course, they would think about that. It's the little details, man, that humors me.

David Muhlbaum: If you can't livestream space, why even go?

Andrew Chanin: Did it even happen, right?

David Muhlbaum: Since you mentioned risk, I want to touch on that a little. We can all imagine what the risks are for human space flight, whether it's as a tourist or not, but can you talk a little bit more broadly about risk in your sector for investors? What are the biggest risks in space investing, maybe over that same 10-year horizon?

Andrew Chanin: Yeah. So there's a lot of things that are going on with space and figuring out who makes the laws for space, is still pretty much up in the air. A lot of things are theoretical. But certainly, one that doesn't get enough mention is space debris. Right now there's less than 3,000 currently functional orbiting satellites. When we look at what some of the next big satellite companies are trying to do, they're talking about sending up tens of thousands of satellites in low Earth orbit. Although it seems pretty darn big, there's only so much space. So there's this new land grab for orbit, for satellites. And so the more things you put there, the more chance you have for collision, and collision creates more debris, and more debris makes it less safe to send other things into outer space.

So there is really a risk of space debris being something that could limit our ability to utilize low Earth orbit. So that's one thing. But at the same time, that could lead to a new industry, trying to help figure out how we remove the debris, or how we repurpose the debris, or how we track the debris. And these are all things that could become opportunities as well.

The other is, we kind of touched on it, it had historically been very difficult for companies to win government contracts. And a lot of these contracts went to the larger players. And now it seems that there's more of an opening up for more companies to get access to these various contracts from the government, military, space agencies, and whatnot. So it is still a risk that they're not necessarily able to see their technologies make it to functionality before they run out of capital. But with the UFO ETF, diversification is one of those things that we hope is able to give people a little less company risk because you're spreading it out across many companies instead of trying to pick individual ones.

Then another one is, what happens if space becomes more militarized? What happens when China builds a permanent military base on the moon, which they have aspirations of possibly doing by 2030? Who sets the rules for the moon when there's actually individuals inhabiting the moon? Who gets to harness those resources? Who else gets to play in this massive sandbox that could have major geopolitical implications surrounding it? So these are all things that we don't know yet because we haven't experienced it yet. And so that certainly is a risk as well, the unknown. But we're also, to my knowledge, one of the first, if not the first ever, financial product to actually include a UFO UAP risk in our fund risk disclosures. And that actually comes with this upcoming UFO report expected to be released by National Intelligence here in the U.S. teaching us about what we've learned from years of observation of Unexplained Aerial Phenomenon, or UFO's.

David Muhlbaum: That's what UAP was. UFO, everyone knows. UAP is... Say it, please, someone.

Andrew Chanin: Aerial phenomenon.

David Muhlbaum: Okay. Yes. Thank you.

Kyle Woodley: So, I wouldn't say that we don't know anything about, say, the future militarization of space. I mean, one thing that we can say with absolute certainty is that every, say, space general, for instance, is going to have to have a copy of Ender's Game on hand, right?

Andrew Chanin: I just hope they're well-read and they understand that space is something that provides so much opportunity, so much possibility, but it's also something that could be poisoned so easily. And there are obstructions. There's ways to hack satellites, to take them over, to make them useless, and to potentially push them into becoming debris to take out other satellites or constellations. And so I think-

Kyle Woodley: The debris thing was really fascinating to me too, because it was actually only, I think, like a week or so ago that I was reading about... It was a British company, I think Astroscale, that's actually working on debris removal. Are there many other companies, any U.S. ones you can think of that are actively actually going out there right now and learning how to basically push debris around, and whatever, get it out of orbit?

Andrew Chanin: We're really in the R&D phase. There are all different approaches. You've got some brilliant minds working on this problem because although it's not a major problem right now, you just see the increased amounts of launches going up, the amount of crafts that we're sending into outer space, and how that could potentially become a very major issue. Right now, we have amazing technologies that track a lot of large debris, even your potential asteroids that could be coming towards Earth. And so we've allocated some resources, but not nearly enough. You have some companies that are trying to deflect debris so that they could have it burned back up in the atmosphere. You also have other ones that are saying it's really expensive to send something into outer space, why do we want to just destroy it if we can capture that, utilize it, and repurpose it to be used in outer space, well, then we don't have to send all this other stuff back up into outer space, which can cost a fortune?

So there's a lot of different approaches. Recycling in space is something absolutely critical. You don't want to just go to the moon and start littering it with trash. You try to use everything in outer space, whether that's even your own urine, so that you can drink water. And so you see-

David Muhlbaum: Or, for example, with an old satellite, there could be a solar panel up there. It's not as good as a solar panel you could launch now, but it's there. That's the idea?

Andrew Chanin: Exactly, exactly. And what's in that solar panel? Well, there's silver and other very useful materials. So even if you're not using that exact thing, but you're melting it down to its core components and utilizing those. Those are all things that could save a ton of time and money because it also takes time to send things into outer space.

Kyle Woodley: So we were talking about space tourism before, for our listeners, space colonization, which I would consider sort of a next step on from that, is listed on the UFO ETF's fact sheet as an emerging space industry where we could see more companies pop up eventually. Are you seeing any kind of green shoots in this area right now?

Andrew Chanin: So this is an area that I'm very excited for, because I think this is kind of how we push humankind beyond just Earth. And so it's utilizing technologies like 3D printing, your drone technology, autonomous vehicles. And what I envision, and it might not be right, but you think about space, space is dangerous. It's very inhospitable. So what do you need to do in order to support human life? You need to have things like food and water, shelter and air. Now, many of those resources aren't necessarily extremely readily available on the moon and Mars.And certainly, we'll try to extract moon ice and whatnot and turn that into water, but your agriculture and shelter and other things, how do we build out this permanent infrastructure that we can utilize? Well, if you can send 3D printers to space accompanied with robotics and autonomous vehicles, you could essentially build an entire habitat that's livable for humans before they even get there. All they need to do is show up, turn on the lights, or the robot can turn on the lights themselves, and it's ready to go. You could even, in theory, have plants growing and so that people have agriculture already in the process of growing when they get there.

So I think our ability to harness technology and utilize it to build out kind of our roadmaps, and floor plans, and all of our infrastructure that we need, can help launch humankind just significantly further and faster. So I'm very encouraged by that. I think it's also a much safer way to allow humans to explore the universe by building up something prior to their arrival. So I think that those are areas that companies are already starting to work on today. There might not be as much of a commercial demand immediately for those. But as we look to see what Elon Musk is trying to do, building out colonies on Mars, certainly these are various technologies that they could utilize that can help do it in a much safer manner.

Kyle Woodley: No, I was going to say, without getting too sucked into the realm of science fiction, I'm not going to ask you to project out, say, 50 years where there are publicly traded phaser companies, but what new opportunities do you see arising in space investing over, say, the next decade or so, that right now you really simply cannot touch?

Andrew Chanin: Yeah. So right now you look at the space economy, and as of the 2019 numbers from the Space Foundation, there's roughly a $424 billion industry. You look at companies like Morgan Stanley, Bank of America, Morgan Stanley projects that by 2040 space will be north of a trillion dollar industry. Bank of America says that by 2045, they believe the space economy will be about a $2.7 trillion industry. You look at that right now and roughly 30% of the space industry is communications. And if you look at how these investment banks and research houses project that we'll get to those north-of-a-trillion dollar estimates, a significant driver is broadband internet, and communications, and 5G, and things like that, connectivity for us here on Earth. And so, people believe that those will be, call it the next 20 or so years, those will be major drivers for space.

Andrew Chanin: But if you want to think a bit further out, the next decade or further, we talked about how expensive it is to send things to outer space, like some of these vital resources, one of the fun areas that we haven't really touched on and I still think we're a ways away, is your extraction of resources. So if you can go to the moon and you can take lunar ice and you can convert that into water, that could be used to drink, to irrigate crops, to do other things. I think that's extremely exciting. Now, extraction on planets, certainly something that I think we would almost need to do in order to survive on the Moon or Mars.

But extraction from asteroids or other types of matter in outer space, these we already know are extremely dense and chock-full of valuable materials, whether it's precious-

David Muhlbaum: Rare earths?

Andrew Chanin: Exactly, precious metals, rare earths, and beyond. So you look at how certain... You have kind of science fiction people look at how we evolve into a much broader space faring species. The ability to not have to send things up from Earth's gravity, if you want them, if we could go to an asteroid, start mining that and send that to the moon, or Mars, or elsewhere, these are all things that can potentially significantly reduce costs. And like we said, there are many asteroids that are extremely rich with these valuable metals. Certainly just the value of the metals themselves is something to be excited about, but the use cases for these as well is something that could be essential for supporting human life as we explore further into the cosmos.

So although many people think of science fiction, we've already started. Japan and the U.S. have already taken samples from asteroids and whatnot and we're sending these back to Earth to do more examination. Just being able to gather these samples and we're doing it on the moon, or on Mars as well, is extremely valuable from a scientific standpoint, to the extent that we actually need to utilize them because we're in outer space and it's a huge cost savings and they're abundant — phenomenal.

David Muhlbaum: It's amazing all the things you can put in space: satellites, test rockets, new space stations, 3D printers, billionaires, maybe not Kyle, but I know there are other people itching to go. So thank you so much for helping us get a grasp on this field, Andrew. And thanks for helping today, Kyle. I really appreciate it.

Andrew Chanin: Thank you.

Kyle Woodley: Great talking to you, Andrew. Thank you so much for stopping by.

Andrew Chanin: I appreciate it. Thanks, everyone.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you liked what you heard, please sign up for more at Apple Podcasts, or wherever you get your content. When you do, please give us a rating and review. And if you've already subscribed, thanks. Please go back and add a rating and a review, if you haven't already.

To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes' transcripts and links are all in there by date. And if you're still here, because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Listen Now

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links and resources mentioned in this episode:

• 2021 Child Tax Credit Calculator
• Child Tax Credit 2021: Who Gets $3,600? Will I Get Monthly Payments? And Other FAQs
• When to Opt-Out of Monthly Child Tax Credit Payments
• Marriage and Taxes: What You Need to Know

Transcript

David Muhlbaum: Some of us are about to get yet another stimulus from the government. The latest version is the expanded child tax credit, which starting this month means payments to qualifying families. Joy Taylor, editor of the Kiplinger Tax Letter, joins us to talk about how all this will work. Speaking of taxes, as wedding bells ring out again, what does that mean for filers? All coming up on this episode of Your Money's Worth. Stick around.

David Muhlbaum: Welcome to Your Money's Worth. I'm kiplinger.com senior editor David Muhlbaum, joined by my co-host, senior editor Sandy Block. How are you doing, Sandy?

Sandy Block: I'm peachy.

David Muhlbaum: Just peachy. Yeah. That fruit is coming into season. Question for you though, have you been invited to any weddings?

Sandy Block: Not recently, but it looks like there might be some out there on the horizon.

David Muhlbaum: Oh, who?

Sandy Block: I can't say, but people are definitely talking about it, getting engaged, talking about it. I've heard a lot of stories about people who were going to get married last year and postponed it until fall of 2021 or even later. So it sounds like there's a lot of marriages sort of in the hopper.

David Muhlbaum: In the works. Yeah.

Sandy Block: In the works. That's right.

David Muhlbaum: Right. Yeah. That's why I brought that up, because I feel like we may be on the cusp of an explosion in weddings. Or, not! What I wanted to talk about was a piece Emma Patch wrote for Kiplinger's Personal Finance that was a good solid recap of how marriage affects taxes. And it's not like those rules are really going to affect whether someone schedules a wedding in 2021, but they're good to know and review — you know, personal-finance guidance. But I thought, hey, let's see what the data says, like, are we on the cusp of a wedding boom? Those anecdotes that you and I have, well, that's great, but is there data on this? An economic indicator? Because as we know, there's a ton of money sloshing around the wedding industry. So you would think that people who rent venues, sew dresses, bag bird seed, whatever, they'd want to know. Now, I found a survey from The Knot, the big wedding website that suggested a boomlet. But, it's a survey of their own readers, so it's kind of a self-selecting group.

Sandy Block: Right. You're not going to The Knot if you're not getting married or at least thinking about it. I guess people could look at marriage licenses. You can't get married, well, legally, without one of those. I remember getting mine and I got some free household goods out of the deal.

David Muhlbaum: Lucky you.

Sandy Block: Oh yeah.

David Muhlbaum: Well, that's true. That's true. But marriage licenses, those are issued by a zillion counties and municipalities, and they don't tell you what kind of party someone's going to throw.

Sandy Block: Right. To bring another Emma story into it; we've got one in the works. Emma talked to a wedding planner in Portland, Oregon who gave the impression that it's not necessarily full steam ahead, party down for the wedding industry. Because a lot of her clients still have concerns about guests who might be immunocompromised or have family members who aren't vaccinated. Young people — what do you do about that? There are still local regulations in many places about large gatherings. So that's just an anecdote, but it's from someone right in the heart of the business.

David Muhlbaum: Yeah. I guess we're not going to get a forward-looking indicator on weddings. So let's recap the marriage stuff so that we at least squeeze in some actual useful facts before we get to our main segment.

Sandy Block: Right. That's marriage and taxes.

David Muhlbaum: Right. That's what we're going to talk about now. Then we're going to talk about children and taxes. So, okay. Marriage and taxes. Now, one of those is inevitable and the other isn't, but when you get married, it can change your tax situation. Now, in the old days, and by old days, I mean before 2017, when you were talking about matrimony and taxes, the word marriage was usually followed by penalty, marriage penalty. It was just one of those things that people like you and me would talk about with the younger people getting engaged. "Well, it's lovely that you and McKayla are tying the knot, but it's a pity about that marriage penalty."

Sandy Block: But nowadays, when someone tells me that their partner doesn't want to get married because of the marriage penalty, I just tell them, "Your partner just doesn't want to get married." Because under the 2017 tax law, the marriage penalty pretty much went away except for the very wealthy. In fact, some couples may actually enjoy a marriage bonus, and what this is all about is the idea of filing jointly, putting the spouse's incomes together. I sometimes hear from people who say, "Well, we'll just file separately and save taxes." No, you won't. The IRS is onto that, and it doesn't want you lowering your taxes by filing separately. But under the current regime, it's very unlikely that filing jointly will result in a higher combined tax bill than you would have if you never got married and just lived together.

David Muhlbaum: There still could be reasons though to file separately, to pass up that new marriage bonus.

Sandy Block: Right. I guess the major one, and this is probably something you should seriously think about if you're thinking about getting married, is that if your spouse commits fraud. Or to be less harsh, maybe your spouse has his own business, and maybe it's not reported all of his or her income. You could be on the hook for that, if you're married. if you're single, you're off the hook. So certainly file separately if you think that the IRS has the goods on your spouse.

David Muhlbaum: Yeah. You might want to have a little chat there.

Sandy Block: I think this is a good thing.

David Muhlbaum: Yeah. But the marriage penalty might be alive and well at the state level, right? I mean, we've got 50-plus regimes to deal with there.

Sandy Block: Yes. Absolutely, and that's something that Emma covered in her story. There are 15 states that have a marriage penalty built into their tax bracket structure. Seven states and the District of Columbia, however, offset the marriage penalty in their bracket structure by allowing married taxpayers to file separately in the state, even if they filed jointly on their federal tax return.

David Muhlbaum: Yeah. Of course, there are a good number of states that don't have an income tax at all, or a flat one. Hey, check out Kiplinger's Tax Map for that, newlyweds. When we return, more on taxes — but different ones — with Joy Taylor, editor of the Kiplinger Tax Letter.

Child Tax Credit with Joy Taylor

David Muhlbaum: Welcome back to Your Money's Worth. The American Rescue Plan, remember that, is still pumping money into the economy. The latest flow starts this month with advanced payments from the IRS, for the expanded child tax credit. Unlike earlier stimulus efforts that went extremely wide with the goal to put cash in the pockets of just about every taxpayer as quickly as possible, the expanded child tax credit is a more tailored affair. Like number one, you've got to have kids, but that's not all there is to it, and a range of income limits apply. Joy Taylor, the editor of the Kiplinger Tax Letter will help us sort out this complex program to make sure you can take advantage of it in the best way for your finances. If you're sitting there thinking, hey, I pay taxes. I don't have kids, what's up with that? We'll touch on those issues a bit too. So welcome, Joy. Thanks for joining Your Money's Worth. First time, right?

Joy Taylor: Yes, it is. Thanks for having me, David and Sandy.

David Muhlbaum: It isn't our first go round with the expanded child tax credit though. Earlier this year, we had Rocky Mengle, Kiplinger's senior tax editor here on Your Money's Worth to talk about stimulus checks. Then Sandy, you asked him about the child tax credit.

Sandy Block: I just like to stay ahead of the news. Are you blaming me for that?

David Muhlbaum: A little. I have no doubt that Rocky did the best job imaginable in laying out how the child tax credit worked up until now, because child tax credits aren't new, let's make that clear. And then, how the American Rescue Plan was going to expand it. But at the end, I was still like, oh my God, this is complicated and who is going to remember all those numbers and phaseouts and income levels? That was even before we knew how the government itself was going to administer the program, which is its own new layer of complexity.

Sandy Block: Right. But the news here is that people are going to start getting checks, and that's one of the things that Joy is going to give us details on.

David Muhlbaum: Yeah. Yeah, absolutely. Absolutely. That's why we're doing this again. But the problem of the numbers, and the phaseouts, and the income levels, it hasn't gone away. So right off the bat, I want to plug a tool that we've come up with here at Kiplinger, that you can go online and use to see how the expanded child tax credit works for you. It's the 2021 Child Tax Credit Calculator, and it does exactly what it says on the tin. Because, even if we do the most exhaustive explanation possible here today, you're probably going to forget some portion of what we said, and in any case, you'll want to run your own numbers. So "Child Tax Credit Calculator," search those words or look in our show notes. The other thing we're going to plug now, and maybe later, depending on how stuck we get, is Joy's FAQ piece, "Child Tax Credit 2021. Who Gets $3,600? Will I get Monthly Payments?" I'll also link to that in the show notes.

David Muhlbaum: Sorry, Joy. I'm trying to make this easier on everyone, you included. In fact, my first question is going to attempt to skip past all those numbers altogether, and just get you to talk about one of the main things that makes the expanded child tax credit so different. That is, if you qualify, you get some of the money upfront, as Sandy mentioned. Government pays you! So if someone wasn't paying attention to us or lived under a rock or whatever, they could end up having money appear in their bank account, starting July 15th, just like that.

Joy Taylor: Yes. That's true, David. The expanded child tax credit allows for advanced monthly payments of the credit. It's sort of based on the stimulus payments from earlier, from last year, and then earlier this year. People who, eligible families who qualify, will receive, starting July 15th, a monthly payment, per child. A monthly credit per child, depending how many children they have, their income, et cetera, for six months this year. So it'll be July 15th and pretty much the 15th of each month until December. They'll be getting these payments of this child credit up front. That puts more money in peoples' pockets to help them, to help them pay their rent, their mortgage, food, or whatever they want to do with the money. Remember, the payments are an upfront sort of advance of a child credit that will be taken on your tax return that you file next year.

Sandy Block: So Joy, David didn't want to get too bogged down in the numbers, but let's go for the big number. What's the most money that parents can get from this program?

Joy Taylor: So it all depends on the number of children you have and the age of the child. So the most money is $3,600 per child under the age of six, $3,000 per child from age six through 17. So when you're talking about, that is the total annual credit per child that you have. When you're talking about advanced payments, you're talking about at least $300 per month, per child under age six, $250 per month, per child age six to 17. Let's say you have two children, one five, one 10, you'll be getting, and your income, you qualify for the full credit. You could get payments per month of $550.

David Muhlbaum: Wow. Okay. Just to be clear, there's no cap on the number of kids, right?

Joy Taylor: Yeah. So there's no cap on the number of kids, there's just a cap on the ages of the children, but not on the number of children.

David Muhlbaum: That's between you and your household, if .. okay, okay., go for it. Since we've gone there, in terms of numbers, let's talk about the income limits. So the child tax credit has always been income-limited, make too much, you don't get it. But now there are two tiers of income limits in effect? Can you outline how that works a little bit please, Joy?

Joy Taylor: Sure. I think the easiest way to do this is to first discuss the rules that were in effect prior to 2021, prior to this year. So the income levels that were in effect for 2020 was $200,000 for single people and $400,000 for married people. So if your income levels exceeded that, that's when the child credit started to phase out. For 2021, you still have those $200,000 and $400,000 income levels for the $2,000 child credit. But for the people who qualify for the higher child tax credit of $3,000 or $3,600, based on the age of the child, those income levels are different, they're lower. So those income levels are $75,000 for single people, $150,000 for married people. So you have two different income levels: You have income levels to qualify for the higher child tax credit of $3,000 or $3,600, and you have the income levels to qualify for the $2,000 child tax credit.

David Muhlbaum: If we're going to try to shorthand those, essentially you can make more money and get the old one. To get the bigger new one, the income limits are lower.

Joy Taylor: Yes. To get the bigger new one, the income limits are $75,000 for single people and $150,000 for married people. By the way, that's adjusted gross income figures, not taxable income figures. One thing though that I should just clarify when we go back to the advanced payments is, people who only qualify for the $2,000 child tax credit — so people with higher incomes, I mean, wealthy people; I'm talking about, up to $400,000 if you're married — you still will get advanced monthly payments.

David Muhlbaum: Whoa! I didn't even realize that one.

Joy Taylor: You'll still get a monthly payment of up to $167 a month. So the monthly payment does not apply only for-

Sandy Block: Oh interesting.

Joy Taylor: The people on the lower end of the income scale. The monthly payments, the advanced payments are for anyone who qualifies for the child tax credit.

Sandy Block: Alright. Lots of people get a check.

Joy Taylor: Yeah. I don't think many people know that-

Sandy Block: No. I think that's really interesting.

Joy Taylor: I don't think that's been widely publicized, because this has generally been publicized and been talked about by lawmakers as an anti-poverty.

Sandy Block: Right. Right.

Joy Taylor: It's an anti-child-poverty measure. So you're wondering, well, why would someone, why would a family who makes $400,000 get $167 a month per child as payments.

Sandy Block: Right. Which is kind of the same discussion that went on over the stimulus checks. But along those lines, we should note that this is, right, a one-year program. So in 2022, the tax credit won't go away, but it would go back to the old values and phaseouts. Is that right?

Joy Taylor: That is right now. So yes, the program is only for 2021. So in 2022, the income levels and ..the higher income levels and the $2,000 child credit will come back. All the advanced payments and the higher child tax credit would go away. However, lawmakers want to make this permanent. As I said, this is a, I'd mentioned before, it's an anti-child-poverty program. So lawmakers, especially Democratic lawmakers, want to make the program permanent. President Biden had proposed for it to go through 2025. He wants to make it permanent too. That's just solely, 2025 is just because of a federal budget issue. But Democratic lawmakers want this to be a permanent, essentially permanent stimulus payments.

David Muhlbaum: Do we have any sense of what the cost of this program is? Essentially by the government passing up revenue by doing this program, the expanded child tax credit?

Joy Taylor: Yeah. The cost of the expanded child tax credit is estimated to be about $107 billion for essentially the 2021-2022 year.

David Muhlbaum: Bingo. Okay. That's pretty precise. So in essence, Joy, on one hand, we could look at this from a policy perspective as: The child tax credit is a subsidy for having kids. Now, it's a more generous subsidy for having kids. There will probably be people who are opposed to government spending on the face of it, they may be opposed to government spending for anything. But I'm just curious, kids are popular, but, is there a constituency that pushes back against this?

Joy Taylor: Well, I don't know, when you say pushes back against this. Some might say fiscal hawks and more conservatives might push back against these government programs or a higher child tax credit. However, when you look at history, in 2017, then-President Trump and Republicans passed a tax reform law. That tax reform law actually doubled the child tax credit from $1,000 to $2,000. So, subsidizing children, it's not a partisan idea.

David Muhlbaum: No. That makes sense. That makes sense. But yes, there could still be... I just sort of imagined in my mind, there are people going, "but wait a minute, I pay taxes, too." But I see your point. Children are bipartisanly popular. Again, Sandy, we've talked in the past about, well, how do other countries do it? Definitely, if you look at the tax regimes of countries like the UK and many others, there are specific carve-outs like this, where there is favorable tax treatment for having children. Sandy, you had a question about how this is actually going to work.

Sandy Block: Yeah. Just last week, the IRS Taxpayer Advocate put out a report, a really devastating report about IRS service. How many tax returns have not been processed. How only about five people in the United States actually got through calling? I'm exaggerating, but hardly anybody who called the IRS talked to a person. So I guess this is a program, once again, that we're looking to the IRS to manage. Are they going to be able to pull this off? They already had to do stimulus checks, unemployment benefits adjustments. I mean, we're really asking a lot of an agency that by every indication is underfunded and understaffed. Is that going to be problem, do you think?

Joy Taylor: So there are definite concerns. I mean, IRS has been underfunded for years. They keep losing personnel. They keep having to deal with changes in the tax laws. So, I can understand those concerns, and there very well could be issues in the future. However, I actually was pleasantly surprised by how well IRS handled stimulus payments. That was put on IRS very quickly. IRS did not know that was coming, and that was put on them quickly. Yes. That was a one-time payment, which actually ended up being three times. But the IRS overall, with hiccups here and there, overall did a good job with the stimulus payments. I think because of that, Congress thought that IRS could handle the job of deal of handling, paying out child payments.

Now, it is going to be difficult. IRS had to create all sorts of systems, all sorts of new tools on their website ... they're going out and doing press. They're trying to advertise this credit to everyone. I mean, not just to people with money and people who might listen to this podcast. But also to people in public housing who would qualify for the credit. So IRS has a lot on its shoulders, but I don't know. At the beginning of this, I had thought that IRS would not be able to handle it, now I'm becoming a bit more optimistic. So far they've been meeting the timeframes.

David Muhlbaum: Well, that's good news. The individual though, has some control here too. You mentioned the systems that the IRS has been setting up to make the system, to make the payouts work. The individual who's eligible can also check in to make things go smoothly. Can you talk a little bit about what those are and how people should do that?

Joy Taylor: Sure. So there are a few things. First off, I guess the first main issue, the first main question is, do you want these child payments? Do you want these monthly payments? Or would you rather take the full credit when you file your tax return next year? As I said upfront, the monthly payments are advances of the child tax credit that you will take on your 2021 return that you're going to file.

David Muhlbaum: As you also mentioned, they may be going to people who, well, it doesn't make that big a difference for them.

Joy Taylor: Right. Right. So some people might want to, instead of receiving monthly payments, maybe they would like a large refund when they file their return next year. So IRS has, well, IRS pursuant to the law because the law requires that IRS allow people to opt out of monthly payments. So these people will still qualify for the child tax credit, but they don't have to receive monthly payments if they do not want to.

Joy Taylor: If you want to opt out, IRS has created a tool, it's called the Child Tax Credit Update Portal. So you go onto that tool online to essentially opt out. You generally have to... If you don't want the payments, you generally have to opt out at least two weeks prior to the next scheduled payment. So it's too late to opt out for the July 15th payment. If you want to opt out for August and the next five payments, then you have to do that I think by early August.

Sandy Block: Joy, can you also use this portal to update information? Maybe you've got a child the IRS doesn't know about?

Joy Taylor: Yes. Although that feature is not yet available, it will be on that portal. You can update the portal to provide if there's a change in your income level, if there's a change in the number of children, the age of your children. Because IRS is generally, if you think about this, IRS is generally going to look at your 2020 returns and 2020 information to figure out the amount, if you qualify for advance payments, and the amount. So if your circumstances are changing in 2021, or you know they're going to, then you are going to want to go on to the Tax Credit Update Portal on IRS's website and make those changes.

Sandy Block: I'm thinking, yeah-

David Muhlbaum: If you have a newborn for 2021 right?

Sandy Block: That's what I'm thinking. If you had triplets this year, you're going to want to go to that portal.

Joy Taylor: Well, you want... Yes, that's true, but remember, you'll want to go to that portal if you want the payments in advance for those triplets.

Sandy Block: I think if I had triplets I'd want that money.

Joy Taylor: Yeah. So you'll still qualify for the credits, right? Do you want that money now? Do you want the money each month? Or would you rather receive, if you're eligible, I don't know, my math is awful. But whatever $3,600 times three is, like $10,000, is it $10,800? All at once.

David Muhlbaum: Well, diapers.

Sandy Block: That's what I was going to say, David. That's a lot of diapers. I think I'd want the money now. The other issue, because this came up with the stimulus checks is: Will people be able to use that portal to update their bank accounts? So I assume most folks are going to get this direct deposit.

Joy Taylor: Yes, and that feature is already up.

Sandy Block: Oh, great. Okay.

Joy Taylor: So yeah. So yeah, IRS is generally going to send, if they have your bank account information, they'll directly deposit the monthly payments. Otherwise, they'll send a check. If you don't think IRS has your information, you can go in and update it.

David Muhlbaum: Got it. Now, we talked about the idea of not receiving the monthly payments because well, you'd rather have the money later or you don't need it right away, that sort of thing. There are good reasons to do that. But it makes me think a little bit of the flip situation, which is when someone not only really needs the money, but that child tax credit could end up being an income to them. What I'm driving at here is the fact that, my understanding is that not only was the prior child tax credit, what's called fully refundable, but the new one is as well. Which means that even if your federal income tax liability is zero, you still get money. Did I get that right?

Joy Taylor: Okay. Well, partly.

David Muhlbaum: Or sort of?

Joy Taylor: Sort of. Sort of. The prior child tax credit was not fully refundable.

David Muhlbaum: Oh, okay.

Joy Taylor: It was only refundable up to $1,400 per child, and only for very low-income people. You had to have at least $2,500 of earned income, meaning you had to have been working, et cetera. All of those limitations are now gone. So now for 2021, the child tax credit is fully refundable, meaning, even if you have no tax liability, you can get the money. You don't, by the way, families do not have to have earned income. So for non-working families, maybe families looking for a job, families on various government subsidies, et cetera. If they don't have any income at all, they're still eligible for the child tax credit payments.

Sandy Block: I guess that's why this is being promoted by supporters as an anti-poverty program, because people who really need the money are going to get it.

Joy Taylor: Well, exactly, I mean, just think if you have a very low-income family with say, three young children under the age of six. I'm just giving an example. I mean, this family will get $900 a month from July through December, and then the remaining credit. The remaining credit they could take on their tax return, and get refunded for the other half of the portion. Because remember these advanced payments are only for half of the higher child tax credit.

David Muhlbaum: Yes. That's a very good point to make, because we do have, as I said at the start, a lot of dollar values floating around. Yeah. You get the money upfront and you get the money at the back. Seems pretty good if you're going to take it. One other fine slice on the question of it being not only fully refundable, but essentially money for people who really need it. There's some question here, whether you could get over-credited in your advanced payments, and then not be on the hook for adjusting. Can you see what I'm stumbling about, trying to get at here?

Joy Taylor: Yeah. So, yeah. So there are instances where IRS is going to probably pay, I don't know maybe as much this year, because they're only paying half of the credit. But maybe they're paying it to people who don't qualify for the credit at all, or to qualify maybe for much less. There are going to be instances where IRS is going to be paying too much of the child tax credit.. Essentially the payments that you receive are going to be an excess of the child credit that you're actually entitled to when you file your return next year.

David Muhlbaum: But it would get balanced out then, but you're never going to have to give money back. You just don't get as much on the second half.

Joy Taylor: Well, you might have to give money back. I mean, it all just depends, when you do the whole balancing out, let's say, there might be instances maybe where the advanced payments exceed the total child tax credit that you are entitled to. Some people will have to pay, depending on your income, will have to pay the excess back. This is unlike the stimulus check or essentially the stimulus check, if you got it and then your income is way too high-

Sandy Block: It was all yours. Yeah.

Joy Taylor: It was all yours. So with the child tax credit, it doesn't quite work that way, but there is a safe harbor though. The safe harbor essentially is, if you're single with income of less than $40,000 or married with income of less than $60,000, you don't have to pay anything back, even if you're not entitled to what you received.

David Muhlbaum: Bingo. Okay.

Joy Taylor: If your income is for single people above $80,000, $120,000 for married people, you'll have to pay anything you received in proper, you'll have to pay it back. Anything excess you'll have to pay back. For people in the middle, they'll have to pay a portion of it back.

David Muhlbaum: Got it. So yet again, there's another income threshold and I'm going to go, it's such a good thing that you put together that FAQ, because when we get boxed into a corner, we can go look at that.

Joy Taylor: Yeah. Sorry about those numbers.

David Muhlbaum: No problem.

Joy Taylor: But sometimes they are important.

David Muhlbaum: Well, thank you so much, Joy, for joining us today, and walking us through our partial knowledge and improving it. I hope you've improved other people's knowledge as well. As I said before, check out those links. They're really good. Thank you so much, Joy.

Joy Taylor: Thank you.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and review. If you've already subscribed, thanks, please go back and add a rating or review if you haven't already. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed. Go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. If you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Listen Now:

Subscribe FREE wherever you listen:

Apple Podcasts | Google Podcasts | Spotify | Overcast | RSS

Links mentioned in this episode:

• Taxes on Unemployment Benefits: A State-by-State Guide
• The Basics of Unemployment Benefits: Who Qualifies, How to Apply, How Much You’ll Get
• Job Listing: Associate Personal Finance Editor
• Job Listing: Associate Investing Editor, ESG
• 10 Best Marijuana Stocks to Buy for 2021
• Investing in Cannabis? Beware These Red Flags
• How Long Should You Keep Tax Records?
• 22 IRS Audit Red Flags
• How to Fix Your Social Security Earnings Record

Transcript:

David Muhlbaum: A few weeks ago we talked about green investing, a very hot sector in the stock market. Today, we're going to cover another kind of green, green gold. I'm talking about cannabis, marijuana, which is generating plenty of investor interest. Also, unemployment insurance and a recovering job market are increasingly at odds. All coming up on Your Money's Worth. Stick around.

David Muhlbaum: Welcome to Your Money's Worth. I'm Kiplinger.com Senior Online Editor David Muhlbaum, joined by my cohost, Senior Editor Sandy Block. How are you doing, Sandy?

Sandy Block: I'm doing great, Dave, back from a road trip.

David Muhlbaum: Okay. Well, over the past year we have cranked out all sorts of content here about unemployment and unemployment benefits because, obviously there was a lot of unemployment. And historically, we paid a lot of attention to unemployment and job creation from this macroeconomic perspective, but this year was obviously much more how-to, here's how you get the benefits, here's how you navigate the system, and here's how you pay taxes on it if you have to.

Sandy Block: Right. And navigating the system turned out to be a real challenge for a lot of people, not only because they were first-timers at this, but because a lot of states were overwhelmed. It wasn't fun, but the unemployment benefits were ultimately pretty good.

David Muhlbaum: Yeah. They were pretty good because of these big bump-ups that came from the federal stimulus programs. Some of these date back to the early days of the pandemic. Congress, over the past year, was, what, $300?

Sandy Block: Yes.

David Muhlbaum: A week to every out-of-work American's unemployment check and-

Sandy Block: On top of what they were already getting from their state.

David Muhlbaum: On top of what they got from the state. And now, we're getting pushback from literally, states, about this sort of thing.

Sandy Block: Right. And that's because, and on my road trip, I saw this everywhere I went. There's the perception that this is causing people to stay home and contributing to a labor shortage. Now, the April's jobs report showed-

David Muhlbaum: What did you see?

Sandy Block: Oh my gosh, every single place I stopped, fast-food, gas, whatever, had a sign begging for people to come in. And places that you wouldn't normally think of as being really generous, fast-food joints, were promising signing bonuses, healthcare, 401(k)s, and my favorite was, free food. Now, I worked in a fast-food joint, free food was a given 40 years ago.

David Muhlbaum: What about a shifty?

Sandy Block: A shifty?

David Muhlbaum: Did you not use that term?

Sandy Block: No. No.

David Muhlbaum: Shifty is a drink at the end of ... at a place that serves booze. A shifty is a drink at the end of your shift.

Sandy Block: Oh, right. Right. No, I never worked at a place that served booze so I only got free milkshakes at the end of my shift and that's not so much fun. But the question is, is the reason that these folks can't hire -- and there really is a problem, I saw a lot of places saying they had to cut back on hours because they didn't have enough people, or were only operating the drive-through window -- is that really because of this extra unemployment benefit? Is $300 a week keeping that many people at home, or are there other factors going on here?

David Muhlbaum: Yeah. Is it a labor shortage, a perceived labor shortage? A lot of this sprung up after the April jobs report with rather disappointing job growth and it's gotten to be a pretty partisan issue too. All the states that are cutting off the additional federal unemployment benefits, all those states have Republican governors. The other side is the Biden administration.

Sandy Block: Right. And again, there's a lot of back and forth on this and it's really not been tested because we don't know what's going to happen. I guess the real test will come in September, when this extra $300 runs out. Is all of a sudden everybody going to go work at fast-food places or are we still going to have a labor shortage because what's also happening here, what we're hearing is that some people are still at home taking care of their kids. Some people don't feel safe going back to work, maybe they didn't get vaccinated, or they don't want to get vaccinated. And in some places, this could be hitting places, where people are realizing, working in a restaurant is a crummy job. You didn't make very much money -- and they are holding out. That actually seems to be working because a lot of places are raising their wages.

David Muhlbaum: Obviously, we're seeing what you're seeing in terms of the signs. I'm seeing it here at my mother's continuing care facility where they are basically putting out apology notes about the food service because they are having a hard time hiring line cooks. But, actually, since I brought that up, it's actually a somewhat odd situation because here at this CCRC, working in food service is really a whole lot different than the restaurant industry that you're referring to. This is normal hours, benefits, actually, frankly, not working for tips. It seems a sort of good place to wait out the pandemic and yet it seems that restaurant owners are at least able to hire away enough of the staff there to make a difference. There are enough people who want to go back to what, maybe I'm calling it the old way, and maybe the money's up.

Sandy Block: Maybe it's, what did you call that, the shifty? Maybe it's the shifty.

David Muhlbaum: Maybe it's the shifty.

Sandy Block: Maybe it's the shifty. I don't think they have a shifty at the retirement community.

David Muhlbaum: No, but they have, I just remembered, they don't have the shifty, they don't have the shifty here, but out in the real world, if you will, they have the Restaurant Revitalization Fund. There's more stimulus money so possibly one of the things behind that rising pay in the sector is all the stimulus money that's flowing in there. If it isn't one stimulus, it's another.

Sandy Block: Right. And that's really why this is, I think, hard to call. Because the stimulus is still unfolding, the checks got a lot of attention from us and others. There's still more money coming from state and local governments, other programs. So I think this supply and demand labor situation is kind of hard to call right now while all of that money is still out there.

David Muhlbaum: Yeah. A lot of firms are hiring including us, Kiplinger.

Sandy Block: Yes.

David Muhlbaum: We are looking for an Assistant Personal Finance Editor. No, seriously. You can help us cover all these crazy times. You could maybe even help on the podcast, if you can talk pretty. And we also need an Associate Investing Editor, someone who really knows ESG, environmental, social, governance factors. It's a close cousin to the green investing that we talked about here a month ago. Both of these positions are on LinkedIn and other sites and I'll put in a link to the show notes.

Sandy Block: Will they get a shifty?

David Muhlbaum: No. But I'd still like to hear from you.

Sandy Block: It's still a great place to work.

Cannabis Investing with Matt Hawkins

David Muhlbaum: Welcome back to Your Money's Worth. Joining us this week is Matt Hawkins who has a long track record in cannabis investing. I'll put in a link to your bio, Matt, but founder and managing partner of Entourage Effect Capital, a leading private equity investment firm, that's your current title. Welcome, Matt, and please feel to correct or clarify my introduction.

Matt Hawkins: That's perfect, thank you. It's great to be here.

David Muhlbaum: Also co-hosting for this segment today is our Senior Investing Editor, Kyle Woodley. Matt, you already know Kyle because, well, Kyle, you explain.

Kyle Woodley: Hello, hello. Matt's CV now includes being a contributor to Kiplinger. He brings a lot of expertise to our coverage of this still-emerging industry, but I think one of the most important things he has to offer to listeners is, being able to not just give us a fish, but teach us how to fish. That is, he can provide the insight that investors need to evaluate marijuana investments for themselves, just like they would, say consumer staples or tech stocks. I'll admit, I actually learned a lot about what I didn't know about the space in his most recent piece for us, Investing in Cannabis: Beware these Red Flags. I'm really glad you could join us today, Matt.

Matt Hawkins: I appreciate that. I'm interested to hear what you guys have to ask me.

David Muhlbaum: Contributing writer for Kiplinger, you're going to have to put that on the top of the resume. That's a great piece. It's one that we want to explore today as well as Kyle mentioned touching on investing opportunities in cannabis broadly and since I've been doing so much of the talking, Kyle really ought to ask the first question.

Kyle Woodley: Every stock market sector, industry, theme, each one has its own set of factors that investors need to heed and do their due diligence on. What makes the marijuana industry distinct? Are there any specific, I don't know, red flags?

Matt Hawkins: Absolutely. The thing about the marijuana industry, especially in the United States is that you're dealing with companies that are either listed on the Canadian Securities Exchange or on the smaller exchanges like over the counter. There's no real action on the NASDAQ or New York Stock Exchange, save for a few ETFs and maybe a couple of non-plant-touching companies. And so it's harder to find out research. It's hard to find the research that's out there. Some investment banks that are more boutique in nature provide that kind of coverage, but for the most part, it's not like going to buy Apple. It's a different program.

David Muhlbaum: I assume that one of the fundamental reasons for that is marijuana's ongoing status as a controlled substance under federal law.

Matt Hawkins: That's exactly right. And until it becomes either quasi-legal through a variety of legislative initiatives, that's going to be the case. There's a couple of things on the horizon, one being the Safe Banking Act, which has already passed the House I believe three times now. It is in the Senate, and I think once the Senate flipped to the Democrats after the Georgia run-offs, the prospects of that piece of legislation being passed by the Senate went up dramatically.

David Muhlbaum: As a follow-up question to that, a number of companies, as you mention in your piece, that are in the marijuana space, are there because they are dealing with these stop-gaps, they are providing stop-gaps because of the legalization status. What's going to happen if/when marijuana becomes federally legal? It's going to change a lot of people's business plans, no?

Matt Hawkins: Totally. And there are some of those stop-gap measures, I think I may or may not have referred to it in the piece, but we like to those companies bandaids. For example, we don't really like to look at alternative banking solutions because I believe they are just bandaids. Once the Safe Banking Act passes, all the big banks are going to want to take deposits. Right now, it's just state charter banks, credit unions, local banks, municipal banks. But the minute BofA can start taking deposits because the federal government lets them, they are going to want to do it. And so all these different mechanisms by which money is being moved or held or whatever the case may be, not only do those business models change, they likely cease to exist.

David Muhlbaum: To step for a moment beyond the immediate legislative outlook of the industry, can we just take a step back to talk about the industry as a whole. We've been talking about red flags, we've been talking about warnings, we've been talking about limited availability of U.S.- traded stocks, but can you just give us some sense of what the big upside is for the marijuana sector? There's a reason you're here, and by that, I don't mean on this podcast; I mean in this sector.

Matt Hawkins: Well, look, I had a luck-in-timing moment back in 2014. I had exited a multi-family play. I had done some private lending in the downturn. I started dabbling in that again and one of the things that I was seeing in 2014, which is when Oregon, Colorado, the State of Washington all went recreational adult-use legal. In Denver, there were warehouse owners looking to refinance their mortgages out of commercial debt into private debt, which would then give them the ability to lease their facilities to growers. They were paying high yields, it was a nice play. You have the security of a first lien on a piece of real property. But my luck-in-timing moment was realizing that if I could somehow figure out how to raise money and underwrite the actual cannabis assets themselves, I would have a first-mover advantage -- and I did.

There was just one or two other groups at the time doing it and we got lucky. We were able to make some big bets in an emerging industry and we've been able to ride that wave, at least initially, and now we've got 68 investments I think to date out of our family of investment vehicles. It's been a good ride, but we're doing it because of what's on the horizon. We won't see anything in our lifetime like an event that brings in this much capital, that can provide a huge boost to the industry and provide returns to early adopters of this sector and that's what we're playing for.

David Muhlbaum: Got it. I'm going to use your explanation of your history to pivot us, I think, to talking about investing, the individual investor's approach. As you've just made clear, you're an investment banker, you raise money -- a lot of it -- to make strategic capital investments in companies. Some of the names I got from your site. Acreage, GTI, Ebbu. Am I pronouncing that right?

Matt Hawkins: I believe it was Ebbu, yes.

David Muhlbaum: And Form Factory. Now, some of these, or the companies that acquired them, are publicly traded, so for reasons I'm sure you'll appreciate, we're not going to talk about individual cannabis stocks with Matt. But if you, listener, are interested in investing in individual cannabis stocks, fear not, we've got just the thing for you, 10 Best Marijuana Stocks to Buy for 2021 by our contributor Will Ashworth. I'll put in a link to that.

Kyle Woodley: But we do want to ask you about cannabis funds, specifically as they are used as just another tool in the toolbox. When you've got an industry that's still in a great state of flux, that's still finding itself, like the marijuana industry is, many investors are probably going to think to themselves, okay, why don't I just buy a marijuana fund, so that I don't have one big single stock pick that goes the wrong way, it doesn't just completely blow up in my face, blow up my whole portfolio. But do you think that investors clip a lot of that potential in the industry by making such a diversified investment or is there enough ceiling for a slew of stocks to collectively make waves?

Matt Hawkins: Let me just give one disclaimer that most of our investing is obviously on the private side but I think the rule of thumb for being diversified in the cannabis industry applies to both public and private opportunities. On the private side, because of the nascency of this industry, and because of the lack of knowledge of what goes on in a cottage industry like this, you would be wise to invest with someone like us, who knows the industry cold, that's been doing it since 2014. And I think the same thing can be said for the public side, is that if you don't have the ability to diversify yourself on a variety of these, maybe it's the top 10 picks that was just referenced, but if not, then perhaps an ETF is better suited for you.

But ultimately, both the public and the private sector are going to benefit from this change of a major dynamic when legalization occurs. There's going to be an influx of capital both on the private and on the public side so I think that only increases valuations.

Kyle Woodley: No. I was just going to follow up on that and just ask, do you have any, out of curiosity, any particular preferred ETFs out there? We talk a lot about the ETFMG Alternative Harvest ETF, that's ticker MJ, which is the largest fund out there by assets and one that a lot of people know. We've actually recommended the AdvisorShares Pure US Cannabis ETF, ticker MSOS, because of its focus on U.S. marijuana stocks versus MJ and others which, they have very distinctly Canadian and international tilts. Are there any funds out there that you look at and you go, this is an interesting way, a distinct way to invest in the cannabis space?

Matt Hawkins: Without giving investing advice, I will say this. We don't look at ETFs, we obviously know the public sector cold. I would say that, because the public sector is our lifeblood, that's where we either sell companies to or we get lucky and do off-market pipes. We know the sea levels of most every important publicly traded company in the United States and so we may be a bit bias, but my opinion is that you'd be much better off looking at an ETF that contains primarily U.S. Assets. And the reason is that the U.S. market is not only the largest cannabis market in the world, but it's about to go through a shift and a paradigm that is like we've never seen before.

Canada has already done that. Canada is already completely legal and the market, God bless 'em, is smaller than the state of California. It's doesn't make much sense, and to me, the Canadian licensed producers have a flawed model, to begin with. Originally they were set up to be the outsource providers to the world, but their cost structure doesn't allow them to do and so a lot of them, Canopy was smart, Canopy tried to get creative with how they could indirectly own U.S. Assets with Acreage and they got ownership in TerrAscend and a few others. But the other licensed producers have been slow to move and so that's problematic.

Kyle Woodley: What was the trigger point for you where you all of a sudden realized, this is the opportunity, because marijuana, to some extent, had been out there in some way or another, but the point at which you go, wait a minute, this is truly an opportunity. What was that flashpoint where you were like this is why I need to be in this business?

Matt Hawkins: I knew that when I took the chance in 2014 that it was going to be a huge risk/reward because I thought there could be something like this on the horizon, but I had no way of knowing for sure. And plus, it wasn't easy raising money back then. Hell, I live in Dallas, Texas and so you can imagine how hard it was to raise money back then, just from the conservative nature of our state, but what that moment in time was, is when California went adult-use legal in 2016. When that happened, that changed everything, and the fact that California became the largest market in the world overnight with this election was just downright, not only eye-opening, but it was kind of like, holy crap, this is going to happen. Then we decided to get really smart about where to pour the capital. We spent a conscious effort to spend the next three years investing a fair amount of capital in that state and now we've got a pretty good presence there. We're excited about the prospects.

David Muhlbaum: It's interesting you mentioned the difficulty of raising money back then in Texas. We talked a good bit about federal legislation and as most people know, marijuana's legality varies by state. We have Idaho and Washington next to each other, very different takes on it and that's a reminder that marijuana has a cultural history as an illegal substance. And it's taken a lot of restraint, I haven't made a single wacky weed joke today. We've treated this sector as oil and gas. Now that might be a future illegal substance, but that's another story. But I am curious about whether, as you go about your business, Matt, whether you get pushback or teasing or whatever, like, the Cheech and Chong stuff.

Matt Hawkins: I certainly did for the first three years of doing this. Not only that, but I had people judge me, like what's wrong with you, and thought I was crazy. Now, those same people either want to join our investments or they want to talk about it and laugh about it and sometimes they ask me for product. I'm like, look, I'm not your dealer. But the truth of the matter is, that just points to the stigma is almost 100% gone. There is still a sliver of the far right in the Bible Belt where I live that thinks this is still the gateway drug and that's unfortunate, because we've seen time and time again the medicinal benefits that this product has. But look, it's still a vice product, there's no doubt about it, and there's always going to be some people that say it shouldn't be used and sold.

The problem I have with that argument is that it's already there so why not tax and regulate it and bring in some revenue to your state and probably reduce crime in the process because you're taking it off the illicit market and bringing it to a more controlled situation.

David Muhlbaum: The flip side is that you may be in a situation where people essentially expect you to evangelize for marijuana, for the product itself, rather than the investment opportunity.

Matt Hawkins: Sure and what I just said is about as evangelistic as I get when it comes to this because that's not what we do. The last thing that we want to do is try to change people's minds if they are opposed to it. It's just not our job. It's not our position. We've been lucky enough in the course of our period of time where we put capital together that the stigma has been lifted and so like I said, some of the same people that were against it, in the beginning, have become some of our better investors just in the past years.

David Muhlbaum: It's also interesting that we talk about "in the past year or so." You are, as we described at the beginning, a long-time investor in the marijuana space, shall we say, I'm not sure, but if we look at it in absolute years, it's not that many years. It's like pot years are measured differently somehow. Things are moving fast.

Matt Hawkins: Exactly, and the same amount of money we have under management would be, if I was just in the lower middle-market PE world, it would be a gnat's eyelash compared to what most of the larger funds manage. But for cannabis, we're one of the largest firms and that's just because of the nature of the world we live in. It's all family offices and high net worth individuals that are putting the capital to work and we're just one of the organized groups doing it.

Kyle Woodley: I can't think of another situation in which so much money was primed to go to work because here, you already know what the product is. The product has been in use for literally centuries. We've just been waiting for the legalization so that it can turn into this actual legal business structure or whatever. But think about any other invention, you had to prove it out to people. Even like the smartphone, we had phones before, but the smartphone, that took some ... We didn't just have iPhones right away, we had the Zack Morris cellphone, first and we made our way along. You had to prove to people, and eventually build up demand from there.

Here there is very, very clear demand for it and everybody is just waiting to be able to put money on that. And that makes this so much different than a lot of the other, almost every other investment opportunity I think we've ever seen in our lives whether that makes it necessarily the best one or not is to be determined, but it is certainly different and exciting from that perspective.

Matt Hawkins: Or you can just quit your day job and come help us put...

David Muhlbaum: To follow on Kyle's tangent for a moment, it makes me wonder, and I don't know my history here, but it makes me wonder what was the scene like in 1933 at the end of Prohibition where there were companies that had been beaten down to a shell of their former selves looking to revive? Were there new entities coming in? They were probably going to be in a more government-regulated space, one that continues to today, in terms of how government has kept a foot in alcohol. That's my riff. Kyle, I think there is a parallel.

Matt Hawkins: There absolutely is, because there's a three-tiered system in alcohol and that's one thing that the federal government would have to get their arms around if they decided to make it 100% federally legal and federal oversight controls everything. Right now there's not a three-tiered system in a lot of states. In some states, like California, you can be vertically integrated completely and that's a huge problem because you're going to have real issues if you try to break up those companies that have done that. That would be next to impossible.

David Muhlbaum: Wow, I hadn't even thought about the regulatory structure from an antitrust perspective. That's a whole 'nother thing.

Matt Hawkins: That makes my head hurt just thinking about all the regulatory nightmares that fair regulators who going to have to go through to try to make it work. It scares the hell out of me.

David Muhlbaum: Right.

Matt Hawkins: But just real quick back to Prohibition, look, you had families that made generational money off some of this ... Look at the Kennedys, my gosh. That could be the case in cannabis, but some of these people that were early, early on founders of some of these large public companies, they are doing things that could be life-changing for their families going forward.

David Muhlbaum: Legacies. Where does the name, Entourage Effect, come from? Your company.

Matt Hawkins: Good question. We originally, back in 14, we started the company, it was called Cresco Capital Partners. Cresco is Latin for grow and then over the years we kept getting confused with our friends at Cresco Labs, which is a multi-state operator, and Charlie Bachtell, who is the CEO, would literally sit there and laugh at conferences about how many times people would ask us about the other and I finally just said to him, "We're changing our name. I'm sick of this." He laughed and said, "thank you."

Entourage Effect is the interaction between the cannabinoids and the THC to give the medicinal benefits of the plant and so we liked that analogy because not only is it applicable obviously to marijuana, but it's also applicable to what we do as a firm.

Matt Hawkins: Like I said, we've got 68 investments. Part of our strategy is to bring everybody together, if there's a way for them to work together, we obviously want that to happen. We have a deep network outside of our portfolio and we bring that to the table to the benefit of our investments and so we aren't just money, we are relationships and we're the Entourage Effect.

Kyle Woodley: I actually did have a question about your status working in private equity, which means, frankly, you get to invest in companies before we do. You get to invest in the earlier stages and that means you're probably going to be closer to the leading edge of technology in this space. And so my question for you is, what is there that you see out there that you look at and you're like this is interesting leading-edge technology of the marijuana industry.

Matt Hawkins: That's a tough one because the technology side, we have made a couple of investments in that space, but I would put breeding and biosynthesis and the propagation of the plant, those things are the genetics, and all those I consider to be the technology side of this. And from that standpoint, I think that's where you're going to see some real interesting things happen over the next several years. You've got botany experts and horticulturalists that are coming into the industry unlike ever before that were coming from other parts of the food chain outside of marijuana. And so that, to me, shows the influx of not only talent but also just insight and development and progress. We've got a few plays in those arenas and we're excited about the prospects.

David Muhlbaum: And maybe also the diminution of the stigma issue for those individuals who choose to participate.

Matt Hawkins: Oh gosh, yes. Look, you're getting C-level people come in now from CPG companies, Proctor and Gamble folks, Starbucks, Amazon. The stigma to me is just not an issue and I think people are now seeing this as a, we may be in the third or fourth inning here and I want to get in on the action while I can, and that's a good thing.

Kyle Woodley: The technology answer was right on the money because technology, what that looks like, just completely different by sector. It's not always like AI or a smartphone in front of you. This is effectively the ag sector, the ag industry and so in that case, yeah, whether you're putting a product out that is either higher potency or better crop yield or whatever, those are exciting technologies, maybe not necessarily to just your passerby or whatever, but they are very exciting if you're inside the industry.

Matt Hawkins: Yep. Couldn't agree more. Those sectors, you'll start hearing a lot more about where they are headed as some of the companies that actually, some of them that we've been involved in for a couple, three years now, once they start making the big headways, you'll start hearing more about that and I think it's one of those things that will be very attractive to the con-agras of the world, for example. They want to be in this business, they're just handcuffed right now because of the legality.

David Muhlbaum: Well, when that happens, I hope Kyle will ask you to write about it for us.

Kyle Woodley: I'm going to be making plenty of asks of Matt here for the foreseeable future so hopefully, we'll get more of his wisdom here on, not just on the show, but also online at Kiplinger.com here for plenty of years to come.

David Muhlbaum: Thank you very much for joining us today, Matt.

Matt Hawkins: Awesome, guys. Thank you so much. Happy to do it.

Tax Documents to Keep, Tax Documents to Toss

David Muhlbaum: All right, Sandy, the tax deadline has come and gone, and at every meeting leading up to the tax deadline that I had with my boss, Robert, he would say, "Has everyone filed their taxes?" And I would kind of look away, but I did manage to file an extension. How about you?

Sandy Block: I had to file my taxes because we owed, which tells you, even though I write about taxes and I do our own taxes, I must not be very good at it because we did end up writing a check to the IRS. Yes, we did file on time, we had no choice.

David Muhlbaum: Well, I filed an extension and I paid what I think I owed. I'll sort it out later. But yes, it's that cobbler's shoes metaphor. I attempt to do as good a job as I think I know I should. But of course, as part of that, I was up to my eyeballs in either paper or digital paper, with my wife using an app to scan and create PDFs out of the things that we still have on paper and then archiving things as I went into the Google Drive so that I can hopefully find them again. But the whole thing reminded me of, a) that keeping paper is going away, but, b) it has not gone away yet so I think we should maybe touch on a little bit of, hey, tax season's over, I hope it's more over for you than it is for me. What do I do with this stuff, because it's just sitting there in a manila folder?

Sandy Block: We've been doing this article for every year and it's always very popular and people always argue with us about it. What to keep and what you can safely throw away. I think most people err on what to keep and actually what your wife is doing is really smart because the IRS does accept digital versions of documents, so scanning things, as long as you've got some kind of system. You don't have to keep everything and you probably shouldn't because then you risk losing stuff that you really want. A couple of things you might want to keep potentially forever is one, just your actual tax return. That's a really good record for-

David Muhlbaum: Forever?

Sandy Block: Well, some financial planners say to keep it, you don't have to. And we'll go through that. But the idea of keeping your tax return is this: It's a really good snapshot of your life at that time and if you applied for a mortgage or want to start a business or any kind of loan, you don't know how far back they're going to ask to see your taxes so I personally keep the actual return. Again, you can keep a digital, if you use tax software, it's probably stored for you somewhere. And you can get it from the IRS, but I do keep the actual return.

David Muhlbaum: One thing you actually mentioned about having it in a piece of tax software is that I think the safer bet would be to make sure you've exported a PDF of the actual file.

Sandy Block: Yeah. I wouldn't want to leave it in the cloud.

David Muhlbaum: And not only because of security issues, but because your financial relationship with that provider, you may not renew it.

Sandy Block: And usually, they will give you a PDF. I have them on my computer. The other thing you might want to keep is your W-2 forms, which is just one thing you get at the end of the year. We're not talking a mass ... and the reason you want to hold onto that is when it comes time to file for Social Security sometimes there are errors in your earning record and that could hurt your benefits so you're going to want to be able to point to these W-2 forms and say, yes, I did work at this place this year and as a result, I owe benefits for that time.

David Muhlbaum: On that note though, you can get ahead of that, can't you, because it's possible to get essentially a Social Security transcript or a statement that reflects each year's earnings.

Sandy Block: You can do that every year, which I have not done. Yes, you could go through it every year and make sure it's right, but just in case you don't, the W-2s are a good backup. And I think it's good to know how much you made. I like to go back and say how did I possibly eat on that salary. That's a journalism thing. The general rule is this, the IRS has three years after the due date of your return or in your case, the day you actually file it, if you get an extension to kick off an audit of your returns so you should hold on to your tax records at least until that time has passed. But as I mentioned earlier, there are some records, like maybe the actual tax return and your W-2s that you want to hold on a little longer.

Sandy Block: Things you can throw away after one year are your pay stubs. After you've checked them against your W-2s, the W-2 has all that information. If all the totals match, you can shred the pay stubs and you can take a similar approach with your monthly brokerage statements, which can really pile up. You can generally dispose of them if they match up with your year-end statements and 1099s.

David Muhlbaum: Or you could have gone paperless, I just want to note.

Sandy Block: Right, exactly. Now, the things you should keep, we mentioned the IRS has three years to audit you. There is an exception that I'll get to in a minute, but because within that period, you should hold onto all of the documents that support any income, deductions, or credits claimed on your tax return for those last three years after the tax filing deadline. And that includes, again, your W-2s, which you're holding forever anyway, 1099s, if you have deducted mortgage interest, and again, a lot of these things are digital. 1098 forms, canceled checks if you made charitable contributions --and you still are able to deduct them.

David Muhlbaum: Okay, I want to challenge this for a moment because many of the forms that you've mentioned are ones that are already being reported to the IRS. If there's going to be a challenge to you, isn't it going to be more about something weird like some stock you sold with a tax basis that dates to 1955 that you got from Grandma?

Sandy Block: That's a good question, but I wouldn't assume that, if your information doesn't match theirs, maybe you were right. I wouldn't count on my brokerage to have them for one thing. What if the IRS comes back and audits you and your brokerage has gone out of business or something? You don't know. Those are just things that the IRS might want to see if you get audited. And the other thing I wanted to mention is you took withdrawals from a health savings account or a 529 plan, you went eligible expenses and contributions to a tax-deductible retirement savings plan, just a traditional IRA, because again, you are deducting these things on your tax returns. If you don't itemize deductions, and most of us don't, you don't have to hold onto as many of these things.

David Muhlbaum: What is it now, like 90% of people are taking the standard deduction?

Sandy Block: Yes. The caveat here is we've got this little break in the coronavirus legislation. We were allowed to deduct $300 of charitable contributions or $600 this year if you're married. So you would want to hold onto records of that. But in general, if you don't deduct, you don't need to hold onto all that stuff because you're not deducting it. If you're not deducting your mortgage interest, you don't need to hold onto documents for mortgage interest because the IRS isn't going to ask you about it.

David Muhlbaum: Right. Fundamentally though, and I guess I'm coming back to my point about which forms and what kind of recordkeeping matters. I agree with you on the principle, but I think one of the things people could almost inform themselves with when making these decisions about where they really need to pay attention to recordkeeping is another bit of Kiplinger content about 22 IRS Audit Red Flags because if you look at those and you look at those and see, is anything I'm doing in these categories? It doesn't mean you're doing something wrong, it just means your tax return has categories that the IRS likes to pay attention to. That's an additional warning that you better have your paper in order if you are filing that kind of return.

Sandy Block: And that's a really good point, because I think one area that I'll just touch on briefly. We could do a whole segment on it, is if you work for yourself. I used to interview a lot of self-employed people and almost all of them had been audited and the reason is when you work for yourself, you're self-reporting. Our taxes are withheld from our paychecks so it's hard for us to cheat or make mistakes really because the money just goes right to the IRS. But if you work for yourself, you are reporting your income. Basically, it's on you to report your income. It's on you to report your expenses and I think the IRS routinely audits a lot of those tax returns just because they don't have a backup like they do. So if you work for yourself, my advice is, keep just absolutely assiduous records. And I think that's a really good idea to put the audit red flags because it will show some other things that just sort of might get the IRS's attention and you do want to keep better records.

David Muhlbaum: And while I agree we should follow the numbers, fundamentally it kind of comes down to, are you a record keeper or not a record keeper? It's like the people who are early to the airport and the people who don't feel satisfied unless the doors shut on their behinds as they got onto the plane. People are just two different kinds.

Sandy Block: I'm the person who leaves the night before, so you can imagine my file cabinets are pretty full.

David Muhlbaum: I'm early to the airport, but I'm a mess at record keeping. I guess you can diverge. Thanks very much, Sandy. Feel free to bug me when it's October and I've really got to file those things.

Sandy Block: Okay.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple podcasts or wherever you get your content. When you do, please give us a rating and a review. And if you've already subscribed, thanks. Please go back and add a rating or review, if you haven't already. To see the links we mentioned in our show along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Listen Now:

Subscribe FREE wherever you listen:

Links mentioned in this episode:

• Kiplinger’s Economic Outlooks: Inflation
• How to Protect Your Home from Natural Disasters with the Right Insurance
• FEMA Flood Maps
• Bitcoin, Should You Invest? With Tyrone Ross
• Insurance Institute for Business & Home Safety – Roof Fortification
• Dogecoin's a Joke. Don't Make Yourself the Punchline.

Transcript:

David Muhlbaum: Storms are coming. Fire, too. Ahead of what looks like a rough season for hurricanes and wildfire alike, we'll talk about what insurance covers, what it doesn't, and how to fill the gaps so that you're prepared against adversity. Also, inflation is here. How worried should we be? All coming up on this episode of Your Money's Worth.

David Muhlbaum: Welcome to Your Money's Worth. I'm Kiplinger.com senior online editor David Muhlbaum, joined by my cohost, senior editor Sandy Block. How are you doing, Sandy? But perhaps more importantly, how's the fuel level in your car?

Sandy Block: Much better right now, thanks for asking. And I know why you're asking too, because of the computer hack that took out the Colonial pipeline and created this gasoline shortage we're living through here and by here, I mean mainly the Southeast U.S., which is here.

David Muhlbaum: So you got gas.

Sandy Block: We got gas. Yes, we did. I think so.

David Muhlbaum: Well, I noticed you said living through. I thought that was telling because, you know, we're all going to be okay. I have confidence to that by the time this podcast drops, the pipeline will be up and running again or the various workarounds -- trucks, ships trains -- will have helped. I like the "Mad Max" franchise, don't get me wrong, but those were movies. We're not there yet.

Sandy Block: Yes. But it sounded like it yesterday when the Consumer Product Safety Commission tweeted out a warning telling people not to store gasoline in plastic bags. I really started to worry for the future at that point. But aside from the hoarding silliness, this gas "crisis" and I'm putting quote marks on crisis, does seem emblematic of a bigger economic concern: inflation. Now I covered the Consumer Price Index for a number of years and you did too, David. And before the economists get all riled, we understand that this gas blip is probably going to be a blip and that inflation numbers that everyone's talking about these days don't reflect the pipeline issue.

David Muhlbaum: A couple of months ago, we talked about doing a longer piece on inflation. In fact, we asked people if they wanted us to do that and, sadly, not much response. At the time, we quoted the Kiplinger Letter and the forecast was basically that inflation would rise enough for consumers to take notice, but that it wouldn't get out of hand. Now I think the first part has definitely come true. People aren't just freaking out about gasoline scarcity, things like the cost of lumber, rental cars, plastics -- it's all getting a lot of attention and from the stock market too. Yesterday, at least and that was Wednesday, May 12th, stocks sank on that CPI report. Sorry, Sandy. I'm talking too much. What's the current inflation forecast?

Sandy Block: All right. So I can give you some insight into the forecast of our staff economist, David Payne, he's working on it for this week's Kiplinger Letter. So, got to stay a bit vague because he's still working on it.

David Muhlbaum: Well, people could subscribe and they could get the final word.

Sandy Block: They sure could, or should. Anyway, the update looks like this, broad inflation is not just a threat it's here. But remember that's not all bad news. One of the reasons prices are up is because people have money to spend. Businesses that can navigate the shortages will have no problem selling their products. The big question is, will it last? And the big player here is the Federal Reserve. And their view is that this is a brief spike. These logistical worries and the shopping frenzy will pass. That's their gamble, and that's why they're standing pat on interest rates. If prices keep rising, then they may have no choice but to raise rates to try and curb inflation and I think that's why the stock market is so concerned.

David Muhlbaum: Right. So, will this be a blip like the pipeline crisis or will it stick around? We'll be watching. So I guess maybe you and I will have to do an inflation check-in every month, Sandy. It'll be like the old days at Dow Jones. Speaking of timing, we have some news for you about Your Money's Worth. We're going to ease up on our schedule for the summer. This is the last weekly episode for now as we transition to every other week or as our British friends say, fortnightly.

Sandy Block: Fortnightly, my liege!

David Muhlbaum: Oh, I like that. So we will be back with another episode on or about June 1st but stick around for our main segment with Kiplinger staff writer Rivan Stinson about making sure your home and insurance are both ready for a potential disaster. We want it to get that one in before hurricane season officially started.

David Muhlbaum: Welcome back. All the people who forecast these sorts of things suggest we are in for both an active hurricane season and that wildfire danger out west is going to be higher this summer. We don't have an earthquake forecast because humans aren't good at that sort of thing yet, but that's another hazard. Now, these threats are new and the risk to your individual property depends on a whole bunch of factors, some of which we have some control over. Plus, in the end, there's always insurance or we hope. But still, May is a good month to take stock of the risks homeowners face and what they can do to mitigate them. And to that end, Rivan Stinson, a staff writer for Kiplinger's Personal Finance, did a roundup on how to know what's covered, make sure you have enough coverage, and where to get that coverage. Oh, and also actual physical changes you can make to your home as well to make it more risk-proof. Obviously what you do depends on what risk you're facing and we'll get into that. Thanks for joining us, Rivan.

Rivan Stinson: Thanks for having me.

David Muhlbaum: At the risk of staying with this doom and gloom tone here, your article started out with some depressing details, not about impending storm, fire, earthquake, cicadas, any of that, but with a study that showed that Americans don't have a great sense of what homeowners insurance actually covers. Can you tell us a bit more about that?

Rivan Stinson: Oh yeah. So through my research, I found Policygenius which is an insurance comparison website, they surveyed homeowners and about 53% of them believed that flood damage was covered in their regular policy. It's not. In the same survey, they also found that 80% of homeowners thought that earthquake damage was covered too. And again, it's not. And depending on where you live at, you do have a higher risk for these things. So you just don't want to be left holding the bag. And I guess that was the scarier part -- to think that people thought that they were covered, and when disaster strikes, then you can just be left out.

Sandy Block: Right -- ow! But I would argue that plenty of people don't know or care about flood insurance because they don't think they're at flood risk or it's vanishingly low. And people who do live somewhere with high flood risk like the outer banks of North Carolina or along one of the big inland rivers, well, they know and they're covered. So what's the problem?

Rivan Stinson: The problem is one, a lot of the flood maps are old for FEMA and just depending on where you live at stuff does change. The person I interviewed for the story out in Maryland, she didn't think her house would have flooded, but we do know rains are getting heavier, don't have construction with storm, clogging the storm drains, you don't have enough vegetation. It doesn't really matter anymore. Your basement or anything does have a chance to flood.

David Muhlbaum: Tell us a little bit more about that term you threw out: FEMA maps. Because again, the people on the coast and along the rivers, they're going to know who FEMA is and what it does and what it's got to do with flooding, but maybe those in between or people who should be paying attention, they don't know. So tell them more about that resource, even if it may be out of date.

Rivan Stinson: So the Federal Emergency Management Agency or FEMA, these are the people who update the maps and you see them when bad storms happen and people are at the gymnasiums getting assistance. These are the people that are running the show through the Department of Homeland Security. So they have a resource on their website under floods and maps. You can click on it and it shows flood insurance, flood plain management, and more importantly for you as a consumer of flood maps. And you can look up your zip code or zip code that you want to live in, somebody else's, just to see your disaster risk of a flood. And again, it's helpful but the thing is, we do know that the maps are out of date. And so, it's just take stock of what's happening in your area that the weather is changing. Does your basement flood? My dad's basement floods all the time. He just doesn't put an insurance claim on it.

Sandy Block: And Rivan, I think one of the things you talk about in your story that has been a big issue after hurricanes or even just really heavy rains is that your policy might protect you from wind, but it won't necessarily protect you from water coming in and there's always a lot of big controversy about where the water came from and whether your insurance covers it. Is that right?

Rivan Stinson: In the insurance world, they are going to ask you, "Did the wind come first or did the rain come first?" If it's a hurricane and the hurricane is slanting water into your house, yes. Your flood insurance is not needed. But if it's coming up from the ground, that's a high possibility, it is a hurricane. Water is coming in. Thinking of a surge. Then it's going to be under your flood insurance policy.

Sandy Block: If you have one. Right.

Rivan Stinson: If you have one. And even now even with hurricane insurance, you need to just be on the lookout for just how bad the wind can be, and that will increase your policy and everything. But again, they will have a distinction on how did the water get into your house? If a pipe burst in your house, it's more than likely covered under your standard homeowners insurance policy, because that's something that's out of your control, especially if it's plumbing-related. The issue with flooding is, did the whole septic system jack up the neighborhood, did the rain mess up the neighborhood? And that's when you have some difficulties.

David Muhlbaum: Well, I'm glad you mentioned wind because I remember in your article too that wind coverage is changing as well in the sense that homeowners can have a separate deductible for wind damage and that could make some real big differences in how much you're paying out of pocket.

Rivan Stinson: Yes. Wind damage is getting much more expensive for you as a homeowner and it is a separate deductible that you have to meet and it's usually doled out to you in percentages, it's not a flat amount. And they're just making everything higher.

David Muhlbaum: So why is that happening?

Rivan Stinson: It's just the part of the industry. It's been gradually shifting just these different deductible types and especially in the 19 states where they're prone to having hurricanes. The insurance company is there to mitigate their risk. And so a lot of these disasters, they're just becoming so prone and they know that it's going to happen, that it's not a once-in-a-lifetime opportunity anymore that they're willing to pay out for. So they're making you, the consumer, just pay more and just realize that this stuff is separate because now it's a known event.

Sandy Block: And I think what you point out in your article, Rivan, is that when they're charging you a percentage of the damage, it can be five to 10% of your total coverage. That could be a lot more than say $1,000 deductible or a $500 deductible, which I think is what most people are used to when they have an insurance policy.

Rivan Stinson: Yes. You're right. So let's say your home is insured for $500,000 and you have a 5% wind deductible, a storm comes and you end up having $30,000 worth of damages because of the high winds. At that 5%, you're responsible for $25,000 out of pocket. And then the insurance will only cover $5,000 of damages because now you met your deductible. But $25,000 is steep.

David Muhlbaum: It might not also be the only hurricane damage you have.

Rivan Stinson: That's right.

David Muhlbaum: So you have a separate deductible to cover for whatever else happened and then you have this additional $25,000. And yeah, that's adding up pretty big.

Rivan Stinson: Correct.

David Muhlbaum: Okay. To paraphrase or rather, mangle the poet Robert Frost, the world might end in a flood or it might end in fire. It seems like every year we get a more expensive wildfire surge out west. What's the story there both from a risk and insurance perspective?

Rivan Stinson: This is the area that I found most interesting. So again, wildfires are becoming a known event. We just know, "You know what? It's going to burn, just be ready." The issue is of some of these insurance companies are pulling out of the areas where people have homes in. So, whereas before you had more choices to even pick a home insurance policy that would cover wildfires, now you're probably down to two to three choices where maybe before you had eight people to pick through. And the deductibles are running high and it can be based on a percentage of your home or just a flat fee for your deductible. And just prices have gone up. And like before a policy could cost you $1,000 maybe a year ago. Now it's probably costing you three to six times that when it's up for renewal. And now let's say you had a policy, things are fine. Now the insurance company can opt to not renew your policy because you just live in a high-risk wildfire area.

David Muhlbaum: And those policies are on a one-year cycle?

Rivan Stinson: Yes.

David Muhlbaum: So yeah, you could be out of luck pretty quickly. Do you think this is going to get to a point where we have a insurer of last resort situation like the state might step in?

Rivan Stinson: I think so only because earlier in the year, the insurance commissioner for California did put a moratorium on policy cancellation. So I do think the state will eventually step in. But that's just my assumption.

David Muhlbaum: Well, yeah. Because no homeowners insurance equals no mortgage, no lah-di-dah. Yeah. That doesn't work.

Sandy Block: Well and in fact, that's what happened with flood insurance. That's why we have Federal Flood Insurance because private insurers didn't want to have anything to do with that business. Speaking of California and disasters that happened out there, let's talk a little bit about earthquakes. It was about 10 years ago here that we in Washington had a significant earthquake, but it just knocked over a couple of lawn chairs. But if you live in California, earthquakes can flatten your home. It can be quite devastating. And as David pointed out at the beginning of this broadcast, they're very hard to predict. So I guess the question is, does homeowners insurance cover damage from an earthquake Rivan?

Rivan Stinson: It surely doesn't. So for those living in California, you would have to get a separate policy, which is similar to the idea of getting flood insurance. And you do that with the California Earthquake Authority and they will set your deductibles and how much your belongings are covered for. And their deductibles do range from five to 25%. So again, similar to when you really are coming out of pocket.

David Muhlbaum: Okay, even non-Californians know that's where the earthquakes happen. But as we see with our Washington D.C. example, earthquakes do happen in other places, sometimes even with damage. What should someone in between, a non-Californian who thinks they're at risk for earthquake, what should they do in terms of assessing their risk and possibly insuring for it?

Rivan Stinson: Honestly, I would talk to an independent insurance agent. I would go to trustedchoice.com and just ask them, they will know your area. They live in your area just like you do and will be able to access that risk for you. Because unlike with FEMA in the flood maps, in my research I didn't see anything that mentioned earthquake map.

David Muhlbaum: Got it. I'm going to check the USGS site because I'm curious, but we could follow up on that. If I do succeed, I'll pop in a link.

Sandy Block: This has been a gloomy conversation, but we like to be actionable here at Kiplinger. So maybe you could talk about a few of the things that people can do to lower their insurance costs or their out-of-pocket costs. And let's start with flooding. What can you do to reduce the cost of damages or perhaps even insurance premiums there?

Rivan Stinson: So for this is just as simple as getting a water leak detector. You want to put it in your basement next to where your hot water heater is at. For example, the Flow Smart Water Detector is about 50 bucks at Amazon and it will notify you through an app on your smartphone that, "Hey, there's a leak happening." And some of these detectors will even do an automatic water shut-off, but those tend to cost more. So you basically just want to get something in that basement or any place that you think is prone to leaking so that the sensors can detect it.

David Muhlbaum: And with fire, there are a whole lot of steps people should be taking and I guess most people in fire zones know about these, but maybe there are people on the edges who should address them as well. What are some of the steps you need to safeguard your house against wildfire?

Rivan Stinson: When I tell you this you're going to laugh because it's just basic home maintenance. You want to keep anything that's flammable away from your house. You want to create what they call these defensible safe zones. So in about the first five feet from around your house, you want to remove any flammable outdoor furniture, combustibles. If you have firewood for a stove, do you have a propane tank? You want to clean out your gutters, keep your leaves raked. If you have tree limbs close to your house, see about getting them trimmed down because you just want to make sure your house is free and clear. And then it's the same type of principle as you walk further and further away from your front door. Just what's around? What could catch on fire? And: move it.

David Muhlbaum: As an East Coaster. I understand exactly what you mean rationally, but I think about my own house and I'm like, "A, I'm nowhere near that and B, it probably doesn't matter. So I guess I'm just lucky."

Sandy Block: The other thing we've been talking about, the increase in hurricanes and the forecast but this year is a lot of hurricanes and you also mentioned the big wind deductibles. So what should you do if you live in an area that's susceptible to hurricanes, tornadoes, and other types of wind storms. And that is an awful lot of territory because we've had some pretty fierce wind storms just around here in the DC area recently. So what should you be doing to strap yourself down?

Rivan Stinson: I'm going to take just what you said. You said, "strap yourself down." You basically want to make sure your roof is strapped down. It's usually easier to do as you're getting your roof replaced. But if you're not doing that, you can make some inexpensive upgrades to it. I'm going to have David drop a link. It's the Insurance Institute for Business and Homes safety Fortify standards will walk you step by step in terms of what layers need to be nailed down. You're looking for these things called ring-shank nails.

David Muhlbaum: Yes!

Rivan Stinson: And they basically hammer in your roof for you.

David Muhlbaum: And it's funny that the cost difference between an individual ring-shank nail and a nail that doesn't have these little bumps on it, it's tiny but all the cost is in the labor and the installation of doing it. So yeah, it really does pay to do that when you make an upgrade or a change because the incremental cost at that point is not much. But it's amazing to think that just by changing the kind of nail you use, you can vastly change the susceptibility of your roof or other things to wind damage.

Rivan Stinson: Yeah. And you also want to look for roof straps and metal connectors or retrofit clips in your attic. You just basically want to make sure that the contractors are keeping everything down together.

David Muhlbaum: I know this is, of course, a very state-by-state thing and I know, for example, Florida has been really on the leading edge of implementing these, requiring these, and having their building code reflect the need for these. So again, if people are in a state that's maybe more inland or not historically at as great a risk as Florida is to hurricanes but they do want to make changes, they might actually want to look to these other states, building codes, and inspiration to see what to do because they've got a wealth of knowledge down there.

Rivan Stinson: And also just think of, are you going to replace your roof soon? It's just something to add to your arsenal, to think about. Asking these when you get quotes about how much it's going to cost.

Sandy Block: So, the final thing that you talk about in your story, which is very relevant to us right now because we're all home. People have been working from home for the last year and a lot of them are going to continue working from home even after it's safe to go out. But what should you be thinking about in terms of your homeowners insurance if your home is your workplace?

Rivan Stinson: Appliances, appliances, appliances. You are at home, you're running the stove more, the air conditioner's running more, the air is running more. You're just having a lot of wear and tear on that. So you just want to add a buffer to your policy and it's very cheap. You can add equipment breakdown coverage, and this will reimburse you the cost for mechanical breakdowns of your equipment due to an electrical problem or something that stems or let's say it got installed wrong. And it's pretty cheap. It's about $24 to add to your home insurance policies. And you also want to think about your computers and your printers, whatever else that you have. And so typically you can get $2,500 in business equipment coverage. It's already in your standard policy. But if you're like me, I have a MacBook, I have a couple of cameras laying around. Stuff just gets really expensive.

Rivan Stinson: So if you have more expensive tech, you want to bump it up and you can increase it to $5,000 and that's roughly an additional $25 a year to your additional policy. So you're adding higher coverage for pennies, but it's for peace of mind. And you also want to think about if you're meeting people at home in the winter, though we are over that at the moment. People do slip and fall and they may decide to sue you. So if you're worried about the $100,000 is not enough liability and your standard homeowner's policy, you do want to get an umbrella policy because it will cover you for more. And the first million is generally $200 to $400 a year. Then the next million runs from $75 to $100. So it just all depends on your level of comfort and how much you want to be protected.

David Muhlbaum: Yes, it depends on your assets in total, essentially. If you don't have any money, they can't take you for much, but if you do, it could be gone. So it is an inexpensive way to provide that peace of mind. I just wish I could find some insurance to assure that my Wi-Fi at home or rather I should say, my internet connection, would be always on but I don't think that's coming anytime soon. Rivan, thank you very much for joining us today. We appreciate your insights on coverage and everyone out there, stay safe.

Before we leave you today, we're going to come back to cryptocurrencies, a topic we took seriously last month when we spoke with Tyrone Ross. I know that episode was not everyone's cup of tea, but let me just say that I get more out of it every time I listen. Now, I have to listen to it because it's my job. But I would say that if your initial reaction was, "What?" -- try going back and relistening or maybe read the transcript because we loaded that up with links to the underlying concepts and terms and frankly, jargon, that Tyrone brought up.

Sandy Block: So David, are you going to just plug past content, or do you have something new to talk about?

David Muhlbaum: I have something new. New-ish! One of the questions that we really didn't get to with Tyrone was the idea that some experts have that cryptocurrencies are -- or at least some of them are -- an overpriced asset bubble. The latest short squeeze or Dutch tulip-bulb craze.

Sandy Block: I'm not going to answer that.

David Muhlbaum: Fair enough. Neither am I. Except for Dogecoin, which is literally a joke. It's an overvalued joke with a market capitalization bigger than say, General Mills, but it's a joke. And here we go name-checking Saturday Night Live again, but Elon Musk, albeit as a character in a skit, he also called Dogecoin a joke.

Sandy Block: I think what he actually called it, and even if you didn't watch the episode, you may have heard this later. He called it a "hustle."

David Muhlbaum: Okay. Fine. A hustle.

Sandy Block: What cracked me up about the bit was how the Saturday Night Live host kept asking, "What is Dogecoin?" Over and over. And I think they were picking up on the zeitgeist there, that fairly reflects the general state of puzzlement over digital currency. So David, please tell the people, what is Dogecoin?

David Muhlbaum: It's a hustle! Okay, fine, fine. Dogecoin is a digital currency. But first we must explore, who is Doge? Doge is a Shiba Inu dog, a doge if you will. And a photo of this dog became an internet meme. Doge drinks bubble tea, Dodge goes skateboarding. My older daughter was into Doge, like, two years ago, which of course is an eternity in meme years. But Doge is cute.

Sandy Block: Yeah. After you sent it to me, I looked at the picture. I guess Doge is not Elon's dog.

David Muhlbaum: No.

Sandy Block: That's what I thought. Actually, he looks a little bit like the first dog my husband and I had. His name was Snoop. Now Snoop died like 13 years ago, so no digital currency for him.

David Muhlbaum: Oh, I don't see why not. Look, if these guys who launched Dogecoin-- and I stress again, they did so AS A JOKE -- why not Snoopcoin? It's not too late. So, anyway, Doge is a meme.

Sandy Block: Okay. David. What is Dogecoin?

David Muhlbaum: I see what you did there. Okay. Let me be clear. I'm cribbing my answer here from an article we published called, "Dogecoin's a Joke. Don't Make Yourself the Punchline." Riley Adams, a contributor, he wrote it. And he explains that Dogecoin, like Bitcoin and other digital currencies, it operates on one of these peer-to-peer transaction networks. We call it blockchain. All the trades get logged in this virtual decentralized ledger by people who verify them by mining. Well, actually for Dogecoin they call it "digging" because Dogecoin creators said dogs don't mine, they dig. Did I mention this is a joke? And so the miners are diggers. They receive a nominal amount of the virtual currency in return. That's how the currency is created.

David Muhlbaum: But people can buy Dogecoin. So it has a value in well, dollars. And at the start of 2021, the value of a Dogecoin was half a cent. It's suitable for a joke. "Hey bro, I got like 4,000 Dogecoins!" Now each Dogecoin is worth 43 cents at current exchange rates, which creates a total market capitalization of $50 billion, more or less.

Sandy Block: That's a lot of money or a lot of Doges, whatever. I take it this isn't going to last, or at least that Riley Adams, the contributor, doesn't think it's going to last.

David Muhlbaum: Well, no. I tend to think that when archeologists look back at the smoking rubble of the 21st century, one of the things they're going to find is Dogecoin. Actually, they're not, because it's only virtual! You won't find a doubloon, but anyway. In fact, after Elon did his little bit on Saturday Night Live, the thing, Dogecoin, lost a third of its value. Now, one thing that brings us full round to cryptocurrency in total is that Riley's article, the one published on Kiplinger, it also breaks down why the Dogecoin situation is not analogous to Bitcoin, or Ethereum, or a few of the other big cryptos. But I am not getting into that because we are out of time. We'll probably come back and talk about crypto some other day. We'll put a link to the article. Thank you.

Sandy Block: There you go.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and review. And if you've already subscribed, thanks. Please go back and add a rating or review if you haven't already. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Listen now:

Subscribe FREE wherever you listen:

Links mentioned in this episode:

• Sell in May and Go Away? Here We Go Again …
• Keith Gumbinger, Vice President of HSH.com
• This Hot Housing Market with Daniel Bortz
• Black Knight Mortgage Data Reports

Transcript:

David Muhlbaum: With home prices on a tear, you might have more money in your house than you think. By that we mean home home equity: the value of your property minus whatever you still owe on it. But turning that into cash that you can put to use can be complicated. We'll dig into the equity market with an expert. Also, you might have heard of "sell in May and go away." Well, should you? All coming up in this episode of Your Money's Worth. Stick around.

David Muhlbaum: Welcome to Your Money's Worth. I'm Kiplinger.com senior online editor David Muhlbaum, joined by my cohost, senior editor Sandy Block. How're you doing, Sandy?

Sandy Block: I'm doing great, David.

David Muhlbaum: Well, good. It's a beautiful May day here, though I closed the windows to keep the bird noise down. And May is the month mentioned in one of those old Wall Street adages, "sell in May and go away."

Sandy Block: Right, and we're in May, and it will still be May when this drops, so anyone who wanted to follow this idea still has time. To sell stocks, that is. But that's not actually our counsel, right? Because that would be market timing.

David Muhlbaum: Yes, that's correct. Our investing writer Dan Burrows has a good take on "sell in May and go away" out -- we'll link to it -- and he's got a fairly sanguine take on the philosophy, he basically calls it a "tired old saw" that gets more attention than it deserves, but still worthy of exploration.

Sandy Block: So is it right or wrong? Are we going to get a binary answer, or is this "it depends?" Not that there's anything wrong with that.

David Muhlbaum: Look, if "sell in May and go away" were flat out wrong, it wouldn't pop up every year, like Punxatawey Phil. It's … you know…. debatable. To quote Dan, "There is evidence that the stock market, on average, tends to underperform in the six-month period between May and October. However, analysts, market timers and academics who have studied the phenomenon extensively can't settle the matter conclusively one way or the other."

And by the way, the basic meaning of "sell in May and go away" is right in there: If stocks don't do well between May and October, maybe you should hold something else. But notice we're talking about May to October? We've already added something there, and we're already complicating the idea of "sell in May and go away." Because it's not, go away forever; you're supposed to buy back in, sometime. It's about when do stocks, as an asset class, perform best … or worst.

Sandy Block: And that's the definition of market timing, which, although it sounds interesting, is something Dan, echoing the rest of us at Kiplinger, actively discourages. Leave your stock allocation alone, except when your personal situation demands changes, such as you're getting close to retirement.. Because, for the regular investor, that sort of portfolio churning, even in the era of free stock trades and such, takes a toll. Opportunity cost, emotional stress. Getting timing right is hard. Do you go back in October? Do you go back in November? You don't know when to go back in, and most people don't get that right.

David Muhlbaum: Right. It's better to stay in, yes. Even though we’ve given away a lot of the plot, Dan's article is still worth a good read, because it lays out the funky history of "sell in May and go away" and provides some current-year advice for more active investors who might want to fiddle. The whole concept seems to have originated centuries ago in England when merchants, bankers and other interested parties in London's financial district noticed that investment returns generally did worse in the summer. Now, they weren't doing quantitative analysis with supercomputers. They were looking at their ledgers and going, "eh….."

Sandy Block: Really, these rich financiers were looking for an excuse to leave hot, smelly London in the summer and retreat to their Downton Abbey summer houses.

David Muhlbaum: Well, yes. "It's malodorous. I think we shall retire." I guess it worked for them. When we come back, we'll go deep into all angles of home equity with market expert Keith Gumbinger.

David Muhlbaum: We'll go ahead and hope that none of you are literally putting money under your mattress these days. But what you might not fully appreciate is how much money you could have under your own roof. We're talking about home equity here, which has been on the rise as a consequence of this sizzling housing market.

A few weeks ago, we talked about that market broadly. And we broached home equity and its significance to people who aren't actively looking to move. But we wanted to dig in a little bit deeper and explore more angles of using what we might call the bank of home.

And so, we reached out to Keith Gumbinger, Vice President of Mortgage Research firm hsh.com. Thank you for joining us today, Keith, to let us pick your brain on all things equity.

Keith Gumbinger: Good to be here.

David Muhlbaum: Home equity seems like one of those things that's sort of highly personal. There are millions of homes out there, and they're generally all a bit different. And they're different in their financing, too. Some people will have a mortgage. Well, actually, most people will have a mortgage with its own rate and term. But then, there's also the question, how much of that has been paid off?

But that said, collectively, home equity, we can track it in some ways. And one thing that we saw, and part of the reason we're doing this topic today, is we saw this value of $7.3 trillion in, quote, "tappable equity." That's from the Black Knight firm. I'll put in a link.

And we're like, "Wow, $7.3 trillion. That's a lot of money." But in part, we also wonder what does that really mean? And so, before we get into building equity and tapping equity and all that for the individual homeowner, can you give us a bit of a sense of the macro picture? Because things seem like they're kind of hopping, right, thanks in part to these double-digit increases in home prices?

Keith Gumbinger: Well, that's definitely where the increase in home equity to that $7.3 trillion has come from, especially in the last couple of years. Home prices have just been skyrocketing. I think the NAR reported March to March existing homes were 17% more expensive this year than last year. And that was on top of a double-digit increase the year before. So if you bought a home within the last couple of years, your equity has been coming up very quickly, mostly due to that fast home price appreciation.

Sandy Block: Because of this big increase in home equity, some people have had concerns about a bubble. They've been talking about making comparisons to 2008, but it looks like that's really not the case now. Not so many people are underwater anymore. Is that right, Keith?

Keith Gumbinger: That's absolutely correct. In fact, from the last downturn in real estate, which is now almost 15 years ago, very few people that actually bought homes at the peak might be still technically underwater in terms of their home value.

The vast majority of borrowers that are experiencing great equity growth right now are homeowners that bought or refinanced within the last five or six or seven years. And they have a very solid equity position to lean on. And generally, this is a comfortable spot for most folks.

In terms of a bubble, there's so few liberal lending opportunities these days. Most underwriting is still very conservative, that borrowers would find it hard to get themselves in trouble. It's never been impossible, but it's difficult.

David Muhlbaum: I feel like in part, the idea of borrowing against home equity in all of its forms, it kind of faded out for a while there, in part because, going back 10 years ago, so many people were underwater or in perilous situations that there wasn't home equity or they were wary of tapping into it. So now that more people have equity and more people have access to it, how does that advantage them? Let's talk about what it actually means in terms of "What can we do with this?"

Keith Gumbinger: Well, certainly it makes people feel better. When you've got equity in your home, you feel like your asset strength is pretty good. That can help you to feel more comfortable in spending additional monies, whether that's necessarily out of your home at an equity expression, or whether you just feel a little more comfortable about spending out of pocket, maybe not saving so hard.

So that gives you a great asset base on which to lean and feel comfortable in your finances with. But for a lot of borrowers, it also can open up tremendous amounts of flexibility for them. If you've got ongoing expenses, maybe medical situations going on for you or maybe your parents or children, educational costs, what have you, this can allow you an opportunity to have access to some funds at a low interest rate environment that gives you flexibility to cover those. Of course, you want to repay them as you go, but it gives you flexibility in your budget.

Sandy Block: And Keith, I'd like to follow up on that. And maybe you could sort of walk us through sort of the basics here, what a HELOC is versus a home equity loan, why you might want to consider one versus the other. And then, as a follow-up, I'm hearing that it's actually getting hard to get some of these now, even though they're very attractive to people. So maybe you could talk to us a little bit about that.

Keith Gumbinger: Oh, sure. A home equity line of credit is just like it sounds. It's very much like a credit card. You set up a dollar amount or are allowed to set up a dollar amount against your house that you can borrow. And you borrow funds and repay them as you go along, usually for a period of about 10 years.

Most of these are based upon the prime rate, which is very low right now, plus a small margin, usually a couple of percentage points. So the average HELOC can have a rate right around 5 1/4% right now. Now, you're allowed to borrow and set up funds against your house, usually up to about 80% of the value of the home minus what you owe on the first mortgage. So you can establish a line of credit, borrow and repay as you go along, and ultimately you're going to give yourself that flexibility you might be looking for.

Now, home equity loans, really they're kind of a fixed-rate, lump-sum disbursement. You get all your dollars at one time, usually for a fixed term: 15 years, 10 years, 20 years. Those are the ones that are hard to come by right now. And that's partly because of a change in the regulatory environment a few years ago that requires more disclosure and more compliance costs on the part of lenders.

Unlike a first mortgage where they can have hundreds of thousands of dollars on which they can make interest, a home equity loan might be $10-, $20-, $30,000 with the high cost of compliance on top of it. It's hard for lenders to make money that way. So those are a little more difficult to come by.

David Muhlbaum: Yeah, that's a reminder that you may have equity in your house, but converting that equity into cash for you to take with you or do whatever you had in mind, there's a bank in the way. And it's got to make sense for you, and it's got to make sense for the bank. Just because equity is tappable, there could be hurdles to making that cash-out happen for you.

Keith Gumbinger: And also, the change in the way equity is made available to you compared to 15 years ago, used to be able to easily borrow up to a 100% of the value of your home. In fact, a lot of homes during the bubble days were financed that way, with a piggyback mortgage, a first mortgage for 80% of the value of the home and a second mortgage of 10%. Lots of borrowers kind of pre-borrowed their equity in order to get into their home.

Today, 80% is going to be about your maximum. It's really hard to get yourself leveraged out to a point where it might be a problem. And this way, you're more likely to be in a sustainable sort of equity environment rather than getting deep in the hole.

Sandy Block: Keith, another thing that was very common 15 years ago was cash-out refinances. People would refinance their homes and take a bunch of money out. And I guess people are still doing that now as they're looking at home equity loans or home equity lines of credit. What are good uses for this money? And what are bad uses for this money? Are there times when it's a good idea to do this and times when it's not?

David Muhlbaum: So judgy, so judgy.

Keith Gumbinger: There can always be good and bad reasons for doing certain things. When we talk about using the equity in your home, and aside from home price appreciation, building equity in your home can take a very long time. You have a mortgage for 30 years. You're making payments over a long period of time. It's hard to build equity.

If you're going to use your equity, making good choices with that money is really what you want to try to shoot for and investing in the asset itself, right? Home improvement is very popular and very useful in terms of using your home equity. Improve the value of the asset. Improve the livability. You can actually make ... perhaps over time, even make all the equity that you spent back, plus then some.

Investing in people, stuff like education for yourself or for your children, for example, is a very effective use of your home equity because again, you're looking to build an asset yourself, your career, or your children's career. So you're going to get some return out of that in the long haul.

And we can talk about maybe not such great uses. If you're going to take money out of your home, an appreciating asset, and put it into something that's NOT an appreciating asset, that might be a car, or that might be a boat, for example. Yeah, that might not be necessarily the greatest use of the equity in your home.

Some of those things, it would be hard to turn to someone and say, "You shouldn't buy yourself a great car." If your car is a piece of junk and falling apart, that's your only avenue to get yourself a better car so you can get to work every day. Is that a valuable use? Yes. Is it an investment-type use where you're going to get a return on it? Probably not.

David Muhlbaum: Could you maybe get better financing from the manufacturer? Probably.

Keith Gumbinger: Possibly, and it's about trying to fit it in and make the best possible use for you out of it. And no, you don't want to go buy fur coats or go on unnecessarily expensive vacations. But for some audiences, a lifetime of wanting to travel the world and a one-time opportunity to do it, maybe that's a great use for you -- provided you're going to pay it back and manage it wisely. You're not going to empty it out and then just hope for the better in the long haul.

David Muhlbaum: Right. Keith, I know you have a lot of tools on hsh.com. And I'm hoping you could review a little bit of them, particularly with the idea of helping people know what equity they have. Unlike the stock market, this one's a little harder to price. People know how much they owe. How much their home is worth is dodgier.

Keith Gumbinger: Well, your equity stake depends upon, of course, not only what your home is worth, but, of course, what you still owe on it. And, of course, you can look right in your mortgage statement and know exactly where you started, from what you borrowed originally, and what you still owe on that. But your equity stake's probably -- hopefully -- going to be a lot larger than that because of home price appreciation.

Depending upon when you bought your home, the payments you've been making, any prepayments you might have made, you can come to a tool like our home equity calculator that will allow you to take a look at establishing where you were, when you started, where you are now in your mortgage, and uses some reckoning tools from the Federal Housing Finance Agency, some of their house price data, to reckon where the value of your home is right now and give you a sense of how much you actually can borrow if you need to.

Sandy Block: Keith, I'd like to ask you a question that always gets a lot of interesting reader responses, and it is this. Particularly if you're getting close to retirement, should you pay off your mortgage?

And I'm asking that question now because mortgage rates are so low that a lot of people are arguing that you should just hold onto that mortgage for as long as you can because there are better ways to use your money. But on the other hand, a lot of people find a great comfort, particularly when they retire, to not having a mortgage. So I'm interested in your opinion on that.

Keith Gumbinger: Well, the answers, of course, are simple, yes and no. There can be a case made for paying off your mortgage, as you know, cleaning up your finances before you retire and your income becomes "fixed," quote, unquote.

There can be reasons to let it carry along. Over the years, I've come to understand the best possible outcome for that. Some of it depends upon where you are in your mortgage right now. If you've only got a few years left and your finances are in good shape and you'll be getting into your retirement age, but your monthly payments aren't going to be unmanageable, should you go cash out an asset to pay off your mortgage? Probably not.

If you're recently in your mortgage, maybe you refinanced. You're 55 or 57. You refinanced to take advantage of great rates, extended your term out to a brand new 30 years, your mortgage is going to be with you a while. And you probably don't want to empty out your retirement account or your savings to go pay that mortgage off.

Part of it has to do with where you are in your mortgage, how far you're going to be paying this into retirement. And, of course, whether or not it's a problem is really what it comes down to. If you are in a situation where your mortgage payment's not going to be a problem for you, you can certainly just carry it along. Leave your finances alone, and save your money as you normally have been for your retirement.

David Muhlbaum: Since we've broached the idea of how much are we paying for our house in retirement, maybe we should just go there and talk about the idea of your house paying you in retirement. What I'm talking about here, of course, is reverse mortgages, which have sometimes been controversial. I'm going to ask you a very open-ended question, Keith. What do you think about reverse mortgages?

Keith Gumbinger: For a lot of borrowers, they can provide a great level of comfort and flexibility. If you are someone who is, and I wouldn't say simply living on Social Security, but whose retirement assets are meager, and if you're in an expensive part of the world, and certainly on the coasts, very expensive, those tax bills come up every year. Maintenance bills come up every year. Your fixed income may not go as far as you thought it might or would.

So, what about a reverse mortgage? What about opening up the equity in your home and establishing a line of credit so you can have some flexibility or an annuity structure so some dollars come in each month, help support you along? Or maybe you just want to ... you want to do a lump sum, clean up all your other finances and give yourself some flexibility in there.

Reverse mortgages can be a very important part of a well-structured retirement plan. Unfortunately, in the early days, they got kind of a bad reputation because of a lot of high fees, a lot of misunderstandings on how these things were structured and how they needed to be repaid after borrowers passed away, very complicated.

What's in the marketplace today predominantly are those home equity conversion mortgages that are backed by the FHA. They're backed by HUD. These are well structured, easy to understand.And unlike in some of the wild and wooly days of yesteryear, you actually have to go get counseling before you can sign up for one. They'll talk to you about the risks and rewards. Fees are more structured and probably more manageable, I guess, than they were at one point in time. Figure around 6% of your available equity will disappear in terms of fees, but you can get yourself in a very good circumstance.

Keith Gumbinger: Most importantly ... and we talked about, should you pay off your mortgage in retirement. If you decide to go with a reverse mortgage, your first mortgage gets retired. You pay it off with the proceeds from this. You eliminate the debt you have to make payments on. You can borrow money that you don't have to make payments on. And this can provide very good levels of flexibility, especially if we're talking about a meager sort of asset structure when you're retired.

David Muhlbaum:We broached the idea of someone who has a house that's worth a lot of money, but maybe not a lot of other assets. I'm curious, though. For other people at other points in their life who maybe have gained a tremendous amount of equity in their house to the point that they are what we might call house poor, what about the idea of borrowing against that to invest, maybe not in an education, to directly invest in the stock market or other assets or equities?

Keith Gumbinger: It's certainly something that folks do. It's not something that you could easily sit there and recommend as a blanket strategy for everyone, right? So you wouldn't want to empty all the equity out on your home and dump it into a market. If you're of the mind that you are comfortable with investing, and you have what you would feel to be some ... and I wouldn't call it excess. But if you feel you've got some money that could be used for a ... and I wouldn't call it play money. That's a bad idea, too -- remembering it's the equity in your home.

But if you've got enough equity, then you've got good financial wherewithal, and you've got some funds you think you want to play with a little bit, and you've got some things you might want to invest in or you're comfortable playing into the marketplace, could you invest in that and get greater returns than in anything else, including education or whatnot? Sure.

One thing that they always tell you, right, is past performance is not an indication of future returns. So you need to be careful about it because once that equity is gone, it may not come back. So caution is to be advised for that, but do people do it? Sure, they do.

Sandy Block: Keith, I'm going to ask you the really hard question. One of the reasons the housing market has been so hot and we have so much equity is because interest rates have been very, very low. And there's been a little bit of an increase, but it seems like every week, then, it goes down a little bit more. What's your sense of how long this is going to last because obviously that is something that would pause or slow down this housing market?

Keith Gumbinger: Well, we would expect interest rates to firm up at some point as the economy gets better. So right, we're still in this, coming out of this COVID sort of arrangement. Economic growth, as I'm sure you've seen, the number is over 6% the first quarter annualized. Growth is really starting to boom pretty well. Before too much time passes, the Federal Reserve is going to start backing down its purchases of bonds. They're going to start lifting short-term interest rates a little bit, and mortgage rates will increase.

Now, what that will generally slow down is refinancing, right? And your cash-out refinancing is a portion of that. As rates go up, it becomes less profitable to refinance, so that will start to slow down. But buying homes, and in terms of home prices and that sort of thing, what we see right now is there's a tremendous amount of demand out there. We've got all kinds of what they would call demographic tailwinds from millennials coming into their prime home buying years. And there's just not a lot of supply. The Realtors reported just about two months of available supply when they prefer to see about six months of stock available to buy.

Home prices are probably going to continue to rise and firm even though mortgage rates will also start to firm up because right now affordability is still pretty good. I'm sure, Sandy, you remember the days of 7, 8, 9, 10%, God help us all, 21 1/2% mortgage rates back in the eighties. People still bought homes then.

And these rates are fantastic compared to almost every other time in history, except maybe the turn of this year, so lots of demographic tailwinds. And even if rates went up a little bit, half a percentage point, even a full percentage point, folks will still be buying homes, and home prices will likely be well supported for a while.

David Muhlbaum: Well, Keith, thank you for being brave enough to go right out there into the rate timing question. And I think the message for our listeners is that there's still time.

Keith Gumbinger: Definitely that's the case for a while yet, probably most of this year, and probably into next year.

David Muhlbaum: Well, thank you so much for joining us, Keith. We really appreciate it.

Keith Gumbinger: It's been my pleasure.

David Muhlbaum: That will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts, or wherever you get your content. When you do, please give us a rating and a review. And if you've already subscribed, thanks. Please go back and add a rating and a review if you haven't already.

To see the links we've mentioned in our show along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date.

And if you're still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcasts@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Listen now:

Subscribe FREE wherever you listen:

Links mentioned in this episode:

• How Annuities Are Taxed
• Annuities Just May Be the Broccoli of Retirement Planning
• Pension or Lump Sum? Compare Payouts and Options Before You Decide
• What Life Is Like After Winning the Lottery

Transcript

David Muhlbaum: Someone once called annuities the broccoli of retirement planning. Well, okay. But the reliable income they provide is nothing to turn your nose up at. We'll discuss how to make them a tasty dish for your income meal. Also, Bernie Madoff died this month, and we have a few thoughts. All coming up on this episode of Your Money's Worth. Stick around.

David Muhlbaum: Welcome to Your Money's Worth. I'm Kiplinger.com senior editor David Muhlbaum, joined by my cohost, senior editor Sandy Block. How are you doing Sandy?

Sandy Block: I'm good David.

David Muhlbaum: Well, good. You know who died since we last got together to record, right? Bernie Madoff. The guy they should rename Ponzi schemes for.

Sandy Block: Right. He died in prison. Apparently, he tried to get a pardon from Donald Trump late last year, but no. And he's had kidney disease for some time, and I think it was always expected that he would die in prison because his prison sentence was very, very long.

David Muhlbaum: Yes, like 150 years or something like that.

Sandy Block: Yes. Something like that.

David Muhlbaum: I don't think a whole lot of tears were shed for Mr. Madoff, but the situation, it does raise my mind a few questions about how we do justice. I mean, in particular, why we imprison people. One reason for locking people up is if they pose a threat to others. And others for rehabilitation, help them find a non-criminal trade. And then another is raw punishment, retribution. I think only one of those applied to Bernie Madoff.

Sandy Block: Well, I think a lot of people would say the retribution was totally justified, but are you suggesting that Bernie Madoff got a bad deal?

David Muhlbaum: Not necessarily. I mean, yes, as financial fraud goes, this was as big as it gets, right? He took a lot of money from a lot of influential people. But his fraud, it came out right around the time when a lot of other things were blowing up in the financial world—this was 2008, 2009?

Sandy Block: Yup.

David Muhlbaum: And so I think some of the generalized anger at Wall Street, to use the oversimplification of the time, it got piled on Bernie Madoff.

Sandy Block: Yes. Something about the art of his con, how he promised solid, but not exceptional returns. How instead of selling himself hard, he didn't look like what you picture a scam artist. He was reluctant to take your money, which increased the applied trust and the amount of money people were willing to give him. You could argue now maybe they should have known better. And I'm sure they asked themselves that later too.

David Muhlbaum: Yes. They're probably pretty tired of us asking as well.

Sandy Block: Yes. Right, right. Blaming the victims.

David Muhlbaum: Right. Well, I mean, both back when he was sentenced and even today, we're wondering, are there others out there? I mean, other scammers, that is. A lot of attention was paid to, where was the Securities Exchange Commission when the Madoff scam broke? But in truth, the SEC had been busting Ponzi schemes before Madoff and they're still doing it today. I looked up one... Here's one from April 6th. SEC Obtains Emergency Asset Freeze; Charges Actor with Operating a $690 Million Ponzi Scheme. That's the headline. There's some C-list actor named Zach Avery. $690 million?

Sandy Block: Right, because they wouldn't do it if it didn't work. One of my frustrations I covered... as you know, I covered the SEC a while ago, and so these things keep coming up again. And what was always so frustrating is even when the SEC did get these guys, by the time they tracked them down, the money was gone. I've rarely remembered anybody getting very much of their money back in these schemes because usually the people had spent all the money or send it overseas or something like that. But let's put some actionable personal finance guidance out on our little reminiscence here.

This is what the SEC says to watch out for, promises of high returns with little or no risk. And I think that was one of Bernie's genius skills was that his returns weren't sky-high, but returns never went down. People never lost money. And that's a hallmark of a Ponzi scheme. Every investment has risk and the potential for high returns usually comes with high risks. And so what we always say, if it sounds too good to be true, it probably already is.

Another thing to watch out for is unlicensed or unregistered sellers. Most Ponzi schemes involve individuals or firms that are not licensed or registered. Even if an investment professional comes across as likable or trustworthy or knows all your friends, use the free search tool on investor.gov to check whether the person is licensed and registered. That's at least an initial, it doesn't guarantee, but at least it's a screen.

David Muhlbaum: And it's so easy. It's so easy.

Sandy Block: It's on the internet. You can just go to the internet, you can Google somebody. This would have helped with Bernie, but-

David Muhlbaum: No, Bernie had a tremendous cover story because he was operating a 100% legitimate business on the side, or not on the side—that was his main business.

Sandy Block: But I don't think Zach Avery did. So that's at least-

David Muhlbaum: Yes, right.

Sandy Block: I don't think Zach Avery had a brokerage shop. And the other thing, and this goes back to Bernie, as I mentioned earlier: overly consistent returns. Investment values fluctuate over time. So you really need to be skeptical of an investment that generates steady positive returns regardless of market conditions. If you are earning 8% a year in perpetuity, something is a little wrong.

David Muhlbaum: Okay. I may be asking a little much of your knowledge of the history of the SEC, but do you think they added that last one as a result of Madoff?

Sandy Block: I think they probably did because I think that, like I said, Madoff was a Ponzi scheme, but it was a Ponzi scheme with nuance. He did not promise people the world. Well, one thing I ran across just in revisiting all this is, you know, what he was running, kind of look like a hedge fund, even though they weren't as popular then, but he didn't charge any fees. And that right there should have been a red flag. It's like, dude, how are you making your money? If you're not charging any fees, what are you doing here to compensate yourself? This isn't a charity, although he did rip off some charities. But yes. I don't know for sure. I don't remember overly consistent returns being a red flag back in the old days, but now it sure is.

David Muhlbaum: Yea. I think in part, because Ponzi schemes tended to—and maybe to some extent still do—they blow up pretty quick. Like, how long the Madoff scam ran was unusual as well.

Sandy Block: And I think it was because of his ability to attract large amounts of money. He was able to attract so much money that he was able to maintain by constantly... That's the thing with Ponzi schemes, right? You always have to get new investors because you always have to have new money coming in to pay out the old people. And he had a really, because of his you know, patina of legitimacy, he was able to keep on attracting real people. And the other thing he did that I see time and time again with SEC enforcement actions is called affinity fraud. And that's basically luring in people within your group and every ethnic religious denomination has an example of this. You trust people who are like you, and maybe that's not always a good idea.

David Muhlbaum: I think we come back to the line trust but verify. When we return for our main segment, we'll talk about annuities, a financial product that sometimes gets a bad rap, but can be a key tool for keeping income coming in retirement.

David Muhlbaum: Welcome back to Your Money's Worth. Today, we're going to talk about annuities, which is a topic that my co-host Sandy Block knows backwards and forwards. So she's going to be our guest, our subject matter expert today. Also joining us is Catherine Siskos, the managing editor of Kiplinger's Retirement Report, because frankly, annuities are usually of most interest to people planning for or in retirement. Though not always; we'll touch on a notable exception too.

David Muhlbaum: A couple of weeks ago, we discussed Bitcoin here and while annuities are pretty much the polar opposite of Bitcoin when it comes to, well, what Sandy?

Sandy Block: Risk!

David Muhlbaum: Well, they also have some similarities. Mostly that they can get really complicated. So to keep things as simple as possible, I'm going to try the journalism who, where, what approach, that I believe served us well with Bitcoin. So Cathy, please, WHAT is an annuity?

Catherine Siskos: It's essentially an insurance contract where you can pay a lump sum or a series of payments, and in exchange, you get a guaranteed income for the rest of your life.

David Muhlbaum: And who would want to do that?

Catherine Siskos: Retirees who typically would like to have a guaranteed income for the rest of their life. Maybe their savings are running a little bit short with a you know a 4% withdrawal rate. And so this is another way to supplement that. It's essentially a way to create your own pension really.

David Muhlbaum: In theory, all of us already have one of those with Social Security.

Catherine Siskos: Sure. But Social Security is not a whole heck of a lot of money. And for most people, it really won't be enough to live on.

Sandy Block: David, what Catherine is talking about is a product that we've actually written quite a lot about. And fairly, you know, think might work for a lot of people. And those are immediate annuities. Basically, you give the insurance company a check for a lump sum of money, and in exchange, they say, we will send you a check for either the rest of your life, you and your spouse's life, or in some cases, just a set period, maybe 20 years or something like that. And I think these products have become more appealing recently for a couple of reasons. One, as Catherine said, it is a way for people who worry that they haven't saved enough for retirement to at least guarantee that they can cover their expenses for the rest of their lives. Maybe they won't make a lot of money, maybe they won't leave anything to their children, but they do have the security of knowing that they won't outlive their savings if they take out 4% a year forever.

The other reason I think they're appealing is because interest rates are so low and some fee-only planners who have historically not been fans of annuities have sort of come around because they think you could use an immediate annuity as sort of the bond portion of your retirement savings portfolio, and possibly get an equivalently higher yield than you would get putting your money say in a 30-year treasury or a 10-year treasury or something like that.

David Muhlbaum: So we've discussed annuities as a potential bond or CD substitute, a low-risk source of income, but let's talk a bit more about a particular kind of risk, principal risk. The risk of everything going south, and you don't get your payouts anymore because the investment is gone, like Bernie Madoff gone. For bonds, we have rating companies to look at, and for CDs, the FDIC is literally standing behind your money, up to a point. But who's behind the annuity? An insurance company? That's it?

Sandy Block: You're right that you're basically relying on the insurance company to be around as long as you will be, and sometimes that could be 30 or more years. And while this industry doesn't provide the same level of security as the FDIC, it is regulated by the states. So there are some requirements. And in reality, there have been very, very few cases in which insurance companies were not able to make good on their promises with respect to immediate annuities. And I think that's because they do a good job of estimating average life expectancy. Remember they only have to pay out for as long as you live, so they have very smart people who calculate how many buyers will die in the next 10, 15 years versus those who will live for 40 years. They can do a pretty good job of estimating that and that reduces the chance that they'll go under.

Before you ever buy one of these, you should investigate; see if they've had any financial problems. They are rated by rating agencies and you should look for the highest-rated insurance company before you give it your money. So it's not without risk. But I would say the likelihood that the insurance company will go under is fairly low.

David Muhlbaum: That's an interesting point about how good the insurance companies are at life expectancy and all that fun and morbid actuarial stuff. But while they may know the averages really well, the individual who's buying an annuity, they know themselves best of all. And by that, I mean, they know their family history, their health, their behaviors, what do you look like in the mirror, or when you turn the front camera on? And so, should that be a factor for the annuity shopper? How long do you think you're going to live and collect that money?

Catherine Siskos: Sure. You should take into account your own medical family history, your life expectancy, because, for one thing, you may not get payments very long, all that money that you put in, you're not going to get back if you don't live for a significantly long period of time. So that does factor into the equation.

David Muhlbaum: But even though annuities are an insurance product, the situation is kind of the opposite of some forms of life insurance. You're not going to need a medical exam or anything like that.

Sandy Block: You don't have to get a medical exam to buy an immediate annuity.

David Muhlbaum: Because they don't care. If you die, BOOM, they keep the money.

Sandy Block: That's right. They would prefer that you're not healthy. All they look at is your age, the amount of money that you have to invest, and your gender. And that's what we like about immediate annuities because they're not that complicated. You can go to a website such as immediateannuities.com, put in your age, your gender and what state you're in, and how much money you have to invest, and you'll get a pretty good idea. And this changes based on interest rates, which you can get a pretty good idea of how much you'll get per month. And it doesn't matter your health or anything like that. It's just a pure mathematical problem for them.

David Muhlbaum: Okay. So that simplicity can be appealing in many ways, but I imagine it can also be off-putting. I'm thinking about the active investors that we assume we have in our audience, they own mutual funds, stocks, bonds, maybe even more esoteric stuff, and they manage them fairly closely. They pay attention. And I can imagine one of the sticking points of annuities for this crowd is the lack of control. You basically hand over your money in exchange for a check, that's the deal. But an annuity might still make sense for them. So what's the argument for those people? How do you get them to make that mental shift?

Sandy Block: It is a tough mental shift and it's why really only a very small percentage of people invest in an immediate annuity because you are giving up a lump sum of money that you usually can't get back. But the argument even for an active investor is this: if you annuitize, just maybe 20% of your portfolio, enough to cover your expenses, you can afford to be a lot more aggressive with the rest of your portfolio, because you can suffer losses. You could invest more in stocks than you would, say if you invested that section of your portfolio in the bond market because if both markets go belly up, you're still getting paid every month.

Sandy Block: So you could actually be a little more aggressive with the rest of your portfolio—maybe buy some Bitcoin even—than you would if you were investing 100% of your portfolio for yourself. You're basically outsourcing a section of your portfolio to cover the bills. There's an argument to be made for that. But I also agree. A lot of people are very uncomfortable giving even 20%, 10% of their money away that they can never get back and that they don't have control of.

David Muhlbaum: Another way annuities can behave differently from mutual funds and other investments people might've been using as they save for retirement is taxation. The payments you get from your annuity, they're taxed as ordinary income, and the rate for that is higher than dividends or capital gains, for example, plus, since we're usually talking about retirement here, we have the added twist of tax-deferred accounts like 401(k)s and IRAs, that kind of thing. Catherine, I understand one approach when buying an annuity is to buy it inside your IRA. Now, how does that work?

Catherine Siskos: The one argument that I've heard that it does help to put it in IRAs, if you're going to use a portion of your retirement savings to pay for that annuity, to essentially produce that lump sum, at least you don't have to take the money out in order to buy the annuity. So that's one reason to do it.

David Muhlbaum: Yes, because otherwise you'd have two taxable events and that wouldn't help. Since we've brought up the question of investing in annuities from within a retirement savings account, we should address another complication that comes up with getting income from one of these, from an annuity, or frankly, from getting an income, period, in retirement, the required minimum distribution, the RMD. So quickly, what's an RMD? If you've saved money in a conventional IRA or 401(k) or a similar tax-deferred account, when you hit age 72, the government says you've got to take some of it out. Whether you want to or not. RMDs are a big deal for a lot of people. But Sandy, you say there's a type of annuity that can lessen that hit?

Sandy Block: There is a kind of an interesting workaround in another type of annuity that we've written a lot about. And that's called a deferred annuity. This is when you give an insurance company a much smaller amount of money, but you don't start getting payouts until you reach a certain age, usually in your 80s. And we call these longevity annuities sometimes because basically, you're buying longevity insurance. If you die before the annuity starts paying out, you get nothing. But on the other hand, if you live long enough, you're guaranteed to have a paycheck for the rest of your life at a time when a lot of people do worry about running out of money. And within these products, there is another sort of wrinkle called a QLAC, Qualified Longevity Annuity Contract. And in this case, you take money out of an IRA or a 401(k) up to 25% or up to 130,000, whichever is less.

Sandy Block: You put it in this deferred annuity and you don't have to start taking required minimum distributions until you start taking money out of the annuity, which usually isn't until your 80s. So you don't avoid RMDs all together, but you get to put them off. You don't have to start taking them at 72. And we're seeing more and more people continuing to work in their 70s. And if you have to take RMDs while you're still working, the tax can be quite high. So kicking the can down the road within a deferred annuity, kind of makes some sense.

David Muhlbaum: In the intro, I mentioned that annuities come up in a context that has nothing to do with retirement income. It's not a common scenario, but it's one that people pay a lot of attention to. I'm talking about the lottery. If you win the lottery really big, like really big, you get a choice. Tell us about the choice our lucky winner has, Sandy!

Sandy Block: You have a choice of taking a lump sum or an annuity for the rest of your life. And the lump sum is basically going to be discounted to represent what the amount you would get if you took the annuity over the rest of your life and you live the average life expectancy. Most people take the lump sum and a whole lot of them blow it because they like money upfront versus counting on getting a check for the rest of their lives. What's interesting is what happens.

Sandy Block: I'm kind of fascinated by stories about people who win the big lottery. What people who take the annuity sometimes do is run up big debts, get in over their heads, and they end up selling off the annuity to someone else for a lower amount in exchange for a lump sum. So I guess the takeaway there, is people don't manage their lottery winnings very well, but it is an interesting, again, an interesting math problem. Do you take the money now with the expectation that you can invest it and earn more than an annuity would pay you out every year for the rest of your life? Or do you take the annuity and then just know that you will never run out of money?

David Muhlbaum: Well, that's the basic core decision, but of course the parameters are pretty different when you've just won big in the lottery versus trying to make a prudent decision for making sure you have enough money in retirement. But yes, Sandy, that does make for interesting stories, sad ones often. So I want to ask another core question about annuities, an added twist with annuities that makes them different from comparable investments, like a certificate of deposit or a bond, the other things we've been talking about, is that with an annuity, you can name a beneficiary like a spouse, and they can, depending on how you set things up, recoup some of the money when you die.

Catherine Siskos: Yes, that's true. That's exactly how it works, except that whenever you do that, you are probably going to accept reduced income for yourself in exchange for that because then the annuity payments continue for the beneficiary's life. You can also not just do a beneficiary, but you can also have somebody who is on the annuity contract with you. So there's two ways really that you can have this. You can either set up a contract where it covers you and your wife, for example, and then when you die, the payments continue until your wife passes away, or you can set it up where you have a beneficiary and that beneficiary can take on those payments after you die. But either way, whenever that happens, the payment that you're going to receive is going to be smaller because you're getting this additional benefit.

David Muhlbaum: Right. Well, which raises the question. Clearly, you can slice annuities a whole bunch of different ways. Is doing that in the individual investor's interest, or should they be trying to, as much as possible, keep things simple?

Sandy Block: Within immediate annuities, there are all kinds of riders that you can attach such as one that you know will adjust it for inflation. As Catherine said, you can have beneficiaries or things like that. We like things simple. And even more importantly, there are types of annuities that get way more complex than what we're talking about, that invest in a portion of the stock market, that have all kinds of, and oftentimes these aren't necessarily targeted towards people who just want to get a monthly check for the rest of their lives. They want to invest in the stock market, but they want to limit how much they can lose. Annuities can do all kinds of things. They're often sold as indexed to certain stock market indexes. Catherine and I agree on this: That's when things can get really complicated. Oftentimes these variable or indexed annuities have surrender charges. If you decide to get out of the contract for a certain amount of time, as I said, they can be very complex. They can have a lot of fees. And oftentimes, the returns you think you're going to get don't necessarily pan out.

Sandy Block: Now, I recently did write an article about some new types of indexed annuities that some fee-only planners are taking an interest in and are recommending for some of their clients. But I do think that people have to be very careful with some of these products because of the complexity, because of the cost. And again, because of the penalties for trying to back out of a contract.

David Muhlbaum: Okay. Yes, yes. The penalties for backing out, getting your money back or out is one of those things that varies by the type of annuity, right? But let's check in on the immediate annuities that we said we were going to try to stick to. In those cases, it's really hard, right? Because the whole premise is: I give you a big chunk of my money, you being the insurance company, and you give me a monthly payment until I die, or maybe after—but no backsies.

Sandy Block: Yes. Right at the beginning of this podcast, we were talking about immediate annuities, where it's a contract where you give an insurance company a lump sum and they give you a monthly payment for the rest of your life. For these, it is very hard to get your money back, if at all, which is why a lot of people are uncomfortable with them. Sometimes there will be provisions or writers that will let you take some money out for emergencies, or you can say you only want payments for a certain period of time, and then maybe get some money back, but basically, you are giving up control of the money in exchange for a monthly check.

David Muhlbaum: All right. So let's say someone's made their peace with giving up some control. They've done a good job saving for retirement, listened to sound Kiplinger advice about investing in low-fee mutual funds, all that good stuff. But now, okay, they realize that an annuity could be a hedge of its own, guaranteed income for down the road. Maybe, even, for when they're so far down the road that they won't want—or be able to—manage their investments so closely. Am I selling this annuity right? In all seriousness though, where and how should people go about purchasing an annuity? Catherine?

Catherine Siskos: Well, probably the simplest answer to that question is to buy an annuity from someone who doesn't have a stake in selling you one, which is hard to do, but it's helpful to get maybe the insight of a financial planner.

David Muhlbaum: Someone who is a fiduciary.

Catherine Siskos: Someone who's a fiduciary. Exactly.

Sandy Block: And actually, as I mentioned here, fee-only planners are increasingly recommending some of these products. If they're not getting paid a commission to recommend a product, then that's kind of a good sign that they're not necessarily looking for one that is the most profitable for them, and might be the most profitable for you. And certainly, if you're working with a certified financial planner, they are required to act as a fiduciary. So I think in that case, maybe the advice would be pretty unbiased in terms of selecting one that's right for you.

David Muhlbaum: Well, we have definitely learned that annuities can be complicated. We hope we've discussed them in a relatively simple way. We are going to include a number of links that will help you sort out the different types and terms and language that we've used here today. Catherine, thank you very much for joining us, Sandy, of course.

And that will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts, or wherever you get your content. When you do, please give us a rating and a review. If you've already subscribed, thanks. Please go back and add a rating or review if you haven't already. It matters. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you're still here because you wanted to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Listen now:

Subscribe FREE wherever you listen:

Links mentioned in this episode:

• Gen I: What Investing's New Class Looks Like
• Time to Face Reality: Your Kids Don’t Want Your Stuff!
• What ‘Non-Financial Assets’ Should Be Included in Your Estate Plan?
• Selling Your Stuff: The Tax Dimension

Transcript

David Muhlbaum: When it comes to estate planning, money is usually front of mind. Makes sense, that's where decisions about wills, trusts and more can realize real tax savings. But it's stuff, tangible things like houses, china and collectibles that often generate drama and conflict. We talk with a financial advisor who's touched a nerve on this front. Also, meet Generation I. All coming up in this episode of your money's worth—stick around.

David Muhlbaum: Welcome to Your Money's Worth, I'm kiplinger.com senior editor David Muhlbaum, joined by my co-host, senior editor Sandy Block. How are you doing Sandy?

Sandy Block: I'm doing good.

David Muhlbaum: Well, good. Short of talking politics, there's probably no quicker way to generate angry feedback than waging intergenerational battles.

Sandy Block: But you're going to do it anyway?

David Muhlbaum: Sort of? I say that in part because while the study I'm going to discuss sounded like it was going to be kids versus the olds, it turns out there's more nuance than that. Anyway, I'm going to talk about Generation I, which isn't really even a generation but rather a handy little term that the Charles Schwab Investment firm cooked up for new investors. By that they mean people who are new to stock market investing.

Sandy Block: And those folks have been the source of some of the market drama we've seen this year like the GameStop bubble we talked about earlier this year.

David Muhlbaum: Yes, yes. There is overlap between the whole meme stocks crowd and Generation I. I stands for investor but since it's a new term, let's start with the definition. What Charles Schwab means by Generation Investor, Generation I, is people who started stock market investing in 2020—not before. So it doesn't matter what your actual age is. There are Generation I members who are Boomers, Gen X, Millennials. Obviously, the group skews younger than investors broadly, but what's striking is that Generation I, according to Schwab, accounts for 15% of all U.S. stock market investors.

Sandy Block: By population, not by dollars invested.

David Muhlbaum: Yes, by population. They don't have a figure for a Generation I's sum assets but I see what you're getting at. And yes, Gen I earns about $20,000 less in annual income, at $76,000 a year, than those who began investing before 2020. And here's another interesting number, half of Generation I says they live paycheck to paycheck.

Sandy Block: Okay. That sounds worrisome.

David Muhlbaum: Yeah, but here's the thing. Some of the so-called Generation I are people who downloaded Robinhood and are watching a handful of stocks for big moves, short term trading. And if they're doing that while missing payments on their car note, okay, that's bad. But at least according to the study, they say they're learning that investing is more about longer-term gains versus shorter-term wins. About learning to do research, diversification, capital market gains, taxes, risk tolerance, all that—the knowledge if you will.

Sandy Block: I'm hearing echoes of what Kyle Woodley was talking about when he joined us for the GameStop discussion about how it's possible for people who came in for this excitement might be convinced to stay around for the long term, grow your wealth, not double your money, kids.

David Muhlbaum: Yeah, I totally agree. However, the big factor here is that the sum of Generation I's market experience is this strong bull market. Will they stick around when things go south, which someday, sometime we'll have a bear market. Markets go up, markets go down.

Sandy Block: That's right, and I'm constantly reminded what our editor Anne Smith reminds us all the time, is that we've been here before, maybe not at these numbers. But in the 90s, when tech stocks were taking off, all kinds of people got in the market for the first time. And while you couldn't make trades for nothing on an app, it was cheaper to buy and sell stocks than it had been in the past. And a lot of these people piled in because they had heard that tech stocks would never go down and they didn't think they would ever lose money and they learned the hard way that they could.

David Muhlbaum: When we return for our main segment, we'll talk with a financial advisor with some insights about the estate planning for stuff. Not just the money, the stuff.

David Muhlbaum: Welcome back to Your Money's Worth. Joining us today is T. Eric Reich, the president and founder of Reich Asset Management in Southern New Jersey. Eric has a whole slew of professional certification acronyms after his name, including CFP. And the way we found him is that he's a contributor to Kiplinger's Wealth Creation Channel. That is an area of our website that has content from a range of financial professionals, CFPs, CPAs, tax lawyers and more. They're qualified and they're good writers. Plus, since they're dealing directly with clients, I'd venture to say that they often have a closer sense of what personal finance guidance people actually need than personal finance writers. So Eric wrote a piece for us called, Time to Face Reality, Your Kids Don't Want Your Stuff. And well, it was a hit. Welcome, Eric. We will get into what stuff and why, but since we've brought up how you professionals get to hear it directly from the clients, why don't you tell us a little bit about the reaction you've been getting? Because, I understand from your assistant that you've gotten a lot of feedback.

T. Eric Reich: We have. We got probably a few dozen emails across the country from different readers of Kiplinger's that saw it and then of course our own clients, of course, were calling us. They were writing or calling and letting us know their thoughts on it. And it's funny, I wrote it because it's such a recurring theme with a lot of people. They're always convinced that people want all of your stuff and they just don't. So I wanted to touch on why, but I knew it was going to get a strong reaction because I hear the same thing all the time from people. So if I hear locally on the ground, then I'm sure to a bigger audience, we were going to even get more opinion on that.

Sandy Block: Well, Eric, I immediately latched onto your piece because I am in the process of... My father passed away a couple of months ago and I'm in the process of distributing and cleaning out his house and it's a mammoth job. So many of the things that you talked about really resonated with me. Obviously, we're going to link to your piece so that people can follow up and read it in its entirety but we're going to hit on some highlights and my question is, what's the number one item people planning their estate think their kids want but the kids don't actually want?

T. Eric Reich: By far the biggest one is the house. And it's not that the kids don't want the house, it's that logistically it just doesn't work. My example: I have three children, I have a nice house and I have three young kids. Let's say my kids were in their twenties and something happened to me. My kids might want the house, but how's that going to work? None of them can afford it because they're just starting out in their careers. There's three of them, they're certainly not going to share it. And then one of them invariably wants to buy it, but they think they're entitled to a discount because they're my kid. But then the other two would be offended if they got a discount because they're my kids, so why should they get shortchanged in favor of another one? So everybody thinks that their kids want the house, but the reality is most often that the biggest misconception is that your kids just really don't want your house.

Sandy Block: So a follow-up question, Eric, if you aren't going to leave the kids your house, how should you plan your estate so that doesn't happen?

T. Eric Reich: So if you're not going to leave the house to the kids, I mean, you can leave it to them, but you can reference in there, "Hey, these are the parameters in which someone's going to keep it." So if you want to keep it, it has to be appraised by two different independent people or three different and you take the average of the three it's bought at fair market value. You have to specify the rules to which someone can keep it because if not, that's where all the fights start, is the more ambiguity you leave in it the bigger the fight. So all of those things should be spelled out ahead of time. If you want it to be sold, say you want it to be sold. If somebody wants to keep it, fine, but here are the rules under which someone gets to keep it.

David Muhlbaum: What about setting up a trust? Couldn't that help establish the rules you're talking about?

T. Eric Reich: It can, I mean, I think a trust in general can help with a lot of things. Again, this is for an estate planning attorney more but to me, I like using trusts in general. Simply because it's a way to control things and I hate to use this phrase, control from the grave, but that's exactly what it is. And sometimes that comes off as sounding like a control freak or overbearing, but sometimes it's for, honestly, just the protection of the beneficiaries themselves. If one's a spendthrift, if one's in a bad marriage, if one has a lot of creditors, you could be doing them a disservice by giving it to them outright instead of via trust.

Sandy Block: So, Eric, isn't the other advantage of putting your house and other items in a trust that it keeps it out of probate?

T. Eric Reich: It keeps it out of probate and the biggest part of that too, is, that's public record. I mean, I remember when a client had a family member pass away, they got a phone call a few months later from a guy wanting to buy the antique car that they just inherited. To which their response was, "Wait, who are you again?" Well, here they looked up in public records that one of the assets was this old antique Chevy and the guy wanted to buy it off him. And I always say, you see it in real life, you know,. Princess Diana's will was published in a magazine. Whereas I always say, "Well, what about, Frank Sinatra?" And they go, "Well, I never heard anything about that." Exactly, because everything was in a trust. So privacy is a big component of that as well. So avoiding probate and also what goes along with that is the privacy factor.

David Muhlbaum: The main family house is one thing but a vacation house can be even more emotionally loaded, no? I imagine someone working on their will thinking, wouldn't be great for everyone to get together at the lake house every summer, roast marshmallows and remember grandma and grandpa for having found this place. And actually the kids are like, "Eh, we like going to Europe."

T. Eric Reich: You're absolutely right. It's definitely bigger for the creator of the estate. It's not that the beneficiaries don't love the idea of the vacation home and everything else. The problem is, and again, I always go back to my example, I have three kids. Who gets to use it when? It's only fit to be used in the summer months. I live at the Jersey shore, so, super-popular here June through the end of August. So, who gets to use it during that time period and what weeks and what holidays? And as I get older and my kids get older, their kids get older,

If one family has five kids and the other has one, are they getting more usage out of it? How are the expenses being paid? Is everyone sharing in that equally? So it really starts to create a problem. One of the ways around that maybe is that if that were in a trust, then I could also put money into that trust for the maintenance of the house, to pay the taxes, it's going to pay everything it needs at least for the next decade. And then after 10 years, you guys have to come up with a solution based on x, y, and z of how we should deal with it going forward.

Sandy Block: Yeah. Eric, my experience with people who have inherited vacation homes, it sounds like a great idea at the time but very often they/ve moved and live many, many miles away. They don't live near the Jersey Shore, they live in California, so it becomes a huge hassle. And I think that's something probably you mentioned that people also need to think about, how close are your heirs to the actual vacation home that they could use it.

T. Eric Reich: Yeah, we actually just had a situation not too long ago. We had someone who owned a house on the beach, a very valuable house. They were kind of house poor; they had a phenomenal house, but not tons of money other than that. But the client really wanted to preserve that asset for a grandchild, the only grandchild, who lived hours and hours away. And I actually suggested, we call the grandchild and ask point blank, "Do you want this house?" The client was floored, like, "Well, of course they want the house, who doesn't want a house on the beach in Ocean City in New Jersey." Well, we called and it turned out the kid said, "That's wonderful but I'm in my 20s, I work 80 hours a week. It's three and a half hours away. I will absolutely never use that house. I'd much rather you sold it and got to use the money and enjoyed it. And if there's something left over, wonderful, leave it to me but otherwise, I really don't care."

David Muhlbaum: Well, sounds like conversations really come down to the core of doing estate planning, especially around stuff. But those could be pretty fraught conversations. It sounds like this one went okay, but I assume they don't always.

T. Eric Reich: Well, yeah, that's true. I mean, the reason we had to make that phone call was because they were adamant that, of course, they would want this. Who wouldn't want it? And the reality is there's a lot of people that wouldn't want it. The beauty of that is in the eye of the beholder, not so much somebody on the other end, but these are real world scenarios that people have to deal with. And of course the house being the biggest, but it's not always just the house.

Sandy Block: Now that leads me to my next question, Eric, because you also talk in the slideshow about your stuff, your collectibles. They may have great sentimental value to you but maybe not to your children. Should you start getting rid of them while you're still around?

T. Eric Reich: We do suggest that sometimes or at least explore it. Or, if not, educate the children on the value of it. A lot of times what we'll see is someone has a collection of stuff, whatever it might be, the owner, of course, knows how valuable it is. They've been collecting it for 20, 30, 40 years, but an heir doesn't necessarily have an idea of what that would be worth. And we ran into a scenario like that: We had someone that was going to basically just sell a bunch of stuff. And I think it was for like $1,000. And then we actually brought a specialist in to review it and turns out it was worth $45 to $50,000. So this poor guy was going to get ripped off because he didn't understand the value of what it was, and that's not uncommon at all.

Sandy Block: That's my Antiques Road Show nightmare, Eric, is that I will give something to Goodwill and be watching Antiques Road Show and it'll show up being worth $50,000 and I'll realize that I gave it away. So I think you're suggesting that you get that stuff valued and appraised while you're still around to help your kids is a really good one.

T. Eric Reich: If you're not a collector, you don't know. Either sell it and let it go ahead of time, or at least communicate that value—and an actual value, because sometimes we also think collectibles are worth a lot more than they really are. We think it's worth $50,000 and it's worth $1, that's more often the case. But nonetheless, an appraisal from an independent person will help.

David Muhlbaum: I'm glad you brought up the point about actual valuation, because my cats eat from some pretty fancy china bowls that someone thought had a lot more value than they did. And I think that sometimes these items that people have had for a long time or inherited from their predecessors, they really don't fetch that much today.

T. Eric Reich: No, because unfortunately some of the things and it's just a generational thing and I use china, actually as the example a lot of times. Because 50 years ago, 75 years ago, china was prized. I mean, for everybody, fine china was a real hallmark of things. Today, I probably have six or seven sets of fine china. Some of them apparently, extremely old, from great-great-great-grandmothers. But the reality is the generation today doesn't use it at all. If they do, they can't use five, six, seven sets of it. But the reality is that value from a long time ago doesn't necessarily translate today for those reasons. So a lot of times things you think are very valuable maybe aren't.

Sandy Block: Yeah. David Muhlbaum: and I have discussed this, and both of us are awash in china. And, I also have at least two sets of silver that again have been handed down from generations. As you said, young people—and this goes for even furniture—young people just don't use that stuff. So I guess, the best thing you can do is either get rid of it or have some instructions for what you'd like to have done with it.

T. Eric Reich: Yeah. And valuation is key for that as long as you have a good value placed on it and you have a sense of what it might be worth? My wife's family, they have a much, much larger family than I do. They'll go to everybody in the family, two and three removed and say, "Hey, does anybody want this piece?" Because it is a family piece. But if not, then what do they ultimately do with it? It sounds sad to have to part with it, if really nobody wants it, and you know you mentioned yourself and you're going through it personally, it's only adding to the problem, we'll call it, of settling an estate. And the less planning involved, the bigger the problem becomes.

David Muhlbaum: I imagine that in your line of work, Eric, you refer people out for valuations pretty often. How can our listeners get good qualified valuations for their stuff?

T. Eric Reich: So there are evaluation organizations. So you basically would want to find certified valuation type of people for that.

David Muhlbaum: Do they have acronyms like CFP?

T. Eric Reich: They probably do. I think I've seen one or two out there, definitely not an expert on it, but it is funny because from the article, I did have two different companies reach out to me and say, "Hey, this is what we do for a living. Feel free to pass our information along." So these companies are out there, they do understand what things are worth. I got lucky in the one example of the $1000 offer for $50,000 worth of stuff. I happened to know a person who had some expertise in that area. But we frequently do refer out to an appraiser, to an estate-planning attorney, to a CPA. And all of them can have pretty good contacts in that world as well.

Sandy Block: Eric, this wasn't in your slideshow, but you mentioned cars. Do you want to talk about cars?

T. Eric Reich: Cars are a big issue for a lot of people. My example: I have an old classic Corvette. I have a 1963 split-window coupe. So among the rarest of the rare. I have one of them and I have three kids. They all are convinced they're getting the, "Vette." Or the yellow car, as I like to call it, when I'm gone someday. Well, they can't all get it. They also probably have no idea what it's really worth. So for that reason just like the house or anything else, get a valuation. Get an appraisal of what is this thing really worth. And then again, if somebody wants to buy it at fair market value, that's fine.

T. Eric Reich: But if not, it has to be sold. So otherwise it's going to be unfair. Now, you can swap assets. You might say, if that car was worth $150,000, okay, well then if you're getting that, then you have to give up a $100,000 of something else. And so that 50 and 50 go to the other two siblings. That's fine you're welcome to do that but my trust would stipulate that. Would lay out the terms at which someone could buy something.

David Muhlbaum: Could people set up a corporation to manage it for them?

T. Eric Reich: They could, that's more of an estate lawyer question from that perspective. But you could, or you could probably do it all through a trust. It might just be too onerous to set up a corporation for that purpose. The logistics and maintenance of it might be a little too much.

David Muhlbaum: One interesting word you used in your article, Eric is "fun." It's a little surprising. Where's the fun?

T. Eric Reich: Well, that's just it, estate planning is never fun. Settling an estate is flat-out awful but the estate planning process and planning for your demise is never something that's fun. But If you don't deal with it, it is going to be a nightmare for the people behind you. So, why not deal with it today, when you're of sound mind and body, as the phrase goes, to make those decisions. And again, try to make it fun, try to involve the kids from day one. It's not like they're fighting over your stuff. If everything's out in the open and it's shared freely, you really can have fun with... You know, I have one kid who's clearly closest to my old Corvette than the other two.

T. Eric Reich: So the other two say, "We want it." But as soon as they leave the room, he says, "Well, of course you know I'm getting it." You can joke around with it that way but sometimes in those conversations, you will find that there are things of greater value to different family members. And it doesn't have to be monetary value, they just really want something special to them. And if that's what they really want, then maybe they get that and somebody else gets the car or the whatever, to be even.

David Muhlbaum: I see an opportunity for the younger generations to help here. As documentarians of a sort. They can take pictures, record, video, ask questions, discuss the things. What are the stories associated with the thing? And then you can decide, okay, we have a record of everything, now, these we're going to keep and these we're going to want to let go.

T. Eric Reich: That's a really good point. I mean, recording it that way. Someone had reached out to me after reading the article and said, what they did, was they took pictures and many, many pictures of all the different things that they had collection wise. Wrote about them and then sold them. So they still have the pictures, they still have the story, they still have the context and everything else. They just don't have the asset by itself, but they still have all the memories of it. They have the pictures, they have everything. So you did keep that meaning alive behind it, without actually worrying about who's going to maintain this asset.

Sandy Block: Eric, it sounds like bottom-line here, a lot of people might be very conscientious about having their beneficiary designations correct for all of their finances, but they really don't think about the solid items that they're going to leave behind. And I suspect this often comes with people—and this is the case in my situation—people who have been in the same home for many years. If you move into a retirement community, you are forced to downsize but a lot of people die in the homes that they lived in. And I can tell you from personal experience, that clean-out can be a real job, especially if you don't know what was the intention for some of these things.

T. Eric Reich: Yeah, it's really the case. You live in the same house, 40, 50, 60 years, you accumulate a lot of stuff. Some of that stuff probably is fairly valuable. And really it is key because, the longer you've been in that house, your reference point is also of that house, and you have special memories of things in that house, because you've been going even yourself to that same place all that time. And that's where a lot of that interest from heirs comes in, is there is a special piece or a special thing that reminds me of mom and dad or grandparents or whoever. And that sentimental value to that item is worth more than the financial value, and that's why that honest, open communication is really key. Have this conversation while you're alive and you're healthy. When you're in more advanced decline is where we see problems come in—or I promised that Corvette to all three kids at some point, because I forgot I promised it to the other two.

T. Eric Reich: Because I might be starting to slip a little bit or I've let things go or I let people take things out of the house over the years, things like that. So it really is important to not just focus on the, "yes, I've done estate planning, I set up a will or I set up a power of attorney." That's the bare minimum but even just writing out things like an ethical will, here's the things I want to happen. This is what I want to see you do with stuff. Or here's what I would love to see happen to the car, if you can't, fine, then do this. A lot of times heirs will try to honor those wishes, if you really put it down in paper. It's not something that would necessarily be part of a will. That's more just the direct transfer of the property but more what I would like to see happen with something.

David Muhlbaum: Write it down on paper, tell people what you want to happen, have honest open conversation, always good advice. And I think we've had a good conversation here today ourselves. Thank you so much for joining us, Eric. We're going to link up to your piece for people who want to dig a little bit deeper into what to do and not to do with your stuff. Thanks again.

T. Eric Reich: Thanks so much for having me.

David Muhlbaum: And that will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. If you've already subscribed, thanks. Please, go back and add a rating or a review if you haven't already, it matters. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. And if you're still here, because you wanted to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS.

Subscribe FREE wherever you listen:

Listen Now:

Subscribe FREE wherever you listen:

Links and resources mentioned in this episode:

• Tax Day 2021: When's the Last Day to File Taxes?
• Most U.S. Taxpayers Don’t Know How Effects Of Pandemic Will Impact Their Taxes: Five Tax Myths Debunked
• Profit With These 7 Planet-Friendly Companies
• Earth-First Funds Are Soaring
• How Green Are Your Bonds?

Transcript

David Muhlbaum: Stock and fund investing meant to also help the environment is nothing new, but boy, has it been a hot sector this past year. In a market full of huge gains, how should you go green now? Executive editor Anne Kates Smith joins us with some stock and fund picks. Also, in a topsy-turvy 2021, Earth Day comes before Tax Day. We'll explain. That's all coming up on this episode of Your Money's Worth. Stick around.

David Muhlbaum: Welcome to Your Money's Worth. I'm kiplinger.com senior editor David Muhlbaum, joined by my co-host, senior editor Sandy Block. How are you doing, Sandy?

Sandy Block: I'm doing good, David.

David Muhlbaum: Good. This podcast is going to drop just a few days before April 15th. And you know what that is, right?

Sandy Block: I know what it's not. It's not Tax Day.

David Muhlbaum: That's right, Sandy. It's not Tax Day. Yeah, of course, April 15th is traditionally the day when we're all supposed to have filed our prior year's taxes or filed for an extension, and traditionally we'd be telling you all sorts of smart moves to make if you're a tax procrastinator, but this year, we're not, not because we don't want to be helpful, but because this year, April 15th is not Tax Day.

Sandy Block: No, this year, basically because of the COVID-19 pandemic, the deadline has been extended to May 17, 2020. So you get an extra month. And that's not just to file your taxes, but also important things like contributing to an individual retirement account or collecting a refund from three years back.

David Muhlbaum: Enjoy your month, I guess. Maybe you knew, maybe you didn't. We got a study across the transom from NORC at the University of Chicago, a research outfit, about what Americans do know about their taxes and it was, well, not reassuring. We got some work to do, you and me, Sandy.

Sandy Block: Well, yeah. But our audience, they know stuff.

David Muhlbaum: Well, let us hope so. But they might know some people who don't know as much.

Sandy Block: Right. So go ahead, tell me the bad news, I'll try not to be smug.

David Muhlbaum: Okay. So the survey was framed as a pop quiz. Five questions about tax myths. Can't do all five for reasons of time, but I'll ask you one. No, I'll do two. I'm going to do the one most people got wrong, and the one most people got right. The first question: People don't have to pay taxes if they didn't earn any income?

Sandy Block: If they didn't earn any income? That's wrong. There are plenty of forms of unearned income, interest, dividends, alimony, lottery winnings. But I only have to change one word to change the answer. If you didn't have any income, you don't have to pay any taxes.

David Muhlbaum: If you didn't have any income.

Sandy Block: If you didn't have any income, you don't have to pay taxes. And this is skipping right over the earned income tax credit, which is really complicated.

David Muhlbaum: Which is a credit, so it comes after your tax obligation, but well, we're getting in the weeds.

Sandy Block: As we do. So that was the question most people got right or wrong?

David Muhlbaum: That was the question most people got wrong. Fewer than a third of people got that one right.

Sandy Block: I'd say that's a reflection of the fact that not a lot of Americans have unearned income. You work a job, you get a W-2 or a 1099 form, there's your earnings. Okay, but what was the question that most people did well on?

David Muhlbaum: That question was: There are no taxes on side-hustle income?

Sandy Block: Oh, we just did side hustles on this podcast. Taxable, of course.

David Muhlbaum: Yeah. Right. And the respondents got that too. In fact, over 3/4 of respondents got it right. But overall, on the five questions in total, just one in 20 U.S. taxpayers, 5%, answered all five questions correctly. On average, respondents answered fewer than three questions correctly. The precise score was 2.89 out of five.

Sandy Block: Well, search kiplinger.com/taxes with your extra month of time. Not for you, of course, but for your friend who really needs help.

David Muhlbaum: Of course.

David Muhlbaum: When we return: Green investing, it's hot. What's really green and what's someone who wants to get into this sector, with such nosebleed prices, supposed to do now?

David Muhlbaum: Welcome back to Your Money's Worth. Executive editor Anne Smith is joining us today to discuss the cover story, stories actually, from Kiplinger's personal finance on green investing. Because, you know, Earth Day.

Sandy Block: Earth Day is every day.

David Muhlbaum: And every day is Earth Day, true, but it's also April 22nd this year and every year and that's just around the corner. So, welcome Anne, as we enjoy a beautiful spring day here, one of those days that makes you think, Hey, maybe everything really is okay in the world and the climate, et cetera, when it isn't. Just read another grim headline from The Washington Post on a new record for carbon dioxide levels, as measured at the Mauna Loa Observatory in Hawaii. Last year's global temperature tied for the hottest on record with 2016. But speaking of heat, we appreciate that climate change is a hot-button issue that not everyone agrees on, we're not here to debate that today. Rather, as Anne can tell us in more detail, investors are very eager to invest in stocks, funds, and bonds that claim to combat climate change, improve sustainability and other environmental goals. You know, follow the money. We are hoping that in our Kiplinger way, to give you guidance on doing that in a way that's most profitable. Wow. Okay Anne, hi, thanks for joining us. Please excuse my lengthy preamble.

Anne Kates Smith: Happy to be here. It used to be, we've been writing about green investing for as long as I've been working at Kiplinger, which I'm not even going to go into it. It used to be that if you wanted to put your money where your beliefs were, when it came to investing in ESG stocks, and ESG stands for Environmental, Social, Corporate Governance values, then you had very few choices and you probably were going to sacrifice some returns. And so the investing philosophy back in the day was, make as much money as you can in the stock market and use those profits to support whatever causes you feel like supporting.

David Muhlbaum: Like write a check, make a charitable donation?

Anne Kates Smith: Exactly. With the money that you make. But these days the choices are more than plentiful, and you definitely don't have to sacrifice returns. ESG investing has not just gone mainstream, it's pretty much taken over. Even in 2020 when people were fleeing the stock market and more money flowed out of U.S. stock funds than went into them, that was not the case with sustainable funds. And those are not just climate funds, sustainable is another word for ESG. So it includes those social and corporate aspects as well, but they are popular investments and some of them are up, two, three, four, six fold. So, no more sacrifice.

Sandy Block: So Anne, thanks for explaining the acronym ESG. And as you pointed out, it covers a variety of investing goals. But the focus of this round of Kiplinger's coverage was on the E, the environment. How come?

Anne Kates Smith: Well, because of Earth Day. We have done a lot of stories in the past year on other aspects of ESG, companies that are great to work for, for instance, and other stories. But this time we wanted to focus on the environmental aspect. Again, this is where the money is flowing. BlackRock, the huge investing giant recently did a survey and they found out that climate related risks are at the top of mind for investors who are investing in ESG funds. In other words, the E is top of mind in the ESG world. And the funds are, like I said, are just raking in money, $50 billion in 2020 into sustainable funds. There have been records set for three or four of the past years and that's double the record set in 2019. And it's 24% of inflows into all U.S. stock and bond funds last year. So, it's just raining money on these ESG funds.

David Muhlbaum: So it's white-hot. I imagine that presents hazards of its own, particularly for people who want to get in now. Like the market broadly speaking has been hitting new highs this year and a lot of those gains are concentrated in green stocks.

Anne Kates Smith: They have been. So, for instance, when we wrote about green stocks in 2020, our theme was that these stocks are going mainstream, that they're being picked up widely by investors. And, in fact, the six stocks that we recommended in that 2020 story are up about 80% on average, just looking at my list here. We had one stock, TPI Composites, that makes the blades for wind turbines. So it was up 176%. Our worst performer was Waste Management. And even that was up more than 8%. And just for comparison, the S&P over that time period was up about 27%. So, the stocks have done very well.

David Muhlbaum: So if you listened to us last year, you could have done well too?

Anne Kates Smith: Definitely. Yes.

David Muhlbaum: Let's gloat a little! It's nice to be right. It doesn't always happen.

Anne Kates Smith: It was easy to be right in that sector, but that made it a little bit more difficult this time around in 2021, when we wanted to write about green stocks with such a big run-up. We've gone well past mainstream with this investing, we had to examine whether or not the stocks were in a bubble and overvalued and ready for a pullback. For instance, I mentioned TPI Composites, that's a great company with a great future, but it's trading at nearly 70 times earnings still. So we're not recommending it for new investors. This year you have to balance your green exposure while also managing risk. This year we focused on, as much as we can say, value-priced plays. They may not be value price plays in the conventional sense, but they're not as high flying as some of the other green stocks. We looked at green chips for the long haul, companies that you can buy and hold, and some indirect plays to the climate and the whole green sector.

Sandy Block: So, Anne, you mentioned green chips, and maybe we could start by explaining what those are. Sort of the, I guess, environmental version of blue chip stocks?

Anne Kates Smith: Exactly. They're the cream of the crop, they're well-managed companies with sizable market shares. They're considered market leaders in their industries. And the two green stocks on our list this year are NextEra Energy, a big utility and Xylem, which is a water treatment company. NextEra is based in Florida, traces its roots back to Florida Power and Light. So it's still part stodgy electric utility. It's got a secure dividend, yielding about 2%, but it also has a clean energy arm with a sizable and growing portfolio, wind, solar, and battery storage projects. NextEra, says it believes it can construct 23 to 30 gigawatts of new renewable energy projects through 2024. To give you an idea of the growth rate here, that's one and a half times the size of its entire portfolio at the end of 2019.

David Muhlbaum: Okay. That's growth.

Anne Kates Smith: That's growth. Xylem is about water, not energy per se, but that's got an obvious green connection. It uses innovative methods to upgrade water infrastructure, delivering clean water to people in about 150 companies, so it's got a global reach. Xylem has digital data-driven approaches to water usage. You think about smart meters and sensors that detect pipe leaks, for example, and it serves industrial firms, utilities, municipalities, and homeowners, helping them to conserve and manage water. Xylem technology also helps to reduce the amount of, and excuse this corporate speak here, non-revenue water. That's a term for the 30 to 40% of water worldwide that's lost due to leaks, unauthorized use and just basic inefficiencies.

David Muhlbaum: Yeah. It's like the water that gets wasted before we have the chance to waste it.

Anne Kates Smith: Correct.

Sandy Block: It's like the water in my basement, right? It's non-revenue water.

Anne Kates Smith: No.

David Muhlbaum: That's expensive water. That's going to cost you, Sandy.

Anne Kates Smith: Yeah. That's very expensive water. Xylem also has treatment technologies to remove harmful pollutants from water and wastewater. So it pretty much spans the gamut in a water treatment technology.

David Muhlbaum: Water is life. I think that's someone else's tagline. Jeopardy question, who knows why it's called Xylem?

Sandy Block: No idea.

David Muhlbaum: Xylem is the part in plant tissue that moves water through the plant. Up or down kind of depending on the season.

Anne Kates Smith: Wow, back to my botany 101 days.

David Muhlbaum: Yeah. So, well, it's green. Back to the stocks. I noticed that your 2021 list has a major electric car maker on it, but its name does not start with T.

Anne Kates Smith: That's right. I told you we were taking a value approach. The car maker in question is General Motors, not Tesla. I don't want to get sidetracked into a discussion of Tesla's value or it's ever moving price targets or any of that, but I don't think I'd get a ton of argument if I were to call it a high flyer. I think the P/E ratio for Tesla doesn't even measure on our scale. GM isn't as sexy as Tesla, maybe, but it's a big player with a huge commitment to the EV market. It's up nearly 50% so far this year. Tesla's down about two over the same period, and for context, the S&P is up about nine. Over the past 12 months, full year, GM is up nearly 220%.

Sandy Block: Oh wow.

Anne Kates Smith: Yeah, not shabby, not as much as Tesla, up about six fold, but not shabby. And I can tell you, the chart is a lot smoother. And GM sells for about 12 times expected earnings.

David Muhlbaum: I know we're talking stocks, not cars, but I just have to interject that I saw some video of GM's new electric truck, the Hummer EV SUV, and that thing is just nuts. It's not just that it's electric, it's how being electric enhances its off-roading capabilities. The thing can crab sideways. I can't tell you that the production Hummer, which is expected to be out next year will be any good, but I can tell you that GM certainly seems capable of generating buzz. Anyway Anne, I'd like to pivot from stocks in part because people can see the other ones we're recommending for 2021 in the story, Profit From Planet Friendly Companies, which we will link to in the show notes, and in part because a whole lot of the activity in ESG investing is in funds. In fact, that's kind of where the whole concept got its start. And in the April forecast, the cover stories, you've got a bunch of ETFs, a handful of bond funds, and one mutual fund that invests in stocks. And all of these are green.?

Anne Kates Smith: Yeah, there are very few pure green plays in the fund world. Most of these funds pay attention to other so-called sustainable investing principles as well. And we're talking about the social values and corporate governance practices that make up the second two letters in ESG. But we chose these funds for their focus on the E or the environmental component of ESG.

Sandy Block: Okay. Can I ask for an explainer then? Because, when we talk about individual companies and stocks, we can make our own assessment of whether a company is doing something green, significant. Some are self-evident, like a company that makes wind turbine blades. Others you got to think about, like General Motors and see what the long-term objectives are. But for funds, who says, "Yeah, this fund is green."?

Anne Kates Smith: And that's a whole other can of worms. There are a host of raters, more coming in every day, each with their own metrics. And one of them that we refer to a lot is the ginormous investment research firm Morningstar. With Morningstar, a low ESG score is better. It's a dynamic area. There are some controversies. Some companies can be accused of greenwashing, for instance, making some of their practices look greener than they actually are. But with funds, here's the deal, you can look at how a fund identifies itself and read the prospectus, see what they consider green and see what they demand as part of their investment criteria before they invest in a stock.

David Muhlbaum: Yeah. I just read an article we posted in our Building Wealth Channel by a financial advisor named Peter Krull, about the distinctions between socially responsible investing -- SRI -- and ESG -- environmental, social, and governance investing, the term we've been using. In short, he says, don't use those interchangeably. We could probably do a whole podcast on that alone, maybe. But I bring that up kind of to say that, we're aware of these issues and there are differing opinions on what's green or green enough, but... Anne, to put us back on track, give us a high level look at how ESG funds are faring. We did talk about inflows.

Anne Kates Smith: Yeah. And I'll just say one more thing about the labels. And this is particularly true in the green bond investing area. There are many, many labels, each with its own set of metrics and criteria. If you limit yourself to the investments that fall within those labels, then you are limiting your universe of investments. So it is a subjective area, and it helps if you do your own homework and keep an open mind. But back to the funds, they are very hot, funds that you invest with environmental concerns in mind have just sizzled. Some have posted triple-digit returns over the past 12 months. And like we've mentioned, investors have just poured money into these funds. The $50 billion that went in in 2020 is more than double the record set in 2019. And it's about 24% of overall inflows into U.S. stock funds for the year.

Sandy Block: Wow. I mean, that's incredible.

Anne Kates Smith: Yeah. Sustainable investing hasn't just arrived, it's taken over. And you can particularly see that in 2020, because U.S. stock investors pulled money out of funds or, investors pulled money out of U.S. stock funds, let me put it that way. But inflows into sustainable funds, ESG funds were positive. So I think that says a lot about how people are consistent investors when they're putting their money where their values are. Also, one other fact, four of the top 10 sustainable funds with the biggest inflows in 2020 were focused on renewable energy. So, particularly hot there. When we talked to Jon Hale, who's the head of sustainability research at Morningstar, he characterized some of the excitement in this area as performance chasing. But you have to put that in perspective, the commitment to green energy from the Biden administration and the future there over the long haul means that the potential is still there.

Sandy Block: And speaking of performance chasing, maybe one of your fund choices, Invesco WilderHill Clean Energy, certainly looks like it's doing very, very well. You could argue that investing in that was going after performance.

Anne Kates Smith: Well, to put it in context, that fund is up about 273% over the past 12 months. So a lot of performance to chase there, but we had already added that fund to the Kiplinger ETF 20, which is the list of our favorite ETFs last year. So, that tracks an index of companies that focuses on green and renewable energy sources like wind, solar, hydro, geothermal, biofuel. It also looks at companies involved in energy storage, clean energy, conversion. Some of these stocks are up over a 1000% in the past year, but we have to warn our readers and listeners that volatility works both ways. The ride in this fund can be a little bit bumpy, and to be honest, it's down about 4% so far this year. Still has that 272.97% gain for the past 12 months. But you have to be prepared for a little bit of volatility.

Sandy Block: Okay. So I'm green, but I don't like volatility. Can you recommend something that maybe is a little calmer for my portfolio?

Anne Kates Smith: Well, there are different things you can do to ameliorate some of those concerns. Like we mentioned, the ETF that's equal weighted, that means that some of the highest-priced stocks, that can be the most volatile and risky, don't dominate the returns. But there's another one, the one mutual fund that we recommended, Fidelity Select Environment and Alternative Energy Portfolio. That's a mouthful. The symbol there is FSLEX. The fund is a diversified approach to companies tackling climate change. It holds stocks in every sector, for instance.

Anne Kates Smith: Mostly companies that get about one quarter of their revenue tied to a smorgasbord of environmentally friendly pursuits. And that means fuel efficiency, generating renewable energy, building water infrastructure, recycling, stuff like that. That means that it holds a handful of big, traditional blue chips. One of them is Honeywell, the giant industrial conglomerate. And it's got Honeywell because that company works with building owners to install more energy efficient systems. 3M is another big conglomerate that's in there. 3M is a huge supplier to solar and wind companies. The fund has lagged the S&P over the past three years, but it's beaten the S&P year-to-date and over the past 12 months and it's neck and neck over the past five years.

David Muhlbaum: Okay. So here I go, talking about my family again, but my younger daughter wants to invest some of the money she saved up from babysitting, gifts and the like, in a green fund. She's off at school in Vermont right now where they go to class and run an organic farm, so it's all very on-brand, if you know what I mean. So I started looking at some of these funds and my God... I keep seeing Tesla as a holding! Like, for that one we were just talking about, Fidelity Select Environment and Alternative Energy Portfolio, it's number one. They literally have twice as much Tesla as Honeywell. I mean, I imagine a part of this is with the way Tesla shares have been rising, it's going to get up there in fund holdings. But it's not exactly reassuring to see this hot potato of a stock keep popping up. To me that is, I don't think my daughter cares. Her concern is finding a fund that has a manageable minimum investment.

Anne Kates Smith: Well, I'll tell you, it's not uncommon to find Tesla in a green fund, but I just have to say, it's by far and away not the only overvalued green stock out there. Tesla has its supporters. It's a company for the long haul, they say. But here's the thing about mutual funds, David, if you hire a pro to manage your green investments, part of the privilege and the benefit of that is leaving those decisions to the fund manager. Now, if you're uncomfortable with that kind of volatility and that kind of risk, you can check the holdings. Mutual funds disclose their holdings periodically, most ETFs do so daily, but you also use some other criteria to choose a fund. You compare expenses, you try to buy a low-expense fund for instance, that's extremely important, and you buy a track record. You don't have to second guess the manager, that's the beauty of buying a fund until such time as that fund no longer suits your needs or the track record crumbles.

David Muhlbaum: It's interesting you mentioned those important parameters in choosing a fund. In the process of trying to advise my daughter, I found myself very much going through those parameters and reminding myself again, why those matter and how we go about picking mutual funds, and it was an interesting opportunity to riff on what I hope I've learned over the years, and that you helped teach us all. There are four other funds in Earth-First Funds Are Soaring that we didn't get to today. I'm going to put a link into that article as well. And as long as we're talking about things that we didn't have time for, we briefly mentioned bond funds, but we don't have time to really dig into that today, but there are green bond funds as well. And again, I'll put a link to that article as well so you can just keep on digging into all the green content that we have put together for Earth Day. Anne, thank you very much for joining us today. We appreciate your insights.

Anne Kates Smith: Oh, it's my pleasure. Happy Earth Day.

Sandy Block: You too.

David Muhlbaum: And that will just about do it for this episode of Your Money's Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. If you've already subscribed, thanks. Please go back and add a rating or a review if you haven't already, it matters. To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts, and links are all in there by date. And if you're still here because you wanted to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Listen Now:

Subscribe FREE wherever you listen:

Links and resources mentioned in this episode:

• Reasons Why Your Third Stimulus Check Could Be Delayed or Denied
• Where's My Stimulus Check? Use the IRS's "Get My Payment" Tool to Get an Answer
• What to Make of Bitcoin?
• On Purpose, With Tyrone Ross (Coindesk podcast)
• Cryptoassets: The Innovative Investor's Guide to Bitcoin and Beyond
• CASEBITCOIN: Making the Case for Bitcoin Every Day
• OnrampforAdvisors

Transcript

David Muhlbaum: We’re going to talk about cryptocurrencies today. No, really, Kiplinger is going to cover Bitcoin. And please, if your usual reaction to Bitcoin is to roll your eyes or put your hands on your ears and go “lalalalala" — we get it. But come on, aren’t you a bit curious about how all this wealth is getting made? Financial advisor Tyrone Ross is going to help us figure out whether you should own some Bitcoin and if so, how to buy it.

Also, still waiting for your stimulus check? Sad. We’ll give you some reasons why that might be and what you can do about it. All coming up on this episode of Your Money’s Worth.

David Muhlbaum: Welcome to Your Money’s Worth. I’m kiplinger.com senior editor David Muhlbaum, joined by my cohost, senior editor Sandy Block. How are you doing Sandy?

Sandy Block: Doing good, David.

David Muhlbaum: Good. Well, in our main segment, we’re going to talk Bitcoin, which in all honesty has been a heck of a topic to research. I’m constantly learning what I don’t know, but before we get to the future of money or whatever it is, we should check in on the currency of right now. I’m talking about stimulus checks.

Sandy Block: Stimmies.

David Muhlbaum: Stimmies. Exactly. Stimmies got name-checked on “Saturday Night Live” this past weekend, which I guess is a cultural watershed for anything, right?

Sandy Block: Yeah. Boomers Got the Vax was pretty funny. I’ve been showing it to all of the people of a certain age and there’s nothing funnier than a bunch of CPAs trying to sound street, but plenty of people are still waiting on their vaccine and also people are still waiting on their stimulus check too.

David Muhlbaum: Yeah. There’s a similar feeling there, a feeling like you’re missing out, but with vaccines, there’s at least supposed to be an order. Elderly, healthcare workers, people with disabilities, et cetera. But what’s the story with stimulus checks? I know we’ve had round after round. If you’re sitting there hitting refresh, refresh, refresh on your bank app and getting no love or money, well, why?

Sandy Block: There can be five main reasons. Rocky Mengle, our senior tax editor, one of our frequent sources and popular guests, has gotten it all lined up and we’ll put in a link to his piece because I think I’m only going to have time to cover two main reasons. I’m going to pick the ones that are less self-evident. You probably already know that if you make a lot of money, probably no stimmy for you at this time. One key thing to remember is that though we keep about checks, most of this money is going out to people through direct deposit.

David Muhlbaum: Well, that’s why I said bank app.

Sandy Block: Right. But let’s say you’ve changed where you bank since you last filed your taxes, this could be a year ago. Maybe you didn’t like your bank anymore. The IRS has a number of ways to determine where to send stimulus money. And one of them is the bank account you linked up with when you filed your 2019 or 2020 federal income tax return. If that account’s been closed, the bank says to the IRS, “Sorry, no one home.” It should get to you eventually by either a paper check or debit card by mail.

David Muhlbaum: Oh, and what if you have compounded the situation by, say, moving yourself somewhere else? A lot of people did that last year.

Sandy Block: That’s right. So now, you’re at the mercy of the U.S. Postal Service and the IRS. If the U.S. Postal Service is forwarding your mail to your new address, your third round stimulus payment will eventually show up in your mailbox. If you didn’t do that, and the payment goes back to the IRS, then the IRS will either wait for you to reach out and update your information or for you to make contact some other way, like filing your 2020 tax return at your new address.

David Muhlbaum: But in fairness to the IRS, it’s not like they’re trying to hold on to the money. They want to get you the money. It’s a stimulus. And so they have this system for you to say, “Yeah, I’m over here. Gimme stimmy.”

Sandy Block: Right. Exactly. And we get to boil this down to three easy words again, “Get My Payment.” Search is your friend here, search, “Get My Payment" and I assure you, you will hit the IRS page where you can put in your updated information.

David Muhlbaum: But not a vaccine appointment.

Sandy Block: No, that’s up to the states, and I’m still waiting.

David Muhlbaum: Right. When we return, Bitcoin for the beginner. We’ll have a discussion with a really fascinating guest who actually understands cryptocurrency and why it matters to us all, even if we’re not ready to invest in it.

David Muhlbaum: Welcome back to Your Money’s Worth. We’re very pleased to have joining us today Tyrone Ross, a man who has a hand in a number of fields. He’s a financial advisor, he’s an entrepreneur and he’s an educator about financial markets and investing. Those talents come together in his role as CEO and co-founder of Onramp Invest and we’ll get into what that does later. But the core of his knowledge portfolio that we’re going to try to tap today though, is Bitcoin. Welcome, Tyrone.

Tyrone Ross: Thank you for having me. This is awesome. I’m excited to break new ground with you guys here and hopefully have a measured and objective conversation about digital gold.

David Muhlbaum: Also on with us today is Kyle Woodley, senior investing editor for kiplinger.com, who understands Bitcoin better than I do, which really isn’t saying much. He’ll be asking the smart questions and I’ll be asking the skeptical ones.

Kyle Woodley: Hello, hello.

David Muhlbaum: Now, those of you who heard our introduction will appreciate that Kiplinger has been institutionally wary of Bitcoin as an investment. And we have a hunch that many of you might be as well. On the other hand, a bitcoin was worth pennies in 2009. It’s now trading for over $50,000. I’m not going to calculate the return on that, but it probably has more zeros ahead of the percent sign than any other investment of the last decade. Talk about your fear of missing out.

David Muhlbaum: And Tyrone, as I’ve repeated more than once, I’ve got a lot to learn about cryptocurrencies and so do most people, I’d venture. So to help with that, we’re hoping to cover a few of the classic journalism questions: Who? What? Why? And also come back to the core investing question, should people be investing in Bitcoin? But I think it might be best if we take them out of order. And the one I want to start with is “what.” Can you please explain to us, as succinctly as possible, what is Bitcoin?

Tyrone Ross: Bitcoin is simply internet money. That is the easiest way to put it. We’ve had everything on the internet besides money, and now we have money that is native to the internet. Simplest way to put it.

David Muhlbaum: Internet money. Okay. One of the things Kyle and I wrestled with ahead of our talk today were the definitional issues, Bitcoin, crypto, internet money, alt-currencies, and the IRS even has a term, what do they call it?

Tyrone Ross: Virtual currencies?

David Muhlbaum: Yeah. So there are a lot of different terms. And I think part of the confusion surrounding this topic is the intermingling of those. I’ve used the term Bitcoin so far and you’ve said internet money. Do you have a sense of what we should be using, going forward in this conversation?

Tyrone Ross: I think we should back up and start here. I hope most of the folks that are listening are skeptics. And I also hope most of the folks that are listening are also open to learning, because I was a skeptic, and there are still some things that you should keep a healthy sense of skepticism, when learning about something that is only 12 years old. Look at anything that is 12 years old, you can’t trust it, right? But if there’s anything that you can trust in regards to a new digital money or digital currency, by the way, it is all of these things, it should be Bitcoin.

Tyrone Ross: When we say internet money and let’s take out all of the things that you hear bandied about on CNBC and all over the place, a lot of that is bunk. But what’s important is you had the internet and the ability for folks to send money over the internet that was borderless, no third party, self-sovereign, all of these different things, immutable, that you hear thrown around, that is a breakthrough innovation, even Ray Dalio thinks so. He’s like, “Great invention. I stopped there.” Even if we get folks to do that, it’s great.

So I think if folks were to just simply, and I’ve been saying this for years, a lot of folks, Corey Hoffstein and a lot of the really smart people that are on Twitter, and I say, "Look guys, I know. I don’t care how you feel about it. Read the white paper. I think you’d have a hard time reading the white paper and going, ’There’s nothing here.’” So I think the fact that now I can send money anywhere in the world, to anyone over a phone with no KYC, AML or whatever, just me to you as, just like I walked up and handed someone cash over the internet. That’s a really powerful thing. So if I walk up and hand someone $5 and walk away, no one knows that transaction happens. Now we can do that with phones. That’s super powerful.

Tyrone Ross: I think if you start there and then broaden out what Bitcoin is to you, because a data scientist is going to look at it different than a financial advisor. I talk to CIOs of RIAs all day and they’re like, “Tyrone, is it digital gold?” I’m like, “Well, I don’t think so, but you maybe think so because it helps you understand it and you can’t go to a client’s portfolio and go, ’Hey, let’s trade out this digital gold for this digital gold or this internet money for this internet money.’” It’s easier to say, “This is similar to the gold that’s in your portfolio now with these different characteristics,” and the client goes, “Oh, okay.”

So I think Bitcoin is a lot of different things to different people, but the beautiful thing about it is it’s all of those things. I have people DM-ing me this morning, “Tyrone, I saw your message about PayPal. Does this mean you don’t think it’s a currency?” I’m like, “Yeah, it’s a currency, but it’s not a currency here in the U.S. yet until the laws change.”

Tyrone Ross: Anyway, I say all that to say, I think as you back up and you start to look at Bitcoin and you start to understand it, is it speculative? Yes. Is it young? Yes. Is it an investment for most people? No. Has it done well? Absolutely. So there’s still a lot of things here, but I think if people could just simply say, “Okay, there’s the internet. If I have an internet connection and I have a phone, I can send value...” Two things here that I think are also very important. I need everyone listening to separate the big B, the Bitcoin blockchain, from the little b, bitcoin, the price that everyone jumps up and down about every time it moves 2%. That’s very important.

Tyrone Ross: The other thing that’s important here is Bitcoin, and we can elaborate on this. As far as a blockchain and a transfer mechanism, it is super powerful and strong and secure. So when Bitcoin is the thing that everyone hopes it is, and it is right now, when you talk about trillions of dollars transferred, it is great for moving large, large, large, very large value of money or whatever it is through time, anywhere in the world, not for a cup of coffee, PayPal. So when you really start to understand Bitcoin, you’re like, “Oh, I get it.” So the “Bitcoin, not blockchain” thing, that doesn’t make sense. The, “Oh, it should be used to go to Dunkin Donuts.” Oh, that doesn’t make sense. So all of these things that are out there now, like this PayPal news today, going nuts, that’s just going to confuse people. Like no, you shouldn’t be spending your Bitcoin.

David Muhlbaum: One of the things you’re talking about is the influence and the significance of Bitcoin as a currency and as a phenomenon and the ability to move large amounts of money, as you said, is a core part of that. In some way, though, that’s the opposite of what it’s meaning is to the individual investor who looks at a portfolio of, I have this much money. I want to diversify it. I want to put some portion of it in an alternative investment. At least as I understand it, that’s investing in Bitcoin.

Tyrone Ross: If you consider Bitcoin to be an alternative, sure. And if you’re doing 5% allocation, where are you taking it from? Bonds? Probably right now, if you look at bonds, well, maybe not right. The 10-year’s moving again. So is it the equity sleeve? Or maybe it’s like venture, it’s a venture bet because it’s highly speculative? What are your goals? What is your tolerance for risk? That’s what I tell financial advisors all the time, why you need to be able to model it so you can say, “Hey, Mr. And Mrs. Client, you see these 80% drawdowns over here, how do you feel about those? And then every once in a while, you’ll get a 30% dip. How do you feel about that? Do you really think this is an investment still or something you’re comfortable with?”

Tyrone Ross: Different conversation with a 50-, 55-year-old, than the 35-, 40-year-olds that are used to it. The 40-year-old was 28 when Bitcoin was introduced to the world, they’ve grown up watching this thing go nuts. It’s normal. It’s a different appetite for risk and understanding of things just being, touch, touch, touch on my phone, digital, virtual. There’s demographics at play here, there’s an understanding. And listen, here’s what I know about the Kiplinger audience, I am certain that people that are listening to this podcast or read your wonderful magazine and your website and everything else, they don’t need Bitcoin. If they want to put a little bit of money into it, great. They’ve done very well; now, it’s about wealth preservation as opposed to wealth creation.

Tyrone Ross: Those of us that are younger are looking at Bitcoin and going, “All right. Best risk-adjusted returns 1, 5, 10 years. Annualized to a 100% or so." What did Paul Tudor Jones say? “It’s the fastest horse.” His job is to find the fastest horse. So if you’re younger, I think it’s hard to look away and go, “ahhhh.” So I think that’s just where we are, but to your point, yeah. If you look at it as an alternative, absolutely. But again, where are you taking that percentage from, in regards to your financial goals and other things there?

Tyrone Ross: Bitcoin isn’t an investment for everybody. I think that’s another thing that needs to change. I’m not even sure if it’s an investment, period. But it can be. But I think that’s something that people need to understand. It’s not about this being an investment, it’s speculative still, there’s still a mania behind it. And again, I’m big as a crypto-hippie as they come, but I think you have to, “Put everything in its place,” as my mother would say. “Put everything in its place and leave it there. Don’t try to make it something else that it’s not.”

David Muhlbaum: So we’re a podcast, audio-only, but when we record, we can see each other on video, just like on Zoom. So Tyrone, would you mind standing up and showing us what it says on your T-shirt?

Tyrone Ross: The T-shirt says, “Long Bitcoin, Short the Bankers.”

David Muhlbaum: Long Bitcoin, Short the Bankers. That’s great. Okay. I can see Kyle is dying to ask a question too, but I’m not giving up the floor just yet, because one of the things that struck me is that while you say you’re a Bitcoin hippie, you even have the T-shirt to prove it, a whole lot of the language that you use will be familiar to people who are more conventionally invested, bonds, equity, risk allocation. What are your goals? What is your tolerance for risk? You’re hitting the familiar financial planner touchstones. I think it’s going to be very reassuring in a way.

Tyrone Ross: For sure. And again, I think, listen, if you grew up reading The Intelligent Investor and Intrinsic Value and Discounted Cash Flows and Efficient Market Hypothesis and all that, it doesn’t make sense. You can’t bring that old hat to this ball, you got to put on a new hat, new shoes. It’s a totally different lens through which you have to look at Bitcoin. And again, everyone is going to come into it their own way. So I think, what I try and get CFAs and CFPs and my colleagues to do is, Yeah, you’re absolutely right. There’s no intrinsic value here, but you have to find the other valuation methodologies for Bitcoin and digital assets. So much so, the SEC tells financial advisors, “We are going to ask you for your valuation methodologies on this. You better have a good answer.”

Tyrone Ross: Even the use of market cap, not the best metric to talk about Bitcoin, but, “One trillion dollars in market cap value." The minute that headline crossed, I did an episode on my podcast. I’m like, “Guys gather around the campfire. That’s not the best use of this. There’s other ways, realized market cap, MVRV, all of these weird metrics that if you said to an advisor, they’re like, 'Huh?'” Or anybody.

Tyrone Ross: So again, I think what folks need to realize, again, 12 years, all of this needs to be expanded, but, I will say this, legacy financial institutions, we saw what Morgan Stanley announced, but the Barrons, the Kiplinger’s, the Wall Street Journals, there’s a responsibility for you all to get it right, and very right. Because those folks that are very well-to-do, knowledgeable, educated, traditional, as you call them, are looking at you all for the best-in-class information. And as far as crypto goes, it hasn’t been good. Not you specifically, but if you look at the traditional media, financial outlets, it’s been really bad information.

David Muhlbaum: I totally appreciate that. What can I tell you? We’re trying. But I heard you mentioned the phrase, “Old hat,” and that made me think about one old hat who really resonates with Kiplinger readers and that’s Warren Buffett. He had that famous line, “Never invest in something you don’t understand.” That seems like it could be a hurdle for some investors with Bitcoin. Can people invest in Bitcoin without really understanding it? And how do you figure out if they do?

Tyrone Ross: I love Warren Buffett too, personally, my favorite investor is Howard Marks, but I could appreciate Warren Buffett, more of a Charlie Munger guy, myself, but I could appreciate Warren Buffett. And I think people invest in things they don’t understand all the time, like marriages, but as a whole ’nother story, but whatever. Moving along. I get that, but people do it all the time. So I do think people can invest in Bitcoin without understanding it. Do I think that’s a good idea? No. Especially with something like this, because if you make mistakes in a traditional world, there are guardrails to save you. You make the mistakes here, your Bitcoin’s gone forever, or a scammer or somebody has your information or whatever. So you don’t want to jump into this and not understand it. We don’t have those guardrails here, so you want to be knowledgeable there.

Kyle Woodley: One of the things you just said is that, We, not like Kiplinger we, but like the financial media, the legacy financial media get wrong, is that we don’t necessarily talk about cryptocurrency in the right way. We don’t get things right. So, the best, most natural question is what do you see that we typically get wrong? On the highest bandwidth platforms, the whatever, the mistruth that you see out there when people are just casually talking about it?

Tyrone Ross: One is avoidance. Just avoiding it. Two, not outsourcing your ignorance. Bring in trusted professionals, and again, you trust me in the sense that you know that I was competent enough to come on here, and that I wasn’t going to carnival bark about Bitcoin going to a trillion and the U.S. dollar is going to nothing. That’s not happening. So folks that are objective, and again, I love Bitcoin. And then also being able to talk about it from a true use-case standpoint and build from there.

So let me go back to step one, avoidance. When you say cryptocurrency, that’s probably like that term cryptocurrency. Now it forces people to say again, they get excited about the PayPal news, you said a currency, and what is this crypto thing? Or are they all cryptocurrencies? Yeah, this probably isn’t the best name. You see Stablecoin thrown around. That’s probably crypto dollars. There’s probably a better name to get people familiar with them. So the jargon, virtual currencies, digital currencies, cryptoassets, Bitcoin, alt-coins. There’s just all of these things here where if you just go, “Everybody stop.” I just did this on live on Twitter for financial advisors, the space moves too fast. They need to slow down and they need their blind spots.

Tyrone Ross: What we need to do is, again, if you just stick with Bitcoin and understand it and completely pick it apart, you’ll go, “Oh, okay. Alright. This blockchain thing, chain of blocks with information, sounds a lot like a budget, but it’s just in blockchain. And then if I get a statement and okay, right. And put those things together, and then it works like a clock because every 10 minutes there’s a new block. Oh, all right.” Just really break it down to that rudimentary level and then understand, Okay. The IRS says Bitcoin is property, the SEC says it’s not a security, the CFTC says it’s a commodity. Right? There’s still a lot of confusion. That’s where people should start. There. “Oh, okay. All right. Not a security. So that’s why financial advisors go, 'All right. Not a security. I’m not touching it because I got my seven and this says only securities and securities only.'" But those of us who didn’t learn about it, no it’s great that it’s not a security, because that means...

Tyrone Ross: So when you go into all these nuances, I think if Kiplinger just did a, “What is Bitcoin” and not “Bitcoin from a Technological Standpoint,” but “What is Bitcoin? And it’s, “The IRS says it’s property. Here’s what property is. The SEC says it’s not a security. Here’s what that means. The CFTC says, it’s a commodity. Here’s what that means.” That’s a beautiful article. And people go, “Oh, okay.” Now you’ve got them, because that’s what they expect from you. I don’t want to go to Kiplinger to hear about SHA-256 and mempools. I don’t want to hear that from you guys. What I want to hear is, “Oh, are the things that... Taxation. It’s taxable, there’s no wash sale rule.” There’s enough for everyone to pick their part of it and educate their audience on that. I think you guys could do a really good job of that.

No one’s going to come here for the technical part of Bitcoin. They’re going to come for, “All right. What does this mean in the portfolio?” “Okay. Well, based on... Seems like up to 5%, makes a lot of sense. Morgan Stanley just put out a report two and a half percent. At Onramp, we did a report right around 5%.” “So I’m figuring I’m one between 1, and 5% if I ever decide to do this.” So all of those things I think is a good place to start, but I think just starting to go into the outer fringes here of what’s going on and the other media chasing that rabbit does no one any good, because there’s enough outlets to get what you need from certain places. And I think that’s what your audience — what I would be looking for — from you guys.

David Muhlbaum: One thing I noticed in there is, you’re using specific percentages for allocations. Now, everyone should discuss how much they’d want to invest with their financial advisor and let’s hope their financial advisor knows something about internet money, but once someone’s crossed that threshold and decided “I want to invest in Bitcoin,” the next question is, how? How should they invest in Bitcoin? Because that’s different too.

Tyrone Ross: A lot of that has to depend on how are they trying to use it as a part of their financial goals or portfolio. If it’s, “All right, I want to put it away for a really long time for my daughter’s wedding, or it’s going in cold storage, away somewhere. And I probably need to use a qualified custodian option for that. But say I just want to mess around with it. Maybe it’s on my phone, a cash app or PayPal. There are so much nuance to go into that because the minute you do it, and let’s just say you have the tech savviness and you’re going to go somewhere and do it and you take the keys, and you have your public key and your private key and your mnemonic seed phrase and all these other things.

Tyrone Ross: Well, now we get into digital fiduciaries and estate planning, all of these things that are really, really important for folks to understand, because if you are the only one in the family who knows what the hell a private key is, and now you pass on or something happens to you, and then the Bitcoin is $5 million, but nobody can get to it. Now what? So I think these are all the contingencies that folks need to worry about. If no one listens to anything else in this podcast, everyone, please hear me, the greatest investment you can make into Bitcoin right now is learning. Listen to podcasts, read, ask questions, be frustrated, be confused, because here’s what I always tell people: When someone asks me what Bitcoin is, and I explain it and they’re not confused, I didn’t do a good job. If you get it right away, I did a horrible job. But if I explain to you and you go, “Huh? I think I kind of get it. Is it money?”

Tyrone Ross: My mother calls it the big nickel. That was a joke on Twitter for a while. She calls it the big nickel and my sister calls it space money. I’m still working on my family. We’ll get there. And those things aren’t necessarily wrong, but people are going to come to it at their own time. Read, ask questions, listen to podcasts, good ones, go to the right outlets, listen to this podcast, obviously, and then get the right resources. And then you’ll start to ask better questions and you’ll get better answers. And then you can determine, “No, this is still very stupid to me.” Or you can determine, “No, maybe this is something I’ll invest in,” but there’s a lot before you get there in terms of where, there’s no limit of retail outlets to buy it. And there’s no limit of ways to get it as an accredited investor or other ways as well.

Kyle Woodley: So two questions that I have. One is, obviously we want everybody who’s listening to this to always listen to our podcast and read our stories for about an hour a day or so, really put in the work, but obviously we don’t own the marketplace of ideas. So like your opinion, where are the best sources of information for people that want to learn about Bitcoin, that are starting from the ground up?

Tyrone Ross: I have it here. You guys can’t see it. I tell every financial advisor, every financial professional, and I need your audience, everyone bear with me here, do not get upset and angry. This book, Cryptoassets by Chris Burniske and Jack Tater one day is going to be the equivalent of Benjamin Graham’s Intelligent Investor for the crypto space. Heresy! I know. And here’s why this book is important, it walks you through what a blockchain is. Notice the name, cryptoassets, not cryptocurrencies, it walks you through what a blockchain is, take you to Bitcoin. First, how this all came about and then it walks you through everything that comes after. And you go, “Oh, okay. So all of these are in some way, a derivative of the Bitcoin blockchain,” after you’ve learned about it. Incredible book, I can’t recommend it enough.

Tyrone Ross: So I think that’s one. There is a media outlet, CoinDesk, that does a really good job, and again, full disclosure. I do a lot of work with them, I put on a Bitcoin FA conference with them. I have a podcast with them. They’re working really hard because they were straight crypto-hippie. They’re working really hard to educate audiences now, especially the wealth management and financial advisor space. And I’m working with them to do that through my own podcast. I would encourage folks here to listen to my podcast, as well. It’s for advisors by advisors. I have one dropping today, actually. It’s all about estate planning in regards to crypto. And I have a gentleman on there, works with trusts and estates, Frazer Rice. And we talk about all of the different issues that advisors need to be concerned with.

Tyrone Ross: There’s a site called CaseBitcoin.com. Awesome, awesome site where they give you basic information you can click through, you can read through. Really, really good resource. And I think after that, I think the best thing to do is Bloomberg Crypto is getting better. I know as a competitor, but Bloomberg Crypto is getting better. And there are some other outlets there that are doing a better job, Forbes and some others. But again, there need to be a Kiplinger Crypto. I’m willing to help you guys to get it right. And only because I think it’s familiar, those names are familiar and brands matter. I always say this, “The messenger is the message.”

Tyrone Ross: And I will say this, and I know those folks are competitors, but everyone should have their lane. Bloomberg and those others are chasing a rabbit. You guys have a real unique opportunity to carve out a lane of those things that I was talking about, those really key investment management, planning type issues around this, I think you guys can own. But those are the best resources, and those are the things that I tell people to read and, and say, “Look, go through it and then ask questions and come back to me and I’m happy to answer any questions you have.”

David Muhlbaum: Well, as long as we’re plugging stuff, let’s get to Onramp Invest. This is the firm you started. What does it do? What are its goals? Tell us.

Tyrone Ross: I’ll keep it brief because I’m doing our first state of the union in a couple of days and we have some big news coming soon, but there are a segment of the population right now that want digital assets from their financial advisors and cannot get them. Onramp is providing the tools, the data, the resources, the education for financial advisors to work with this new asset class in a compliant, regulatory manner, with their clients right inside their existing workflow. No TAMP, no funds, no ETF. Like, everyone else is building the hotels, we’re building an interstate. We’re connecting it all. So a financial advisor can go into her workflow and model for a client, plan for a client, bill, do all of those things that they can’t right now.

Kyle Woodley: Out of curiosity, how much access does the advisory world actually have in this right now? If I have just, Joe Financial Advisor or whatever, can I just go to any financial advisor and invest in crypto through them? Does everybody have access right now?

Tyrone Ross: You can’t and that’s the thing that’s frustrating right now for a lot of the larger RIAs. What’s amazing is as we sit here right now, Morgan Stanley can offer their financial advisors and clients Bitcoin. Some of the largest RIAs in the country cannot. That is astounding. So, most RIAs can in some capacity, right, we’ve heard GBTC thrown around, there’s ads everywhere, it’s been on CNBC, so most can in that regard, but there’s also a large segment that can’t. And again, I think that there’s been so many emails and texts and things that I get from folks that say, “I asked my financial advisor about this, and he won’t talk about it," or, “he won’t do this,” or, “she won’t do that.” So advisors right now, again, just the regulatory hurdles, they don’t know what they can and cannot say.

Tyrone Ross: One of my mentors runs a multi-billion dollar RIA, and he won’t even come on my podcast to talk about it. He’s like, “No!” So that’s where we are. And he’s like, “I manage money for some of the wealthiest families in the country. I have a multi-billion dollar RIA, do you think I’m going to take a risk for a 1% allocation to some invisible money?” I get it, and I completely understand that. And there’s no reason for him to do it, but again, those that are building practices and those that have gargantuan firms with clients banging on the door about it, may have to answer that call.

Kyle Woodley: So Tyrone, several crypto funds already exist, but there’s a lot of anticipation for an eventual Bitcoin ETF, but you don’t seem to be a huge fan of investing in Bitcoin or digital currencies via any sort of fund. Do you care to elaborate?

Tyrone Ross: Again, I love the folks at Grayscale and I Dig and also their friends. I know them all. Again, me and Matt Hogan, while we’ve been at, I don’t know how many conferences arguing about a Bitcoin ETF, it’s stupid. And I just don’t think of any other way to put it. And we’re going to get it because Wall Street is greedy and they love money. So we are going to get it and I’m still going to have the meltdown that I’ve been telling everybody that I’m going to have.

Tyrone Ross: My issue is this, why take a Ferrari engine and put it in a Honda body? It doesn’t make any sense, like we’re going to take this beautiful, elegant asset that trades 24/7, 365, liquidity, borderless, self-sovereign, immutable, and we’re going to put it in this wrapper and make sure it stops trading. And then we’re going to put all these fees on top of it. I just don’t understand that. And I get it, again, because it’s a lot of money to be made and Wall Street loves money so the financialization of Bitcoin was to come.

Tyrone Ross: So we’re going to get these funds. We were just passing around the fees in our Slack channel, our Onramp Slack channel, of some of those Morgan Stanley funds. Oh man, I’d sling that bad boy too. There’s so much money to be made. So I get it. The fund structure, the ETF structure is all about the dollar, dollar bill you all, it’s about nothing else. It’s about nothing else. It’s about ease of access to sell and push on retail. And what Bitcoin was invented to do was to, was again, to be anti-establishment, but it’s gotten there. We are here now.

Tyrone Ross: But the beautiful thing is for those who still want to opt out of the system and get it directly, you can. And for me, this is why I am so passionate about it, because the one and arguable use-case that the Bitcoin has is for the underserved. And that is the Bitcoin blockchain, not the stupid token. It’s the power of this to give people who don’t have access to financial services, access to financial services. That is worth a ga-billion dollars somewhere in the solar system.

Tyrone Ross: So I think a fund, you can’t corral that, you can’t put the Bitcoin blockchain into a fund. So it is still going to operate as is. And that’s a powerful thing to me, and again, for people who grew up like I did, who had to use alternative financial services, the paradigm shift has been broken. I think it’s less about when we’re going to get a Bitcoin ETF, but more about when are we going to have a real-time payment system in this country? When am I going to be able to put my check in the bank and the money settles then so that if I get paid on a Friday and I’m going to get evicted Sunday. That my money settles now, and my landlord doesn’t throw me out. That’s a bigger innovation in our Fed, FedNow that they’re saying is coming in 2023. You got to love the name, FedNow, but we don’t get it for another two or three years.

Tyrone Ross: These are the things that I think people need to be concerned with and why Bitcoin is so powerful, as there are so many people in this country who are locked out of financial services and it’s breaking down barriers, whether you like Bitcoin or not, it’s forcing our financial services system to get their act together and stop being so antiquated.

David Muhlbaum: Those issues of access, of disruption, payment processing, the future of the Fed, all that, digital currency, they’re really important and I’m glad you brought them up. However, we are out of time, but Tyrone Ross is an easy man to find online, and he’s got a lot more to say there. Plus he’s got a podcast it’s called, On Purpose. So please look him up, I’ll put in links. And I hope we can have you back here too, Tyrone, soon, to dig in deeper. Thanks very much for joining us.

Tyrone Ross: No, thank you guys for having me and making room for the conversation. And I think your listeners will really get something from this. I think there’s a little something for everybody. I appreciate you guys.

David Muhlbaum: And that will just about do it for this episode of Your Money's Worth. If you liked what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. If you've already subscribed, thanks. Please go back and add a rating or a review if you haven't already, it matters.

To see the links we've mentioned in our show, along with other great Kiplinger content on the topics we've discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. And if you're still here because you wanted to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Listen Now:

Subscribe FREE wherever you listen:

Links and resources mentioned in this episode:

• Home Buyers Loving the Suburbs Again
• 11 Home Features Today’s Buyers Want Most
• 6 SPACs to Buy for ’Smart Money’ Returns
• 8 Tax Tips for Gambling Winnings and Losses

Transcript

David Muhlbaum: It’s time we checked in on that crazy housing market going on out there. What does the run-up in home values and prices mean for people looking to buy or sell, and also people with no intention of moving? Contributing writer Daniel Bortz gives us a fix on real estate today. Speaking of rising asset values, what’s up with SPACs? That’s all coming up on this episode of Your Money’s Worth, stick around.

David Muhlbaum: Welcome to Your Money’s Worth, I’m senior online editor David Muhlbaum joined by my cohost senior editor Sandy Block. How are you doing today, Sandy?

Sandy Block: I’m doing great.

David Muhlbaum: Well, good. And how are your brackets faring?

Sandy Block: All messed up, but I’m still having fun watching the games. And yours? Oh no, no wait, sports aren’t your thing. That was my old cohost, Ryan.

David Muhlbaum: Yeah, you’re right about me and sports. I was just being polite and trying to set up our closer today where we are going to talk about sports gambling and taxes. But first I want to talk about another sort of gambling, stock market gambling. Okay, maybe that’s a bit harsh, stock market speculation? Specifically these things called SPACs, special purpose acquisition companies. It seems like every day a new celebrity puts their name on one like, Jay Z, Shaquille O’Neal, Colin Kaepernick .... Sammy Hagar. Because next week in our main segment, we’re going to have a guest on to talk about bitcoin. And I want the practice of discussing something I don’t totally understand, and tell a cautionary tale.

Sandy Block: Okay. Well, we talked about SPACs actually at this week’s editors’ meeting and yes, risky is a word that came up a lot and there was a lot of head-shaking too, but we should start with what the darn things are. Most people are familiar with an initial public offering or IPO. Special purpose acquisition company or SPAC, is another way of bringing a company public. But while they have some similarities, they also have key differences from IPOs.

David Muhlbaum: Okay. I just love these acronyms. We’ve got SPACs, not PACS, which are for politics and not Spanx, which are for bellies. They’re not an acronym either, but okay.

Sandy Block: Yeah, don’t go there. Right, SPACs. So a SPAC is a publicly traded company that lists on a public stock exchange, but unlike an IPO, which is usually for a company that builds, makes or sell something and wants to cash out and get bigger, a SPAC’s purpose is to buy something else. It’s just a pool of money with managers, a board, and of course, shareholders, including some small retail shareholders.

David Muhlbaum: Who are getting a chance to play in the private equity world. They’re going to be like the next Bill Ackman, except just one little chunk of him.

Sandy Block: Right. That’s their hope, big paydays, the kind formerly reserved for early investors in public offerings. So the A is for acquisition; they’ve been buying lots of tech startups and of course electric vehicle companies because everybody wants to own the next Tesla. Plenty of startups like the idea of SPACs competing for them too. It raises valuations and is a whole lot easier and less public than going through the IPO process.

David Muhlbaum: Oh yeah. And sports gambling too. One of the biggies that went through the SPAC process was DraftKings. That was a year ago or so and they now trade on the Nasdaq, DKNG.

Sandy Block: Exactly. You can gamble with DraftKings or on DraftKings. And also yes, that one was a year ago and yes, we’re aware that SPACs are not anything all that new in the market, but they have been on an absolute tear lately. There’s substantially more money being raised this way than through traditional initial public offerings. And that’s one of those phenomena that is raising the “uh, oh, irrational exuberance” warning flags in the markets.

David Muhlbaum: So even if you as an individual investor who shakes their head and goes, “Thanks, but no thanks” about investing your own money in a SPAC, there’s still some exposure in a way.

Sandy Block: Markets go up, markets go down and sure, you can mitigate risk by being diversified in big index funds, but to an extent, we’re all in the same boat. I’m not saying SPACs are what’s going to turn around this bull market, but you can’t rule that out either. The SEC is making some noises about that.

David Muhlbaum: SEC, another acronym. This one’s familiar, for Securities and Exchange Commission, the feds, the government, the regulators. Okay. I got a headline, “SEC Spanks SPACs.”

Sandy Block: Okay. That hasn’t happened yet, but they have warned people about not being too wowed by the celebrity veneer being applied to these things. I’ll quote, “It is never a good time to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.” Basically, just because Shaq thinks it’s a good investment, doesn’t mean it’s for you.

David Muhlbaum: Or Sammy Hagar.

Sandy Block: Or Sammy Hagar. I’m dating myself here.

David Muhlbaum: Yeah. I was wondering what the Red Rocker had been up to.

Sandy Block: Well now you know, he’s raising money. Sammy’s is a businessman. Caveat emptor.

David Muhlbaum: When we return, we’ll look at the ups and bigger ups of today’s real estate market. Want to buy a house? Better be ready to move fast and write a nice note.

Welcome back to Your Money’s Worth. Joining us for our main segment today is Daniel Bortz, a contributing writer for Kiplinger’s Personal Finance. One of his latest pieces for us is a wide-ranging look at the real estate market, which is a particularly good topic for him because he’s also, get this, a licensed real estate agent. Welcome Daniel.

Daniel Bortz: Hey, thanks for having me, David.

David Muhlbaum: Daniel, you had your work cut out for you because you have to cover not only the significant demographic disruption that the COVID-19 pandemic had on real estate last year, but the ongoing flurry of activity. In 2020 sales of previously owned U.S. -homes hit their highest level in 14 years, and a lot of economists say this year is going to top that, and prices of course are continuing to rise.

David Muhlbaum: Since we’d like to be forward-looking here, we’re probably going to spend more time asking you to speculate about what’s to come. But to start, can you give us a quick recap on 2020? We had a couple of months of freak out and lock down and then, well, people figured out pretty quickly how to trade houses in the middle of a pandemic. What were they looking for?

Daniel Bortz: Sure. So, they were looking for two main things and they’ve been pretty well reported, so I won’t belabor them too much, but they’re quite real. At the top of the market, you have wealthy urbanites who didn’t have a second house in a more rural location. So they went out and bought one. And this happened in your traditional summer destinations, but also places like Bozeman, Montana and southern Vermont. So if you’re buying a home, that’s in a more rural location without too many people around, those were getting really snatched up by people that were living in cities.

Sandy Block: Yeah, I see that. As David and listeners know, I spend part of my time in West Virginia and I’ve certainly seen that happening. There were people from the DC area snapping up properties in the Eastern panhandle. So, the rich take care of themselves and I guess developers or anyone else with building lots, like the people on my street, are making out well too. But what about people in the less exalted areas of the market?

Daniel Bortz: Well, that’s the second thing that we’re seeing. So the motivations were similar, and so was the behavior. People were moving from densely populated locations. You’ve got the big cities and tightly packed suburbs and they were moving to the exurbs where they could have a bigger, more affordable house and be farther away from other people.

So the dollar values there were lower and so sometimes were the distances that they moved. The main difference was the really rich could always move, and what let these people move now, in these circumstances, was that they have the freedom to telecommute.

You have big companies like Twitter and REI and Square, they’ve announced plans to let their employees work remotely indefinitely. And there’s one recent survey that found a third of workers that they would quit their jobs if they couldn’t continue working remotely after the pandemic. Now, I don’t really think a lot of people would follow through on that, but it does show that a lot of Americans, they do really want to continue teleworking after the pandemic.

Sandy Block: Right. And I read recently that Ford is telling people they can work from home indefinitely if they have, obviously they’re not building cars, because I don’t think you can do that from home. So this is what’s driving the market a year in, even as maybe just maybe the end of the pandemic is in sight.

Daniel Bortz: That’s a great question. So here’s the general forecast for what we’re looking at for the rest of this year in terms of prices and inventory and mortgage rates. So for the economists that I interviewed for the article, the economists at redfin and zillow and realtor.com, they’re all forecasting modest home price gains this year, and that’s largely because mortgage rates are still historically low. They’re not as low as they were at the beginning of this year, but they’re expected to stay low.

The last time I checked in with the Mortgage Bankers Association, they told me that they were predicting rates will rise to just 3.4% for a 30-year fixed-rate mortgage by the end of the year. So relatively speaking rates are still going to be pretty great. Also, certain properties at the same time are not selling as well as other properties. You’ve got these condos and townhomes that are located in big cities and downtown areas.

Those are a little bit harder for sellers to move and mainly because people right now, with what’s going on with the pandemic, they want access to outdoor space. So if you are trying to sell a small townhouse or condo in, say, the middle of Washington D.C., And you’ve got no outdoor space, you have no backyard, you’re going to have a harder time selling that.

David Muhlbaum: So we have a seller’s market for the foreseeable future. What’s a buyer to do?

Daniel Bortz: The most important thing that they can do is to make what we call a clean offer. With so much competition among home-buyers right now, you want to be submitting an offer with as few contingencies as possible. That’s what’s going to really strengthen your bid.

David Muhlbaum: Cash is king!

Daniel Bortz: Cash is always king. Now it’s interesting, there’s a new, I think it was just released actually last week or maybe even this week. Redfin’s been tracking how many of their winning offers have gone up against other offers, and this time they found that six out of 10 offers that were written by their agents actually faced bidding wars last month in February. And that’s the 10th straight month where more than half of Redfin offers encountered competition.

Daniel Bortz: So in situations where you’re going up against a ton of other bids, you might want to consider waiving some contingencies. For example, you might forgo your right to home inspection. Now that is a risk that you take, especially when you’re buying an older home. So one strategy that we have, if you know you’re going up against other offers, is to perform what’s called a pre-offer inspection before you submit your offer.

So that’s where you’re going to come in, where you look at the house during a showing or an open house, decide you like it, and before you write an offer and give it to the seller, you’re going to hire your own inspector to sort of kick the tires on the house, take a look, see what’s working, see what’s not and decide for yourself if the house is in good enough condition that you’re willing to buy the property as is and then you can waive that home inspection contingency.

David Muhlbaum: I love the kick the tires analogy because it reminds me of checking out a car before you buy it. Yeah, but this has all got to happen pretty fast, right? I’m thinking anecdotally about literally the house next door to me here. The sign went up, coming soon, they had a few previews before the weekend open house and there was a contract on it by the end of the weekend, like boom, four, five days. So if you want to do one of these pre-offer inspections, you probably better have that person sort-of on contract with you, ready to go.

Daniel Bortz: Yeah, you need to have all your ducks in a row in that sense. Your agent is where you can really lean on for this. Your agent can connect you with a really quick, responsive home inspector. And since homes are selling so quickly, you want an agent who’s really tapped into your market. For example, two friends of mine, they recently purchased a house and they did a pre-offer inspection, but they were able to do that, like I think within the first hour that the property went on the market, because the seller knew when it was being listed. So they were the first people to get in there and they did their inspection right away, and they submitted an offer within hours. And even though they went up against, I think more than 10 other bids, having that home inspection contingency waive was what really gave them the edge. And so they won that house.

Sandy Block: Yeah. Dan, not to promote your license too much, but it sounds like in this kind of market, having a good real estate agent is... they earn their pay because you do need kind of an inside track on some of these deals.

Daniel Bortz: Yep. Absolutely. And something buyers should consider if they’re thinking about not working with an agent, they should remember that the buyer’s agents commission is paid for out of the seller’s proceeds when they actually go to closing and they sell their house. The buyer doesn’t actually, nothing comes out of their pocket in addition to what they’re paying for the house to pay their agents. So essentially, a buyer’s agent for a home buyer is free.

Sandy Block: So Daniel, what are some of the nonfinancial things that you can do? I’ve heard stories about people actually writing letters to sellers to try and get in it. Does that work?

Daniel Bortz: It does. So even with homes selling above list price right now, you really want to be tugging on the sellers’ heartstrings. And you could do that by writing a personal letter to the seller. This is a really old-school tactic that performs well in today’s market. Actually one of the sellers I interviewed for the story was a couple selling their home in Carmel, Indiana. It was about 30 minutes outside Indianapolis. They got five offers when they sold their house last December, and the winning offer was from a buyer who wrote them this really heartfelt letter that outlined their struggles of finding a home in the area. And it’s what really resonated with the sellers.

What we recommend is you can have your agent help you write a letter and the letter should be pretty short, no longer than a page, but just really speaking to what’s going to resonate with the seller and having that personal touch with your offer is what can potentially give you an edge over other buyers.

David Muhlbaum: Yeah. It might not hurt to do a little Google stalking on the owners too. So you can align your story with theirs. English majors, this is your chance! So, what guidance do you have for sellers, I mean, besides judging these essay contests?

Daniel Bortz: If you’re planning to sell your house, you want to do it in the first half of the year. Mainly because that’s going to help you beat an expected increase in supply. We’re going to see more homes coming on the market this year, later this year, as we go through the pandemic, as we continue to see vaccines being rolled out. You’re going to have more homes being listed and buyers are going to have a larger selection of houses to choose from. So you want to list your home kind of as soon as possible when supply is lower.

And another thing that you can do to really make your house, your listing shine and get top dollar for it is you’ve got to hire a professional real estate photographer to take photos for your listing. But what’s interesting is in addition to doing those photos, virtual tours, it’s also called 3D tours where buyers can basically walk through your home online. That’s really standard operating procedure right now.

Also, staging is crucial. If there’s no furniture for buyers to focus on when they walk inside your house, they’re going to see every little flaw. They’re going to see the scratches on the floor, they’re going to see the paint smudge on the wall. They’re small flaws, but they can really stick in a buyer’s minds later on.

Staging also, it costs money, but it usually offers pretty good return on investment. So professional staging costs on average $500 to $600 per room per month, but it really pays off. Staged homes, they sell faster and for more money than unstaged homes, that’s according to research by the National Association of Realtors. And some listing agents will even include staging services as part of their listing service.

David Muhlbaum: Yeah, that’s interesting because I think in a seller’s market like this, there can be a temptation for sellers to get complacent, to just be like, I’ll get lots of money, and not even sweep the garage out. But there’s a danger, I think of frankly, insulting your buyers if you don’t make an effort.

Daniel Bortz: I think that’s right. I think buyers, even though they know that sellers are in the driver’s seat right now, they still want to be working with a home seller that cares about their house, that kept their home in good condition and that wants to sell to a buyer who’s going to come in and treat their home as well as they did.

Sandy Block: So Dan, you talked earlier about mortgage rates and we saw this yesterday with Freddie Mac’s report, creeping higher. Let’s talk about that for a minute. Are we going to see them going up enough to sort of dampen the roaring housing market that we’re seeing?

Daniel Bortz: So if things continue on the path that they are right now, they’re going to increase this year, certainly, but they’re not going to price home buyers out of the market. Essentially, you’d have to see significant interest rate hikes for that to happen. We’re talking mortgage rates for 30 or fixed mortgages going well over 4%, which is not likely to happen by the end of this year even.

Sandy Block: Well, as an old person, 4% to me still seems really cheap. It was 5% for years and I’m old enough to remember when it was over 10. So yeah. I think you make a good point, it’s still a pretty good deal.

Daniel Bortz: Yeah. I mean, historically it’s interesting, like you said, mortgage rates 20 years ago were sky high compared to today’s rates. But for instance, my wife and I, we just closed on a beach house that we bought, not to brag, but we were able to get a 30 year fixed rate mortgage at 2.625%, which is just crazy.

Sandy Block: That is crazy. Awesome, congrats.

David Muhlbaum: We’ll be over. Now, one thing I wanted to touch on also is: All of this activity is really one thing to pay attention to if you have the intention of buying or selling a house, but it could also have an effect if you’re sitting in one without intending to move, and you’re seeing your home equity going up and up and up. What are people doing to tap into that?

Daniel Bortz: So like you said, you have homeowners who are staying put. They’re sitting on a lot of home equity right now and what a lot of people are doing is they’re taking that money and they might be getting a cash-out refinance and then using that cash to make renovations to their house. And some of them are doing this just to kind of improve their own enjoyment of their property. They might be adding on screened-in porch so that they can spend time outside in the summer without having bugs get at them while they’re eating dinner. But you also have people that are still always sort of laser-focused on their return on investment and people who are making improvements that are going to actually have their home sell for a significantly higher amount of money in a few years.

Sandy Block: And actually, that’s a good promo because we are working on a story for an upcoming issue on the types of home improvements that add the most to the value of your home. And some of them are kind of surprising. Like I think number one was like a new garage door or something like that. But, the lowest cost with the biggest value. But I know that’s going on, guys, because as we are recording this, if you hear any ambient noise, it’s a house two doors down from me is just putting on a great big addition and replacing their siding with brick or something like that. It looks very expensive and it’s been going on and it’s really loud.

David Muhlbaum: Oh yeah. Just before we started out, I heard beep, beep, beep. I thought, Oh my God, here we go. I looked out the window and sure enough, someone’s rolling a dumpster into the driveway. I’m like, okay, going to have to find out what’s going on down there. There is a lot of rebuilding happening and yeah, I presume that’s a lot of that’s happening with HELOC money, home equity line of credit.

Daniel Bortz: Yeah. Sandy, I hope the construction crew doesn’t get started too early in the morning.

Sandy Block: It’s early enough.

David Muhlbaum: There are a lot of local laws about that sort of thing.

Sandy Block: Yeah, well, I don’t see any cops on the street. I just see a lot of saws and construction trucks.

David Muhlbaum: Yeah, well, it’s them versus the leaf blowers. All right, Dan. So what could stop this juggernaut? We think mortgage rates are going to stay okay, but anytime the real estate market is doing gangbusters, a lot of us think back to the mid 2000s and we get a little edgy. This time is different?

Daniel Bortz: So, unlike during the last recession when we had the housing crisis, today’s buyers are extremely well qualified for mortgages. They are vetted top to bottom, they have to provide a ton of paperwork just to get pre-approval. Buyers can’t really make offers on homes until they have a pre-approval letter from a mortgage lender in their hands.

David Muhlbaum: So everyone’s getting sniffed over so well that we’re not really headed for the credit quality crisis that we had back then?

Daniel Bortz: No, definitely not.

Sandy Block: But still to David’s question, what would slow things down? If it’s not a credit quality issue, what do you think could, not necessarily put on the brakes, but make this not so crazy?

Daniel Bortz: I think as we see rates continue to tick up, we’re going to have some buyers who might put themselves on the sidelines again, especially younger home buyers. There is that frenzy right now that they want to lock in a rate around the magic 3% number. And in fact, if the mortgage rate for 30 year mortgages goes significantly higher than that, I think you might see some buyers pull out of the market.

David Muhlbaum: Well, there’s nothing wrong with a nice calm ending to a run-up. It sure beats the alternative. Thanks very much for joining us today, Dan, we appreciate your insights into this market and I hope you enjoy the new house.

Daniel Bortz: Thank you.

David Muhlbaum: We started out today talking about investment options that are speculative, and we’re going to close by talking about gambling straight up, being in the middle of March Madness and all. Now, I must confess that while I don’t pay much attention to spectator sports, I pay even less to gambling. I just missed those genes or something. But what I have noticed is that plenty of people who don’t necessarily know much about NCAA basketball are perfectly happy to fill out a bracket and throw $10 or whatever into the pool.

Sandy Block: Oh yeah, for sure. I mean 11 months a year, I don’t do any sports gambling and my mom used to say about basketball that you could get it all by watching the last two minutes. But come March, I am all in. And this year I really miss the whole thing where someone comes around and picks up my sheet and my money and then we have whole weeks of gloating or moaning in the office kitchen about how our brackets are doing and how there were these big upsets. And since I always put West Virginia in the final four, which hasn’t happened in a long time, I never have to worry about winning or paying taxes on my winnings. It’s just a social thing.

David Muhlbaum: Right, social. I get it, even if I don’t do it. You mentioned taxes though, and that’s the personal finance angle here. In theory at least, if you won your pool, you don’t owe taxes on that.

Sandy Block: You’re right. In theory, gambling winnings are taxable income.

David Muhlbaum: But in practice?

Sandy Block: Not so much. Now, I’m not here to say you shouldn’t report it if you won big in your bracket pool, and God knows we’re not in the business of telling people to cheat on their taxes. But as far as I can tell, there aren’t a lot of people putting their bracket winnings on their 1040s. And I haven’t heard anything about the IRS pursuing people for under-reporting their brackets. The agents might be too busy worrying about their own brackets.

David Muhlbaum: Well, okay. There’s a national mania for you I guess. So fine, a little fun money with friends, whatever, but the legal sports gambling industry is very much on the rise these days. I hear radio ads and such all the time and they too, they’re looking to cash in on basketball betting. People who are experienced sports betters, they presumably know the drill when it comes to gambling, winning, losing, and the taxes on that. But I’m just wondering about people whose office pool got canceled this year, maybe because they’re literally not in an office anymore and who are neophytes to online gaming, if they’re going to be in for a surprise if they play — and win — and then next January get a form from whatever site they used, which is basically the gaming site telling them and the IRS exactly how much they won.

Sandy Block: Well, yeah. You can do all sorts of March Madness stuff online at the gaming sites. And I’ve seen those commercials too; they’re ubiquitous. You can try to do the traditional brackets and the payouts, they could be huge. Or you can get in during the tournament, busted brackets, round by round, all sorts of stuff. But here’s the deal. If you win more than $600, generally you will get a W-2G form, which is what you mentioned earlier, David, maybe now, maybe later. And yes, you’d be an idiot as well as a cheat if you don’t report that income and pay taxes on it because the IRS gets it too.

Sandy Block: But also if you win really big, generally, if you win more than $5,000 on a wager and the payout is at least 300 times the amount of your bet, the IRS requires the payer to withhold 24% of your winnings for income taxes, just like a paycheck.

David Muhlbaum: And the actual rate will be whatever your income turns out to be once you’ve considered all the other lah-di-dah and income.

Sandy Block: You could owe more than that.

David Muhlbaum: More or less. Yeah, and maybe the state too?

Sandy Block: Well, that depends on the state.

David Muhlbaum: I thought you didn’t gamble on sports, or at least you didn’t win at it.

Sandy Block: I don’t, but I know taxes!

David Muhlbaum: Okay, fair enough.

And that will just about do it for this episode of Your Money’s Worth. If you like what you heard, please sign up for more at Apple Podcasts or wherever you get your content. When you do, please give us a rating and a review. If you’ve already subscribed, thanks. Please go back and add a rating or review if you haven’t already, it matters.

To see the links we’ve mentioned in our show, along with the other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date, and if you’re still here because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

Subscribe FREE wherever you listen:

Listen Now:

Subscribe FREE wherever you listen:

Links and resources mentioned in this episode:

• Kiplinger's Inflation Forecast
• Sidehusl
• Unemployment Tax Break: Don't Amend Your 2020 Tax Return to Claim the New Exemption
• Taxes on Unemployment Benefits: A State-by-State Guide

Transcript

David Muhlbaum: The side hustle. Originally, it was something you did in addition to your main job. Increasingly, people are patching together side hustles to be their primary income. Kathy Kristof, who runs a website that helps people find good gigs, joins us to talk about the changing field of contract employment. Also, are you afraid of inflation? Or would you rather not talk about that? All coming up in this episode of Your Money’s Worth. Stick around,

David Muhlbaum: Welcome to Your Money’s Worth. I’m Kiplinger.com senior editor David Muhlbaum, joined by my co-host, senior editor Sandy Block. How are you doing Sandy?

Sandy Block: Hi, I’m doing great.

David Muhlbaum: Excellent. I want to start out talking about something and whether we should be talking more about it. I know that sounds a little bit cryptic. So here’s the topic in question: inflation.

Sandy Block: Like the economic topic, not tire inflation, which is what you tend to go on about at great length.

David Muhlbaum: Yeah, right. I could do tire inflation and how you need to check pressures with a gauge, even though cars have TPMS, but no, I mean inflation in the U.S. economy, the general increase in prices and fall and the purchasing power of money.

Sandy Block: Ah, okay.

David Muhlbaum: Yeah, well I’ve heard that reaction before. In truth, not everyone here at Kiplinger agrees inflation is a good topic to talk about on a podcast. In part, because while it’s both real and can affect everyone, there’s not a whole lot we can do about it. And some people think it’s boring.

Sandy Block: Except for inflation hawks.

David Muhlbaum: Yes. Inflation hawks, closely related to the deficit hawks we talked about earlier this year. In fact, these two creatures share a lot of DNA, and they’re both squawking these days, but I’m going to stop now and say, dear listener, this is supposed to be a two-way street. We spend a lot of time stroking our chins, deciding what to feature each week on this podcast, but you can let us know, too. We’re on Facebook, Twitter, Instagram, and of course, good old email, podcast@kiplinger.com. So, do you want us to do a full-length feature on inflation risks with a guest? An interesting one, I hope. Speak up! In the meantime, we’re going to take a quick crack at it anyway. And so you can also write us and say that was enough, or too much, no more on inflation, thanks.

Sandy Block: Or just say hi, or suggest something entirely different. But inflation, then, it’s a staple of the Kiplinger Letter. They can’t avoid the topic, what with having to put out regular economic forecasts.

David Muhlbaum: Exactly. They’re stuck with it, but even so, we’re in a time of heightened inflation talk, as the Letter laid out last week. And no, I didn’t say we’re actually in a time of inflation. We’re in a time of inflation fear. The fear that in the future, prices will start rising and cutting the ability of people, particularly those on fixed incomes to afford things, and making it hard for businesses to plan, and devaluing investments, bonds in particular. That’s what people are afraid of with inflation.

Sandy Block: Right. And in fairness, a lot of the conditions that can set off inflation are in place. I’m harking back to my econ classes, and these things would all be written on the blackboard. Government spending, as we’re seeing with another round of economic stimulus. Another big factor is pent-up demand. People coming out of lockdown, itching to spend on everything from meals to travel, to haircuts, to clothes for the office. But just because inflation could happen, doesn’t mean it will.

David Muhlbaum: Maybe part of the reason that inflation danger draws so much eye-rolling is that these warnings, they’ve been sounded so many times before, and yet over the last dozen years or so, it’s been deflation, falling prices that’s been the bigger risk.

Sandy Block: Right. Now I’m back to Econ 101.

David Muhlbaum: Yeah. I brought in another term. I’m sorry. I’ll wrap this up by doing my best to summarize the Kiplinger Letter’s take then. They agree that the ingredients for inflation are in place now, and they think inflation will rise enough for consumers to take notice. In part, because we measure prices by where they were a year ago. And frankly, last year, in 2020, things were weird. I mean, think about the price of gas during the pandemic, but the letter editors, they have faith that the Federal Reserve, whose job it is to keep inflation in check can get it from getting out of hand.

Sandy Block: Right. And Federal Reserve head Jerome Powell is testifying in front of Congress as we speak.

David Muhlbaum: Yeah, you’re correct. I will try some listening instead of more talking. But as we said, if you want us to come back and wrestle with inflation fears some more, we might. Let us know. When we return for our main segment, we’ll talk about the gig economy, how the pandemic has changed it, and a key way to find good jobs in it.

David Muhlbaum: We’re back for our main segment with another Kiplinger alumna, Kathy Kristof, who might be familiar to some of you for her Practical Portfolio series, where she put her own money to work trying to beat the market, and she brought us along for the ride. But her main endeavor for the past few years has been a company called SideHusl. And that’s spelled S-I-D-E H-U-S-L because, well, this is the internet. SideHusl, no T and no E around the L. It’s a site that helps people find and vet gigs. And we’re going to talk about how it’s doing, but Kathy, as with so many things, we want to talk about pandemic effects. And so what would you say are the biggest changes the corona economy has had on the gig economy? Maybe you could give us one good and one bad.

Kathy Kristof: Well, it’s eliminated certain types of jobs, jobs in entertainment and travel, pretty much just disappeared over the past year. And then meanwhile, jobs in delivery, shopping for other people, all sorts of artistic gigs went absolutely nuts, which is fun. All sorts of people who basically were out of work because of the pandemic ended up using their free time to do some crafty thing. And I’ve talked to people who not only replaced their previous income, but made hundreds of thousands of dollars because they somehow connected with people who wanted their t-shirts that were maybe mocking the pandemic or that were connecting to a particular group or people who make puzzles, puzzles were giant during the pandemic. So you think about millions of people stuck at home and getting sick of Netflix. And so now you create a product for them to hang out with their family.

So it changed the world. And I think it also made people way more aware that even stable jobs are not quite as stable in the real world. And so we saw a giant increase in interest in side hustles, our site traffic doubled over the course of the year. And it’s kind of maintained that.

David Muhlbaum: Wow, that’s impressive. The delivery thing, well, I knew about that. The games and design, frankly, I didn’t. And so you’re able to see what’s happening, not just by site traffic, and congratulations on that. But I presume also by categories, you’re having to add categories of things that are side hustles that weren’t before.

Kathy Kristof: Oh yeah, yeah. And the online tutoring platforms have gone absolutely gangbusters, as you probably are not surprised, right? Because distance learning has really failed kids. So parents, and particularly now as more and more school districts are talking about going back to in-person learning, and you have testing, and a lot of kids, you just would call the last year, a lost year for them. And so now they have to catch up. And so again, the tutoring platforms that were gangbusters at the beginning of the pandemic are again gangbusters now, because again, you realize, okay, we got to catch up, we got to get back to something that’s close to our grade level.

Sandy Block: So Kathy, why don’t you tell us a little bit about what SideHusl does and how it sort of helps people who are interested in gig jobs particularly now, because maybe they need the extra income, just maybe a little bit about what you do.

Kathy Kristof: Sure. Well, it kind of helps to tell you how I started. I was reporting as a freelance reporter, and I was writing for all sorts of different publications, including Kiplinger and Reuters and whomever, CBS News. And I was constantly getting pitched by these companies that were purporting that they were onto some new way to make money in the gig economy.

David Muhlbaum: The Uber of so-and-so.

Kathy Kristof: Oh yes, everything was the Uber or the Airbnb of whatever it was. And so I started digging in, as a reporter will do. And I wanted to just get more detail, of how much money do you make, and where is this available? And what are the risks? What are the rewards? All that stuff, what are the parameters? You get their answers. And then you read the terms and conditions, because I’m actually a reporter. And when you read the terms and conditions, what you realize, first of all, is this whole industry, this whole gig economy is unlike a normal employment arrangement like with normal employer/employee relationships, where you’re governed by labor law. With side hustles, you’re governed by contract law. And so if it’s in the contract, if it’s in the terms and conditions, they can do almost anything. And there’s no disclosure requirements. So people get into these gigs, and way later they find out, oh, guess what? It’s totally like a credit card deal.

So you build up points with a credit card arrangement. You think you have $500 built up in points. And then the credit card company says, “Oh, you violated our terms. We’re taking away that $500.” And that’s what they’re doing with people’s income, or some of these platforms were doing. And so I was horrified. Because I’m like, first thing kind of seduced by this thing, I think is kind of cool. You have a lot of freedom, like whatever. And then when you start reading the terms, again, on the surface, you can’t tell the difference between a great side hustle and a bad side hustle. And that’s when I decided I had to create, because I was gathering information just for my own edification. And then I thought, “Oh my God, people need to know this.” I mean, these two online platforms that supposedly give you the same opportunity, one is really good, and one is abusive, and people wouldn’t naturally know that.

And so that’s what I started doing is just trying to create a standard format like you would have when you wanted to buy a mutual fund, so that you could actually go this is what the performance has been. This is the risk, this is the rewards. And so that’s what I was trying to do with SideHusl is just to have a really standard format. This is what the job is. This is what you should expect to earn. This is the commissions and fees taken by the platform, where it’s available, what the requirements are, just basic information. And then we do a review that takes all that stuff and we give it a Husl$core, which is our best evaluation of how well this serves a freelancer. And over the past, it hasn’t been quite three years, but almost three years since we went live, we have 350 online platforms, research reviewed and rated. And we add more every week, we added six last week, it’s an ongoing process. And we’ve just, this is the tip of the iceberg. I mean, this is just a giant and growing part of the economy.

And where like the bad things are that there are some of these platforms that are really abusive, one of the good things is that there are also platforms that are awesome. And there’s so many opportunities. There’s so many opportunities for kids who are in deep debt, and for retirees who didn’t save enough. I mean, everybody can find something that they can do to earn money, which is really, really cool. And then, just on what we do, the thing that really makes me happy is over the past year, I’ve started getting emails and complaints and threats from companies that we have reviewed poorly, because we are showing up in search results, very high in search results, and they’re pissed off. And so I get to say to them, and in some cases this actually had an impact. I say, “Well, if you want a better review, be better to freelancers. Do a better job.”

Sandy Block: Well Kathy, let me ask you this. Because I don’t think, obviously you are reviewing these gigs, these outfits, and you’re not paid by them. So how does your venture make money?

Kathy Kristof: Well, advertising, like a typical, independent publication, we run ads on the site. They’re unrelated to us. Frankly, it’s all Google AdSense. We’re syndicating our copy. We also make money from that.

Sandy Block: But you don’t get paid for good reviews.

Kathy Kristof: No, no.

David Muhlbaum: Let me ask you another sort of industry at large question, if I might, which is, you’re noticing through SideHusl all these new companies and all these platforms and you’re reviewing and making categories for and describing, are you seeing any sort of consolidation, where essentially the big fish are going to start eating up the little fish, and the platforms are going to become more like the way things have gone down in say, online retail?

Kathy Kristof: Yeah, absolutely. There’s already a certain amount of consolidation. There’s a huge amount of movement in this burgeoning industry, as I think is true of almost any young industry. You see a lot of companies starting, and a lot of companies failing. A lot of companies that have done pretty well, getting eaten up by a bigger competitor. Some of that’s good, some of it’s bad, but yeah, it’s a dynamic market. And our goal is to review pretty much everything that’s widely available, and then go international.

Sandy Block: So you’re scaling up too. Well, Kathy, sort of following up on what you just said, given how this industry is so dynamic and so changing, have you had to alter or change your rating system, or any updates or new considerations when choosing and vetting a side hustle, just given how much things change in this business?

Kathy Kristof: Yeah, no, our rating system, it’s not an algorithm. It’s an individual rating system. And that allows us to pay attention to what the competitors are doing in that particular industry. And so you may, say if you’re in online tutoring, which is a pretty good job for your average side hustle, right? Because you can do it from home, you earn a decent amount of money, you can set your own hours. You can choose your own topic, all those things. But because online tutoring is generally a pretty decent side hustle, now, even if you’re a little bit off of what the standard is in that industry, we can rate you against the standard in that industry. And so you don’t want to have all the tutoring sites be way up here on the ratings scale, and all, say the driving and delivery way down here because you’re using your own car and using your own gas. So you get a relative rating as well. So it is complicated, but we think it’s fair.