Five Minute Finance

With the advent of the index fund in the 1970s, the battle began: actively managed funds versus passive index funds. Which belongs in your investment portfolio?

Actively managed funds have people responsible for deciding which companies to invest in and include in the fund. These funds will typically have a strategy to invest in a certain sector or style such as US large-cap growth companies or emerging market companies. 

Passive funds, on the other hand, use rules that define which companies to include in the fund. Examples include the S&P 500 (500 largest US companies) or the Russell 2000 Index (the smallest 2,000 companies in the Russell 3,000 index). These funds typically have very low ongoing expenses since no one is employed to actively research and make investment decisions.

This obviously begs the question: which is better for your investment dollars?  The research is in: the chances of you picking an active fund that outperforms a passive index is very small. In virtually every category of public investments, the index funds outperform a majority of the actively managed funds.

Investing in low-cost index funds has other benefits as well:

1. You don’t waste time researching which manager to pick
2. You don’t worry about a year of underperformance and if you should switch managers
3. You can automatically add funds each month with no ongoing effort

It’s comforting to know that you will not only make more money over time but also spend less energy using passive index funds. Not often in life do we get such a win-win scenario.

Other topics discussed include:

• Should you pay a wealth manager or financial advisor to “actively” manage your portfolio?
• Are there scenarios where you recommend using actively managed funds?
• Why do so many people still invest in actively managed funds?

Resources:

• SPIVA Reports

The majority of advice online is too generic to take seriously for your personal finances. The 60/40 portfolio (60% stocks and 40% fixed income) is used in academic research and might be the median portfolio for retirees - but that doesn’t make it appropriate for you.

How should you construct your own portfolio for now and the future? Think about when you are going to spend your money and divide it into three categories:

1. 1-2 years: Invest this in CDs, checking/savings accounts or money markets
2. 3-7 years: Invest in a mix of bonds (or a bond fund) 
3. 7+ years: Invest in stocks

I recommend taking out a piece of paper, dividing it into 3 sections and write out the actual dollars you might spend in each section, beyond what your income will cover.How might this apply to you? 

1. If you are young, just starting your career maybe you want $30k for a home down payment (1-2 years) and the rest is for retirement (7+ years)
2. Middle career with a young family: Maybe $50k towards college costs (3-7 years) and the rest for retirement (7+ years)
3. Near or in retirement: Living expenses (1-2 years and 3-7 years) and the future (7+ years).

The point is: apply this to your situation with actual dollars. At that point you can figure out the percentages in each category: stocks, bonds and cash.

Resources:

• Which Accounts Should I Fund First?
• How to Create a Paycheck in Retirement

As Independence Day approaches, it makes me think about all of our freedoms including the choice to make work optional. It’s a modern convenience, to be sure: retirement is a very modern idea.

The interesting thing about financial independence is that it leads to other freedoms. Not only can you choose how to spend more of your time, you can speak your mind without fear of being cancelled. Ever notice how older friends tend to “tell it like it is”? As we gain wisdom, and freedom in life, we are more free to be ourselves in all things.

What does it take to become financially free? Consistently saving and investing throughout your career. I recommend that everyone reach a savings rate of 15% of your gross earned income. If you can start that with your first job, you will easily adopt a lifestyle to live on the other 85%.

Everyone’s road to success is different, but knowing you are on the right track will help you stay consistent. One rule of thumb is that your retirement portfolio will need to be 25x your yearly expenses (not including social security and other pension income). This is only a starting point. And realize that the road to 25x starts slowly, but compounding will kick in heavily at the end.

This weekend make sure to celebrate all of life’s freedoms. 

Resources:

• How much should I have saved towards retirement?

Bitcoin and other cryptocurrencies are all the rage. But should you invest your money in them?

I recently received this listener question:

“There is a lot of talk going on about Bitcoin and Dogecoin. Are they good investments?“

Bottom Line Up Front: I do not currently recommend putting money in cryptocurrencies, because it would be mostly speculation and not investing. Realize that if you do not participate there’s a good chance of FOMO with the constant news and watercooler discussion (is that still a thing?)

Julie and I discuss the following:

• A well-diversified, low-cost index fund portfolio will serve you well. There’s no need to speculate with cryptocurrencies.
• Realize if you put money into Bitcoin, it’s not an investment, but a speculation. There are no fundamentals - you are hoping that someone else will pay more in the future. The entire value right now is an implicit societal agreement that it’s worth something.
• Cryptocurrencies are built on the Blockchain. This technology is a massive breakthrough and will be heavily used on the internet. Speculation in crypto is not an investment in Blockchain.
• Bitcoin and other crypto assets are not currencies: they are too volatile. Currency exchanges do fluctuate, but not that fast. And when they do, it’s not a good sign!
• There are a lot of risks with putting money into cryptocurrencies: Regulatory, Security, Insurance, Fraud, Market and Liquidity.  Be aware.

Resources:

• Larry Sweadroe discusses his view of investing in crypto at the start of this podcast. 

Find out more about Mike at https://www.mortonfinancialadvice.com and connect at https://www.linkedin.com/in/mwsmorton/

Inflation is all over the news: it’s a scary subject encouraging you to read more headlines. But how should you actually prepare your investment portfolio for potential inflation? As always: it comes down to planning.

If you have a well-diversified portfolio of stocks and bonds then there’s good news: you can do nothing. Be ready to make adjustments as those investments go up or down, as you typically rebalance. 

There are two potential action items below, but first let’s consider:

• Gold: It’s not a given that gold does well in inflationary environments. I don’t typically recommend gold because its long-term returns are fairly average and well below stock returns.
• Crypto: Is this the new “store of value” and replacing gold? Not with all the current volatility.
• Commodities: They typically will rise ahead of inflation, and we’ve seen that over the last 12 months. Will they continue to climb? Unknown.
• Real Estate: Your home is a great investment during inflation periods because you have a fixed-rate mortgage where dollars are worth less in the future. REITs and rental properties might increase in value or not, depending on increasing rents which are not always guaranteed with inflation

Two areas to consider making changes:

• Refinance your Mortgage: If you can borrow more or refinance at today’s low-interest rates, that could be a good idea when inflation kicks in. The fixed dollars that you pay back 5 years from now will be worth less than they are today.
• Short-Term Bonds: If rates rise, as is often the case during inflationary periods, then bond prices will fall. Stick with short-duration bonds that get reinvested more often.

Find out more about Mike at https://www.mortonfinancialadvice.com and connect at https://www.linkedin.com/in/mwsmorton/

How can you create a financial plan before you know where to aim? Your unique goals in life, what drives you, what you want to accomplish and what’s truly important - those are the targets. Not simply “retire someday”.

You don’t have to read a ton of self-help books or try to discover this on your own. There is a process that has been refined by the Kinder Institute of Life Planning to help individuals and couples discover their most important desires and how to live the best life possible.

Brad Tafoya is a Registered Life Planner and joins the podcast to discuss this process and how you can apply it yourself.

Our discussion includes:

• Why the process of figuring out what is truly important to you comes before the technical stuff: budgeting, accounts, portfolios, investing, etc.
• When you discover what fulfills you, it creates massive energy that empowers you to effect change in your life.
• The 3 questions that are at the core of the process for discovering what truly matters to you
• How to use what you discover to create a vision and overcome obstacles

This is financial planning done right. 

Resources:

• Kinder Institute of Life Planning
• Life Planning For You

Find out more about Mike at https://www.mortonfinancialadvice.com and connect at https://www.linkedin.com/in/mwsmorton/

Congratulations! As you approach retirement, your investment portfolio has grown to a size that you suspect you’ll be fine to stop working and live the good life. But…. how do you actually generate income from those retirement accounts?  And how should you invest now that you’re so close to retirement?

I use a bucket strategy to talk about investing in retirement.  There are three mental buckets:

1. CASH: This is money you need in the next 1-2 years. It should be held in cash or money market accounts and ready to spend.
2. INCOME: This money you will want to spend in years 3-8. It should be invested in a mix of bonds to keep up with inflation, but not lose much value in a volatile market.
3. GROWTH: This money you’ll want to spend in 8+ years and can be invested in a well diversified portfolio.

How do you decide how much you need in each bucket? Simple: Calculate your expenses for each year and then subtract any income (social security, pension, etc). Total years 1-2 for the first bucket, 3-8 for the next bucket and the rest is for the third bucket.

After all the calculations, you should be left with a mix of cash, stocks and bonds to invest your overall portfolio.

Find out more about Mike at https://www.mortonfinancialadvice.com and connect at https://www.linkedin.com/in/mwsmorton/

You don't often think of a retirement account for your children, but the Roth IRA is too appealing to pass up. Once you get money into a Roth IRA, it grows tax-free forever, which is a very long time for a young child!

Megan Russell from Marotta Wealth Management joins me to discuss the myriad of benefits of this amazing account.

Tips covered in this episode include:

How Young?: You can start this anytime that your child can independently do tasks that you're willing to pay her for. You can open up a Roth IRA for any age child and contribute any amount (yes, as little as a $1!)

Earned Income: Your child has to have earned income to contribute to a Roth IRA. That income can come as a household employee which has a lot more relaxed rules from the IRS. All those chores that you already give your child can count.

Keep Records: The IRS can be a stickler for records, so make sure that you keep track. Record when the job was done, how long it took and how much you paid. File that spreadsheet along with your regular tax information each year.

Contributions: Do you think your child will contribute the money that you gave him to his own IRA or spend it on candy? The parent actually wears two hats: the employer gives money to the child (who is going to spend it!) and the parent gifts money to the child who puts it into his Roth IRA (of course, you can transfer it directly).

Other topics include:

• What it takes to actually open the Roth IRA (custodial account)
• What investments to choose in the Roth IRA
• Benefits beyond contributions - such as your child learning about money, investing, working, etc
• Tax implications (none if your child makes less than $1,100 from all sources)

Resources

• Marotta On Money
• Megan Russell
• Do Children Need to File a Tax Return to Fund Their Roth IRA?

Find out more about Mike at https://www.mortonfinancialadvice.com and connect at https://www.linkedin.com/in/mwsmorton/

Yes, you can turn $3,000 into $50 million dollars. What's the catch? It takes a long time. So, unfortunately, you won't be around to spend it. But this is a great way to think about setting up your kids or grandkids for long-term financial success.

It's really simple math that relies on compound interest to generate significant growth over many years. The basics:

1. Invest $3k into a Small Cap Value Index Fund when your child is born.
2. Assume 12% growth of that fund (which is the historical average for the last 100 years for SCV funds)
3. As your child has earned income, slowly transfer the account balance to her Roth IRA to grow tax-free forever.
4. At age 65, your child now has a balance of $4.75m.
5. She starts taking out 5% / year from the account and it continues to grow at 12% / year.
6. When she dies at age 95, over the last 30 years she has taken out and spent roughly $20m (5% / year) and the balance is $30m = $50m

Ok, does that seem far-fetched? Well, it could have easily happened over the last 95 years (if there had been a small-cap value index fund in 1926!

There are a number of ways to think about this for your own life:

• Invest some amount, whatever you can afford, for your child or grandchild. Let it ride for a long, long time.
• This could be for their retirement, or for a home down-payment or something else.
• Think about setting aside a small amount each month for something "down the road" for your kids, or grandkids.
• Invest in a single stock when a child is born for their high school or college graduation gift (whatever it grows to!)

The point is the earlier you can invest, the more compounding kicks in. The longer the child can stay invested, the more compounding works for them.

Resources: This post is inspired by Paul Merriman's fantastic work on this topic. Check out his entire site for great investing resources.

Find out more about Mike at https://www.mortonfinancialadvice.com and connect at https://www.linkedin.com/in/mwsmorton/

If you are thinking about investing in individual company stocks, what should you consider? In today's episode we discuss:

• Risk versus Reward: A company that does well has the potential to have its stock price go up over time, making you a lot of money. However, the opposite is also true: you can lose all your money if it goes out of business.
• Diversification: Owning a single company makes you tied to their individual success or misfortune. Even if the sector or economy does well, you may not make money.
• Portfolio: You can create your own portfolio using individual stocks - but it takes quite a few (20+) to get real diversification. Or you can invest a majority of your portfolio into low-cost index funds and use a small portion in individual stocks.

What are the pros of owning individual stocks?

• No trading fees
• Complete control: own exactly what you want to
• Tax management: Buy and sell for tax advantages, when you want.

What are the cons of owning individual stocks?

• Diversification: it's harder to diversify your holdings
• Time: it takes time to monitor your portfolio
• fees: there are trading fees including spreads
• Emotions: It's hard to not get carried away by emotions when evaluating your stocks

Ultimately it's up to you to decide if you want to invest in individual stocks. Just make sure you understand the risks and go in with eyes wide open!