You Know Enough About Investing to…Still Mess Everything Up (S3 E2)

Transcript

I love speaking with investors who have dedicated themselves to fully understanding their personal financial situation and are taking actions accordingly. As you’ve heard me say over and over on this podcast, managing your investments should be pretty easy, and when you realize this, it can be empowering. However, before you declare yourself the hero of your own adventure, you better make sure you fully understand everything you are doing. Because if you aren’t careful, you may end up winning the battle, but you could still lose the war.

Welcome to the third season of Invested Poorly: Sad Tales of FInancial Fails, now part of the Bold Departure Network. Invested Poorly is a short-form podcast designed to help everyday investors make wiser investment decisions by learning what NOT to do with their money. Host Jeff Harrell shares timeless stories from his former life as a financial advisor, about the poor—and irrational—choices he witnessed investors make that disrupted their journey to financial independence, or FI. Your ability to recognize, and avoid, similar mistakes could make all the difference for you along your path to reach FI.

Check out the “Introduction” episode for more background on Jeff, why he created this podcast, and how it can guide you to becoming the hero of your own investing story. Now, on with the show.

This episode is going to be packed with information on common investment strategies investors use but find a way to mess up. Brace yourself because I have a feeling that after this episode you are either going to feel really good about how you are managing your investments, or you may now have a major homework project.

First, all my listeners know by now that I’m a huge advocate of index funds. These can be bought in the form of mutual funds or ETFs. Either way, you can’t go wrong, as the differences are real but relatively insignificant for most investors. However, what isn’t insignificant are the potential fees involved with purchasing index funds. It is very common that when investors learn about low-cost index funds, they gravitate towards Vanguard mutual funds and ETFs. Again, this is 100% appropriate and I fully endorse this decision. However, things can go horribly wrong at this final step, because what you decide to buy and where you decide to buy it makes a huge difference.

For instance, if you buy the Vanguard Total Market Index mutual fund, symbol VTSAX, at Vanguard, they won’t charge you any additional fees. But if you buy the same mutual fund at Schwab or Fidelity, they will. Although the fee varies based on numerous factors, the point is, there is a fee to buy this Vanguard mutual fund at another institution, and under no circumstances does this make sense.

Instead, if you want to buy the Vanguard Total Market Index at Schwab or Fidelity, you should buy the ETF version, symbol VTI. There are no transaction fees for buying this fund, VTI, at either location, or at Vanguard for that matter. This is extremely common nowadays because most large brokerage firms charge nothing for stock and ETF trades, but they may charge fees for mutual fund trades outside of their own. So the first takeaway from this episode is to make sure you aren’t paying unnecessary fees if a similar, nearly identical, investment option is available without a fee.

Another oversight I often see investors make involves the final step of investing, which is actually placing a trade. I see people sign up for their company retirement plan all the time, start deferring money into the plan, but then fail to set up the last step, which is to actually invest the money. This can almost always be done automatically, so please don’t forget this final step.

On a similar note, many of you may be familiar with the strategy of using your Health Savings Account or HSA as an investment account. If you are unfamiliar with this strategy, be sure to check out my link in the show notes for an HSA article from The Mad FIentist. His explanation of using an HSA as a retirement account is one of the best I’ve ever read. The Mad FIentist has a ton of great blog posts and podcasts for those seeking financial freedom.

Now, as powerful as this HSA strategy can be, the final step is the most crucial. Make sure you invest the money. Sometimes this can be a little difficult depending upon where your HSA is located, so you will have to figure this part out on your own. But point number two of this episode is to make sure after you get your savings into the appropriate account, such as a 401k or HSA, don’t forget to invest it.

Another common oversight I see investors make all the time is failing to reinvest dividends and capital gain distributions from the mutual funds, ETFs, or stocks they own. Failure to do so will result in cash building up over time, which will likely result in lower returns. This can easily be prevented by setting up your investments to automatically reinvest dividends and capital gain distributions when you first purchase them. Usually, it is as simple as checking a box when you place the trade.

So, unless you are 100% sure you already have this in place or use another strategy to invest your idle cash, it might not be a bad idea to review your accounts immediately after listening to this episode, to make sure all your investments are set up to automatically reinvest dividends and capital gain distributions.

The next item I want to address is the Backdoor Roth IRA. In case you are not familiar with this strategy, I’ve included an article from Morningstar in the show notes. Put simply, the Backdoor Roth IRA is a way for high income earners to gain access to a Roth IRA despite having income in excess of the income contribution limits. The commonly missed step with this strategy is the failure to “clean up” your old IRAs before starting the process.

The Morningstar article does a good job of explaining how to do this, but to sum it up as succinctly as I possibly can: you must consolidate all of your old deductible IRA money into a company-sponsored retirement plan before you perform the backdoor Roth contribution. If you know what I’m talking about, the odds are pretty good that you did it correctly; if this is news to you, you better read the Morningstar article that I’ve linked to in the show notes.

Keeping with the Roth IRA theme, I often hear investors tell me that a Roth IRA is always better than a traditional IRA. Oh boy, does this one drive me nuts. The decision whether to contribute to a Roth IRA or 401k, versus a traditional IRA or 401k, comes down to one factor…taxes. Do you want to pay taxes now or later? Which is indirectly asking you whether you will be in a higher or lower tax bracket after you reach FI.

Without question, this decision is personal for all of us, so there is no way to give advice that will apply to everyone listening. My general rule of thumb is if you are currently in one of the bottom two tax brackets, the Roth option is probably a no-brainer; and if you are in one of the top two tax brackets, the traditional is what I would go with almost every time.

Now, if you are somewhere in between, then you need to think about it before making a decision. But make sure you understand how your tax bracket will change after you reach FI. Again, this is not perfect advice for everyone listening, but if you have a high savings rate, which I’m assuming many of you do, my bet is you will be in a lower tax bracket post FI.

Why? Because, by definition, you should be spending significantly less money than you were making when you were working full-time. So when you start actually living off your assets, you won’t be realizing on your tax return nearly as much income as you are now. This obviously will not be true for everyone, but I’m comfortable saying it will apply in the vast majority of cases.

I explained my personal situation in Episode 5 of Season 2 which illustrates why making traditional 401k contributions was so beneficial for me now that I am FI. Definitely check out this episode, but to try and drive my point home, my advice is that in most cases, opting for the traditional IRA or 401k contribution is the best option, unless you are in one of the bottom two tax brackets.

I’m going to wrap up this episode with a bit of a surprise with comments about paying for financial advice. I often hear do-it-yourself investors say advisors are way too expensive and everyone should be able to manage their own money. While I agree that most of us should be able to manage our own money, the idea that all financial advisors are bad couldn’t be further from the truth. In many cases, individuals are really bad at staying on top of their finances and investments, so even an expensive advisor may be better than no advisor at all if someone is going to completely neglect their finances.

Advisors also serve to keep a second set of eyes on your financial situation. To remind you, I was a financial advisor and although I’m extremely frustrated with the industry as a whole and how it prices its services, I’ve provided countless examples in previous episodes of how my clients benefited from my service over the years. I’ve got a couple more good examples coming up in future episodes this season as well.

As I’ve said before, having someone in your life—be it a friend, family member, or paid financial professional—who you can trust is of immense value. I sometimes recommend individuals who are just starting out, hire an advisor and see how things are going. If you find a good one, they will help consolidate your accounts and set you up for success by automating many things. As time goes on, you can decide if they are providing value, and if not, you can cut the cord when you are ready.

Another option you have when your net worth is a little higher is to allow an advisor to manage a portion of your money. Depending upon the advisor, they may be willing to offer their entire suite of services even if you only give them a portion of your assets. It will likely depend on the situation and the advisor, but trust me, it happens all the time. Use this knowledge to your advantage.

So I want to wrap up my final point by disagreeing with the notion that paying for financial advice is always bad. This couldn’t be further from the truth in my opinion. But without question, fully understanding what you are paying for when it comes to financial advice, and what a reasonable fee is for the value being provided, specifically to you, is very important.

Seriously, don’t miss my emphasis on “specifically to you” because how much each of us is willing to pay for something is different. Don’t assume because your best friend is a do-it-yourself investor and loves to talk investments with you, that you should be doing the same thing.

Hopefully this episode helped you realize that even those who know a lot about investing can still make mistakes. There is nothing wrong with asking questions when it comes to your finances because a small oversight on your part could result in an unnecessary obstacle on your path to FI.

I sure hope you enjoyed this episode of Invested Poorly and will be able to take something from it to improve your decision making as you navigate the twists and turns of your personal investing adventure. Be sure to check out my website at AreYouFI.com (that’s A R E Y O U F I dot com) where you can find resources and show notes with the charts and graphs I mention during the episodes. These are like little treasure maps that can help you choose more wisely along your quest to reach FI, or financial independence.

Never forget, in the short-term the stock market is unpredictable, and as my mischievous little nephew likes to say, “things just happen!” So focus on the long-term, by controlling your emotions, simplify your investments, and always… ignore the noise.

I’m your host, Jeff Harrell. Thanks for listening.

Invested Poorly: Sad Tales of FInancial Fails was created for informational purposes only and should not be relied on for specific tax, legal, or investment advice. You should consider consulting a qualified professional to review your situation before engaging in any transactions. Investing involves risk, including loss of principal and past performance is no guarantee of future results.

This podcast was produced by Ted Cragg. Learn more about creating podcast mini-series like this by visiting QuickEditPodcasts.com.