Should You Buy a House Right Now?

Ask the Compound - January 7th, 2024: Summary

Key Concepts:

• Housing Market Investment: Evaluating homeownership as an investment, considering time horizon and location.
• Roth vs. Traditional 401(k): Analyzing the benefits of Roth contributions, particularly for younger, high-earning individuals.
• Margin Usage: Assessing the risks and potential rewards of using margin in a portfolio.
• Tax-Advantaged Account Balancing: Strategizing the allocation of assets across pensions, taxable accounts, and tax-deferred/Roth accounts in retirement.
• Early Retirement Savings: Best practices for saving for retirement in one’s 20s.
• AI in Investing: The emerging role of Artificial Intelligence in portfolio construction and analysis.
• Box Spreads: A complex strategy for borrowing against a portfolio at potentially favorable rates.

I. Introduction & Market Context (0:00 – 2:30)

The episode begins with a nostalgic reference to a 1950s public service announcement promoting stock ownership, highlighting the potential of investing. Ben Carlson introduces the show, “Ask the Compound,” and acknowledges a week-long hiatus. He outlines the topics to be covered: home buying, Roth vs. traditional 401(k)s, margin usage, retirement account balancing, and early retirement savings. The show is sponsored by Public, an investing platform now offering AI-powered “Generated Assets” – customizable investment indexes created from user prompts. Carlson and Bill (a recurring guest) discuss the potential of AI to revolutionize retail investing, acknowledging the risk of “paradox of choice” but emphasizing the potential benefits for individual investors. They note the usefulness of AI for stock and ETF analysis, but stress the importance of verifying AI-generated information.

II. Home Buying in the Current Market (2:30 – 12:30)

The first question addresses the viability of home buying for a couple in their late 20s, given current high prices. Carlson acknowledges the affordability challenges but points out that historically, nationwide housing prices rarely decline – only seven down years since 1950, clustered around 1990-91 and 2007-2011. He introduces a chart illustrating the probability of positive housing price returns over different time horizons: 90% over one year, 98% over ten years, and 100% over fifteen years (using Case-Shiller data). He cautions that these figures don’t account for ancillary costs (realtor fees, taxes, maintenance).

Carlson suggests strategies for mitigating investment risk: a smaller down payment (leveraging), and extending the time horizon of ownership. He emphasizes that the longer a homeowner stays in a property, the better the potential outcome, citing the high percentage of Baby Boomers who have owned their homes for 20+ years. He advises considering a “forever home” (10+ years) rather than a starter home, to avoid frictional costs associated with frequent trading. He acknowledges location is crucial, noting price declines in areas like Texas and Florida.

III. Roth 401(k) vs. Traditional 401(k) (12:30 – 22:30)

The next question concerns a couple in the 22% tax bracket considering Roth vs. traditional 401(k) contributions. Bill strongly advocates for maximizing Roth contributions, arguing that the tax benefit is “in the rearview mirror” and avoids future regret. He emphasizes that people rarely revisit past tax decisions. He frames the decision as a psychological one – people are more likely to stick with a Roth contribution once made. He notes the increasing prevalence of Roth 401(k)s and the tendency for individuals to maintain the same savings rate regardless of tax treatment. He highlights the importance of understanding one’s tax bracket and the potential for charitable giving to offset tax liabilities.

IV. Margin Usage in a Portfolio (22:30 – 31:30)

A question is posed regarding the use of 5-10% margin in a well-diversified portfolio. Carlson acknowledges that, historically, borrowing to invest has been profitable, but stresses the importance of considering both upside and downside scenarios. Bill cautions against margin for most investors, but concedes it might be reasonable for a disciplined investor with a strong financial position. He introduces “box spreads” as a potentially more efficient way to borrow against a portfolio, offering lower interest rates and potential tax benefits (capital loss harvesting). He emphasizes the complexity of box spreads and the need for careful consideration.

V. Retirement Account Balancing (31:30 – 42:00)

The discussion shifts to a couple with a substantial pension, traditional IRAs, and brokerage accounts. The question focuses on balancing traditional and Roth assets for tax efficiency and inheritance planning. Bill advises prioritizing Roth assets for inheritance due to the tax-free nature of distributions. He acknowledges the potential for IRMAA (Medicare premium surcharges) and suggests strategies to mitigate them, including charitable contributions and potentially accelerating Roth conversions. He highlights the importance of considering state estate taxes.

VI. Early Retirement Savings (42:00 – 48:00)

The final question concerns a 22-year-old with a $100,000 salary maximizing a Roth IRA and contributing 10% to a 401(k). Bill and Carlson overwhelmingly recommend continuing to prioritize Roth contributions, given the individual’s young age and potential for future income growth. They emphasize the power of compounding and the likelihood that her income will increase, making current tax savings less significant. They highlight the importance of maintaining a consistent savings rate and living within one’s means. Carlson notes that the individual is already in the 98th percentile of earners for her age.

VII. Conclusion (48:00 – End)

The episode concludes with a call to action: email questions to askthecompoundshow@gmail.com, leave reviews on Apple Podcasts, and comment on YouTube. They thank Bill for his expertise and reiterate the importance of responsible investing.

Technical Terms & Concepts:

• Case-Shiller Index: A leading measure of U.S. home prices.
• IRMAA: Income-Related Monthly Adjustment Amount – a surcharge applied to Medicare premiums for high-income individuals.
• Secure Act: Legislation impacting retirement account rules, including the 10-year rule for inherited IRAs.
• Box Spreads: A complex options strategy used to borrow against a portfolio at potentially favorable rates.
• Generated Assets: AI-powered, customizable investment indexes offered by Public.
• MPV (Most Probable Value): A statistical measure of the most likely value of an asset.
• FICA: Federal Insurance Contributions Act – taxes for Social Security and Medicare.
• Leverage: Using borrowed capital to increase potential returns (and risks).
• Nominal Basis: The original cost of an asset, without adjusting for inflation.
• Tax Bracket Creep: Moving into a higher tax bracket due to increased income.
• Step-Up Basis: An adjustment to the cost basis of an inherited asset, potentially reducing capital gains taxes.