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Simple Isn’t Easy

Jonathan Clements  |  November 17, 2018

ALLAN ROTH likes to describe himself as argumentative—and, on that score, it’s hard to argue with him. But it’s also hard to argue with the points he makes, because he has this nasty habit of being right.

Roth is the author of How a Second Grader Beats Wall Street, a financial planner who charges by the hour, and a contributor of financial articles to AARP.org, Financial-Planning.com, NextAvenue.org and other sites. I caught up with him last month at the Bogleheads’ conference in Philadelphia. Here are just some of his trenchant comments:

On financial advisors. “Every time a dollar changes hands, there’s a conflict,” Roth contends. That’s clear with commission-charging brokers and insurance agents, who have an incentive to get customers to trade and to buy products that generate the highest commissions.

But as Roth notes, fee-only advisors are also conflicted. If they’re charging, say, 1% of a client’s portfolio, they may advise against paying down debt, because that would reduce the size of the portfolio they manage. They may also advocate complicated strategies simply to justify their own fee. Even hourly advisors, like Roth, have an incentive to string things out, so they can bill for more hours.

On simplicity. “There are so many forces pushing us toward complexity,” he says. It isn’t just advisors looking to justify their fee. Anxious to get published, academics are constantly trying to uncover new factors that explain market returns. Seduced and bullied by yo-yoing markets, investors are forever making portfolio changes.

Roth, by contrast, favors buying and holding a simple three-fund investment mix—a total stock market index fund, a total international stock index fund and a total bond market index fund. But as he points out, “How could an advisor charge even 0.3% to put you in one or three funds, and keep charging you every year to stay the course?”

On active investors. “I love active investors,” Roth says. “I owe my financial future to Jack Bogle—but I also owe it to active investors, because they keep markets efficient.”

On investor behavior. “Minimize expenses and emotions, maximize diversification and discipline” is Roth’s succinct formula for investment success. “It’s easy to say. It’s a lot harder to do.”

He continues: “Indexing is fine for controlling costs. But you can panic just as easily with a broad market index fund as any other investment.” Roth allows that even he had moments of doubt in early 2009, as share prices plunged toward their bear market lows.

“Humans are predictably irrational,” he says. “When stocks drop, I can tell you that people—including financial advisors—will panic. That creates an opportunity for those who can go against the herd.” One way to make money: Regularly rebalance your portfolio, both between stocks and more conservative investments, and within these asset classes. That’ll help you to buy low and sell high.

On the role of bonds. “The purpose of fixed income has never been income,” Roth opines. “The purpose of fixed income is to keep up with inflation and taxes, and to be the stable portion of a portfolio. It’s the shock absorber. It allows you to buy stocks when stocks plunge.”

While many investors are disenchanted with today’s low bond yields, Roth argues they’re better off today than they were in the early 1980s, when high-quality bonds offered double-digit yields. “People may feel better earning a 10% yield when inflation is 12%,” he says. “But they’re better off today earning 3% if inflation is only 2%—and that’s especially true after taxes.”

Despite that, many investors today are shunning high-quality bonds and instead chasing yield with master limited partnerships, high-yield junk bonds and high dividend stocks. “We have such short memories,” he says. “The stuff that blew up in 2008 is the stuff people are now moving toward.”

On dividends. Investors today are disgruntled with not only bond yields, but also stock dividends. But Roth contends that yields are far higher than many investors realize—thanks to stock buybacks. He concedes that corporations buy back their stock “for all the wrong reasons and at the wrong time.”

Still, he says that the true yield on U.S. stocks today may be 4½%, comprised of a 2% cash yield and perhaps 2½% in annual share buybacks. Like a cash dividend, the latter represents money returned to shareholders, who benefit from the shrinking number of shares outstanding.

But what if you want more than 2% in cash from your portfolio each year? Easy, Roth says. Just do a little selling: “It’s more tax-efficient to buy the total market index fund and sell 2½% every year than to buy a high dividend fund.”

The reason: While 100% of a dividend is taxable, less than 100% of a realized capital gain will be taxed, because you’ll have some sort of cost basis on the shares. Moreover, not all dividends qualify for favorable tax treatment (though that’s also true for short-term capital gains). On top of that, you have to pay taxes on your dividends every year, but you can control when you sell your shares—and, in some years, you might choose not to sell, thus sidestepping the capital-gains tax bill.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Fanning the FlamesJust Asking, Warning Shot and Ignore the Signs.

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