Annuities and Cash Secured Puts in Low Yield Times – Podcast #208

Intro:
This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high-income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahle.
Dr. Jim Dahle:
This is White Coat Investor podcast number 208 – Annuities and cash secured puts in low yield times.
Dr. Jim Dahle:

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Dr. Jim Dahle:
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Dr. Jim Dahle:
All right, let's get into your questions. The first one's a doozy, it came in by email. “In light of current interest rates and bond yields, could you comment on cash secured puts as an investment strategy?”
Dr. Jim Dahle:
It's very interesting to me. Everybody wants to do something different due to low yields these days, and all of a sudden, just because yields are lower, people want to do sometimes some crazy stuff to try to increase their investment returns. Not always a good idea. Sometimes maybe you should just accept lower yields, that you have lower expected returns on your stocks, on your bonds and on your real estate.
Dr. Jim Dahle:
But let's talk about this one in particular. First, let's talk about what a cash secured put is. A put is a type of option, right? There are basically two types of options. There's a call option and a put option, right? A put is the ability to sell for somebody else to buy something. And a call option is the ability to buy something if you want to. And so, buying and selling calls, buying and selling puts, they're kind of opposites of each other.

Dr. Jim Dahle:
What you are doing with a cash secured put is you are selling it and you're trying to get a premium for it. And that's where your yield is coming from, it’s the premium that you're being paid by somebody else to have the ability to put their stock to you or their ETF shares, whatever it is at a certain price.
Dr. Jim Dahle:
So, let's say for example, an ETF is trading at a hundred bucks a share. And they are basically buying a put from you at a strike price of $97. So, at any point in the next three or four weeks maybe, they can force you to buy their shares at $97. And so typically with options, you do these hundred shares at a time. And so that might be worth a premium of $3 per share or $300.
Dr. Jim Dahle:
So, the yield on that is going to be because it's a cash secured put, you got to put money down, the money you would need to buy that stock $9,700 for a hundred shares of that stock worth $97 a share, in order to earn that $300. So, you divide out and that's how you get the yield from it. And if you earn that every month, that's obviously a lot more than you're going to earn in your money market fund.
Dr. Jim Dahle:
The problem with this sort of strategy as a cash replacement or a bond replacement, is dramatically more risky than buying a bond or investing in CDs or a savings account. And where does the risk show up?
Dr. Jim Dahle:
Well, this is a good time to talk about Larry Swedroe’s quote, that if you ever see an investment with a higher yield than another one, and he's talking about fixed income investments with this, it's because it's more risky. Just because you can't see the risk doesn't mean it's not more risky. And that's a good way to tell the risk of one fixed income investment to another. And so, when you see this, the possibility of earning 2% or 3% a month, that's 24% or 36% a year – There's a lot of risk baked in there.
Dr. Jim Dahle:
So, what's the risk? Well, let's say you're willing to buy the stock for some reason or the ETF shares, whatever they are at $97 a share, but you're not willing to pay $100 a share for some reason, for this investment, for the long-term, which obviously it doesn't make a lot of sense, but let's say that's the situation you are. So, you're perfectly happy to pay $97 a share for it.

Dr. Jim Dahle:
Well, one of the risks is that the price never comes back to $97 a share. It just keeps going up and up and up and up and you never get a chance to buy it. And you should have bought it at $100 a share.
Dr. Jim Dahle:
But that's not the main risk we're talking about when you're selling these things. The main risk is that it really crumps, let's say it goes to $90 a share, a 10% drop. Now all of a sudden, they're coming to you and go on, you have to buy my shares at $97. So, $97, minus $90, that’s $7 a share. You got a hundred shares, right? So that's $700. So, you were hoping to earn $300 and instead you lost $700.
Dr. Jim Dahle:
This is kind of the way leverage works. Options are a lot like leverage in that respect. You can control a lot of money with very little money but small changes in price on the underlying asset can really dramatically affect the return on your investment. You've gone now from a yield of a 3% to a yield of minus, I don't know, 8% or whatever it works out to be. And so pretty dramatic turn of events.
Dr. Jim Dahle:
Now obviously the worst-case scenario is this ETF, or more likely in the case of an individual stock obviously is that this thing goes to zero, right? Maybe you're selling cash secured puts on GME or something and it really tanks because everyone gets sick of squeezing the short sellers or something. I don't know.
Dr. Jim Dahle:
But what if this goes to $10 a share, right? So now you've gone from $100 a share at a $10 a share, and you're required to buy that fellow's shares at $97 a share. So now you're out a lot of money. You've had a very much a dramatically negative return.
Dr. Jim Dahle:
And so, while cash secured puts are not among the riskiest of options strategy, they're kind of like covered calls that way. They're far more risky than investing in a savings account or bonds. And so, this is not an alternative to bonds. It's not an alternative to cash. It's not even an alternative to stocks. It’s something completely different.
Dr. Jim Dahle:
And what is it? Well, it's essentially a gamble. Because remember what options are, right? Options are a zero-sum game. What you lose, somebody else gains. What you gain, someone else loses. And that's before costs and taxes. Once you add in costs and taxes to the process, the overall return is negative. It's now a negative sum game. And the problem with that is if you start doing it for the long-term, you eventually end up losing.

Dr. Jim Dahle:
Plus, when you're trading options, you're usually trading with somebody who knows a whole lot more about the security than you do. And so, you got to think about who's on the other side of that bet, who's on the other side of that trade. And do I really want to be taking that?
Dr. Jim Dahle:
Honestly, in my portfolio, I try to only have assets with a positive expected return, hopefully a positive real after inflation expected return. So, I look at things like stocks that provide dividends and have earnings. I look at bonds that pay interest. I look at real estate that pays rent.
Dr. Jim Dahle:
Options don't pay that stuff. You're just making a bet. And what you're betting when you do a cash secured put is you're betting that the stock price will not fall below the strike price. That's essentially what you're betting. And that's a pretty decent bet. You just don't know what's going to happen. And since my crystal ball is always cloudy, I recommend against betting on short-term stock market movements, which is what you're doing when you're buying and selling options, whether it's calls or puts, whether they're secured by cash or not.
Dr. Jim Dahle:
So not an approach I recommend. Obviously, some people are going to go play around with this stuff now that they can do it on Robinhood, right? They've gamified investing. And now you can trade options on Robinhood with a hundred dollars or whatever the minimum investment is there. But just because you can do it, it doesn't mean you should. If you get into that game, try to limit how much money you're doing it with and recognize what you're doing and don't put serious money into it.
Dr. Jim Dahle:
Let's take a question off the Speak Pipe now. This one comes in from Dave and he wants to talk a little bit about retirement accounts and asset location.
Dave:
Hi Jim, this is Dave in DC, and I was hoping for your advice on allocating retirement funds between all the accounts available to me. I fortunately have a lot of tax protected space available and believe in maxing this out before using my taxable account. I thought I'd been maxing everything out, but it just came to my attention that my wife was in public school and as a teacher has a governmental 457(b) available to her on top of her 403(b). As I've read, I think government 457(b)s are considered quite reliable.

Dave:
Currently, we're maxing out my 401(k), her 403(b), backdoor Roth IRAs for both of us, and then an additional $15,000 available to me via my employer. And what essentially is a mega backdoor Roth that they just cap at $15,000. All of these things together amount to about 20% to 25% of our yearly income, which is even a little bit above our typical goal. So, I don't feel the need to necessarily do the $15,000 backdoor Roth, mega backdoor Roth, and this 457(b). I think I would put as well past our goal.
Dave:
Any advice on how to choose between these two? It seems to kind of boil down to the typical Roth versus traditional question, but I would appreciate any guidance or insight on the pros and cons of those two spaces. Hope you're doing well. Appreciate your help.

Dr. Jim Dahle:
All right. Great question from Dave in DC. It wasn't exactly what I was expecting. It's simply choosing which one to fund. Now, obviously, ideally, you're doing both. Tax protected, asset protect space is great. Whether it's tax-free like that mega backdoor Roth IRA option in your employer's 401(k) or in the governmental 457(b), where it will be tax deferred money.
Dr. Jim Dahle:
Both great options. I'd try to do both. But if I had to choose the general rule is tax deferred during peak earnings years. It sounds like you're in your peak earnings years. So, I lean toward the 457(b).
Dr. Jim Dahle:
Now there's a few nuances there, right? Obviously, if you are a super saver and you expect to have $15 million in retirement accounts when you retire, maybe you want to lean a little more toward the Roth. Also, if the 401(k) that you'll be investing this mega backdoor Roth into is particularly awesome, has great investment options, and low costs, maybe you lean more toward that.
Dr. Jim Dahle:
Likewise, if the governmental 457(b) is particularly low cost, particularly good investment options, particularly good distribution options, you really need more money in that for planned early retirement or something like that. Well, maybe you lean a little more toward that.
Dr. Jim Dahle:
But all else being equal, in a typical physician situation, in your peak earnings years, I'd probably do that 457(b) over the mega backdoor Roth option. But who are we trying to kid? You know what I'd do. I'd max them both out. I really would. I'd just cut somewhere else out of my income and I'd save it. 25% isn't that much. And you can probably do that if it's a big priority for you and you'll reach financial freedom a little bit earlier, but that's really up to you and how much you want to save. So, good question. Good luck with that.
Dr. Jim Dahle:
Let's do our quote of the day. This one comes from Phil DeMuth, who we had speak at WCI con in 2020. He said, “Especially for young high earners, retirement accounts are a money machine. This is one of the few hiccups in the tax code that favors the high net worth. So, take advantage of the opportunity”. It sounds like Phil would tell Dave in DC to max out both of them as well to me.
Dr. Jim Dahle:
All right, let's take another question. This is an anonymous question off the Speak Pipe about a 1099 income and LLCs. Let's take a listen.
Speaker:
Hi, Dr. Dahle. I need some help trying to figure out what will be the best way to deal with my current situation. I just finished fellowship in December of 2020. I have decided to start my own practice and I've already established an LLC. In the meantime, I've taken on a 1099 position in another state for a few weeks, each month to help cover living costs.
Speaker:
Now I'm just trying to figure out what the best and the right thing to do with that income. Should I have 1099 payment be submitted to my LLC name? Especially since I will have many start-ups business cost in the upcoming few months. If that's the case, should I still set aside my 30% – 35% for taxes each quarter? Or should I continue paying myself under my own social security number and set aside the tax money and continue to fund my LLC as I grow forward?
Speaker:
I'm sure there's many other ways to think about this, but to start, I just want to make sure I'm maximizing my practice startup income and utilizing the taxes correctly, especially when there are business costs coming up. At the same time, I want to be able to pay myself enough for my living expenses. Thank you for all you do. I appreciate your help.
Dr. Jim Dahle:
All right, great question. I think you are separating things they don't need to be separated here though. You own the business, right? This practice you're starting up, it's a business. It's going to have legitimate income. It's going to have legitimate expenses. You also are doing some work for which you're being paid on a 1099. Guess what? You own that entire business too.
Dr. Jim Dahle:
Really, the way it's going to boil down in your taxes is as if it's all one business, right? If you have a loss in the practice, but you have all this income from the 1099 gig, they're all going to wash out together on your taxes. If you decide to take that income and have it paid to the LLC, it's all going to work out the same on the taxes.
Dr. Jim Dahle:
So, I would do this in the simplest way possible. I would simply have him pay your LLC, run it all through there. All the income goes in there, all the expenses go in there and whatever his profit is in the end, you keep 30% or 35%. It seems a little high to me, but maybe if that's really what you have put aside, 25% maybe, toward your taxes.
Dr. Jim Dahle:
And you want to make sure you have that when it's time to pay your estimated taxes, but you don't have to put aside money for which you have business expenses to offset it. If you spend $50,000 setting up this practice and you only made $50,000 moonlighting, you haven't made any profit yet. You don't own any taxes. So, keep that in mind, that might help with some of your cash flow issues.
Dr. Jim Dahle:
All right, let's take the next question off the Speak Pipe. This one's about duration risk and TIPS funds.
Speaker 2:
Hi, Jim. I was wondering if you could share your opinion on duration risk to TIPS funds such as Vanguard inflation protected securities fund, which has an average duration of 7.4 years as compared to pivoting to a short-term inflation protected fund from Vanguard with an average duration of 2.8 years, given the current very low interest rate environment. Thank you.
Dr. Jim Dahle:
All right. More questions about low interest rates. Everyone's worried about low interest rates. How should I change my investing strategy? Guess what guys? I didn't change anything with low interest rates. When interest rates go down, you have lower expected returns for your stocks because the price of the stocks gets bid up because they would seem more attractive compared to bonds. You have lower expected returns on your bonds because the yields are now lower, right? You have lower expected returns on your real estate because it gets bid up in price. And so, you're paying more for the same amount of rent.
Dr. Jim Dahle:
The expected returns on everything goes down relatively equally. And so, I don't change my asset allocation in response to a change in interest rates like that. Just the opposite occurs when rates go up, right? Your stocks become less attractive relative to bonds, but the future expected returns are better. The value of your bonds takes a hit, but the yields are now higher. It becomes a little bit harder to buy real estate. And so maybe the value of real estate goes down, but the cap rate gets better, right? So, all this stuff is affected by interest rates, but relatively equally. So, I wouldn't change anything based on that.
Dr. Jim Dahle:
Now, let's talk about duration. We're talking about two TIPS funds. Vanguard has two. I think the regular fund is a mutual fund. I think the short-term fund is actually an ETF, but they're all really basically the same. So, your question is, what duration should I be using? And in order to answer that question, I need a functioning crystal ball. If rates are going to go up between now and whenever you're done, you should use the short-term fund. If they're not going to go up, or if they're going to go down, or if they're not going to go up for a long time, you're better off with the longer duration fund.
Dr. Jim Dahle:
As a general rule, you just want to make sure your duration is lower than your investing horizon. So, if you're investing for four years from now, you don't want to duration of eight years. Because if interest rates go up, it's going to take eight years before you're better off at those higher interest rates than you were, had they not gone up.
Dr. Jim Dahle:
But keep in mind, rising rates are good for bond investors in the long run. As soon as you get to a period of time longer than the duration, you're coming out ahead. It's actually good for rates to go up for you. This is assuming all else being equal and inflation doesn't go through the roof and those sorts of things, but in general higher interest rates are good for bond investors.
Dr. Jim Dahle:
It’s just getting there that you take an initial hit on it. And that hit is defined by how long the duration is. If you've got a fund with five-year duration and interest rates go up 1%, you're going to lose 5% of the value of that fund. Now it's going to take you five years for that extra 1% yield to make up for that loss that you had. But that's just the way duration works. That's the way bond funds work.
Dr. Jim Dahle:
So, which one do I use? I use the regular fund with the duration of six or seven years, whatever it is. It varies over time a little bit. That's the one that I have TIPS money in. Actually, I think I'm in the Schwab ETF right now, but it's pretty similar just because I have it in my 401(k) that's held at Schwab right now. But when I've had that asset class at Vanguard, I've had it in the regular Vanguard fund, not the short-term ETF.
Dr. Jim Dahle:
But like I said, to know the right answer, I have to have a functioning crystal ball and I just don't. So, if your convinced rates are going up, keep it short term. If you don't know what's going on and you got along investing horizon, just stay in the regular fund.
Dr. Jim Dahle:
All right. We have now on the podcast, Don Wenner, the CEO of DLP Capital Partners. Don, welcome back to the White Coat Investor podcast.
Don Wenner:
Hey, thanks Jim for having me. I’m really excited to be here.
Dr. Jim Dahle:
We just want to do a quick segment to catch up with you a little bit here and talk a little bit about real estate. For those who are interested in DLP, they can get more information at whitecoatinvestor.com/dlp and learn more about the funds that you offer and that I invest in.
Dr. Jim Dahle:
But the first thing I wanted to ask you about was what's your outlook for real estate investing both on the equity side and the debt side for 2021?
Don Wenner:
Great question. One I get a lot. And as we sit here today, it is truly an incredible market we're all in it. I think it's hard to kind of get caught up and not even realize how tremendous of a market environment we're in. We have arguably the greatest under supply of housing in American history right now. And that's leading to pretty incredible demands for housing, both for sale, for purchase, for homeowners as well as for renter-ship.
Don Wenner:
And certainly, there are certain markets that are hotter than others, but really nationwide we have this tremendous under supply leading to all time high occupancies, both on homes owned by individual homeowners and on renters throughout the United States.
Don Wenner:
Rents and home prices are soaring. It's hard to believe a year ago was kind of the start of COVID with how unbelievable the market is today. And that incredible resilience of the market, the incredible demand, the low interest rate environment, is leading to a tremendous opportunity where cashflow is strong and the outlook looks strong, both on the debt and equity side.
Don Wenner:
So, as you know Jim, we play on both sides. We run direct lending funds, lending money to full-time real estate investors. We just had our greatest quarter ever, lent twice as much capital out as we did Q1 of last year, very competitive rates and hit double digit returns to investors and our yields are actually trending up net to investors.
Don Wenner:
And on the equity side, we just concluded a quarter where we bought over $250 million with real estate. We acquired more real estate in Q1 than all of last year. And so, despite the incredible demand for housing, we're still finding volatility and opportunities and inefficiencies in the market that we're able to capitalize and generate double digit return.
Don Wenner:
So, if you invest with strong operators and still pay attention to the importance of fundamentals, there's really, really tremendous opportunities in this market right now.

Dr. Jim Dahle:
Do you think these rapidly rising prices in many places for single family homes, they are pushing people into renting in these properties that DLP owns in their fund?
Don Wenner:
Yeah, I think the rising prices are pushing people into renter-ship as well as just simply even if you are willing or able to pay, just inability to even find a home is so difficult in so many markets you're hearing and seeing 10, 15, 20 offers. We run a real estate brokerage as well. And the vast majority of the homes we put on the market we're literally having 10 plus offers.
Don Wenner:
So, you sell your home and trying to buy and you getting bid out soon as there's no other option, but to rent as well. So certainly, when prices, the cost of home ownership climbs that pushes people to renter-ship, which unfortunately for the average American is generally not more cost-effective or much more cost-effective with today's interest rate environment, but with the incredible demand many are being pushed into rentership or choosing rentership until the market settles down and they can take their time and find the right home. So, whatever the multiple reasons are certainly, it's only pushing up occupancy for rent.

Dr. Jim Dahle:
Yeah. Now the White Coat Investor and DLP had been partnering for a few months now. What's the response you've seen from White Coat Investors and why are so many of them finding investing with you to be attractive?
Don Wenner:
Yeah. Thank you, Jim. And I want to thank you and I want to thank the White Coat Investor base for the amazing response. We just concluded a quarter in and to give a kind of little stat here. Our first quarter of the year, we were targeting to bring in $50 million of new capital commitments into our funds. And we brought in over $100 million, over two times what we targeted. We welcomed about 250 new investors to DLP in Q1 alone.
Don Wenner:
And I don't know the exact stats off hand here but I would estimate close to half of them were affiliated with White Coat Investor and immediately jumped on providing us an opportunity.
Don Wenner:
So, the question we asked ourself was why didn't we start working with White Coat and why weren’t we specializing and working with those in the medical industry, doctors and so forth here sooner because of the response and appetite is great.
Don Wenner:
And I think the reason is that our investment vehicle it's not overly complicated, it's not difficult to understand and figure out and make sense of. And then obviously the track record at this point in our growth and our years of doing this are very consistent. So, it's a place you can park money, it makes sense, generates good returns, have liquidity and not have to worry about it, pay attention, to be able to focus on your real passions, I think has been a big part of what the messages that we've heard from many of the great investors that have joined us from White Coat.
Dr. Jim Dahle:
Awesome. Well, thank you for the service you're doing for them. I know it's a difficult thing sometimes to choose a fund manager or sponsor and a place you know you can trust to put your money. So, I appreciate what you do.
Dr. Jim Dahle:
For those who are interested in learning more about DLP, you can get more information at whitecoatinvestor.com/dlp. Thanks for coming on the podcast, Don.

Don Wenner:
Thanks Jim.
Dr. Jim Dahle:
All right. Our next question comes off the Speak Pipe. This one comes from Phil. He wants to talk about annuities. Yet another question about a low interest rate environment. Let’s take a listen.
Phil:
Hi, Dr. Dahle. This is Phil from Oregon. My question has to do with whether or not you see any role for annuities specifically deferred or fixed index type annuities to replace a portion of one's fixed income holdings within a well-diversified index fund portfolio.
Phil:
Assume that one has maxed out available tax advantage IRA space and has significant taxable holdings. Specifically, I'm interested the mid to late accumulation phase. It seems that given the current interest rate environment, bond funds will likely have dismal returns over the next 10, 15 years.
Phil:
Do you see any role for these products? I'm a bit apprehensive about the costs, fees, and difficulty of shopping these sorts of products, but it was inspired by reading Dr. Wade Pfau book on Safety First Retirement Planning. Any thoughts? Thanks.
Dr. Jim Dahle:
All right. Low interest rates causing us to do all kinds of crazy things, such as predict the future returns of bonds for 10 to 15 years. I have no idea what bond returns are going to be over the next 10 to 15 years. Do I expect there will be lower than they were over the last 10 to 15 years? Yes, I do. But you know what's interesting about all this talk about low interest rates? Everyone was talking about this in 2010 too. Saying, “Oh, get out of bonds. Rates are sure to go up”.
Dr. Jim Dahle:
Well, guess what happened over the next 10 years? Not only did they not go up, they went down even more. So, when you really don't know what's going to happen with interest rates, don't kid yourself that you can predict the future. If you think you can start writing down what the future is going to hold.
Dr. Jim Dahle:
All right. A couple of comments on other parts of that question. Wade Pfau. Wade has taken a stance on some insurance-based investing products that I don't necessarily agree with. He has somehow become convinced that maybe it's not such a bad thing to have some whole life insurance and some annuities in your portfolio later in your career, in order to smooth things out during the withdrawal phase in retirement.
Dr. Jim Dahle:
I look at the data he looks at, I look at the papers he's published. I don't agree with all of the assumptions and thus don't agree with all of the conclusions, particularly with regards to the whole life insurance aspect of his message.
Dr. Jim Dahle:
In fact, at WCI con 21, which is now available as part of our Continuing Financial Education 2021 online course, I gave a whole talk on insurance-based investing options. Everything from a variable universal life and index universal life and index annuities and fixed annuities and deferred annuities and all kinds of annuities. I spent a whole hour talking about it. So, if you really want the in-depth answer to this question, check out that talk.
Dr. Jim Dahle:
But let me go through some of the basics of annuities. The most commonly used and most common-sense annuity in my view is a single premium immediate annuity. And what this is, is this is buying a pension from an insurance company. You give them a lump sum of money and they give you a certain amount of money every month from now, until whenever you die. Whether you die at 65, whether you die at 103, they're on the hook to pay you every month, okay? Single premium immediate annuity.
Dr. Jim Dahle:
It can be a great way to spend your money in retirement. For example, if you know you don't want to leave any money to heirs, you don’t want to leave anything to charity, you want to spend as much as you can. This is a pretty good way to do it. Especially if you're buying one of these things in your 70s. It pays a lot more than the 4% withdrawal rate. So, you can actually get more from your portfolio without having to worry about running out of money, because you have this guarantee that it'll pay out until the day you die.
Dr. Jim Dahle:
And so, it's totally reasonable, especially for somebody who barely has enough, or doesn't quite have enough to really put a floor under their retirement spending and put the who knows 10%, 25% of their portfolio into an immediate annuity at some point between age 65 and 75 or so. Totally reasonable thing to do.
Dr. Jim Dahle:
Another type of annuity is deferred income annuity. And this is probably best thought of as longevity insurance. It kind of gives you some permission to spend early in retirement, knowing that if you do live a long time, you've got another source of income coming in. And this deferral period can be anywhere from 5 years, 10 years, even 30 years. So, you could buy this thing at age 40. It doesn't start paying out until age 70.
Dr. Jim Dahle:
And the cool thing about it is because it doesn't pay you for years. When it does pay you, it pays this super high yield on your initial investment. Now the insurance company got to use your money for 20 or 30 years, over the time period. So, they should pay you well on it, but that's the way it works. So, you might buy one of these. Maybe you buy it at age 70 and it doesn't start paying out until age 90.
Dr. Jim Dahle:
But the yield on that can be pretty high. And that allows you to spend in your 70s, spend maybe more of your nest egg than you otherwise would if you didn't know that you had this annuity backstopping you in the event that you really lived a long time. And so, that's the theory behind longevity insurance or a deferred income annuity. And I think that's a reasonable use for an annuity as well.
Dr. Jim Dahle:
However, when we start talking about replacing bonds or replacing CDs in your portfolio, what we're really talking about is a MYGA – A Multi-Year Guaranteed Annuity. This is a form of a fixed annuity. And what it is good for is you might get a higher yield on it than you do on a CD. That's not usually the case for six months, one year, maybe even two-year CDs.
Dr. Jim Dahle:
But as you start getting out longer than that, you can actually earn more on these annuities than you can on a CDs in today's low yield environment. And it's not like some exciting return. Maybe you get 2% instead of 1.5%, or maybe you get 3.2% instead of 2.3%, right? So, you do a little bit better and it has one other cool feature.
Dr. Jim Dahle:
The other cool feature is that if you roll it into another annuity, when that period is up, that term is up, you don't pay taxes on it, right? This tax is deferred essentially until you're done rolling up from one annuity to another. So that gives you a little bit higher yield too than the CD, which you would pay taxes on it at ordinary income rates as it pays out. And so, that's kind of a cool feature of annuity too.
Dr. Jim Dahle:
Another feature we occasionally see people use is a trick when people are dumping their whole life insurance, that they still have a loss on. They might exchange it into a low-cost variable annuity. I think last time I looked Fidelity had some of the lowest cost ones, and then let it grow back to basis, which growth is now all tax-free and then surrender the annuity and move on with your life. It's just kind of a trick to make a little bit of lemonade out of lemons when you got suckered into buying a whole life insurance policy.
Dr. Jim Dahle:
But in general, remember that annuities are products made to be sold, not bought. They put lots of bells and whistles on them. And when you start looking at it, you realize that somebody selling it to you is making a pretty big commission, particularly on index annuities.
Dr. Jim Dahle:
It sounds like an index fund, so it must be good, right? No, the commissions are way higher than you would pay on a SPIA or even a DIA or a MYGA. You end up paying maybe even 8% commissions on those. Stay away from those. As a general rule, stay away from variable annuities. You should have a very unique reason to get a variable annuity, and you need to make sure it's a very low cost one with good investing options if you go down that route, but for the most part, you don't have to touch that stuff.
Dr. Jim Dahle:
And honestly, for the most part, bonds and CDs are still fine. Yes, you might be able to get a little more yield out of a MYGA, but chances are, if the rates end up going up as a lot of people think they will at some point, I really have no idea. The bonds are going to be just fine again, they're nice and liquid, you don't have to deal with an insurance company. You don't have to deal with somebody trying to sell you more, sell you whole life insurance, that sort of stuff.
Dr. Jim Dahle:
So, as a general rule, I don't like mixing investing and insurance, but that's kind of the deal with annuities, places where you might want to look at them a little more carefully and things to be aware of.
Dr. Jim Dahle:
All right. All this talk about low interest rates. Let's talk a little bit about some real estate investing. Here's a question about a property from Robin off the Speak Pipe.
Robin:
Dear, Dr. Dahle. I'm 36-year-old finishing my orthopedic subspecialty fellowship. I have a wife and two young kids, and I just accepted my first attending job with a for-profit multi-specialty group in a moderate to high cost of living area. My wife and I will have a combined income of $600,000 a year when I start.

Robin:
We currently have about $200,000 in our retirement accounts and about $50,000 in savings that we're hoping to use for a down payment on a house. I luckily have only $140,000 in federal student loans.
Robin:
My question is about a real estate investment that I made over a decade ago. Right after the 2008 crash, my buddy from college and I purchased a small single-family residence with a mother-in-law apartment. Over the years each of us has used the place as our primary residence on and off, and most recently my family and I lived there throughout my five-year residency and vacated just a year ago. The value of the home has luckily more than doubled since we bought it. And I have about $200,000 in equity in it. Currently we run out the house for a modest income of $500 a month.
Robin:
Given that my family has lived in the house for four out of the last five years, we can claim it as our primary residence and thus, any proceeds from a sale would not be subject to federal capital gains taxes.
Robin:
So, my question is this, what is the most prudent use of the property at this point in my career for my family? Is it A) To hold onto it as a relatively passive income stream in order to get the tax benefits? Or B) To sell the property within the time window in which we can use the proceeds tax-free to pay off my student loans? Thanks so much.

Dr. Jim Dahle:
All right, Robin. I don't think I have quite all the numbers I would necessarily need to really make a decision on this. I can't quite tell if the rent is really $500 on something where just your half of the equity is a couple of hundred thousand dollars. But if so, that sounds like a terrible investment. If I was only getting $500 in rent a month out of something that's worth $400,000 plus, that's not a good investment. I'd get rid of that.
Dr. Jim Dahle:
This is a great time to get rid of it, right? Because you don't have to pay on those gains because you can count it as your residence. If you wait too long, that's not going to be the case. And so, this might be a great time to sell it.
Dr. Jim Dahle:
Now, you might also be saying that you're getting $500 in cash flow left over after paying all the expenses. Still, I'm not super excited about that if that's several hundred thousand dollars tied up to get that sort of a return. That might be tax protected income, but it's not very good.
Dr. Jim Dahle:
If you're now moving to or are already in a moderate to high cost of living area, it seems to me like you could use a lot more than $50,000 as a down payment on your residence. So, why not cash this thing out? Take that $200,000. Now you've got $250,000 put down on your residence. That seems a lot better to me. I think that's probably the direction I would go in. But I don't necessarily have all the details.
Dr. Jim Dahle:
Likewise, if this property is in a different town than you're going to be living in, I'm really not a fan of being a long-distance landlord. I didn't really like doing that when I did, it was just too hard to drive by the property. It was too hard to manage it. It was too hard to meet people face to face. I ended up introducing a lot of risks and a lot of expenses that you don't otherwise have if you're doing direct real estate investing someplace close to where you live.
Dr. Jim Dahle:
So, all in all, I think this is one I'd probably move away from. And this is a great time to cash it out because you can do so tax free. So, congratulations on your success so far with it. I'm not sure I'd push my luck anymore.
Dr. Jim Dahle:
All right, let's take another question. This one comes from email. “How to decide how much money to comfortably keep in business account versus taking out as distributions? Which practice loans to pay down and how quick as I have building loans and practice loans, or both? Fortunately, lots of dentists still have their own businesses so these are the questions I struggle with”.
Dr. Jim Dahle:
Well, these are pretty common questions among business owners. In general, how much should you keep in a business account? Well, you don't want us to be laying awake at night worrying about making payroll. So, I think at a minimum months’ worth of payroll.
Dr. Jim Dahle:
But just like an emergency fund, it's probably a good idea to even be closer to maybe three months of business expenses in the business account. And that can allow you to, I think, not worry nearly as much that you don't have enough cash. Now, is there going to be a drag on that? That could be money you pulled out as distributions and invested. Yes, there's going to be some drag on that, but I think that's a reasonable amount to have in there.

Dr. Jim Dahle:
Also keep the FDIC limits in mind, right? You might only be limited to protection of $250,000. So, when you start getting much more than that, you got to start wondering, “Well, what if the bank goes under? Am I going to lose a bunch of money?” So maybe you don't want to have much more than that sitting in the account for long periods of time. I know that's something we've thought about a lot at WCI, especially as business expenses have gone up and you're always weighing those two factors.
Dr. Jim Dahle:
Which practice loans do you pay down and how quickly as you have building loans and practice loans, or both? People do this from two approaches. They either snowball it where they start with the smallest loan, no matter what the interest rates are and pay that off and then roll what they're paying toward that, into the next larger loan and really feel the behavioral benefits of building momentum toward becoming debt-free.
Dr. Jim Dahle:
Other people look at paying off debt and they go, “Well, I want to start with the one that's mathematically correct”. Which is usually the highest interest rate loan. And there's no right answer to that. I tend to lean more toward behavioral solutions and mathematical solutions, but they're both right answers. And so, I understand you're struggling with those things.
Dr. Jim Dahle:
You're also struggling with deciding how much to invest versus how much to pay down on your mortgage versus how much to pay down on a practice loan versus how much to pay down on the building loan versus how much to hold in cash.
Dr. Jim Dahle:
And the only time those questions get easier is as you start paying off loans and you have fewer options with your money. That's something that lots of us struggle with, especially just coming out of training. We've got a limited amount of money, a limited amount of income, even though it feels like money coming out of our ears to what we used to be making, but just tons of great uses for it.
Dr. Jim Dahle:
A typical doc coming out of residency needs to build up an emergency fund. Might have some credit cards to pay off, might have a car loan to pay off, has a bunch of student loans to pay off. Might want to open a practice, might want to save up a down payment to buy a house. Now with all these retirement accounts available, he wants to max out, maybe wants to get into real estate investing, right?

Dr. Jim Dahle:
There are all these uses for cash and not enough cash to do them all. So, you just have to decide what your financial goals are and you work your way down until you run out of cash. When you run out of cash, then that's where you stop on your list of priorities. I hope that's helpful.
Dr. Jim Dahle:
All right. Let's take a question from Chris who has some questions about some earnings from a gap year.
Chris:
Hi, Dr. Dahle. I'm an incoming MS-1 between my undergraduate career and my upcoming medical school career. I took a year off. I did a research at the NIH. I actually was able to have a very high savings rate because I was living like a monk, but I was able to gather about $15,000 to $20,000 during my year here.
Chris:
And I'm not quite sure what to do with it because I have undergraduate loans. They're all federal. So, they're kind of in that COVID stall that we're in. And I obviously have upcoming medical school loans, which will be much more significant likely than my undergraduate loans.
Chris:
So, my main question is what do you think a student should do who's gathered money in their gap year with that money over the course of their education journey in preparing for medical school?
Chris:
My current plan was to use that for rent and food during my first year and whatnot. But I wasn't sure if you had any other ideas. I don't know if I should just throw it all at my undergraduate loans, in which case it would just kind of evaporate immediately. I wasn't sure if you had any other ideas, so thank you for what you do.
Dr. Jim Dahle:
All right, Chris. Good question. One, a lot of people have. I want to correct one of the ways you're thinking about this money though. You're saying if you put it toward your undergraduate loans, the money evaporates. And I would say that is not accurate. What the money does is it eliminates those student loans.
Dr. Jim Dahle:
So, let's say you have $30,000 in student loans and you have $30,000 in cash. Your net worth is zero. If you take that $30,000 in cash and you pay off the $30,000 in student loans, your net worth is zero. It didn't evaporate. You're exactly in the same place, except you're no longer paying interest on those loans. So that's one of your options. Probably not the one I would take.
Dr. Jim Dahle:
Another option that some people might say is, “Oh, you got cash. You don't want it to evaporate. Invest it”. Whether you do it conservatively in CDs or something, or whether you do it aggressively in stock mutual funds or real estate, or whether you do it in a speculative fashion, you put it all in Bitcoin and hope for the best, I wouldn't necessarily do that either.
Dr. Jim Dahle:
At this stage of life, the most important investment you're making is in yourself. Your education, your future earnings ability. Every dollar that you don't borrow to pay for medical school is essentially providing you a 6% to 7% per year guaranteed return. That's a pretty good guaranteed return these days.
Dr. Jim Dahle:
I got all these other people that want to sell secured puts, that are wanting to buy annuities, that are wanting to change the durations of their TIPS fund. Also, they can make 1% or 2% on guaranteed investments. And you have one that pays 6% or 7%. That's a great use for your cash.
Dr. Jim Dahle:
So, how do you get that? Well, you get that by using the money to live on during medical school. To pay tuition, to pay for books, to pay for fees, to pay for housing, to pay for food to eat. You got money. You got a huge expense in front of you over the next four years. Use the money for the huge expense.
Dr. Jim Dahle:
These days I also have people going “Well, what if I get my loans forgiven via public service loan forgiveness?” That day is a long way away. At a minimum it's 4 years of school away and 10 years of making payments before you receive public service loan forgiveness. Lots of things can change in 14 years.
Dr. Jim Dahle:
Now I don't necessarily think that people who have student loans that qualify for public service loan forgiveness, I think they're going to be grandfathered in. I don't think that's a big problem, but I probably would not take out extra loans in hopes that my career path aligns with a PSLF strategy. I wouldn't do that. I'd keep my loans as small as I could do by using any cash I have, anything my parents or other family members might help me with for medical school barring having to pull it out of a retirement account and pay taxes and penalties on it. I would use that money to pay for medical school.

Dr. Jim Dahle:
So, it sounds boring. Right? You wanted something more exciting to do but I think you ought to just use it for medical school. That's what money is for, right? The reason you save money, it’s so you can spend money later. You save this during your gap year so you could pay for medical school with it. So now pay for medical school with it and don't feel guilty about it. Don't feel like you're doing anything stupid with it. I think it's a completely smart thing to do.
Dr. Jim Dahle:
All right. Let's take another question from Greg about backdoor Roth IRAs and getting set up so he can do them.
Greg:
Hi Jim, this is Greg from San Jose. I'm wondering if it is worth rolling IRA money into 401(k)s in order to do backdoor Roth IRAs. I'm married and my wife and I have about $40,000 in traditional IRAs. Our income puts us above the contribution limits for Roth IRAs.
Greg:
Generally, I like the fund options in the IRA better than our 401(k)s, but I don't know if I will necessarily get better returns in the IRAs. If we did do the backdoor Roth, we would be putting $12,000 less into our taxable brokerage account or whatever the contribution limit is in the future.
Greg:
I can see us retiring in our 50s with money from our taxable brokerage account. Withdrawals of about $80,000 per year would be comfortable for us. If the capital gain is our only income, the gains would certainly be less than $80,000 and the federal tax rate would be 0%. And then we may owe state taxes depending on where we are living.
Greg:
Given this I'm not sure if it is worth the hassle to roll over our IRA money in order to do backdoor Roth IRAs. But I know the capital gains tax brackets will change over time. So, I also wonder if the Roth IRAs would be more future-proof for the money that we won't need until standard retirement age. Thank you for your thoughts.

Dr. Jim Dahle:
All right. So, this question really deals with two different things. The first thing is what should you do with those $40,000 in IRAs in order to be able to do a backdoor Roth IRA? That's number one. Number two, are you better off investing in a Roth IRA or in a taxable account?
Dr. Jim Dahle:
So, let's take the first question. Well, you got $40,000 in IRAs. You've got two options. You can roll them into a 401(k). There's a little bit of hassle there. And when I say hassle, I'm talking about five or six pages of paperwork and scanning it once and mailing it in. That’s not exactly a ton of hassle. It's pretty easy. I've done a lot of rollovers in my life. A little bit of hassle. No tax cost to doing that. You might have a little bit higher expenses, a little fewer investing option in the 401(k), et cetera.
Dr. Jim Dahle:
You also get a little more asset protection in many states in a 401(k) than you do in an IRA. So maybe that compensates for some limited investing options, maybe slightly higher fees.
Dr. Jim Dahle:
The other option is to simply convert that $40,000 to a Roth IRA. You tell me you have a high enough income that you have to do your Roth IRAs through the back doors. That means you're making at least a couple of hundred thousand dollars.
Dr. Jim Dahle:
So, what are the taxes going to be on a $40,000 IRA? Well, maybe they're $12,000, something like that, maybe, right? It's not going to be that much money. You can probably come up with that money if you want, if you really want to keep money in IRAs and I don't see any reason why you wouldn't want to, then you can have it in Roth IRAs. It's just going to cost you a little bit of tax now. But in the end, you end up with a much larger Roth IRA. So that's not necessarily a bad thing. So, I'd really consider that if it was only $40,000.
Dr. Jim Dahle:
Now, if you told me, you had $400,000 in IRAs, I'd probably lean more toward just rolling that into a 401(k) rather than paying that tax bill. That'd be a lot more significant for a typical physician income.
Dr. Jim Dahle:
Okay. So that brings it to the second question. Should you invest in a taxable account or retirement accounts? Now the general rule here is retirement accounts are way better than a taxable account. You get not only tax protection. You get that tax-free growth and maybe you leave that money in there until you're 90. So, you're getting five or six decades of tax protected growth off of it, rather than not getting that in a taxable account.
Dr. Jim Dahle:
And you also don't have to worry about changes to laws, like step up in basis going away that could really hose people with a lot of money in a taxable account or increases in the capital gains rates or the PPACA taxes that could increase your tax rates on those capital gains and dividends. You don't have to worry about that stuff when you have it in a retirement account.
Dr. Jim Dahle:
Sure, there's always the possibility that congress can decide it's going to tax Roth IRAs, but that just seems a lot less likely to me than seeing some changes to capital gains rates for instance.
Dr. Jim Dahle:
Plus, in the retirement account, you get asset protection. In most states, IRAs get significant asset protection, not always as much as a 401(k), but it's way more than your taxable account, which is basically not protected at all unless you can somehow title it as tenants by the entirety and only one of you get sued.
Dr. Jim Dahle:
So, I think those are two great reasons to go with the Roth IRA over the taxable account. Another great reason is the state planning is way easier with a Roth IRA than it is a taxable account. You can just name a beneficiary and it goes to them. And they can stretch those tax-free benefits and that asset protection benefit for another 10 years after you die. So, another awesome benefit of a retirement account.
Dr. Jim Dahle:
So, what do people worry about? Well, they worry about that stupid age 59 and a half rule, but the truth is there are so many exceptions to that rule, so many loopholes that are large enough you can drive a semi through them. You can take money out for a first home for yourself, your kids and your grandkids. You can take it out to pay for education. You can take it out if you get disabled. You can take it out, obviously in the event of death because it’s an inherited IRA.
Dr. Jim Dahle:
But you can also take it out for early retirement, the SEP rule – Substantially Equal Periodic payments. So, let's say you retire at 55. You basically are limited to how much you can take out there but the limit is like 3% or 4% a year, which is about what you want to take out anyway. So, you can take that out. Once you start them, you got to keep going for like five years, but you can get to that money penalty free before age 59 and a half if the purpose is early retirement. You just have to abide by the substantially equal periodic payment rule, which isn't that hard to do.
Dr. Jim Dahle:
Don't get me wrong. You don't want to not follow that rule, that can really lead to significant penalties, but it's not that hard of a rule to follow and you can do that. So, in this sort of a situation, I would just go ahead and invest in the backdoor Roth IRAs. It's not going to be that hard for you to get rid of the $40,000 IRAs. I might even just convert them, but this is going to work out just fine for you.
Dr. Jim Dahle:
And chances are by the time you get to be 55, you're probably going to have a big taxable account anyway, because you're paying attention to this stuff and you're a good saver. And so, you probably won't touch those Roth IRAs anyway. So, I wouldn't shy away from it all right now. I'd probably do the hassle so that you can do backdoor Roth IRAs each year. I hope that's helpful to you.
Dr. Jim Dahle:
All right. As I mentioned earlier in the podcast, the financial educator of the year award, you got to send your nomination into awards@whitecoatinvestor.com by the 30th. That's by tomorrow if you're reading this the day it dropped and hopefully the person you nominate wins the award.
Dr. Jim Dahle:
Also check out Peter Kim's course Passive Real Estate Academy. That's at whitecoatinvestor.com/prea. It'll teach you how to evaluate syndications and funds like the ones we talked about with Don Wenner of DLP earlier in this episode. And you can check those out as well.
Dr. Jim Dahle:
Have you ever considered a different way of practicing medicine? Whether you're burned out and need a change of pace or looking to supplement your income, locum tenens might be the solution for you.
Dr. Jim Dahle:
If you're not sure where to start, locumstory.com is a place where you can get real unbiased answers to your questions. To answer basic questions, like what is locum tenens to more complex questions about pay ranges, taxes, various specialties, and how locum tenens works for you go to whitecoatinvestor.com/locumstory and get the answers.
Dr. Jim Dahle:
Thanks to those of you who've been leaving us five-star reviews. It really does help spread the word about the podcast. The most recent one came in from Nicole who said, “Love the details. I listen to several financial podcasts but I especially love the WCI podcast because it is so detailed.
Dr. Jim Dahle:
I feel like I can take action on what is discussed and appreciate when he references blog posts with even more detail. I also appreciate the ease of access to ask questions- I have left 2 Speak Pipe questions that have been answered on the podcast. Even though I am not a physician (dual-pharmacist household), I don’t feel excluded and can apply most things discussed on the podcast to my financial situation too. Thank you for all that you do!” Well, thank you for the five-star review, Nicole.
Dr. Jim Dahle:
All right, keep your head up, shoulders back. You've got this and we can help. We'll see you next time on the White Coat Investor podcast.

Disclaimer:
My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcaster. He’s not a licensed accountant, attorney or financial advisor. So, this podcast is for your entertainment and information only and should not be considered official personalized financial advice.