What’s the difference between active and passive investing, and when should you use mutual funds versus ETFs? In this episode, John and Tommy break down essential investing concepts that federal employees need to know, covering everything from the fundamentals of stocks and bonds to practical cash management strategies.
Listen in to learn about active versus passive investing philosophies, the mechanics and tax implications of mutual funds and ETFs, and why dollar-cost averaging can help overcome emotional barriers in investing. Whether you’re just getting started or looking to fine-tune your portfolio, don’t miss these actionable insights for federal employees.
Listen to the full episode here:
What you will learn:
- The key differences between active and passive investment strategies. (04:23)
- Understanding stocks and bonds: what they are and how they function in your portfolio. (16:05)
- Mutual funds and ETFs explained: pros, cons, and tax considerations. (24:08)
- Practical approaches for managing your cash effectively. (34:56)
- Why dollar-cost averaging is a powerful tool for investors who are hesitant to dive back into the market. (41:18)
- The strategic use of municipal versus corporate bonds based on your tax situation. (50:54)
- How financial planners differ from product sellers and investment aggregators. (53:21)
Ideas Worth Sharing:
- “One of my favorite things about investing is remembering that sometimes no action is action.” – Mason & Associates
- “We would classify our investment management style as strategic or passive, which means we want to have global market exposure. We want to have access to all asset classes.” – Mason & Associates
- “Whichever strategy you pick, you probably need to be committed to it—all in—whether it’s the active or the passive or anything in between.” – Mason & Associates
Resources from this episode:
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Read the Transcript Below:
Congratulations for taking ownership of your financial plan by tuning into the Federal Employee Financial Planning Podcast, hosted by Mason & Associates, financial advisors with over three decades of experience serving you.
John Mason: Welcome to the Federal Employee Financial Planning podcast. Today, we’re discussing investing principles, how to structure your investment portfolio. In today’s episode, we’re covering things like mutual funds versus ETFs and individual stock positions. We’re gonna talk about your cash strategy. What is a dollar cost average and municipal versus corporate bonds?
Be sure to listen till the end, where we discuss the difference between products, investment aggregators, and financial planners. Unlike many content creators, we’re financial planners first, and we do this second, and each episode we share real-life experiences from decades of helping federal employees navigate complexities of their benefits and all areas of their financial plans. Tommy, welcome to the Federal Employee Financial Planning Podcast.
Tommy Blackburn: Thank you, John. Always great to be here. Excited to crank out another episode and we think some really good foundations we’ll go over today. So looking forward to it.
John Mason: You know, investments are something that you and I don’t get overly excited about most of the time.
I will caveat that where I was feeling pretty good about myself, December 31st, 2024, looking at our net worth, looking at how the investments performed, looking at the Mason & Associates client returns, and I was like, “Man, this was a fun year.” So I don’t typically get excited about investments themselves, but it would be kind of a fib to say I don’t get excited about good performance, ’cause it’s always nice to have that.
Tommy Blackburn: Yes, I agree. That whole wealth effect that they talk about and we know to not be emotional, but we go through bear markets and bull markets, so we get excited.
I’m with you because I know it’s like we should probably be stoic and not get excited about these good years of returns. But we also had just recently came from through a bear market, so it just, it’s nice to see that. I agree. And it’s hard not to be excited. But we always wanna have that long-term perspective, which I know we’ll be chatting about today.
But yeah, so, we get emotional too, but I think we recognize it, and we come back to our principles anytime we begin to question ourselves,
John Mason: And I think we’re good specifically, we’ve gotten better over the years, 15 years of doing this where I think we allow ourself to really enjoy the good years, like seeing our client assets go up last year, seeing clients have a really good year in retirement, seeing our personal accounts grow, allowing ourself to enjoy that, and then also allowing ourself to be like, “Man, 2022 really was pretty terrible.” And embracing that emotion too, and knowing, one of my favorite things about investing is remembering that sometimes, or no, remembering that no action is action.
No action is action. So in 2022, we didn’t panic, like did I feel good about life in 2022? Some aspects, but I didn’t feel good about the market. And it went down and it didn’t feel good and it was really frustrating. And I’m not gonna pretend for the audience’s benefit that it just didn’t affect me. It’s like, no, it did. Like I did not enjoy 2022, but that doesn’t mean I made a change.
Tommy Blackburn: Intentional. Right. I love it. I agree. Yes, we’re human. We feel it too. We don’t enjoy a bear market more than anybody else does. Maybe we’re disciplined about it and we know that a lot of times taking no action was the intentional action because in investments, we don’t wanna make rapid, knee jerk moves. We want them to be intentional. A lot of times in life, people aren’t unintentionally take that action, right? They stick your head in the sand. No action is still taking an action. We just wanna be intentional about it.
And then a lot of times, yeah, investment’s long-term focus, you have to always try to come back to that.
John Mason: We didn’t say in our intro, active versus passive, but I think that’s where we should start in our kind of investing 101 or investing principles, whatever we end up calling this episode, and that ultimately you have to decide what is your investment philosophy. Are you active? Are you passive? And then we can talk about the tools that we use in that underlying strategy. For our audience’s benefit, we would classify our investment management style as strategic or passive, which means we want to have global market exposure. We want to have access to all asset classes.
And we will make some tweaks from time to time, but we’re not gonna take huge bets and we may even employ or use an actively managed bond fund. Like a Voya or a PIMCO or what have you. And we’re gonna allow that active manager to do their thing, but we’re not like swapping positions all the time throughout the year.
We’re not materially, Tommy, going from 80% stocks down to 50 and anywhere in between. We’re certainly not going to cash based on what we think is gonna happen with tariffs. Today is April 2nd, I think President Trump’s calling it Liberation Day. We’ll see how that reverberates by the time this podcast is released. But there’s a fundamental difference, Tommy, between active versus passive.
Tommy Blackburn: Yes. And part of that’s like the timing of the market, which we don’t do, right? Like we just hands down, we’re not trying to time the market and figure out like this is the time to get out and the time to get back in, ’cause there you had to at least be right twice, which is almost impossible. Some of the world’s greatest investors, who are even, you would say, active like Warren Buffett, which by the way, his strategy is all one, is to like take control of a business or have a pretty strong interest in it. So he is not like a minority shareholder, but he’s a very long-term guy.
And he would say he is not trying to town the market, now he does keep a lot of financial resources around so that when the market is panicking, he can act and take advantage. But different guy, main thing I wanted to say there is he would tell you don’t try to time the market and investments are long-term.
So for what it’s worth, probably one of the brightest minds in investments, there you go. We don’t try to time it, and from further in that active passive, that’s a big one. And John, as we were talking about this, to take a step back maybe goes in line with it of like timing and active is we think a lot of value, not only aligning your investments to your financial plan and what you are trying to accomplish and what works for your plan is let’s try to just avoid doing dumb things. That’s part of, I mean, that’s really a big part of the strategy, and I say it, I don’t mean to be harsh there of doing dumb things.
It’s like acting or reacting emotionally or going to the latest craze, half the time just avoiding those things and sticking to a strategy get you 90% of the way there. So that’s a big principle is it’s not just react to things. Let’s try to avoid, stupid or dumb is a harsh way to say it.
If I have mistakes, trying to avoid some mistakes is half the battle. So that’s a big one. And then we’re passive strategic, but we do have some satellite positions. They’re not huge. And some of that is allowing, as John said, trying to allow a bond manager to add some more diversification to it, right?
Like we’re diversified, we’ve captured the market, we’ve captured the asset classes. Now we think that this fund, this company, these individuals, with a small waiting, nothing huge, they can round this out a little bit and potentially add some value, if nothing else, than just diversification. And even the same on the stock side, just to give us a little bit more of a well-rounded portfolio, but by and large, passive strategic with some tweaks here and there.
John Mason: So avoiding mistakes, I think, is very important, Tommy, in avoiding dumb things, avoiding mistakes, avoiding things that could be catastrophic to your financial plan. And an easy way to do that to avoid mistakes is just not making any calls, being invested all the time, being invested broadly diversified, and letting the market give you whatever it’s going to give you. And in order to not make a mistake in that scenario, we have to acknowledge that humans, as humans, that there’s gonna be a 10% drop once every year. There’s gonna be a 20% drop every three years, I think. And then every once in a while, you could see a 30 to 50%.
And where you make the mistake is if you freak out and go to cash, or you freak out and pull out of the market. That’s that mistake. The act of tactical or the active or the active tactical. Every time you make a trade, you’re opening up your portfolio for a mistake. Am I in the right asset class?
Should I be in, should I be out? So there’s a lot of opportunity for mistakes. There’s a lot of opportunity for heartburn if you go into that strategy. So I think about right now a little bit, Tiger Woods. We’re getting really close to Masters at Augusta and I saw a YouTube video the other day, Tommy, where it was like five or seven people.
Brooks Keka, Shane Lowry, a few others were talking about how they prepare for Augusta and Shane Lowry said, “I can tell you exactly what tee shot I’m gonna hit on all 18 holes at Augusta, and I hit the same tee shot every time.” He’s not gonna deviate, he’s not gonna change. He knows his plan going in, whatever wind direction he’s gonna hit that shot.
He said he learned so much from Tiger Woods and the thing he learned from Tiger Woods when he played with him was how Tiger Woods shot four under, I believe, in 2020. And Shane Lowry said he didn’t even play well and he shot four under, but he always missed to the right spot. He never went into the bunker on hole three or four.
He missed the green on 15 to the right side. He knew exactly where he was going to miss on every shot. He plotted his way around the golf course, conservatively to the right spots, gives himself an opportunity to make the putt, didn’t have to be a hero on every shot, and he’s won the second most majors of all time, 80 plus wins on the PGA tour. There’s something to be said for missing in the right spots.
Tommy Blackburn: That’s a, yeah. I love that analogy there, very strategic and some would say probably boring, but a lot of times, yeah, but that is, but it’s the strategy that works most of the time. So that’s a great analogy. I was thinking, John, I don’t necessarily wanna spend way too much time on passive and active ’cause we have other things to cover, but I certainly don’t mean that to move you on if there’s additional ones you wanna hit.
But on the active passive, we do believe that active management can work. We just think it’s much harder. It’s much harder to be consistently correct. And typically, it’s a more expensive strategy. So when you factor in, and we’d even say could be emotional, depending on what type of active management we’re talking about.
If we’re trading quite frequently, that to us is very emotional, ’cause you’re wondering like, did we get the trade right? Are we where we need to be? All these things, John, went into, but it’s even, the market’s here and it’s pretty reliable and we’re investing in the economy. We’re just be betting in that these companies diversified are going to work by and large, and at the market, by and large is gonna make the adjustments for us because companies that fall out of favor, they disappear or go lower in the waiting and the others come up.
So it’s kind of just designed to already work for you, whereas active has to overcome that. And there’s just fees involved with it. So a lot of times it’s, “Hey, we can get to a better place, a more predictable place,” and not even have to worry about overcoming that additional fee barrier. The other nice thing about, as I think about like the passive strategic approach or being that diversified, as you say, kind of let in with is market moves quick.
That’s one why it’s hard to time it right because it can move very quick and in ways that you don’t expect and it sometimes irrational ways, but trying to time that is very hard. And a lot of times when those gains happen, I mean, when lightning strikes, you want to be there, right? Because we just see a lot of times the market kind of flies along and all of a sudden boom takes off.
And if you were in the wrong asset class, you weren’t there when lightning struck. So this is why we want kind of some just analogies around the different philosophies here.
John Mason: Lightning struck in March of 2009, right when I think the market rebounded like 50% and in a matter of months, lightning struck during COVID very fast after 30 to 40% drop.
Lightning struck again at the end of ‘22 going into ‘23. Or maybe it was mid ’23, whenever it was. ‘23 lightning struck and lightning will strike again. And to your point, Tommy, just being in the market, being there, we always mention to our clients, “Control what you can control.” And we can’t control the stock market.
We can’t control algorithms and AI and whatever investing craze is coming our way, but we can control a lot of other things and letting the market just give us solid, predictable returns is a good way to go. I do want to acknowledge the idea of active management. If you are a very emotional investor, meaning you’re gonna freak out when the market goes down, maybe you would benefit from a portfolio strategy where somebody’s gonna get you in and get you out and move you to cash and et cetera.
And at least if you like, arguably just sticking to that is better than you trying to do the passive thing and freaking out all the time, right? So, whichever strategy you pick. You probably need to be committed to it all in, whether it’s the active or the passive or anything in between. And I do want to just say really quick, Tommy, that there are different layers of active.
So there’s like the active passive, which we hire some active managers from time to time in our strategic or passive portfolio for a sliver. And then there’s the active-active. The active-active is the people who are buying active managers. Then actively trading all the time too. And then there’s like the active-tactical, which is like, I’ve got this universe of funds I’m in and outta cash.
I’m materially changing my investment allocation any given day. So for our audience, it’s important for you to really understand if somebody says they’re active or somebody says they’re passive, there’s always some level of active. There’s always some level of activity. So is it like the passive active, the active-active or the active-tactical, and then being able to understand in the investment strategy, especially if you’ve hired somebody, is super important, so.
Tommy Blackburn: I love it, John. Yeah, so we can go like super deep and hopefully we’ve given you a good overview here of it. What’s most important, I know that we come back to is what is your financial plan?
What is your cash strategy and which one of these strategic fits with it? So it’s really, again, control what you can control. We focus on those other parts I mentioned on let’s fit the plan, let’s fit the investments to that plan. and be able to ride it out and appreciate that asset allocation should work for us.
Diversify, like we’ve minimized all the risk we can, but they will remain and this is why we focus on now the other things, taxes, cash flow, strategy. What are your goals?
John Mason: I love it, Tommy. Let’s go right into the next topic, which is helping our audience understand the difference between a mutual fund, an ETF, and an individual stock.
And maybe we can just start with stocks and like, what is a stock?
Tommy Blackburn: So a stock is just an ownership interest in a corporation. So could be Coca-Cola, just thinking of some big name. Maybe Tesla, NVIDIA, those are big ones right now. Amazon, Microsoft, you can own stock. Those are, you own a percentage of ownership in that company.
So as the value of it goes up and down, you get to participate. If they distribute out cash in the form of dividends, you get a chance of that. And if the company goes bankrupt, you’ve lost your investment and you also get to vote, based upon, in the general stock, like the most pure of stock you get to vote.
But typically in a publicly traded company, your ownership is so diluted that vote is not making a huge difference, but collectively, that dictates what the board of directors and so forth who are running the company, what they can do, and I guess the natural next stop, so here’s the stock, then there’s also bond, right?
John Mason: So a bond’s basically a debt instrument. So it’s like the company loans you money, or I’m sorry, you loan the company money so they could do something with it. And in exchange for that loan, they’re gonna pay you a coupon payment or an interest payment, maybe 6% or 8% every six months, a fraction of that every six months.
And then at the end of 10 years, for example, you get all of your money back. So on a bond, you have this like not guaranteed, but you have like predictable, steady income or coupon payments, and really no appreciation because you’re just getting your money back at the end of the day. Now, if you were to sell that bond somewhere in between years one and 10, you could be selling it at a premium or a discount based on where interest rates are.
So what I mean by that is if your bond’s paying eight and then going interest rate is four, your bond’s very valuable. If your bond’s paying four and the current rate is eight, your bond stinks and people are not gonna pay you very much for that. It would trade at a discount. So if you hold it till maturity, you get your money back and you made 6%.
Makes sense. Bonds are more, arguably more conservative, stocks are more aggressive. They have different risks. So bonds are subject to interest rate risk. They’re subject to the claims paying ability of basically that company, and some political risk too. Stocks on the other hand have a additional risk.
Your stock investment could go to zero. You have all sorts of stock market risk, political risk, geopolitical risk, and more. So stocks are–and bondholders get paid first, Tommy.
Tommy Blackburn: I thought that was an important point. Yeah. Bond holders get paid first, particularly like if we go to bankruptcy, bondholders are ahead of those stockholders and getting their investment back.
So premise there, yeah. Risk return, right? Buying lower risk, lower return typically, and stock are gonna be higher risk, higher return.
John Mason: And I’m buying stocks for either the, basically, I’m looking at are there earnings going to go up? So I’m like betting on the future earnings of that company. I’m also betting sometimes on the people, like a lot of people have purchased Tesla. I know Elon is in the news right now and Tesla stock is down as of this recording, but the company’s innovative. They have the next AI, so it’s the current earnings, the future earnings, and then sort of like speculation too. It’s like that chance for material appreciation is why you buy stocks. You’re typically buying bonds for the more stable income. Historically, individual stocks and individual bonds were not really investments that were accept, not acceptable.
Individual investors, most of the investing public couldn’t really build a diversified portfolio, Tommy, around individual securities and individual bonds. But that is changing a bit.
Tommy Blackburn: Yeah, and I guess the premise there, it’s kinda like how do we get to mutual funds and ETFs was that, you know, if a share of stock is a hundred or $150 a share, and then a bond is a thousand or more, depending on the face value of it, most people, you only have those denominations available in so many ways to begin investing, right?
And so you could only buy so many shares, so many bonds. And then if you wanted to diversify, multiply that by X number of companies to try to get some diversification, just very quickly kind of got to the point where you didn’t have enough dollars, it wasn’t easy to do that. So by and large, here was how the mutual fund was born.
John Mason: Yeah. And to be clear, to your point, Tommy, fractional shares didn’t really exist 20 years ago, 30 years ago. I mean, you couldn’t buy just 0.1 shares of Google or Meta or what have you.
You had to buy a full share. And also 20 or 30 years ago, technology isn’t what it is today. Like we used to trade by telephone not that long ago, and there were commissions and fees and it was expensive and hard to trade. And so the amount of trades that it would take for you to buy 10 different stocks and 10 different commissions and 10 different et cetera, versus buying one share of a mutual fund that already owns those 10 companies, it was a much more efficient use of capital.
Arguably lower commissions, lower fees, diversification, fractional shares exposure to a variety of companies. Now, in the last five to 10 years, that’s changing a bit ’cause some of these investing platforms do allow you to buy fractional shares of S&P 500 components, for example.
But it’s still arguably inefficient for you as the individual investor to try and create a broadly diversified portfolio of fractional shares where you could have just bought, I think VOO, right, is the S&P 500 ticker?
Tommy Blackburn: I think that’s right. Let’s double check, ’cause there’s VO, VOO.
John Mason: Yeah, VOO Vanguard S&P 500 ETF. It’s a lot easier to buy that than it is to try to buy 500 fractional shares of all the companies that exist within the S&P 500. And we’re not bond trader experts, Tommy, but I don’t think that the bond trading has become nearly as easy or efficient, so for individual investors trying to buy individual bonds, it does seem, my understanding, easier to buy fractional shares right now of stocks than it is to go to a bond desk, right, to buy these individual bonds.
Tommy Blackburn: Yeah, there’s been improvements in the bond market, but yeah, that one’s a little harder to crack and I think, to your point, the mutual fund and ETF space has gotten so efficient by and large. It’s just simpler. So it seems like, yeah, the technology’s there and it’s kind of cool to do some of these fractional things, but it feels unnecessary and still more complicated than doing it these other ways.
So mutual fund, that was born from, hey, it wasn’t efficient from me having enough money, a cost-effective, et cetera, to go out and get a diversified portfolio. So now let’s us as investors, we’ll all throw in our thousand dollars or whatever it is that we need for this mutual fund. They aggregate it all and say, “Well, now I’ve got millions. Now I can go out and I can buy all of these and I can administer it cost effectively so that you, the individual investor, now own a piece of me, the mutual fund and I the mutual fund own this diversified portfolio or this particular asset class or whatever strategy it was we wanted to accomplish.”
So it made investing accessible to many, many people, much, many more people, to do it in an efficient and diversified or just more sophisticated way.
John Mason: And inside of those mutual funds you can have active or passive. Passive funds who just buy the S&P 500 or active managers like American Funds, who is maybe picking a subset of those S&P 500 securities and trying to outperform. Fees are gonna be different depending on the type of fund that you own, strategic or passive funds are typically cheaper on the expense ratio. Actively managed funds, typically more expensive. If you can trust AI overview on Google, the first mutual fund was established in 1924. I have not fact-checked this AI, but that’s what it’s telling me when I Googled it and that’s what Wikipedia says too. So hopefully that’s right.
Long time ago, a hundred years ago, the first mutual fund was created and they’re still being used today.
Tommy Blackburn: Still being used today. Yeah. And like, like you said, John, different strategies in there, different expenses. The expenses by and large have come down quite a bit.
Even with those over time, like the ticker charges, the internal expenses still depends on what platform and what the strategy is inside of it. Mutual friends. No, I was just gonna say, so those were great and I was thinking we would kind of pivot into how do we get to exchange-traded funds. I know one of ’em is kind of the tax efficiency, but, where were you wanting to go?
John Mason: Yeah, so we definitely can’t call this investing 1-on-1 because we’ve gone down rabbit holes already, so the mechanics of a mutual fund, that makes it a little bit unique. And you’re right, Tommy, I was thinking about tax too, is if you’re contributing to a mutual fund, you get the price at the end of the day.
So your money hits the net asset value at the end of the day is what you purchase it for. If you were to sell a mutual fund, then you’re gonna get the net asset value or NAV at the end of the day. But then one of the things that really stinks about mutual funds is if you’re the investor that holds tight and you don’t panic in bad times, but everybody else in that fund starts selling, the mutual fund is gonna have to redeem securities to give everybody cash.
And at the end of the day, that’s gonna result in capital gain distribution to get passed on to every single shareholder regardless of whether or not you sold. So if you went back in 2022 or you went back, any negative year, there are mutual funds that do, it’s kind of adding insult to injury. You’re already down and then you get a taxable capital gain distribution, which is really frustrating.
That shouldn’t necessarily scare you away from mutual funds, but we should be understanding of what we own inside of like taxable brokerage accounts because even Morningstar does do like a tax-efficient cost or a tax cost ratio based on these capital gain distributions. So that’s kind of the mechanics.
Mutual funds are also confusing. So like Vanguard, Tommy, has they’re normal shares and then Admiral shares. And the Admiral shares are cheaper than the normal share. So arguably, you always want Admiral, but then it gets crazy. Then you go over to a company like American Funds. They have A shares, they used to have B shares.
I’m pretty sure those have been outlawed. C shares exist. A and C have the similar investments, but it compensates the commission-based salesperson differently. Then you go into F shares. And it gets even crazier ’cause you have F1, F2 and F3 based on whatever cost or revenue sharing arrangement they have with TD Ameritrade, who doesn’t exist anymore.
Schwab, Fidelity, whoever. Then you go five 20 nines and there’s 529 shares, 529 A, 529 C. And then you get even crazier ’cause then you get into retirement plan shares and you have R1, R2, R3, R4, R5, and R6. So the same daggone fund, I don’t know how many shares that is. It’s like 25 different share classes.
Tommy Blackburn: It is typically you just want to get the lowest share class you can and you qualify for, but it’s worth being wise or having somebody in your corner like an advisor who can say like, “Yeah, hey, in the right share for you. We’ve got institutional shares available.” So yes, there’s many, so that can certainly be confusing, but you wanna look for the lowest cost share.
John Mason: So then ETFs, exchange traded fund or ETF for short, Tommy. Again, if you can trust whatever Google AI is spitting back at me. This surprised me. When do you think the first ETF was launched?
Tommy Blackburn: Yeah. That’s interesting. It feels like a more modern thing of when it took off, but I don’t know. Maybe it was like in the seventies.
John Mason: You’re closer than me. I was, 1993 first ETF. SPDR S&P 500 SPY launched on January 22nd, 1993. I was thinking it was in like the 2000s or something like.
Tommy Blackburn: Oh, I knew it was like kind of a trick to us. Like it feels like it was a very recent, but I’m guessing the first ones are going back further then ’cause for our mutual fund to have existed in 1923, clearly it took a while for it to like become really accessible to the public. So, yeah, so the nineties. Makes kind of sense, technology was a little more advanced, obviously, than in the twenties.
John Mason: So the, and I was thinking, the Mutual Fund Investment Act or whatever of 1940.
I was like, well, that seems like when the first mutual fund would’ve existed around the same time as that 1940 act, but almost 20 years before that. And I don’t know, I remember in 2010 or so when I joined investment managers and reps from like ING or wherever were coming over and they were like, “Hey, we’ve got these new ETFs.” And it was like–
Tommy Blackburn: Yeah. They were new. Yeah, I agree. That’s when it kind of seems like it was really beginning to take off and more access to ETFs when it became prevalent is in that timeframe you’re talking about. But, so an ETF is, I would, my way of thinking of is like just take everything you learned about a mutual fund and now translate that into an ETF.
So we’re just grouping a bunch so that we can go then buy cost-effectively. Where the differences come in is this is now, I think John mentioned, you go to the mutual fund, it’s placed at the end of the day, the closing value. ETFs are traded throughout the day, so those are on an exchange you can buy or sell whenever throughout the day on the exchange.
And they’re more cost-efficient. So typically, so again, there’s some mutual funds out there that are very cost-efficient, but ETFs don’t pass through those gains, or at least not typically, like John was talking about. So a lot of times, particularly in those non-qualified accounts, those non-retirement types, we like to use ETFs.
I mean, we like ETFs in general because they’re not gonna pass through those unexpected capital gains. They’re just a far more, by and large, tax efficient. But very similar to a mutual fund. But those are some of the main differences that I can think of. There’s probably more, but those are the headliners.
John Mason: And I don’t claim to be the smartest person of all time. I don’t know that there are different versions of ETF shares, right? Like an ETF’s just an ETF. So it’s a little bit simpler.
Tommy Blackburn: Yeah ’cause I think you then would have a different ticker. Yeah. So I think we’re, neither us is 100% on this, but we haven’t seen, to our knowledge, different classes. So it’s just the ticker is what the ticker is.
John Mason: And it’s different because I think with mutual funds as well, if it’s an open-ended fund, they just continue issuing new shares all the time, versus a closed-end fund there’s however many shares that exist that can be traded. I think an ETF is more like the closed-end fund, right? There’s only so many ETF shares, do they continue, Tommy, issuing new shares all the time.
Tommy Blackburn: I’d say very kind of, I think, complicated as to how the ETFs work from that, because I think they do create additional shares, but they do it in a way that doesn’t like impact the existing amounts. I forget how to explain it, but you know, people are like buying VO, more people could be buying VO and I think they go and they create additional amounts, but they don’t have to redeem and go through the same exercise like a mutual fund does to create it, and that’s another part of where they’re more efficient.
John Mason: I love it. So we use a lot of ETFs for the flexibility. Typically a little bit less expensive than the mutual fund counterpart, but like we said earlier, mutual fund fees have come down, ETF fees have come down. The spread between the two is not as big as it used to be, and one of the things you have to watch out for with ETFs, specifically my understanding, bond ETFs or more thinly traded ETFs, meaning positions that don’t trade as much throughout the year is you always have a bid and ask spread, Tommy, between those.
So ETFs can be inefficient in that you’re paying this kind of hidden cost between the bid and ask spread where, I guess, and audience, I don’t know, we’re not, again, trading experts here. We more focus on the planning, but you do have to worry about that with ETFs or I don’t think you have to worry about that as much with funds.
Tommy Blackburn: Yeah, yes, you’re correct because, so the mutual fund, when it goes to give you cash redeemed shares, I mean, they’re saying like at the end of the day, everything we owned, here’s here was what it was worth, divided by whatever you’re asking for your shares, that’s what you get. So it’s what the assets were valued at.
Whereas the ETF could be like, “Hey, I’m trading at a penny or two less than what my actual underlying withholdings are.” Like if you actually own those and went to sell, typically it’s very slim, but particularly on a very largely traded position, like an S&P Vanguard 500 type of thing. But you’re correct, yes.
So we do need to look and see like how efficient are they there so that there’s not this huge spread between what the underlying assets are worth and what the ETF is trading at. It should ideally be priced at exactly what the value of everything it owns is.
John Mason: Agreed. I think we’ve heard it called as slippage before, right? Like then we hear about that term.
Tommy Blackburn: Yeah. Slippage spread. Yeah. There’s different, and there’s a lot of complexities here if you really get into the weeds, but I think that’s probably going far deeper than we need or want it to go today.
John Mason: So I thought where we go next, Tommy, is talk about market makers. Just kidding. Yeah, that’s, if I studied the series 24 again, back from our commission days, I’d be more up to date on market makers and all those kind of things. But why don’t we kind of hit cash strategy and dollar cost average now?
Tommy Blackburn: Yeah. So when I think about cash strategy, it’s kind of how, what’s your emergency fund? How are you meeting your spending needs? Like where is income coming from? Social security, pension, portfolio, all of those. What is our cashflow strategy as well as. How are we earning interest on the current cash we hold in the bank? Those are cash flow strategies.
And the big one is, yeah, how am I gonna meet my eat, drink and be merry? How do I pay the mortgage? How do I live month to month? What’s the cash flow strategy? And your portfolio should be aligned with that as to how aggressive and conservative. Is it, how is it going about the distributions, and what are the tax ramifications of those distributions?
So John, at a high level, that’s how I think of a cashflow strategy, and it all needs to fit together.
John Mason: I agree with everything you’re saying. Going a little bit deeper into how I think about my cash strategy too, is I kind of like to have half of my cash liquid and then kind of half of my cash tied up a little bit, and what I mean tied up, it could be like a 18 month cd or a money market mutual fund, government money market fund, paying between four and 5%. So some money at the bank, some money in like a higher yielding. I’m not super jazzed about making my life too difficult by having all my money in a money market mutual fund and then having to do like sales and transfers all the time.
So find your happy zone where you have enough in your liquid cash and then have your like cash that’s actually doing something and earning something for you. So there’s like money market mutual funds, I think, can be really great. High-yield bank accounts can be great as well. 50,000 for our retired clients feels like a good number for a lot of folks, but we do have some folks who want to keep about a hundred thousand or more in ready access cash.
So it does go back to your individual plan, Tommy, and in our investment portfolios, we try to keep about one to 2% in cash. Ideally closer to one, but sometimes we creep a little closer to two. And then sometimes in non-qualified accounts it can go a bit higher ’cause we’re not trying to realize a bunch of capital gains for no reason. So non-qualified portfolios are always harder, but a good target for a managed account is somewhere between 1% or 2% in cash.
Tommy Blackburn: That’s correct. And then again, the portfolio strategy that fits within it, which is, hey, good times, bad times, yes, the account’s gonna be down, or at least it’s gonna say it’s down based on what the market’s doing right now, but it’s diversified, it’s got the correct asset allocation. It’s built on a long-term strategy, so it’s going to reliably kick off your monthly income that it’s supposed to like we said. And we never were expecting so much from it that now we’re scared, like it’s all part of a stress test plan, right? So that’s part of that cashflow strategy.
We’ve got social security or don’t have it coming in, the pensions coming in. So all of this adds up to our goals and maybe there’s one-off distributions and looking at, is that okay? Not okay? Is now, I say, a good or a bad time? Again, typically, we’re planning 30 years for you, where if that was in the plan that we were taking a big trip and now we need 20 grand, even if the market’s down.
Sometimes, yeah, maybe we could have got in front of it. A lot of times, no, like we said, things happen quickly, but it’s okay. Yeah, we’re down. The S&P could be down 10, but maybe your bonds have appreciated as part of that asset allocation. So your portfolio is only down somewhere between five and seven and it’s all part of the plan, so it’s okay.
And let’s look longer term. I’m just thinking, some conversations I’ve had here was like, “Hey, is now a good time?” It’s like, well. Let’s look a year or two from that last bear market, and we’re still way up from that one. So yeah, this wasn’t as good as it was a month or two ago, but this is still a very opportune time to take that distribution.
But at the end of the day, the portfolio, we really zoom out. It was designed for this. It is designed to go to this market and still support your cash flow, or it should have been designed that way.
John Mason: Big expenses, to your point, one-off big expenses don’t typically hurt your financial plan. A consistent butt whooping of high expenses will hurt your financial plan over–
Tommy Blackburn: Particularly when all of a sudden we go down.
John Mason: Committing to boats and second houses and RVs and you stress your plan and you put a lot of guaranteed expenses in your plan. Sure, like that’s gonna be stressful. But if we just assumed a 5% withdrawal, Tommy, on assets for easy math, if a client comes to you and says, “Okay, Tommy, I need a hundred grand.”
Like, okay, so you can take out a hundred grand. And worst case, that probably reduces your retirement income by $5,000 a year or $400 a month. That’s not that significant. If you have to do that every once in a while, but chances are you could do that one-time expense and not have to reduce your living expenses.
I’m just kind of trying to paint the picture that when you think about extracting that much value one time, what it does to your monthly flow is pretty small, even if you did have to adjust down.
Tommy Blackburn: Yes. Yeah. And there are ways we look at things. Sometimes, many times, we don’t need it, but others are, all right, we just took a large withdrawal.
Mark is down 20%. You’re continuing to take large withdrawals. I probably need to have a conversation about making some adjustments to shore this thing back up, make a cut, as John said, but many times these are discretionary expenses. Yeah, 5%. It’s like, okay, that’s fine. That’s what this portfolio is here for.
Let’s revisit next year. Or maybe we kick it and we probably don’t need to kick this down the road, but let’s take it. It probably was a discretionary expense to begin with. So maybe next year it’s 80,000, we’re thinking about on a one-time instead of the a hundred thousand or so forth. So it’s just understanding all those ramifications and what a good planner’s here for. The issue is, hey, we started out aggressive and we continue put a lot of stress on the portfolio, then we went through a rough market to put even more stress on it. Yeah, now we’re really in decision time versus it’s fine, normal fluctuations, healthy distributions to begin with go through pretty much any market.
John Mason: I love it, Tommy. So kind of wrapping up the cash strategy let’s, quickly hit on dollar cost average and we do this a lot with clients and one of the reasons that we’re hired is not to necessarily babysit people, but sometimes the people that we’ve met have made decisions to exit the market or sell and go to cash or TSPG fund, and they did that whenever, 2008, 2020, 2022, and then they get cold feet and they never know when to get back in.
So this goes back to the active-passive debate is once you got out, it’s really hard to get back in. You need a mechanism to get back into the market. A lot of times the folks who have excess cash or excess g fund are saying, “I’m just waiting for the opportune time.” And then it’s like, “Well, you be sure to tell me when that is.”
Because it seems like almost every year, something scary is happening. Yeah. I mean, in my experience over 15 years, I’m not sure that if I had a like a million dollars in cash, that I would’ve ever necessarily classified something as like, “This is the time I have to get in. Like right now, this is the opportune time for a million bucks.” I’m not sure that I’ve ever had that much confidence in 15 years, so I would dollar-crossed average.
Tommy Blackburn: Yes, I agree. There have been opportune times, but one, it was having to cash and then having, yeah, the real, the guts to make that call.
Not easy to do in those situations. Yeah. And you have to get it right if that’s your strategy. Much more probabilistic to be invested, it’ll work. Three quarters of the time market goes up. Let’s stick with that strategy. Dollar cost average. This is, I think what we see a lot too right now is COVID scared people or the inflation scare when the market went down in ‘22.
Yeah, they got out. And they haven’t figured out how to get back in and they’ve missed a lot of gains and usually the conversation’s fun like that. “Will you be sure to tell me?” And they’ll, and when they’re pushed, it’s. Well, I’m not trying to get it perfect, but the problem is like, I just don’t even, I’m frozen, right?
Like I’m just frozen as to making a decision on this. And so behaviorally, one of the way, one of the things we like is this dollar cost average, which says, let’s take the million and let’s agree to a time period that feels comfortable. A lot of, we’ll just use a year as an example.
Over the next year, we are gonna take that million and just piecemeal, start deploying it into the market, and the idea is that it’s momentum. Let’s just start taking some steps and keep that momentum going. And then it’ll help smooth out volatility. So instead of us throwing a million right back into the market and we chose the worst possible day, and now you get to experience 20% down, that’s not fun and doesn’t make any, that’s probably just not gonna lead to success.
Whereas we don’t know what’s coming, so let’s do this over a year so that you can buy at various points. If the market goes down throughout that year, you got to buy at cheaper and cheaper prices as you were buying in versus all million just depreciating. It can work against you if you, if the market is going up over a year, you’re now buying at higher and higher prices.
But again, it’s the momentum of you probably weren’t gonna do it. Ever. So now, let’s just begin purchasing to get back in. So it’s just, it’s behavioral. It smooths out the volatility and we like it a lot to get people back into the market when they’re coming from a place of, like, “I made a decision years ago and I just haven’t been able to figure out getting myself back in.”
John Mason: So we’ll typically use a money market mutual fund earning four to 5% and then we’ll dollar cost average into the market from that. 12 months is pretty common, Tommy, and as you said, the one of the negatives is the market could go up while you’re dollar cost averaging, and that’s also what makes it so hard to get back in from a cash position because if seven outta 10 years the market’s up, every year that you’ve been in cash, you’re like, “It’s higher than it’s ever been.” I’m not, it’s like eventually, we just need a systematic approach or a mechanism to get this money deployed. And I have two clients in my head right now. One, I think they’re both dollar cost averaging over five years, and that is a long dollar cost average.
And the audience is probably like, “What are you doing?” Well, one person may or may not buy a house. We’ve been sitting on two, three, $400,000 in cash for three years, four years, five years, and home prices have gone up, interest rates have gone up. So we had an honest conversation. We said, “Are you ever gonna buy this house?”
“Probably not, but if the right house comes along, I wanna be able to.” So it’s like, okay, let’s DCA over five years. Like let’s at least do something. And that way if this house does come available in April, then we haven’t deployed all the money right before the—the other person may have some ability to buy some additional company stock in the future, but we don’t know when or if that stock will ever become available, so we could be paralyzed and sit in cash forever or we could kind of like conservatively over five years get this money working for us, knowing that we’ll probably be able to build savings over that time too. So, design it for you. The DCA is an awesome tool. It’s a mechanism to get that money deployed. Six months, 12 months, 24 months, whatever. Whatever works.
Tommy Blackburn: Don’t let perfect get in the way a good enough there. It’s a great mechanism. It’s not without its own flaws, but it’s a good mechanism to get you in there. It’s better than nothing. And one of the things, John and I were talking about kind of sketching out this episode before we got going was many times our federal retirees can come to us and if they’ve done the whole career, what their pension will be, plus social security is gonna cover their lifestyle, their current lifestyle. Like many times that’s the case. Most of the time that’s the case. When we look at it where it’s like, “This is great, these things, fun to have to, is to keep maintain that standard of living or very close to it.”
So it’s like, “Why take on the risk? I could just sit in cash.” But that’s where we, again, look out over a 30-year retirement and we’re like, “Well, you could meet your needs or you could live your best life. You could live a great life. You could have flexibility options, get to go out and have an awesome retirement.”
Now, one, you probably need to take on some risk. We wanna minimize as much of it as we can. But if we put that portfolio to work, man, your plan just got so much better and more flexible, and the entire time you keep your needs covered anyway with that pension and social security. So that’s a real fun conversation.
We can say, “Look at how much more we could spend or the different things we could do.” And so now let’s put the mechanism in place to get us back into that portfolio that over a long term is gonna give us more flexibility. And even if something like long-term care comes along, having that money invested so that when that event comes along, again, that money was working for us to help with it.
So that’s why maybe we didn’t have to take on risk. But we don’t always wanna live with the haves or the needs, right? We want to have the best we can with the least amount of risk.
John Mason: And it also continues, Tommy, towards they could increase what you do to charitable contributions, can increase what you do to, as far as like legacy planning and generational wealth transfer and the ability to go on vacation with your kids and grandkids or pay for your grandkids’ college.
You just start thinking about the opportunities. It doesn’t necessarily have to be for you, the retiree or the client, but you start thinking about the power of compounding and the power of investments and the power of being in the market, earning real returns, and what that could do for you, for the community, for your family.
It’s a big deal. Let’s skip really quickly over muni versus corporate bonds and just say that municipal bonds and corporate bonds are very similar. We told you we would talk about ’em, we’re gonna gloss over it today. Corporate bonds, you would typically buy inside of an IRA or Roth IRA or a taxable brokerage account.
Corporate bonds typically have higher yields or higher coupon payments than municipals. I guess you could argue that corporate bonds maybe are a little more aggressive than municipal bonds, but–
Tommy Blackburn: Depends on the municipality, I guess.
John Mason: Correct. But corporate bonds typically higher yield. You would typically own those if you’re in a retirement account or you’re in a relatively low to moderate tax bracket.
Municipal bonds have, there’s different kinds, but generally speaking, we will start using municipal bonds when clients start to encroach on the 32% or higher federal tax bracket. And then depending on the client, you could even layer in some state municipal bonds, and the state municipal bonds may have some tax-free state treatment too.
So what you’re looking at, Tommy, is I’m giving up yield on the municipals, but I’m getting tax-free stuff. So what tax rate does the tax-free lower muni actually provide a better return than the corporate? It doesn’t appear that’s below 32%.
Tommy Blackburn: No, which makes sense, ’cause that’s, market’s smart.
It’s pricing things accordingly, right? So that’s typically you had to be in a very high tax bracket, or maybe live in a very high tax state, but then do the math to figure out like what your tax equivalent on a corporate versus a muni is based on your situation to get you to that right answer, as you went through, John, there’s some different risk characteristics and they’re all very specific to kind of, is it California bonds, is it US bonds?
Like what are we talking, Virginia bonds? So there are some individual things that you have to look at to really get it down to where it’s, but that’s the high level.
John Mason: And both of those are available as individual securities or in a bond–
Tommy Blackburn: Basket, like a mutual fund or ETF.
John Mason: Exactly. So wrapping this up, audience, we wanna discuss products, aggregators, and financial planners and investments, generally speaking are a product. Your investment could be pretty simple product consisting of ETFs, mutual funds and stocks, or it could be a very complicated product that consists of things like variable, an annuities index, annuities, life insurance policies, whatever the strategy may be. So it’s important to understand that the investment product that you own should coordinate with your financial plan.
But purchasing an annuity or purchasing a mutual fund or purchasing an ETF in itself is not a financial planning strategy. We all have to purchase something if we’re going to be invested, even if it’s just cash. We have to buy something. We have to allocate our money to some type of product. So understanding that a product is just that, it is, should be a piece of the financial plan. That’s how you allocate your money is to a product. Then we think about like the commission-based salesperson or some of these big mega, Tommy, RIA aggregators of assets and the products among those two people are different. But globally speaking, both of these people are product salespeople.
The commission-based salesperson is selling you whatever he’s selling you, and he is gonna get paid one time and he may never call you again. Granted, there are really nice commission people who probably don’t operate their business that way. Then there’s the RIA aggregators, we won’t call any names, who get all your money in and say, “We charge you a fee. We do better when you do better.” And they allocate you to a product of investment portfolios. And that’s all they do for you. And they charge you one or 2% to do that. But in either scenario, all these people did was help you purchase a product.
They didn’t actually add, maybe they added investment value. Maybe they did add some money on the investment side. Maybe they did help you select a good product. But that’s a, there’s a fundamental difference between those two people, Tommy, and like what we do at Mason as what we would say like financial planning actually is. So maybe you can share that with the audience.
Tommy Blackburn: Yeah, I’m even thinking like in my mind, visually, it’s like a circle of like planning and then it’s like the product within it, whether it’s the managed portfolio or perhaps an annuity, whatever it is, it’s like those are pieces of financial planning, but they are not financial planning, right? So again, the big circles of financial planning, and these are all pieces, tax planning, estate planning, risk management, cash flow strategy, those are all in that circle of financial planning.
So advisor is there to, yeah, help you control what you can control, align these different things to your individual plan and circumstances, and their value is somewhat these individual pieces, but it’s adding up to the greater whole and the bigger piece of that being the advice, pulling this all together for the ultimate strategy and walking alongside you to give you advice and be your partner throughout this journey, or as long as this journey that you go together is.
John Mason: So a rectangle is a square, but a square is, no, a square is a rectangle, but a rectangle is not a square, right?
Tommy Blackburn: Square is a rectangle, but a rectangle is not a square. I think that’s correct because square has four, four sides, but equal, whereas a rectangle has to have, unequal.
John Mason: Yep. Exactly. So I kind of think about that when I think about the commission-based sales person, product person or the RIA aggregator person, they’re the rectangle.
And then the financial planner is the square. Like they can do all of those same things that those other two people can do, but they’re a square and they’re materially different in the offering that they have. Like the product offering at Mason & Associates is the service and the value of all of the services that we provide.
Federal benefits, everything that you hit on, Tommy. So a square is a rectangle, but a rectangle is not a square is kind of how we want to differentiate the sales or product people versus real financial planning. So hopefully that’ll help the audience as they think about potentially hiring or just the difference between one versus the other.
Tommy Blackburn: Right. And I, as I even think about it, those are great, John. And it’s, is the person you’re talking to, are they just talking about the product, that managed portfolio? Are they spending forever talking about it? Are they spending forever talking about this annuity, the bells and whistles of it? And maybe individually, those things are fine, but that’s not an advisor and they shouldn’t be charging you the same as an advisor.
And you won’t hear us typically spending a lot of time belaboring these points with our clients. We’re really talking about the other things we can control while taking care of these and say, that’s the planner.
John Mason: Well, another great episode, Tommy, of the Federal Employee Financial Planning Podcast.
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