owl: the savings waterfall (february 2013)
TRANSCRIPT
DisclaimerPAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, AND ANY EXPECTED RETURNS OR PROBABILITY PROJECTIONS MAY NOT REFLECT ACTUAL FUTURE PERFORMANCE. FURTHERMORE, PAST RETURNS REFLECT THE PERFORMANCE OF ASSETS FOR A FINITE TIME, DURING A PERIOD OF EXTREME MARKET ACTIVITY. ALL INVESTMENTS INVOLVE RISK AND MAY LOSE MONEY. There can be no assurance that an investment plan or any projected or actual performance shown on the Site will lead to the expected results shown or perform in any predictable manner. It should not be assumed that investors will experience returns in the future, if any, comparable to those shown or that any or all of Owl's customers experienced such returns. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.
About Nirav Batavia
• BS in Economics (Finance Concentration) from Wharton, May 2003
• MBA University of Chicago, Booth School of Business, June 2012
• CFA Charterholder
Education
• Over 10 years in finance• Sales & Trading, Hedge Fund, Chartered Financial
Analyst Experience
• Disciplined Financial Planning• Helping you “Invest Wisely”• Keep More of Your Hard-Earned Money
Passion
The Background of Owl
Nirav Batavia (CEO)Chartered Financial Analyst
Founder
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The Keys to Financial Security
Financial Security Does Not Come from Skipping Lattes
It Does Come From Getting The Big Decisions Right
The Savings Waterfall
1. Where you put your savings will make MILLIONS of dollars in difference in your long-term outcome.
2. For most households, these decisions matter MORE than what you actually invest in.
3. Understanding where to invest and what to invest in are two sides of the same coin. Focus on both to maximize your financial security.
4. Whether you are just starting or have millions you can make the savings waterfall work for you (Waterfall Image)
Step 1: 401(K)/403(B)/Profit Sharing Match
You Always Want to Get FREE Money
a. The company match is FREE Money, do not pass it upb. Borrow, Beg, Steal but make sure you contribute enough to get
your full matchc. Average Company Match is 4.1% of Employee Salary
Biggest Mistakes People Makea. Not Getting The Full Matchb. Putting away additional money into 401(K) before getting through
the rest of the list (401k logo)
Step 2: Debt Paydown (of any debt >5%)
Investing while carrying high cost debt is MATHEMATICALLY INSANEa. Realistic future expected returns are 7%-8% for stocks
3%-4% for bonds PRETAX (after-tax is obviously lower)b. Debt above 5% provides an after-tax return of the
interest rate with no risk (unlike an investment portfolio)
c. Generally this includes Credit Cards and Most Student Loans (but not most Mortgages and Car Loans) (Image of Credit Card and Student Loan)
Step 3a: Set Up an Emergency Fund
Rule of Thumb is that Emergency Fund = 3-6 months of expensesa. A household can expect to have a major
unexpected expense (replacing a vehicle, unexpected illness, etc.) every 10 years or so
b. You don’t want to take out credit cards or loans against your 401(k) because it can take years to get back on track
Step 3b: Fund Any Near Term Financial Obligations
You should not risk money that you need soona. These are major obligations like down
payment on a house, buying a car, paying for higher education, etc.
b. Our rule of thumb is to set aside 100% for any expenses inside a year, 2/3rd for any expenses that are 1-2 years out, and 1/3rd for anything 2-3 years out.
c. Again, just like the emergency fund, put it in checking and do not touch it.
Step 4-8: Invest Whatever is Left Over
Take advantage of the best investment vehicles for your savings.a. Step 1 Covered FREE moneyb. Step 2 Covered High Interest Debtc. Step 3 Covered Any Set Asides
(Emergency Fund + Major Obligations)
d. Now we focus on putting your money in the right types of investment accounts so that you minimize taxes
Step 4: A 529 Plan
If you have a child, set up a 529 Plan for higher educationa. You can set up a plan for any state, and it can be
applied to a college in any state b. In some cases there a State Income Tax
Deductions for 529 and for some tuition discounts as well (look it up at savingsforcollege.com)
c. Generally, contribution limits are based on gift tax exemption ($14,000 for 2013)
d. Rule of Thumb: you need approximately $60,000 initially to fund higher education, also use NY and Utah plans if you are not benefited by in-state deductions
Step 5: Roth IRA
A Roth IRA investment means no taxes EVER
a. An individual can contribute up to $5,500 in 2013 ($6,500 if 50 or older)
b. Income limits are the biggest problem ($125,000 for single filers and $183,000 for married, with phaseouts starting at $110,000 and $173,000 respectively)
c. All contributions are after-tax (still preferable to traditional IRA or 401(k) with no match if you meet income qualifications)
d. You cannot generally access money until you hit 59½
Step 6: Max out your 401(K)/Roth 401(k)
401(k)s and Roth 401(k)s have higher limits than IRAs
a. An individual can contribute up to $17,500 in 2013 ($23,000 if 50 or older)
b. All contributions are pre-tax for 401(k), after-tax for Roth 401(k)
c. You cannot generally access money until you hit 59½
Step 7: Backdoor Roth IRA
This is a complex strategy only for people who are above the income limits to contribute to a Roth IRA
a. This is a 2-step processi. Contribute to a non-deductible IRA after-tax (up to $5,500/$6,500
over 50 for 2013)ii. Convert the IRA assets to Roth IRA
b. Since IRA contribution was after-tax, no additional tax on conversion
c. Money that would have been in a brokerage account and subject to taxes is now in a Roth IRA (no taxes EVER)
d. WARNING: You cannot do this if you have existing Traditional IRAs
Step 8: A Brokerage Account
The final step if you still have savings left over is to invest it in a brokerage account
a. Brokerage accounts are taxable so you will pay capital gains on any gains and qualified dividends, and ordinary income taxes on interest income
b. DO NOT put bonds unless you have to in this account (and if you do put a municipal bond ETF)
c. Minimize trading to defer any tax consequences (do trades and rebalancings in other accounts)
A Simple Example
How the “Savings Waterfall” Worksa. Monthly Savings = Income (after-tax) – Expenses = $2500/monthb. Step 1: 401(k) Match = $200/monthc. Step 2: High Interest Debt and Step 3: (Emergency Fund and Big
Purchases) = Noned. Step 4: No kids so no 529 contributione. Step 5: Roth IRA ($5,500/year) = approx. $460/monthf. Step 6: Max out 401(k) = additional $1,145/monthg. Step 7: Already made Roth contribution so no backdoor Rothh. Step 8: Put the remainder ($695/month) in your brokerage
account
The Payoff
Getting the “Savings Waterfall” right is worth millionsa. Getting your full match is worth 3-4% of salary
over a 30 year career (approximate value for someone earning $60,000 ($500,000 over career)
b. Roth IRA Contributions with no taxes ever saves you $600,000 in taxes vs. a brokerage account
c. Paying off debt and setting aside emergency fund reduces potential interest payments (very situational)
Lowering fees: The average fund charges 1.15% in expenses + the average advisor 1%. We try to keep combined fees at 0.6%.
Net benefit to customers is $26,575
annually1 (2.65%) with easy to implement, high quality investment
advice.
$21,500cost
$4,375cost
Tax-Efficient Allocation: By allocating ordinary income investments to deferred accounts and moving capital gains investments to tax-exempt accounts.
$0cost
Diversification and rebalancing: The Benefits of Rebalancing(Buetow 2002)
Annual Difference1 For a customer with $1.00MM in Investible Assets 50%/50% allocation and 50% in deferred accounts and in 35% tax bracket.Assumes a 5% return on bonds.
Standard Costs Owl Invest
$6,000cost
+$700benefit
$0cost
+$6,700benefit
$25,875cost
Owl InvestBUILDS
CUSTOMERS WEALTH
0 5 10 15 20 25 30$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
$700,000
$800,000 Percent DiffWith Owl Invest
41% MORE
ASSETS
5% MORE ASSETS
Years
Inve
stm
ent S
ize
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