Prioritizing Capital Preservation for Short-Term Goals Over Investment Gains

Key Quotes

"The acronym is FIRE with two I's: FI/RE. I'm your host, Paula Pant. I trained in economic reporting at Columbia. Every other episode, I answer questions that come from you, and I do so with my buddy, the former financial planner, Joe Solsi."

Paula Pant, the host, introduces the podcast's framework, "FIRE with two I's," and her co-host, Joe Solsi, a former financial planner. This establishes the show's focus on Financial Independence, Retire Early (FIRE) principles and the expertise of its hosts.

"Thank you for the question, and you have asked one of the most common questions in financial planning, which is what to do with funds for a medium-term goal. I think most of the people who are listening to this know that if you have a 10-year goal, then you can invest that money because that money is likely to grow in the next 10 years if the future is like the past. And most people know that if you've got a one-year goal, you keep it all in savings. But that three to five year, that middle term, that's the big head-scratcher. That's the question mark."

Paula Pant identifies Jean's question about saving for a medium-term goal (3-5 years) as a common challenge in financial planning. She highlights the distinction between long-term (investing) and short-term (savings) goals, framing the medium-term as a particularly difficult decision point for many.

"I think the more that you think about this question, the more when you look at studies over short periods, like five years, the things that can go wrong versus what can go right, and the threats, and what the biggest driver of your gains is over a five-year timeframe, and bar none, the number one thing you can do to rock this over the next five years is save more money over the next three years."

Joe Solsi emphasizes that for short-term goals, like Jean's three-year sabbatical, the most impactful strategy is to increase savings. He suggests that over a short period, the potential for negative outcomes in investments outweighs the potential gains, making aggressive saving the most reliable path to success.

"I think it's interesting, kind of the yin and yang of this, that in general, with a lot of financial planning questions, when somebody's talking about taking a life risk, like I'm going to have this period of no income, we want the other side, the portfolio side, to be less risky. We want it to be much more certain. Where if you're 30 years old listening to this, and you're going to have an income stream for a long period of time, as far as you can project, hopefully you'll have it for a long period of time, well then very comfortably nudge up the risk in your portfolio because you have the safety of this career, this money coming in that you think is going to continue."

Paula Pant introduces a core financial planning concept: balancing risk. She explains that when a person takes on significant life risk, such as a period of no income, their investment portfolio should be less risky to provide stability. Conversely, those with stable, long-term income streams can afford to take on more investment risk.

"I think that when you talk about risk too, we don't talk broadly enough about risk. Like we get questions, you and I, all the time about taking more risk in your portfolio, but really a lot of the time, the portfolio risk, you can do that, but the juice may be worth more squeeze if you take some more risk with your income streams, or you take some more risk in your life, you decide to take a sabbatical like Jean is and go do the thing. I feel like when we talk about risk, we're always talking about our money, and I think if you expand that, especially the more I see numbers lately about the huge impact your savings rate makes..."

Joe Solsi argues that the conversation around financial risk is too narrowly focused on investment portfolios. He suggests that taking calculated risks in other areas, such as pursuing income-generating opportunities or life changes like sabbaticals, can yield greater rewards than solely focusing on portfolio risk management.

"First, if someone thinks the problem with 401(k)s is that people don't earn a living wage plus enough to save, then why would we think an employer would, from a total compensation approach, would provide a living wage and a robust enough pension? So like, I don't understand how to reconcile that. Second, pensions often require vesting. For myself, I was part of a job where I was covered by a pension, but I left within the first five years, and I'll never see that money again, whereas with a 401(k), I would have been able to take my money with me."

Jared outlines several drawbacks of pension plans. He questions the feasibility of employers providing robust pensions if they struggle to offer living wages, and he highlights the issue of vesting periods, where employees can lose pension benefits if they leave before a certain tenure, unlike more portable 401(k)s.

"I think sadly, the pension system went away, Paula, partly because of the way companies do business, and the workplace became much more fluid than it used to be. I mean, the average person will have, what's the number, 4.2 different jobs during the different companies they'll work for over four companies during their career. So they're not going to stick around for a long time with one single employer for all that long, for long enough for a pension to make sense."

Joe Solsi explains that the decline of pension systems is largely due to the changing nature of the modern workforce. He notes that increased job mobility, with individuals holding multiple jobs throughout their careers, makes traditional long-term pension plans less practical and sustainable for both employees and employers.

"Ah, Mia, thank you for the question, and you have tapped into how wealthy people avoid paying taxes, borrowing against securities, right? That's how you avoid capital gains because when the interest that you're going to pay on the loan is lower than your capital gains tax, then you come out ahead. So you like this strategy."

Joe Solsi validates Mia's inquiry about using a securities-backed line of credit (SVLOC) as a tax-management strategy. He confirms that this is a method employed by wealthy individuals to defer capital gains taxes by borrowing against their assets when loan interest rates are lower than potential tax liabilities.

"I will say for myself, historically, my bias has been generally to be quite conservative about leverage, so I am a little surprised by my own answer, and it's a little outside my comfort zone to hear myself even give that, the answer that I've just given. This is probably not an answer that I would have given three or four years ago