In this podcast, Motley Fool host Ricky Mulvey and senior analyst Asit Sharma discuss:
- What's going on with Schwab.
- Takeaways from bank earnings.
- A deadline for the Microsoft/Activision deal whooshing by.
Motley Fool personal finance expert Robert Brokamp answers listeners' questions about 529 plans, target-date funds, and investing in a 401(k).
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on July 18, 2023.
Ricky Mulvey: Deadlines sure have a way of flying by, don't they? You're listening to Motley Fool Money. Asit Sharma joins us now, Asit, how you doing?
Asit Sharma: I'm doing well, Ricky, how are you, my friend?
Ricky Mulvey: Up to an excellent, it has been a big day for the bank watchers and investors with several big ones reporting today but let's turn our attention to Charles Schwab, the multinational financial services company, you may note is the custodian of your retirement account and it has a lot going on Asit. Just some of them it's trying to integrate TD Ameritrade. Its net interest income is down about 10% year-over-year. Its actual assets under management are up, but those low-interest-paying deposits are down by a third from the prior year, the stock is up 13% this morning. What do you think its investors are cheering?
Asit Sharma: Ricky, I think investors are looking at the rate of those deposits leaving and they see that rate of outflow slowing down. Now some of that outflow isn't really outflows. Some of that money is just getting reoriented inside of Schwab into higher-yielding money market funds. But a lot of the bulk of this huge outflow that Schwab saw during March and into April is slowing down with this last report that we got.
Ricky Mulvey: Yeah. Schwab is working through a balancing act, it seems. A while back, there was a huge bearish sentiment around Schwab, basically that it may have been the next domino after Silicon Valley Bank after many depositors fled that tech-focused bank. But it may be proving that it's not quite the same story for this giant with $8 trillion under management.
Asit Sharma: That's true, Ricky. Even when you look at the balance sheet in terms of being a bank, Schwab's assets don't look a lot like the banks which were under so much stress in March and through really early summer of this year. Their receivables from brokerage clients is a ready money asset. They have available-for-sale securities held to maturity securities, which have some unrealized losses associated with them. But their realizable, their liquid. There's not a lot of loans that Schwab is collecting in the form of, let's say, residential mortgage loans or other types of commercial loans to businesses. They're not really in that line of business as are most banks. So when you look at the quick assets that Schwab has against demands that could come in the form of deposits leaving the bank, they stand on pretty square ground as far as I can see.
Ricky Mulvey: Yeah, but they do have to take out some more expensive debt. The Schwab has lost $140 billion in deposits over the past year. Right now it has about 50 billion in cash on hand. That means the company has to take out some higher-interest debt in order to pay that cash sorting. That means issuing CD's higher-yielding offerings. Do you think this is a long-term problem or are they taking care of this issue?
Asit Sharma: Yeah, Ricky, I actually don't think it's that much of a problem for them. I mean, they have had to, as you mentioned, issue, I think it's a couple of billion dollars of debt. But there's a strange dynamic going on, again related to the balance sheet. This time, last year, Schwab was obtaining an average yield of about 1.5 percentage points on its interest-earning assets. Today it's earning around 3.25% on a smaller base. But the difference in that average rate is generating enough interest income that they're making up the difference, even as they still have a lot of interest liability on their books. When you look at the net interest revenue that Schwab was able to generate in this last quarter on a percentage basis, that net interest income is actually moving at a higher rate and since those balances are big, as you point out, that balance sheet is so large, they're covering their obligations. I think over time, given the liquid complexion of the assets that we talked about, there's really not a lot of fear here unless we get into this extreme stress banking scenario that Schwab can't stay whole as it did in March. I think what you're getting at those huge assets, and of course, in the trillions of assets, that's when you're talking about assets under management. That on the brokerage side, plus this banking solidity, I think means that the short-term implications of having to take on some more expensive debt will get worked out as we, let's say fast-forward about three to five years from today.
Ricky Mulvey: Plenty of other banks reporting today. Morgan Stanley, Bank of America, PNC included any takeaways from that group.
Asit Sharma: Just think big banks are getting it done, in different ways, Bank of America, which we expected maybe to have a higher net interest income margin in the past quarter has finally showed some this time around, so investors cheered that. Looking over at Morgan Stanley to me, they actually with a little bit on their net interest income component, but they have a lot of great momentum going in private Wealth Management, in assets under management. The bigger banks have many tools at their disposal to make shareholders happy in a time like this. I will say, Ricky, as you go down in asset size from these really huge banks that are reporting now, down to the regionals, even to publicly traded community banks, which I like to invest in here and there, I think we'll see a more mixed bag as we go on. Maybe later in the earnings season, if you and I have a chance to get together, we can pick apart some of those smaller bank earnings. But so far so good at the outset of earnings season.
Ricky Mulvey: Let's do it. Today was the deadline for the Activision and Microsoft deal but in the words attributed to Douglas Adams, I love deadlines. I like the whooshing sound they make as they fly by. That seems to be the case for this major deal. Asit, Activision could receive a three-billion-dollar termination fee if the deal doesn't get done. You're an Activision shareholder at this point, are you rooting for the deal to get killed?
Asit Sharma: I mean, maybe I'm not a shareholder myself, but you look at what Activision has done over the years. Even though we know they've got some problems at the top, that cultured Activision isn't that great. This is a company that's become really good at extending franchises. There's a recurring revenue component to Activision, which is very impressive and attractive. If you had $3 billion to just fall on your balance sheet that you could put aside for further innovation. Would this be accompany that current shareholders would want to hold on with that cookie dropping there? Potentially, I still think though this deal is going to close and I think Microsoft is going to get ever stronger. We probably should talk about why the deal didn't close today.
Ricky Mulvey: Yeah. Why is that?
Asit Sharma: Yes. Microsoft was seeing some momentum. The FTC had come in and tried to stop the deal, and a federal court said, no, we're going to let this proceed. Now, I should say the FTC is still in the game trying to sue to prevent the deal from closing, but it looks like it's moving to closure. Now, the issue is that Microsoft has one wrinkle left, one major wrinkle, and that's to be able to convince UK regulators that the two companies should merge. Yesterday, Microsoft and Activision convinced the UK's Competition and Markets Authority, or CMA, that they needed a little bit more time to work out the issues that were steaming them from a regulatory standpoint in Britain. The CMA granted two months in which the parties can try to make British regulators a little more happy with the deal. But there are some pieces fall into place that indicate this will go through. Ricky, you mentioned one of these to me, which is a deal that Sony and Microsoft signed over the weekend.
Ricky Mulvey: Yeah, Microsoft signed a 10-year deal with Sony over the weekend in order to keep Call of Duty on PlayStations. In some of the gamers were skeptical about this because Microsoft has a history or already has acquired gaming companies and then made future games exclusive to the Xbox deal. In the case of Sony though, do you think this is a business decision, a token for regulators or both?
Asit Sharma: I think it's more token for regulators. I think that Microsoft has an interest and not trying to totally kneecap Sony after all. It is an extension for their games, the Sony devices. But I think at this point, Microsoft is just really itching to go ahead and make these companies merge. When they look over the total live stream of the revenue here, it's almost you're cutting off your nose to spite your face if they don't do a long-term deal with Sony. But I do think there's just a little under current here, still ill will between the parties. It makes a little bit of business sense, but it makes a lot more regulatory sense to sign up for 10 years together.
Ricky Mulvey: It always surprises me just how large the gaming industry is or the video gaming industry. Activision's Call of Duty Modern Warfare 2 was released in November of '22. It made a billion-dollars in 10 days Asit. That was 150 million more than Avatar, the way of water did internationally. I heard it a lot more about one of these and the other.
Asit Sharma: Ricky, this blew my mind when you shared that with me earlier, and I must say, time changes, things change several years ago, the people who are staying home now playing these games would have been out in the theater for the big Avatar released. Not that they weren't. It did pretty well, but it's just not as feasible how big an industry is to most of us, how much time is being spent and how much free cash-flow companies can generate off of folks playing these interactive shoot up games with each other.
Ricky Mulvey: Asit Sharma, I always appreciate your time and your insight.
Asit Sharma: Thanks so much Ricky. I always love to come on here.
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Ricky Mulvey: Before we get to our next segment, sometimes it pays to wait for a pullback. Our analysts at Motley Fool Stock Advisor have compiled a list of five stocks whose prices have tanked, but still have strong fundamentals and potential growth ahead. Just one example is a company that lost more than three-quarters of its value despite showing surging revenue. We're revealing this stock, along with four more in our new five pullback stocks report available for free only to Stock Advisor members. Simply go to fool.com/pullback to learn about these stock picks. We'll also include a link in the show notes. Now, you've got questions, he's got answers. Robert Brokamp takes your questions about student loans 529 savings and target date funds. Our first question comes from Bill. I've come across some ETFs that invest in options on broad-based index funds. They seem like cheaper version of what many annuities are trying to accomplish. If you check these out, do you think they are good investments for retirees?
Robert Brokamp: Well, about lots of types of types of annuities and ETFs, but I think you're referring to our equity index annuities and then some so-called buffer ETFs that are trying to do the same thing these equity index new is trying to do. Let's start with the annuities and how they work. Basically, what they're trying to do is capture the upside of the market, but limit the downside, which sounds great, but the upside is limited. Sometimes these new annuities are like your account will grow if the S&P 500, for example goes up but only up to 8%, and it usually doesn't factor in dividends. But in exchange for limiting the upside, if the market goes down, you won't lose money or there's a limit. You might just lose five or 10%, but no more than that. It all sounds good. The problems with the annuity part is that with all annuities, the cost tend to be high. That in both in terms of the annual expenses as well as the commissions that are paid to the insurance agents that sold them, but they also tend to be pretty illiquid. Meaning that you can't access your money when you need it often. There's often a limit on how much you can take out in a specific year. There are some ETFs that have come along and they're trying to do the same thing. Again, give you some upside, limit the downside and they're able to do it cheaper.
The annual expense ratios on these ETFs are about 0.8%-1%, and they're more illiquid because they're ETFs you can buy and sell them whenever you want. How are these annuities and ETFs able to do these things while as you point out bill, they're using options. Essentially, what they're doing is they're selling call options and buying put options. Now I don't want to make this whole thing about options. It's basically a collar strategy. Go ahead and maybe do an online search if you want to learn a little bit more about how they work, but that's how they do it. Again, you're some upside with limit, but you're limiting the downside. Because these ETFs are relatively new. I don't want to come out strongly for or against them. If it's attractive to you, I think it is certainly worth investigating the ETFs versus the annuities. I looked at a few and some definitely held up pretty well last year. Remember last year stocks were down 20% or 30%, and bonds were down more than 10%. Others didn't hold up so well. You definitely want to look at how they've performed in good times and bad times to see if they're doing what they say they'll do. But here's the deal. If you want a portfolio to go up, when stocks go up, you're willing to cap the upside in order to get some downside protection, there's another way to do it, and that is not invest your entire portfolio in stocks, and have some invested in cash and bonds, which essentially accomplishes the same thing. I think that's the way most people should go.
Ricky Mulvey: I'm going to rare bunch these days that we'll still be drawing a pension in retirement. I'm 32 years old and after 30 years at the job, my pension will be approximately 50-60% of my monthly income based on the average of my highest paid three-years. Additionally, I contributed 18% of my income into a 401(k) and I put half of every raise toward those savings. Does my pension allow me to be riskier in my 401(k)? How would it affect your financial planning? From Jazz.
Robert Brokamp: Jazz, you're definitely indeed in the minority, especially when it comes to private workers. According to the US Bureau of Statistics, in 2022, only 15% of workers in the private sector had access to a defined benefit pension. However, 86% of government workers had access to one. So if you like the idea of a pension, you might want to work for the government. Actually your question, anything that adds diversification and maybe a level of stability to your overall financial picture, theoretically allows you to take more risk in your portfolio. This could be a pension but could be other things like maybe rental properties, side businesses, maybe a trust fund. But before you get too aggressive, you do have to do some thinking about how much diversification those assets really provide and how they possibly might all struggle at the same time during an economic downturn. Now with a pension, the good thing about a pension is it's like a big holding and bond. They pay you a certain amount of interest and they usually don't go down when times get tough. But you do have to factor in the strength of the company or entity backing the benefit and its funding status.
Pension from the federal government is a lot safer than a pension from a struggling private company with an underfunded pension, so you definitely want to keep tabs on your pension's funded status and with private pensions, you generally have an annual report that you can look at ticket the funded status. All this said you're 32 years old, so even if you didn't have a pension, you probably should be investing rather aggressively as long as you can take the ups and downs of the stock market. Plus [inaudible] to change between now and when you're in your '60s, the company offering the pension may struggle, or you may switch employers in a few years, in which case your pension really won't be very significant. At this point, I wouldn't think too much about the pension. You keep doing the other excellent things that you're doing, which is saving 18% of your salary, which is great. Most experts say you should save about 15%, so you're doing even better, and you're saving half of each raise, which as we've talked about on the show, was that idea from one of our listeners and that got him to a point where he was saving 40% of his salary by the time he reached his 50s and allowed him to retire early, so both of those are great. Now if you're still working for this employer down the road, maybe your 40s, certainly your 50s, and the pension looks like it's in good shape, then you can factor it more into your retirement plan and your asset allocation.
Ricky Mulvey: Hello, and thank you so much for sharing your experience and expertise. I'm learning so much more in the past year-and-a-half of being a listener than I had in the previous 30 some years. Thanks. Should I set up one or more 529s for my three children? Although they will have most educational expenses covered if they attend a state college. I've the Wisconsin GI bill that will help them out as well as my VA disability rating being 100%. It may not cover everything though and they are still young, 11, 5 in less than a year. But the benefit of starting soon will be the growth and the 529 would help immensely if they choose not to stay in the university of Wisconsin system. Also, with years between them, should I open a single 529 and they pull from it as needed while keep adding into it or would it be best to separate it per child? From Jeremy.
Robert Brokamp: Let's start with the benefits of a 529 plan. The money grows tax-free as long as withdrawals are used for qualified education expenses. If in college, there could be room, board tuition, but also books, also computers, software, and anything that's required to attend the school. It can also be qualified expenses for elementary school, middle school, and high school. In most states that are 13 states that don't allow that for most states you can use it for that. Now, there's a lot of ways to use the money. But what if you don't use the money? Well the withdrawals for non-qualified expenses will be taxed and penalized, and it's just the growth that is tax of penalize, not the amount that you put in. That said you have options. First, you can transfer the money that's not used for one kid to a qualifying relative, could be the other kids, could be cousins, could be you and your spouse if you plan to go back to school. Or you can leave the money alone and eventually transfer it to your children's children, in other words, your grandchildren. Then starting next year, up to 35,000 can be transferred to a Roth IRA for the beneficiary. Now, there are a lot of rules about this and just a few of them are that the account has been open for at least 15 years, you can't transfer any money that you contributed or earned on the investments in the last five years.
A lot of rules about it. But it's good to know that you have options for that. One thing about the way I've been curious about is if there's unused money, you could transfer the money to yourself, I know you can do that, but can then you then transfer that money for a Roth IRA for you? I haven't thought a definitive answer on that. I reached out to Mark Kantrowitz, which is considered one of the most knowledgeable people about these types of things, author of many books including How to Appeal For More College Financial Aid. He thinks that it is possible as long as you satisfy all these other holding requirements. But that's something to pay attention to, so it could eventually be a Roth IRA for you. Jeremy, if you start saving the 529 and you don't use the money, you have options. But this doesn't answer your primary question, which is, should you open these accounts at all given that they'll have most of their expenses covered if they stay in state. I can't answer that for you.
But you did mention a disability, so I would say that you should first-priority, prioritize your own financial security, including retirement planning, and then contribute to 529 if you're able because it sounds like your kids will be able to get a good education regardless. As your final question, should you put it in one 529 or three separate ones? I would do three separate ones. I mean, the kid has to be the beneficiary of the account to use the money for qualified withdrawals, the kids are different ages, so they would have different investing timelines, different asset allocations, plus Wisconsin is one of the 30 states that gives you a state tax deduction on the money you put in up to a limit. You more likely to be able to take multiple deductions because the limits are usually per beneficiary or per account. You'll likely be able to take a bigger deduction if you put it in three separate accounts rather than if you put it in one.
Ricky Mulvey: I have not been paying down my student loans since the freeze in hopes of cancellation. Now that those hopes have been dashed, I'm trying to figure out the best way to repay them. I might be missing something, but it seems like i could open a 529 account for myself, contribute with a tax benefit then use the account balance to pay down my loans, which would basically give me a 20 to 30% discount on my loans because of the tax advantage. Is this correct? If so, why isn't everyone talking about this? That's from Nick.
Robert Brokamp: You're right, Nick about the ability to use 529 money to pay off school loans. It's a $10,000 lifetime limit. It's not a lot, but it's still very helpful. I'm a little curious about where you got your math in terms of the 20-30% discount. I'm guessing it's possible that you believe that you get a federal tax deduction when you contribute to a 529 if that's what you believe, that's actually not the case. There is no deduction federally for contributing to a 529. Now, you might get a deduction on your state tax return. Sometimes you have to contribute to the states 529, some states will allow you a deduction for contributing to any 529. But that's not going to give you a 20-30% discount. The highest state tax rate in this country is in California, that's over 13% and you have to make over $1 million for that to happen. You might be mistaken about that. Plus, by the way, there's some rules that states have in terms of being able to take deduction. For example for some states, the money has to have been there for at least a year. You can't contribute the money one week, take it out the next week and still get the deduction. So you definitely want to pay attention to the rules around your state's tax deduction. I suppose it's possible that you're also thinking of putting money in a 529 and letting it grow over several years then taking out the money. In that case, yes it could be a tax break worth 20-30%. But that doesn't sound like your situation. It sounds like you have school loans now, and if that's the case, I think it's just better to take the money to pay off the loan rather than put it in a 529.
Ricky Mulvey: Last question comes from Abram. I'm 28 and love the show. I'm interested in my target date funds are recommended for retirement accounts over S&P 500 index funds. It seems the index funds are more stable and consistent, but it's better to stay in target date funds since they make aggressive investments early on.
Robert Brokamp: That's an interesting observation Abram, your age would be looking at like a 20-60 target date fund. It'll be very aggressive and like all target date funds, it'll be a mix of stocks, cash, and bonds, although the vast majority of it will be in stocks at your age, international small-cap, large-cap growth value. I can see how someone, looking at one of those type of target date funds, would see it as less stable than S&P 500 index fund, because over the last decade and even more really, US large-cap stocks, like the stocks in the S&P 500 have been the best investment. Anytime you had thrown in something like international small cap, it would seem less stable and certainly not performing as well.
However, from the benefits of the target date fund is that it does gradual rebalancing and gradually gets more conservative as you approach your retirement age. So if you are looking at more like a 2030, 2040 fund, those actually would be more stable than an S&P 500 index fund. There are some arguments about whether any one your age should be in a target date fund because like I said, they do have a little bit of cash and bonds and anyone who's 28 and has 30-40 years until they retire, should they have anything in cash and bonds? If you can stand the ups and downs, the stock market, maybe not. You might want to go just with an S&P 500 index fund. But generally speaking, I do like target date funds because of the automatic rebalancing, because they are very diversified, and because they gradually get more conservative on a regular schedule, which is like a one-stop-shop investing for most people who really are not overly involved in managing their portfolios.
Ricky Mulvey: If you have a question for the show or Robert Brokamp email us, at podcasts, that's podcasts with an s, at fool.com. As always, people on the program may own stocks mentioned in the Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.
