The below Q&A is a list of questions from Harvard Business School students. The Women Student Association & the Women in Investing club brought me to camps to talk about investing and student loans.

Investing & Diversification

1. How would you classify equity in a company or fund where you’re employed? Can you talk about diversifying from having both your salary and some investment in the same place?

I would classify equity in a company or fund where you’re employed as any stock you own in your current employer.  This includes stock purchased through an Employee Stock Purchase Plan (ESPP), Restricted Stock Units (RSUs) granted to you as part of an employment package, and Incentive Stock Options or Non-qualified Stock Options (ISO / NSOs).  If you have $50,000 in Uber stock and $100,000 in your other retirement accounts as your main assets, you have 1/3 of your net worth in one stock.  While you may believe in the short-term success of your employer, it’s harder to predict what that will look like in 30 years.  McKinsey estimates that the average lifespan of companies in the S&P 500 is only around 20 years.  Individual stock prices are more volatile and are riskier than investing in a broad basket that is reflective of the overall market.  In addition, you could lose your job at the same time that your nest egg takes a hit as happened to some Uber employees back in March 2020.

Note: you should not include stock that has not yet vested in your net worth.  For example, if you get a large RSU grant after three years of working at your post-MBA job, do not include that stock in your net worth until year three.  You should also be careful of having too much net worth in a former employer.  There is less risk because your income and your portfolio are less correlated, but having a large position in one company is always riskier than being diversified.

2. Is the 10-20% rule of not more than that in one company applicable if you work for a PE fund?  Since it’s technically a fund and not a single company’s performance?

Good question, I should also preface this and say none of the below should be considered investing advice.  While most of the time I don’t believe in having more than 10% of your net worth invested in your employer, since a Private Equity fund does have exposure to more underlying assets, you may feel comfortable having 20% of your net worth invested through your job.  However, many Private Equity funds are sector specific and there is risk related to liquidity, operations of the funds and portfolio companies, etc.

That being said, risk is all relative.  If you have $300,000 in net worth, having $150,000 in your Private Equity fund is a meaningful part of your portfolio both as a percentage and in terms of absolute dollars.  On the flip side, if you have $2,000,000 in net worth with $400,000 in your Private Equity fund, you may be more comfortable having a higher percentage of your net worth invested.  Your main concern is to limit your downside risk and having a financial loss that would severely impact your ability to live your life or meet other goals like retiring comfortably.

3. The #1 sin of investing you listed is holding too much cash. What % of cash do you recommend, and what high yield savings account do you recommend? (especially now when interest is very low for most)

I don’t think about cash a percentage.  It’s more related to the amount of cash you need to cover your bills.  If your expenses are $4,000 / month, you would want to have 5-6 months of cash on hand in case you couldn’t work for an extended period of time or had another life emergency.  This would mean keeping ~$20K-$24K in cash in a high-yield savings account or money market account.  If you have dependents, a mortgage, are risk averse, or work in very cyclical industry, you may feel more comfortable with a 1-year emergency fund.

I personally use Ally bank’s high-yield savings account.  They have consistently had interest rates in the top 10% of all banks.  In addition, they have “savings” buckets so you can keep your house down payment, business startup, and emergency fund separate.

4. How regularly should you re-evaluate or re-balance your exposure/portfolio? What are some reasons to not hold and actually cash out on something?

You should aim to rebalance once a year.  For some people, it may make sense to only check your portfolio this frequently.  If you are stressed out by market dips and rises and you’re investing for the long-term this can be a good strategy.  Cashing out makes a lot of sense when you have a lot of equity compensation and are starting to build up a meaningful position in a single company stock.  This also makes sense if you are on track for retirement and have brokerage assets that you want to sell for a medium-term goal like a home or a business fund.

5. Homes are typically thought to be good, safe investments. At what point would you suggest we think about buying a home?

For our parents and grandparents, homes were a great way to grow wealth, and I hope to own a home one day.  However, I disagree that homes are safe investments.  If you ask anyone from Houston where houses flood, California where forest fires threaten homes, or who has ever been underwater on their mortgage, houses have risk just like all other investments.

Traditionally, real estate has grown at 3-4% while the market has grown closer to 10-11%.  While obviously there are exception to this, I think of real estate as one part of a diversified portfolio.  I think a lot of HBS students feel pressure to buy earlier than they are ready because it is seen as such an important life milestone.

I recommend buying a home when:

• You know where you are going to live for the next 5 years.  If you plan to move in less than 5 years, the transaction costs to buy and sell a home will likely overwhelm any gains you make.  Transaction costs are generally 2-5% of your total housing costs.  If you buy a $500,000 house, this could be $10-$25K.  You will also have to pay transaction costs when you sell including a 6% realtor fee.  Therefore, if you sell your home within 1-4 years of buying, the transaction costs will likely wipe out any appreciation.

• A 20% down payment on the property would represent 40% or less of your net worth.  In the same way, you don’t want too much of your net worth in a single company, you don’t want too much of your net worth in a single asset.  If you want to buy a $600,000 house putting 20% down, you would have $120,000 invested in your home.  If you only have $100,000 invested in retirement and other assets that would translate to 55% of your net worth invested in the house.  Houses are more illiquid than stocks or bonds and are also more exposed to idiosyncratic risk than the market.

• Your monthly mortgage payments + property taxes and insurance would represent less than 28% of your income.  Sometimes, you can afford the down payment but the monthly cost to own a home will make it hard for you to pay for child care, save for retirement, and enjoy your life.  If you are earning $240,000 / year in Brookline, MA as a married couple, your take home pay after tax is $13,449.   You would want a home with all-in costs (remember property taxes + insurance + maintenance can add up to almost the same as the mortgage) below $3,765 / month which means the $1.5M house is out.

6. Do you think the case for paying an extra ~.1% in fees annually for target dated funds vs a standard total stock mkt fund is worth it?

Here’s an example to make this real.   You have $150K invested and you’re maxing out your 401K each year with another $19.5K / year at 30 years old.  Assuming you get a 7% investment return each year before fees and are investing until you’re 65 years old, the difference between paying 0.1% for a Target Date Fund and 0.09% for an index fund is $10,828.  Even with the higher fees, this individual would have $4,187,467.51 in retirement.   Link here if you want to play with different numbers.  Stressing about the 0.1% in fees is likely less important than making sure you consistently invest.  I see many HBS grads who keep too much money in cash outside of their brokerage accounts or 401Ks which is likely a much bigger drain on your portfolio than 0.1% in fees!

Roth vs Traditional IRAs / 401Ks & Taxes

Note: that I am not a tax advisor and you should consult an individual tax advisor before making any decisions.

7. Does switching your 401k from target date fund to other funds within the same manager (e.g., Fidelity) trigger any taxes?

No.  Your 401K is a tax-deferred account.  You do not have to pay any capital gains tax for transactions in your 401K.  You would pay taxes if you sold and bought funds in your brokerage account.

8. What’s the difference between a Roth and a Traditional IRA and 401K?

The main difference is when you pay taxes.  With a Roth, you pay taxes now and the earnings come out tax free.  With a traditional 401K or IRA, you pay taxes later.  Generally, if you believe that you will be in a higher-tax bracket later in life, it makes sense to use a Roth, and vice versa.  Most 401Ks default you to a traditional account, but more and more companies are offering a Roth 401K option.  There is also a lot of flexibility gained by having some of your retirement income in a Roth and some of it in a traditional account.  While there are income limits on when you can contribute to a Roth IRA, these limits do NOT exist on a Roth 401K.    There are other differences including how and when you can access the money before you’re 59 ½ and when you have to take withdrawals. You can read more here.

9. Should we consider rolling our precious 401k’s to IRAs right now since our current unemployed/student tax rate is low?

You should consider rolling your 401K to a Roth IRA in what is called a Roth conversion.  However, you should work with a tax advisor if you decide to move forward.  The graphic below is a simplified example that shows the potential tax savings.  If you convert $30K from a traditional 401K to a Roth IRA while you’re in school, you may pay taxes at a 12% marginal tax rate instead of 32%.  The other big perk of a Roth IRA is that all of the earnings come out tax free. If your IRA grows from $30,000 to $230,000 over 30 years, that is $200,000 that would come out tax free.  Note: this is a very plausible situation.  Just check the future value of $30,000 growing at 7% over 30 years.

The big catch to a Roth conversion is that you owe a tax bill, maybe a big one.  In the below example, you would owe $3.5K in taxes to convert $30K.  If you were to convert more money, you would owe more and at higher tax rates.  Because a Roth conversion requires additional cash, this is only a good strategy if you already have an emergency fund built up, don’t have high-interest debt like a credit card, and you won’t need to borrow extra in loans to cover the tax bill.  This is finance 2.0.  To me, taxes are about optimization.  I did not do a Roth conversion when I was in school.  Don’t worry if you cannot afford to do one right now.

Thanks for making it this far! If you have additional questions, please reach out here.  I teach a 10-week personal finance class that goes deeper into taxes, Roth IRAs, 401K roll over, and how much to save for retirement. Class includes homework exercises and templates to help you understand your own money and includes a 30-minute one-on-one with me to answer all your money questions.

Disclaimer: The information presented is for educational and information purposes only and contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this presentation will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.