Transcript
Intro
Stephan Shipe: Welcome back to the Scholar Wealth Podcast. This week, we’re starting with two listener questions that reflect the kinds of trade-offs many high-income families are wrestling with right now.
First, we’ll talk about how families should think about funding a 529 plan at a time when AI is rapidly changing education, careers, and how people develop skills.
Then we’ll turn to a more personal question about lifestyle as income grows and families begin to enjoy the rewards of their work. How do you balance spending on experiences like travel while raising kids who stay grounded and understand the value of money?
In the second half of the episode, we’re joined by Stace Sermons for a deeper, more technical conversation about REITs. We’ll talk about how REITs work, the differences between public and private structures, and where they may fit into a diversified portfolio.
So let’s go ahead and get started.
Question 1 – Funding 529 Plans in an AI-Driven World
Listener:
How much should we be putting into a 529 plan when we don’t know what AI is going to do to universities? Or should we put our money elsewhere if AI is going to entirely change the job and education landscape?
Stephan Shipe:
Well, we have to think about for this, and this is something that’s come up a lot recently. In fact, I even had an extension onto this question that one of the main things I’m hearing is not just how do we fund 529 plans or not fund 529 plans for uncertainty around education, but also we’re starting to see a rise in people saying, do I need to be saving even more to provide more support for kids even after college?
So we’re seeing this extension from maybe it’s not 529 savings, but maybe it’s just general savings for kids and how long of a time period is going to be needed there.
When we go to the 529, the 529’s advantage is really twofold. One, one is that if you’re in a state that provides you with a tax benefit on your state taxes for contributing to the 529, then that’s wonderful. That’s not that common.
So the bigger advantage of the 529 is tax-free growth as long as it’s used for education expenses. Sometimes that gets overstated. And I say that because with education savings, the timeline is significantly shorter than a retirement timeline.
So when we think about a retirement timeline, somebody saving in their 20s or 30s for retirement or 40s for retirement, you’ve got decades that you’re investing that. So compound interest kicks in, all the great things you see have the compound interest curves going up. All of that comes into play with 529 funding.
You don’t have decades and you don’t have a goal that is spread out over a long period of time. When you say for retirement, you retire at, let’s say you retire at 60, well, you’re going to spend that money for decades. So it’s not all needed in the first year or else we’d have to be really risk averse with the money.
For 529 savings, that’s exactly what happens. And you have a short time horizon. So you save for 18 years, but those last four to five years anyways, you have to have a reduced risk on that portfolio because you can’t weather a storm of the market dropping when your kids are their senior year of high school.
And you can’t say, well, let’s wait four years for the market to recover before you go to college. That’s not how it works. It’s not going to fit anybody’s plan.
From a risk perspective, we have to scale back the risk significantly into high school. They’re mostly in bonds, which means there’s not that much growth going on. And if the only advantage of the 529s is the tax-free growth if it’s used for education expenses, then it’s easy to say, I’m still contributing to a 529 while they’re in middle school and high school. But we’re not actually expecting that much growth to occur during that time.
And I say that because I don’t want it to sound like if you don’t save in a 529, there’s no other options available to you, that if you’re saving for college, it has to be in a 529. I’m all for saving in a 529, even with the uncertainties around future job markets and future roles of universities, but we have to do that in a thoughtful way.
In other words, we don’t want to go and say, I want to send my kids to private school. It’s going to be $60,000 to $70,000 on the low end per year. So we’re going to fund for four years of private school and grad school and put all that together and we’re going to have $700,000 in a 529.
That is not what I would go with, even if that’s your plan.
If something like that is your plan, I would still scale that back, fund the 529 at least to public school, which is probably $25,000 to $30,000 all-in for a cost there per year. That’s going to significantly reduce the size of that 529 to give you the flexibility where if there are changes, whether it’s from AI or anything else to the education landscape, you’re not stuck with half a million dollars in the 529.
You may have $100,000, $200,000 in the 529, which is going to be a lot easier to move around. Or if you have to pull the money out, you would have to pay a penalty and tax only on the gains, not on your contributions.
So if you had $200,000 in that 529 and $150,000 of that is your contributions and $50,000 is growth, you would get the $150,000 back. You’d only have to pay the penalty and tax on that $50,000 at the end there.
This isn’t an uncommon scenario. As I mentioned, I think the government’s kind of getting in on that as well, that there may be changes down the road. One of the things that came up with the SECURE Act was the ability to have some flexibility on how those 529 plans are being used.
So with that new act, what you can do with a 529 is you can take $35,000 out of a 529 and put that into a child’s Roth IRA, the beneficiary. So five years, $7,000. That at least gives you a $35,000 buffer where if you overfund by $35,000, that gives you $35,000 you can move out.
The other factor is how broad the term education is. If we get into a situation where AI truly disrupts how education is done and the types of education that are available, I think we may see the 529 rules become a little bit more flexible of what’s considered education.
It’s already pretty flexible now of what’s going to be considered education. It doesn’t have to be your traditional four-year university, but it can be certain trade schools and everything else. So there’s already flexibility there no matter what.
What I would go with is a nice combination of 529 savings, even with this uncertainty, with some sort of taxable account as well. And that could be your own taxable account. That doesn’t have to necessarily be some sort of UGMA account or a minor’s account that you establish.
That can be money just going into your brokerage account that you’re building up with the expectation of if they end up burning through the 529, we still have supplemental savings to be able to fund the gap.
We really want the 529 gone. There’s a lot of ways, and we’re talking about it today, there’s a lot of ways to get into that 529 and maybe you can use it this way. You can always change the beneficiary and move it back to another child or somebody else or even to yourself if you want to go back to college after your kids are done. Lots of options there.
But ideally, we want to burn through that 529 in college and really run that down to zero in their junior year. And if you can pay for their senior year in cash from a brokerage account, it’s going to allow for a lot more simplicity of your finances and still allow that optionality of having multiple paths, whether it’s traditional education, other types of education, or whatever the world may bring us here in the future.
Q2 – Enjoying Lifestyle Growth Without Raising Entitled Kids
Listener:
My wife and I are both in our mid-40s and our combined W2 income is about $900k a year. We’ve started allowing ourselves more room in the budget for lifestyle and convenience. We’re prioritizing travel now that our kids are old enough to really enjoy it, including international trips and nicer accommodations. My concern is that our kids will grow up expecting this level of lifestyle without remembering the years we spent grinding and living very modestly to get here. How do we balance enjoying what we’ve built without raising kids who feel entitled or disconnected from the value of money?
Stephan Shipe:
Massive question. That’s why it gets asked all the time. This is one of the biggest fears that we see with parents who are successful.
And a lot of times it comes from parents who are in your situation where they’ve gone through, they’ve seen both sides of that coin. They saw the grinding years and then they saw the fruits of their labor. Now everything’s going well. And they’re saying, hey, my kids missed out on that part. They only saw this part.
So we don’t want them to only think that this is normal. This isn’t normal. We had to make this the new normal. And that’s a big part of this.
I will, to hopefully put your mind at ease a little bit, what I don’t think is the case. I think it’s very easy to meld a couple of personalities with income together. It’s really easy to say, well, if my kids go on nice vacations, they must be growing up to be entitled.
Or if I deprive them of those types of trips, then that means they’re going to be great kids.
And what I’ve seen over and over again, and at all different ages of people I work with and kids, is that you see both ends of the spectrum.
I’ve seen situations where children have grown up in households where they have all of the things you’re talking about for their entire life. And they’re very grounded, very responsible with money, extremely educated, everything that you want them to be. They’re good people.
And we’ve seen the other ones where they’ve had the kind of stereotypical entitled lifestyles and everything else. And the parents are worried about them throughout their life of saying, they just can’t manage the money themselves. They can’t handle themselves.
And the difference between the two typically comes down to the conversations around money that parents have had with their kids throughout life.
One of the worst things you can do is to create all the secrecy around money and success, not telling your kids. Now, again, I’ve said this before on the podcast, I’m not advocating let’s share bank accounts around the dinner table and see how much money mom and dad have. That’s not what I’m going for.
I think that it’s important though is that you bring them into some of those financial decision-making conversations.
So it’s not just when you’re planning, like the example you gave, your international trip, nicer accommodations. Let them see that trade-off. Let them know how you made that decision.
That you’re going to stay at this hotel and that’s important to you because it’s going to be able to give you all more time together or that’s more comfortable. Or remind them of the days where this is really exciting for you too because of how much you’ve saved.
Because you remember the days where those were not the types of hotels you were able to stay at or trips at all that you were able to take.
And there’s a fine line there. And I can’t say that I have the perfect answer to that situation, but there’s a fine line of we’ve seen on the other end where kids will feel guilty about that because their parents are constantly telling them how they have it much better than they had it growing up.
So comparing the kids’ lifestyle with the parents.
And the reality is you’re never going to replicate the lifestyle that you had, the grinding lifestyle that you’re talking about, that you built up. That will never be there for your kids.
So then that shifts to what must be a values-type relationship with money. It’s helping them understand how you make decisions. It’s helping them understand in their situation now what the difference was from when you started to where it is now.
To show them the fruits of that labor. Show them what success looks like. To show them what you’re working toward and build out that work ethic because they’re still seeing you work hard. They’re still seeing the values that you place forward.
That’s a really important thing that has nothing to do necessarily with money other than the situation in which you’re having that conversation.
We see this regularly, multiple generations, especially family businesses. And one advantage that I would say that you have is that you did go through that grinding time period in your life where you’re building everything up and now you’re able to enjoy it.
Because whether they know it or not now, they’re going to know you went through that.
So that’s always the first-generation scenario. The first generation kind of grows that wealth for the first time.
Believe it or not, the second generation actually does really well with wealth because they tend to see or they’ve seen the growth of that wealth. So they remember back when mom and dad had to work hard on it or the business was getting started or anything like that. Those stay with their kids for a very long time.
The issue typically comes with the third generation.
There’s an old phrase of the first generation starts it, the second generation grows it, and the third generation blows it.
And the common mistake there is that the third generation has a hard time seeing the work that went into creating it.
So your kids are going to see that wealth creation and that change go on throughout their lives and throughout your lives just having conversations with you and understanding those changes in decisions.
But actually what’s going to be harder is when they have kids, your grandkids are talking to their parents and they didn’t see that same level. That’s where it becomes a lot harder.
And there’s still ways to do that too with values and those same types of conversations.
But I wouldn’t necessarily, not saying not to be concerned about it, but if anything, it’s a good opportunity for you to bring them into those conversations.
Because what we don’t want is them to look and just say, well, mom and dad buy whatever they want whenever they want to buy it. So nice hotels and international travel is just part of the deal.
They just get it whenever they want and we get it whenever we want.
Bring them in to say, this is a thoughtful decision that we’re making. We’re thinking about the trade-offs. We can’t do this every single weekend. So we’re having to be thoughtful where we’re going to go, how much it’s going to cost, what types of accommodations we’re going to live in or stay in.
And there’s always a comparison above, right? There’s always going to be a next level that you can compare to.
And maybe you have to look at it and be like, well, in your situation, international trips, you could say, well, we’re going to fly, we’re going to pay for some upgraded seats on the flight. But it’s because we have to focus on that as opposed to flying private overseas.
Who knows what the scenario is, but show them that there’s some thought going into this and that some work had to be done to be able to get to that situation.
And the fact that you’re thinking about this and having these thoughtful conversations with each other and then hopefully with your kids, I think is going to be probably the biggest asset that you have to hand down to them.
From the Field – Dr. Stace Sirmans – REITs
Stephan Shipe:
Today I’m joined by Dr. Stace Sirmans Professor of Finance at Auburn University. Stace earned his PhD in finance from the University of Florida and his research spans investments, real estate, bond markets, and risk.
We receive a lot of listener questions about REITs and real estate. We wanted to bring in an academic perspective today for this conversation rather than somebody pitching their newest and latest and greatest real estate investment opportunity.
So the goal is to better understand how REITs are structured, the role they can play in a diversified portfolio.
So Stace, welcome to the show. Start off, give us a little background, how you got into this space and a little bit about yourself.
Stace Sirmans:
So I’m Stacey Sirmans I’m an associate professor at Auburn. I do as part of my job, I do a lot of research and real estate is one of my primary areas, including REITs. And so, you know, I look at is, looking at managing REIT investments, optimizing risk and return looking at, characteristics that seem to drive REIT returns. And I just got back from REIT World last week, which is put on by NaReit, the industry organization. And so I have some perspective on REITs and some perspective from that too in terms of what people are talking about right now.
Stephan Shipe:
On the research side, are you mostly in the public side of things or private REITs as well or a little bit of a combination of the both? Because I imagine there’s a big difference of data availability to do research on the private side.
Stace Sirmans:
Yeah, for the most part, I’m looking at publicly traded REITs because the data is available.
Stephan Shipe:
So how do those differ? Because a lot of talking to clients when they’re coming in with REIT ideas and different investments, it’s actually rarely the public side. It’s mostly all of these kind of one-off private REITs that come.
How does that structure differ between if I were to open up a REIT today and it’d be just me buying some multifamily homes around North Carolina and packaging them together versus what a public REIT would do like a Simon property group or something along those lines.
Stace Sirmans:
Yeah, well, I mean, there are a lot of differences. One of them has to do with size and scale. Publicly traded REITs tend to be much larger and they tend to have better access to capital and more diversified portfolios and being publicly traded, they’re more easily accessible and potentially more competitive in terms of hiring talent and managers. But REITs in general, the IRS has a specific, you know, legal description of what a REIT is. And as part of that, you know, they have to hold real estate and they have to derive most of their income, from real estate assets and they have to pay most of the income that they generate out to investors.
But as part of that, REITs have to be diversified in terms of the number of shareholders. And that may be a little bit difficult. to do for a private REIT. Yeah, I mean, those are some of the differences. In general, publicly traded REITs are much more accessible and much more transparent.
Stephan Shipe:
How does that work? Cause that’s one of the things that always throws people off. I guess maybe even take a step back to be classified as a REIT and have different types, cause there’s tax benefits there if I’m not mistaken, There’s some benefits and that has to do with how much you’re paying out and everything.
How do you grow as a REIT if you’re paying out most of your earnings? Are you banking mostly on appreciation? Is there a difference from net income coming from like true NOI compared to appreciation of properties and selling them, is there a distinction there for the IRS or is it just all income?
I have to pay out X percent of it. And I guess what is that X?
Stace Sirmans:
Yeah, 90%. So it’s pretty strict.
The job of a REIT is to own and manage real estate and derive income from that real estate. That’s the main purpose. So if you want to grow as a REIT, that 90 % payout rule, what you have to do is external capital. So REITs are known to be very dependent on external financing from financial markets and so being a publicly traded REIT and having access makes things a little bit easier to grow.
Stephan Shipe:
So is there a cap then of how big a REIT could get? If you think about this from a, if you’re teaching REIT 101 right now to somebody and they say, well, that makes no sense, Stace, because if I have a hundred million dollars and I go buy a hundred million dollars of assets and maybe I leverage it up and I have 60 million of that is done, then over time, am I just taking my earnings net of the loan repayment and debt servicing?
And that’s how much you’re paying out. And then the hope is you pay down the a hundred million dollar debt and then releverage to get to higher properties.
Is that, is that the concept or is the gross earnings? What’s included on that, that 90%, not including the debt servicing. I guess, are we looking at the income statement or the cashflow statement when we’re trying to figure how much the payments are going to be.
Stace Sirmans:
So you’re looking at the cash flows coming in from the properties. And yeah, REITs will use leverage and compared to non-REIT industrial firms, they typically use more leverage
And part of that is because they’re leveraging against tangible real estate assets, tend to be relatively safe. But the, REITs main objective is to acquire properties and hold those properties and, manage them and derive income from those properties.
Stephan Shipe:
And the dividend yields then not comparable. We can’t compare like a dividend yield on a Johnson and Johnson to a dividend yield on a REIT because of what, because of that you almost have a return of capital aspect coming in. And how does that impact taxes then or taxation on REIT dividends?
Stace Sirmans:
Basically, dividends are tax deductible for REITs, whereas for non-REITs industrial firms that’s not the case. But non-REITs are constantly reinvesting back into the company, whereas REITs are incentivized not to do that, or at least not to hoard the cash, but distribute back to share holders. So dividend yields are gonna be relatively high for REITs compared to non-REITs. As part of that requirement, REITs are going to be.heavily dependent on external capital for growth.
Stephan Shipe:
How does that impact the riskiness of the asset then? Because you have two things, it seems like you’re balancing, you’re balancing leverage aspect and the cash flow aspect of it, which are two ends of the risk spectrum. When those combine, how does that compare to like an S&P 500 type of scenario whether it’s a beta comparison or a standard deviation of publicly traded REITs versus the average market?
Stace Sirmans:
I mean, if you think about like: their main objective is to hold and manage real estate properties. And the relationship the cash flow there is going to be through the tenant and lease agreement. And lease agreements tend to be relatively stable. So the cash coming in for REITs compared to non-REITs tends to be relatively stable. And for that reason, they can maintain a little bit higher leverage, REITs depending on which sector they’re focusing on, may, they’ll strike a balance between what’s appropriate in terms of leverage compared to the riskiness of the cash flows coming in.
Stephan Shipe:
Do you know off hand and I’ll put you on the spot for this one roughly what is the correlation between the S &P 500 and public REITs on the average?
Stace Sirmans:
Yeah, I think on average, it might be in the range of 60 to 70%. And it tends to increase during market crisis.
Stephan Shipe:
Are there any areas right now, because you’re, I mean, I know you’re going to the conferences, you get the inside scoop for us on this one. On the public side, or maybe the private side, if you want to comment on that as well, where’s the big growth right now in REITs?
It seemed like a few years ago, it was big and multifamily, and that seems to have slowed down a little bit, at least anecdotally, from what we’re seeing. What are you seeing out there now on the newest trend?
Besides all the AI data centers, if that seems to, if that’s the case.
Stace Sirmans:
I mean, that’s what I was going to say.
Stephan Shipe:
Really? See, that’s disappointing me a little bit because I was hoping that that was just a really small segment of the market and you were going to tell me everybody’s a little bit more rational.
Stace Sirmans:
So yeah, okay. you know, have the traditional sectors like multifamily, office, retail, things like that. But one of the things that everybody was talking about last week was data centers and I think the reason being is because the growth in that sector is expected to be huge. Large amounts of capital being put into it. So the expectations are really high.
Stephan Shipe:
That’s interesting. And I say that because it must have been a year or so ago, I was talking to somebody who was working in the space and they were talking about how they were taking these data centers and they were leveraging the data center as it was being built.
So they would build like 20% of the data center and they were already like leveraging up taking out debt for that section and then using that section as collateral for the next section. And like it’s the same building. We’re just splitting the building up into five chunks and we’re… they’re literally taking cap, is what blew my mind.
That’s still there. You’re seeing that as a big area right now. Yeah.
Stace Sirmans:
Yeah. And these, you know, some of these data centers are huge, there’s one, I think it’s near Atlanta that is supposed to be bigger than, in terms of square footage is then the Atlanta airport.
Stephan Shipe:
So how does that work then from a risk perspective. If somebody’s out there and they’re trying to look at REITs, they say, you know what, listen to Stace, it sounds like a great idea. I’m gonna add some real estate into my portfolio, publicly traded REITs, easily accessible and all of that.
Do you look at just a broad REIT, something like a Vanguard ETF, or do you think there’s more dispersion in real estate that’s probably better to focus a little bit more on what holdings those are? In other words, I guess you always hear it’s like, well you invest in the index and you own the S &P 500. Do you feel the same way about real estate or is there a little bit more nuance to choosing industries or different areas of REITs because of the risk profiles?
Stace Sirmans:
Yeah, so I would imagine that it depends on investors’ preference, but I would say for the vast majority of investors, it make sense to buy into a REIT index. Then you’re buying across the property sectors. So you have a little bit of office and retail and multifamily. A bit of everything.
Stephan Shipe:
Are you seeing the same concentration risk that we’re seeing in the overall market right now where the S&P is what 30% plus, maybe 40% tech at this point or has the AI data center area gone to the same percentage or is that not nearly as much?
Stace Sirmans:
Honestly, that’s not as much of an issue for REITs as it is for, industrial firms, for tech firms.
Stephan Shipe:
Good. Well, that’s a silver lining, I guess, out there for the market aspect of if we’re kind of wrapping up the conversation where we’re at now, what are some of the big misconceptions that you typically see, whether it’s from who are in the research area about REITs, that if you have your chance to those issues, what would they be?
Stace Sirmans:
I mean, one of the issues I think would be that, people would expect REITs or real estate to be a good inflation hedge. And it kind of is. And in general, when you experience inflation, it’s good to be an asset owner. So from that perspective, sure. But it’s not the best inflation hedge. And part of it is, like I mentioned before, the cash flows come in are from lease agreements that you have with tenants on the properties that you own.
And some of these lease agreements can be relatively long term. And so if you have, you know, the cashflow is locked in, and then you experience inflation, then those cash flows are worth a little bit less. That aspect hurts REITs in terms of being a good inflation hedge. But I think at the same time, REITs are a good diversifier for broadly diversified stock fund. So I think that’s one of the main positives.
Stephan Shipe:
I said we were wrapping up, but now I have two follow-up questions on those.
You’re looking at some of these, especially if you’re looking at the index fund, one of the big arguments I’ve heard lately is, and I can give credibility to, is like, well, now we’re looking only at the United States. Maybe we should be considering more international and international stocks had its issues in the past and all of that.
When you look at real estate, you don’t get the same international exposure, do you, as you would like an S&P 500.
You can make a pretty good compelling argument that if you’re owning the S&P, those companies have plenty of international operations. So international diversification is not as important.
Should I be looking at international REITs now to truly balance that out? Is that more important than in the equity market?
Stace Sirmans:
So yeah, that’s an interesting point. Over the last couple of decades, the real estate investment industry outside of the US has grown a lot. Historically, real estate has been kind of a segmented asset class. Information is kind of hard to come by. But in the US, we have the Real Estate Investment Trust legal definition. Which opens the doors kind of democratizes access to real estate. But see, that’s a legal definition that we have in the US that not every country has, right? And so a company that looks like a real estate investment trust may be very different outside of the US. But over the last couple of decades, more and more countries have adopted the REIT kind of style definition of a real estate company. And that has opened access to real estate outside of the US. So it’s growing, but yeah, historically it hasn’t been as open outside the US as traditional firms have.
Stephan Shipe:
Are there any countries that you’re seeing right now really kind of advantage of that or in particular that you’ve seen start to try to come up with their own?
Stace Sirmans:
You know, not any country in particular, but more developed countries in Europe, in Asia.
Stephan Shipe:
Very cool. Well, this has been extremely helpful to have some background there on the REITs and how they’re structured and what to watch out for and the good and the bad. So thank you very much for coming on today.
Stace Sirmans:
Yeah, thank you.
Outro
Stephan Shipe: And that’s our show. Thanks for listening and we’ll see you next week!
Disclaimer: The information provided in this podcast is for general informational and educational purposes only, and is not intended to constitute financial, investment, or other professional advice. The opinions expressed are those of the hosts and guests and do not necessarily reflect the views of any affiliated organizations. Investing in financial markets involves risk, including the potential loss of principal. Past performance is not indicative of future results. Before making any investment decisions, you should consult with a qualified financial advisor who can assess your individual financial situation, objectives, and risk tolerance.