Jonathan Clements's Blog, page 142

Finding Your Purpose

IN MY LAST ARTICLE, I wrote about how Harvard and other colleges are offering programs to help growth-oriented retirees find new meaning and purpose. Having a sense of purpose improves our quality of life and provides a sense of well-being.

But most of us, including this writer, can’t afford Harvard’s program. That’s why I’m going to show you how to find your main reason for being within the comfort of your own home—using the ikigai method. Ikigai is a Japanese concept that describes a deeply personal process of aligning what we do with who we are.

The beauty of ikigai is its simplicity. It’s easy for retirees to use because by now we should know ourselves reasonably well—what we love to do, what we’re good at and what we struggle with. I’ve used the process to find the work I do now, as well as to help others find the work that they were meant to do.

To begin, find somewhere quiet where you can focus. Then go deep within yourself by asking four questions:

What do you love to do?
What are you really good at?
What do people need help with?
What kind of work could you do and potentially be paid for?

Use a notebook to record your thoughts. Come up with a few answers for each question. It can help to go on long walks as you ponder the four questions, and also to ask these questions of others who know you well.

Ikigai provides clarity. It opens our eyes to how we’re uniquely wired and what we were born for. It shows us how to put our gifts to work so that we work for the pure joy of it. The goal is to identify those things that we’re naturally good at, the things that energize us. The best pursuits put us in a state of flow, where we lose track of time because we’re so immersed in what we are doing. As we answer the four questions, at some point things will start to connect and our purpose will become clear.

Use ikigai to help others. Ikigai can be used to find suitable volunteer work if we ask these questions of ourselves:

What good deed do we want to do for the world?
What problem can we help solve?
What kind of meaningful contribution can we make?

Retirees can find a sense of purpose by helping others. They volunteer because it makes them feel good and it gives them a sense of accomplishment. They can feel significant by having a positive effect on others. Being able to describe how we help others will give us a sense of pride and put a smile on our face.

Do stuff that matters. Without something worthwhile to do in retirement, we may flounder and find that we grow older faster. But it doesn’t have to be that way. Finding our ikigai—our purpose—will help us reengage with life in a more meaningful and fulfilling way. It can make us feel connected with the world and give us something to live for.

It can make us feel that we still matter in this world, that we can still contribute and be relevant. It allows us to express our new identity to others, which is far better than answering with the standard “I’m retired.” Let’s face it, that answer can get a little boring.

People who find their ikigai never really retire. They keep doing what they love until they can’t do it anymore. By keeping their minds and body busy doing things they love to do, they may end up living longer than most.

If you’d like to learn more about ikigai—and how others have used it to find new purpose—consider downloading Longevity Lifestyle by Design, the free book I co-authored.

Mike Drak is a 38-year veteran of the financial services industry. He’s the co-author of Longevity Lifestyle by Design, Retirement Heaven or Hell  and  Victory Lap Retirement . Mike works with his wife, an investment advisor, to help clients design a fulfilling retirement. For more on Mike, head to  BoomingEncore.com . Check out his earlier articles.

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Be Careful Out There

FINANCIAL FRAUD against Americans age 60 and older costs $3 billion a year, and the average loss per incident is $120,000, according to a 2020 study by the AARP Public Policy Institute. And scams against older Americans are increasing. The FBI reports that losses more than doubled from 2019 to 2021 and internet swindles against elderly victims rose 84% in 2022.

My wife was the target of a fraud and you may have been, too. As an IT specialist, I’ve learned that most cybersecurity breaches suffered by organizations could be prevented with simple safeguards, like long and hard-to-guess passwords, keeping operating systems updated and encouraging employees not to click on links in unfamiliar emails.

Such simple safeguards will also help keep you safe at home. Here are some of the most common phone and online scams, along with suggestions for how to protect yourself against them:

“Grandpa, I’m in big trouble.” In the grandparent scam, you receive a call from someone claiming to be your grandchild or other close relative. The scammer says money is urgently needed to pay medical or legal bills. The caller might also claim to be a law enforcement officer or medical professional asking for money to cover hospital bills for your family member.

You shouldn’t feel pressured to send money immediately. We all love our families, so our first instinct is to help when someone’s in trouble. The scammer may use artificial voice generation and clues from social media to make the impersonation sound more convincing.

Be wary. Make sure the call is legitimate by asking the caller questions that only your relative would know the answers to. You can also call or text the family member who’s reported to be in trouble to see if it’s true. If you realize you’re being scammed, hang up.

“Your computer is infected.” You receive a phone call or pop-up message on your computer claiming your computer has dangerous malware that’ll lock up the machine or delete your data. The caller may claim to be from a well-known company like Microsoft, Apple, Norton or McAfee.

The scammers may insist you pay hundreds of dollars for repairs or new software. Or they might try to trick you into giving them remote access to your computer and then install actual malware that steals the personal and financial data stored on your machine.

Feel free to hang up if you get an unsolicited call from someone claiming to provide tech support for your machine. Legitimate companies don’t contact you out of the blue offering tech support. You can also shut down a fake pop-up message by closing your web browser. Consider using a website malware scanner to check the websites you visit for malware.

It's a good idea to regularly scan your computer with reputable antivirus software, and to keep your operating system, browser and security software up to date. If you believe your computer might have a problem, consult a trusted and knowledgeable technician.

“You owe the IRS back taxes.” You get a call from someone claiming to be with the IRS, Social Security Administration, Medicare or law enforcement who says you owe taxes or fines. It may be a recording demanding you call a number or send payment immediately to avoid arrest or legal action.

Again, feel free to hang up and ignore the call. Government agencies don’t initiate contact with you by phone to ask for payment. They’ll mail or deliver an official letter if there's a real issue.

“Click here for a great deal—limited time only.” You’re doing an internet search or visiting a website when you see an enticing ad for, say, “25% off iPhones for AARP members—limited time offer.” You click on the ad and are taken to another site that appears legitimate. But that site is run by scammers and can infect your machine with malware or steal your personal information.

This is a relatively new scheme known as malvertising, or malicious advertising, that unfortunately has become widespread. There have been malvertising campaigns specifically aimed at older adults. Scammers might target folks who use search terms related to tech support, recipes and cooking, online dating and games like solitaire. Other popular search terms, even innocuous ones like “weather forecast,” are also targets.

Antivirus software is intended to protect your machine against malware like this. You might consider installing a reputable antivirus program on your computer and keeping it up to date.

You could also install an ad blocker on your computer. It may prevent malicious ads from appearing in the first place. Be warned: Some websites might not function properly if an ad blocker is running.

If you see an ad or message with an enticing offer from a retailer, it’s a good idea to check the ad carefully before clicking on it. Fake ads often have misspellings or grammatical errors, or the URL might be off. When in doubt, consider going to the company’s website directly or phoning the firm.

“Get your prescription medications at 50% off.” Many Americans are looking for ways to save on their medications. Scammers take advantage of this by offering prescription drugs of dubious content and quality over the Internet. Others offer tests, vaccines or “cures” for COVID-19.

This scam can endanger victims’ health, as well as their bank account. One group in Arizona, whose members later were convicted and imprisoned, sold $1.5 million worth of fake Botox before they were arrested.

It's advisable to order medications only from reputable pharmacies that will require a prescription from a qualified medical professional and provide information about the drug’s uses and side effects. A site like the FDA’s BeSafeRx will help you verify the legitimacy of an online pharmacy.

Legitimate pharmacies also have a physical address and licensed pharmacists available for consultations. A pharmacy that offers medications significantly below market price is cause for suspicion.

“What's your Social Security number?” Most of us are familiar with the threat of identity theft. Recently, my wife was a victim. Scammers opened an account in her name at a well-known online retailer and charged several hundred dollars in merchandise.

Fortunately, a credit monitoring service alerted us to the fraudulent account and helped us work with the retailer to close it and cancel the charges. Identity thieves commonly target older adults because they typically have more financial assets. Also, many don’t check their account statements regularly.

You can get a copy of your credit report for free from each of the three major credit reporting agencies. Review it carefully for discrepancies. You might also consider enrolling in a reputable credit monitoring service. If you were a victim of a security incident, like the 2017 Equifax breach that affected 147 million people, you might have been offered free credit monitoring services.

If you or someone you know has been a victim of a scam, there are ways to get support. The Department of Justice created the National Elder Fraud Hotline to help you report a crime and connect you to other useful resources. The hotline receives 500 calls per month.

The Senate Special Committee on Aging has also created a fraud hotline to receive fraud reports and provide information about common scams. Similarly, the Federal Trade Commission takes reports of fraud. It can’t help you get your money back, but it works with law enforcement agencies to investigate and publicize scams to prevent others from becoming victims. Finally, many state governments have adult protective services programs to protect older adults from abuse, including fraud.

Max Chi retired in 2022 after a career as an IT specialist. He also has a background in physical science and digital marketing, and a strong interest in personal finance. Max enjoys traveling, sightseeing and freelancing. He and his wife live in Texas.

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Fuel or Friction?

I RECENTLY LISTENED to an interesting Hidden Brain podcast discussing different ways of bringing about behavior change. The guest on the podcast was Loran Nordgren, a professor at Northwestern’s Kellogg School of Management and coauthor of a book entitled The Human Element. The discussion centered on two related concepts: fuel and friction.

Fuel is the stuff we use to motivate ourselves and the people in our lives. It can be positive or negative. Let’s say you’re an employer trying to get employees to save more in the retirement plan. To fuel their participation, you might explain the benefits of compounding, tax deferral and the employer match.

Friction is the stuff that produces drag—things that hold us back or create obstacles that prevent us from acting. Continuing with the example above, a website that’s hard to navigate could prevent employees from signing up for the company’s 401(k) or increasing their contribution.

Nordgren contends that, “Removing friction is often more powerful than increasing fuel.” He provides a variety of interesting and amusing anecdotes to support his thesis. One of my favorites stories was a self-acknowledged failure. Nordgren described how, despite many attempts at fueling, he couldn’t convince his 95-year-old father to get a cell phone. He concluded he’d have been better off finding a way to make it easier for his father to embrace technological change.

I’m a big fan of reducing friction in our financial lives. Today’s technology makes this easier than ever. Here are my favorite ways to reduce financial friction:

Automate savings. Thanks to direct deposit, it should be simple to direct some of your paycheck to your savings goals, as well as to your regular checking account. My wife and I have both a checking account with a brick-and-mortar bank and an online savings account. They’re tied together so I can transfer money between them if required.
Automate bill paying. Again, the banking technology is available to automate most or all of our regular bills. Some companies will even give a discount for automated payments.
Automate retirement savings. Sign up for your employer’s retirement plan, being sure to capture at least the employer match. Better yet, try to save a little more than you’re comfortable with, and see if you can learn to live on whatever remains of your paycheck.
Automate transfers to an investment account. This has become very easy to do. Once you’ve established an account, also be sure to automatically reinvest your dividends, so you acquire even more shares.
Automate withdrawals. We have cash investments in my IRA from which we take planned monthly withdrawals. This is new this year, and I’ll monitor this to see if it’s the right amount or if we can hold less cash. If it proves insufficient, it’ll tell me we’re spending more than I realized.
Automate debt payments. If you have a mortgage or other loan, many companies will offer an interest rate reduction for automatic debits.

During our working years, my wife and I tried to automate our saving and investing, leaving a relatively meager amount in our paychecks for us to spend. I wouldn’t recommend making it so tight that you end up with credit-card debt. But make it meager enough so that you have to think hard about that next splurge.

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D Is for Dilemma

IF MEDICARE’S A MAZE, its Part D drug plan is a maze within a maze, with no one good path and plenty of so-so choices, along with a couple of potential “gotchas.”

Until 2006, Medicare offered no coverage for outpatient drugs, so today’s situation—however imperfect—is certainly an improvement. It’ll improve even more for people with high drug costs in 2024 and 2025, as I’ll explain at the end of this article.

What if you have Medicare Advantage, rather than traditional Medicare? Some Advantage plans include drug coverage. That coverage is typically modeled on Part D and conforms to its rules. Meanwhile, drugs administered in hospitals and doctors' offices are usually covered under Medicare Part A and Part B.

Most Part D plans have five drug tiers and four coverage phases. Premiums, deductibles and co-pays vary. You buy coverage from an insurance company, not Medicare, and each plan sets its own prices and creates its own “formulary.” The formulary lists the drugs that the plan covers. Some drugs, such as those for HIV and cancer, must be covered, and each plan needs to have at least two drugs in the most commonly prescribed categories and classes. Still, no plan covers all drugs. The plans available to you will vary depending on where you live.

In my zip code and county, there are 24 plans, with premiums ranging from a low of $4.20 a month to a high of $132.50. The maximum deductible is set by Medicare and is $505 this year, but some plans charge no deductible. Four of the most expensive plans available to me have a zero deductible, partly offsetting their high premium cost, while the cheapest plan charges the full $505. Medicare has a good tool for comparing plans, which you should use before you choose a plan for the year ahead.

Insurance companies can set their own drug tiers. In general, those tiers are preferred generic, generic, preferred brand, non-preferred drug and a specialty tier. The latter is also known as Tier 5. The tiers—combined with the so-called coverage phases, which I’ll get to in a moment—determine your co-pay. If your plan has a deductible, you pay the full cost of your drugs until the deductible is met.

In the initial coverage phase, which you enter after you’ve met the deductible, your co-pay depends on the drug tier and your plan's requirements. You might pay just $1 per prescription for a preferred generic, while another plan could charge $5. There may be restrictions on Tier 5 drugs, such as a requirement for prior approval or a quantity limitation. I stayed with the same drug plan for years because I’d already been approved for my Tier 5 drug.

Once you and your plan spend $4,660 on covered drugs in 2023, you reach the coverage gap, otherwise known as the “donut hole.” If you take a brand name drug, you pay 25% of retail, your plan pays 5% of retail and the manufacturer discounts the rest. There’s also a small dispensing fee. If you take a generic, you pay 25% of retail and Medicare pays the rest.

Note that “retail” refers to the price negotiated by the insurer for your specific drug at your specific pharmacy. The charge might be different at another pharmacy. The total amount you pay for your drugs, plus the manufacturer's discount, if any, needs to add up to $7,400 this year for you to reach the catastrophic coverage phase. Once in catastrophic coverage, you’ll most likely pay 5% of retail.

Want to see what the gory details look like? This is the coverage chart for the mid-range plan I used last year. The premium for the plan is $34.60 a month and the deductible is $505 a year. If you have difficulty paying, there’s a program called Extra Help, though I doubt many HumbleDollar readers would qualify. Manufacturers often have programs to help people with the most expensive drugs, but these programs aren’t available to people on Medicare.

You can also save if the drug you need can be given in a doctor's office. The first drug I tried for my rheumatoid arthritis was given by injection in my doctor's office and was covered under Medicare Part B. At that time, I had original Medicare plus Medigap Plan F, and there was no charge to me.

What are the “gotchas”? The first has to do with the formulary. Each year, you sign up for a drug plan during open enrollment, which is Oct. 15 through Dec. 7 this year. The coverage goes into effect on Jan. 1 of the next year. You can't change plans again until the next open enrollment period.

This wouldn't matter if the insurance companies were under the same constraint, but they aren’t. They can choose to add and drop drugs from their formularies at any time. If your drug is dropped, you can have your doctor file for an exception, but it may not be granted. And, of course, you have no way of knowing when you apply to a plan in November what new drug you might need next August.

Today, there’s no out-of-pocket annual maximum for Part D. If you spend enough to make it to catastrophic coverage, you might be charged as little as $10.35 per brand-name prescription. That’s also what’s charged by the private group Medicare Advantage plan that I’m on this year. But drug costs aren't necessarily that low. All of the Part D plans available to me charge 5% of retail once you reach the catastrophic coverage phase.

The drug I’ve taken for the past five years for rheumatoid arthritis currently retails for more than $6,000 a month—and 5% of $6,000 is a significant amount. The good news: Last year's Inflation Reduction Act made three key changes to improve Part D’s affordability.

First, in 2024, if you make it to catastrophic coverage, co-pays will be eliminated. Second, in 2025, there will be a $2,000 annual out-of-pocket maximum for Medicare drug coverage—assuming these changes survive Washington’s budget negotiations. Finally, starting in 2026, Medicare will be able to negotiate directly with manufacturers on the price of some expensive brand-name Part B and Part D drugs that don’t have competition.

Kathy Wilhelm, who comments on HumbleDollar as mytimetotravel, is a former software engineer. She took early retirement so she could travel extensively. Some of Kathy's trips are chronicled on her blog. Born and educated in England, she has lived in North Carolina since 1975. Check out Kathy's previous articles.

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Improving My Habits

THE PROLIFIC MR. QUINN recently wrote that people who were irresponsible in one area of their life, such as failing to return shopping carts, also tend to be irresponsible in other areas, like managing their finances. He’s probably right. Still, I’ve had times when, even though I’m a “responsible person”—I’ve had a successful career, my kids lived to grow up, and so forth—I nonetheless had pockets of disorder in my life.

For me, the two biggest areas of chaos were managing money and maintaining a healthy diet and exercise regimen. I’m embarrassed to think back on the bounced checks, late fees, and even the checks I accidentally threw away because I was distracted and disorganized. I’m even more horrified to think about how many fast food and vending machine “meals” I ate because I hadn’t been to the store or found time to eat a proper breakfast or pack a lunch. There was even the gym membership that I had for seven years, which I paid for—but never once used.

These unacceptable patterns needed to be changed. Responsibly managing one’s finances is important. Ditto for attending to one’s health, as Rick Connor has written in several pieces. Thus, I’m happy to report that I have restored order in both of these important areas.

Our bills are paid on time, our credit scores are pristine, we have no debt beyond our mortgage, and we have savings, insurance and an estate plan. As for health and fitness, I’ve lost nearly 60 pounds since 2020, I’m absolutely devoted to working out and I’m now at a healthy weight for my height. When I had recent lab work, my doctor told me everything looked great, and “just keep up the good work.”

How did I do it? The short answer is habit formation—James Clear’s Atomic Habits was very helpful to me—with an assist from automation. My personal finance transformation happened some years before my success with diet and exercise. To improve my health, I applied many of the “automation” lessons that worked with our finances. Still, the real key is that I’ve made decisions and built habits that have helped me reach my financial and health goals.

Automating our finances. It was around the mid-2000s when I started using the online bill-paying service that our credit union offers. Since then, I’ve moved to setting up automatic payments directly with vendors, including the utility, phone and insurance company, rather than having checks sent from the bank.

Every time I get a new credit card, I set up my online account with automatic payments on the statement due date. Our retirement contributions and health insurance payments come straight out of our directly deposited paychecks. I opened a donor-advised fund with Fidelity Investments so our charitable contributions would be automated, and I set up an online account to make automatic quarterly tax payments to the IRS.

Now, it’s rare that I ever write a check or pay cash for anything and, on the infrequent occasions that I do need to pay a bill myself, I just go online and take care of it promptly. Because most of the task is automated, I have the time to attend to the parts that still need my attention, such as checking our bank accounts and credit card statements to make sure there’s nothing amiss.

Automating weight loss and fitness. Slowly but surely, I’ve learned what works for me. Where does automation fit in? It’s helped me stay on top of a sometimes mentally challenging process.

Specifically, an online calculator that considers age, gender, height, current weight and activity level provides me with recommended daily and weekly calorie ranges for losing or maintaining weight. I also rely on an online calorie-tracking website and app called MyFitnessPal. I have the tracker set to a lower calorie goal for workdays and another, higher one for weekends. In addition, I use an app called Happy Scale to enter and track my weigh-ins.

Using MyFitnessPal, I enter upcoming meals and snacks for the day ahead, inputting the information either the night before or first thing in the morning. Taking five to 10 minutes to plan reduces decision fatigue throughout the day, especially if I’m hungry, tired or stressed. I can just work the plan I’ve made rather than relying on willpower when the flesh is weak.

Since I like to cook, and meal planning is crucial to my success, I use an online recipe organizer called Copy Me That to collect and edit recipes that I’ve tried and decided were keepers. I also have themed Pinterest and Facebook folders to save new recipes I want to try. When it’s time to plan dinners and make my grocery list for the coming week, I consult these sources.

My fitness and exercise goals are tracked on my Apple Watch and on the Peloton app. I always “stack” my workout on the Peloton app—meaning I pick out and bookmark the classes I’ll do the next day—so that the decisions have already been made. The app also keeps track of my metrics in the Peloton classes. Meanwhile, the watch tracks my steps and my non-Peloton activity.

As with my financial management tools, I do have to get involved. I have to plan and cook the meals, pick out and do my workouts, and stick to the plan. But having all these tools reduces cognitive overload, and makes it more likely I’ll stick to the plan (well, most days) and make progress toward my health goals.

Dana Ferris and her husband live in Davis, California. She’s a professor in the writing program at the University of California, Davis, and is the author or co-author of nine books on teaching writing and reading to second language learners. Dana is a huge baseball fan and writes a weekly column for a San Francisco Giants fan blog under the nom de plume DrLefty. When not working, she also loves cooking, traveling and working out. Follow Dana on Twitter @LeftyDana. Her previous articles were Buying Time and A Better Plan.

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Loosening My Grip

AS I WROTE THIS STORY, the word count kept climbing and climbing because it has more twists and turns than a detective novel. It was so long I was afraid no one would read it, not even my mother. So, here is a condensed version of what I wanted to say.

The hardest transition for some folks as they reach retirement is to go from a saver to a spender of what they’ve saved. You spend a lifetime saving up money for your golden years and then that period of saving money ends. You should now spend and enjoy some of your hoard.

That was—and still is—difficult for me. After all, it’s rare for folks to flip a switch and suddenly change their whole personality. This is true if you’re going in either direction.

My wife Cindy was age 22 and I was 31 when we married. I had always been a supersaver by nature, so I had a good-sized net worth at the time. I tell people that those years before Cindy were my single and “rich” years. I had a great job and low expenses because I was only responsible for myself. I could spend a fair amount but I was saving even more. I had a great life. What about Cindy? She really had nothing because, well, she was 22.

But I wanted more and I wanted Cindy—badly.

After we got married, I lost that great-paying job due to massive cutbacks at my employer. I never had another job as good as the one I lost. We both wanted to stay in our little town, where few jobs were available. I had to take whatever I could find, and that resulted in my pay dropping in half overnight.

Over the years, our family grew to five kids. Kentucky is known for poverty. Most jobs are low paying. For 12 years, Cindy stayed at home with the kids, while also managing to work two part-time jobs. After that, she went back to work fulltime.

Meanwhile, I had a fulltime and two part-time employers, plus I put in almost 43 years of active and reserve duty in the armed forces. I was shocked by the change in my status. I went from single and “rich” to married and “poor” in almost one fell swoop. Still, I was a saver and I became the most miserly person you would ever meet. It was not pleasant.

I was legendarily tightfisted. Take buying something at the candy machine at work. The wheels in my brain would start churning through reams of mental data, calculating the cost of a daily purchase from that machine extrapolated over days, weeks and years. The result was I wouldn’t buy the item in question. I did that with everything.

Spending money became repugnant to me even when we could well afford it. Any windfall we received went into our retirement accounts. Our net worth climbed and climbed. But in the process, we fought over money more and more because saving became an obsession for me.

What an awful position to be in. You have all this money but letting it go makes you miserable. You never feel rich. You always feel poor. It seemed that every time I made a purchase that was an “extravagance,” no matter how small, I would almost become physically sick. It was after one of these mental episodes that I thought, “Good grief, am I going to be this way for the rest of my life? Will I ever be able to enjoy spending the money more than I enjoy watching it accumulate in my bank account?” Such thoughts depressed me greatly.

But I changed and continue to change over time. How? First, two of my brothers died, one at 64 and another at 68. It was a shock. My dad died at 92 and my mom is still going strong at 95. My mortality was staring me in the face. I am not going to live forever. Would I be on my deathbed staring at my financial accounts? I doubt that.

Second, I realized that, at age 65, we pretty much live on my military and civilian pensions. I still haven’t had the need to even touch my Social Security or retirement savings. Those savings are substantial by the standards of our Kentucky town. One day, our tax bill will be enormous if we don’t start spending down our savings.

The upshot: I decided to turn over to Cindy most decisions on giving to charity, gifts to our children, vacations, dining out and, yes, going to the candy machine, with limited input from me. It made my wife happy not to be married to a money-grubbing control freak. And I was happy to get to enjoy what our hard-earned money can buy.

No, I’ll never be a big spender. But we enjoy our life, and my marriage has become stronger by letting go of some money. The golden years are becoming so much better now that I’ve learned to spend some of our gold.

Ken Begley has worked for the IRS and as an accountant, a college director of student financial aid and a newspaper columnist, and he also spent 42 years on active and reserve service with the U.S. Navy and Army. Now retired, Ken likes to spend his time with his family, especially his grandchildren, and as a volunteer with Kentucky's Marion County Veterans Honor Guard performing last rites at military funerals, including more than 350 during the past three years. Ken's previous article was How I Got This Way.

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Two Dollars to Win

PEOPLE WHO INVEST in the stock market and people who bet on horses both hope to win. I expected the efficiency and behavioral finance that rule the stock market to have similar effects on horse betting. Instead, I found just the opposite.

The story begins 40 years ago. A few years after we were married, I suggested to my wife that we spend a day at the fabled Saratoga Race Course in Upstate New York and watch the thoroughbreds run. At the time, we were living in nearby Schenectady. My wife was fine until I suggested we bet on each race. She was appalled, declaring, “Neither of us knows anything about horses.”

There were going to be eight races that day. I said I would put $32 in my right pocket. That would be enough for each of us to place a $2 bet on all eight races. Our bets would be simple—$2 on a single horse to win. We would put any winnings in my left pocket. Racetracks keep about 20% of what is bet and pay out 80%. If we bet $32 randomly, at the end of the day we should have $25 or $26 in my left pocket. If we had a bad day, we might have $23. If we had a good day, it could be closer to $28.

My wife asked how she should select a horse. Though I wasn’t able to clearly articulate it at the time, I believed horse betting was “efficient.” Therefore, I said it doesn’t matter—she might select based on a horse’s name or the color of the jockey’s garb, she might pick the horse with the best odds or she might opt for the long shot. It truly didn’t matter. Each race, we dutifully placed our $2 bets. That made for a more exciting day, as we cheered on our horses. As I recall, by the end, I had about $25 in my left pocket. We got a lot of enjoyment for the few dollars we lost.

What does betting on horses have to do with finance? Actually, quite a lot.

History tells us that value stocks outperform growth stocks, although this hasn’t been true recently. Behavioral finance provides a reasonable explanation for this outperformance. “Herd behavior” bias says we’re inclined to mimic what others are doing. If others like a particular stock, we tend to join the crowd and push the share price to a level beyond what’s reasonable. Conversely, if a particular sector is out of favor, we tend to shun those stocks, causing them to become undervalued.

People expect both favored horses and growth stocks to do well. Thus, favored horses should be overvalued. Meanwhile, as with value stocks, people don’t expect much from long-shot horses. Long-shot horses should be undervalued.

All of this came to mind recently when I was going through my study, trying to figure out what I could toss. I came across a paper I wrote in 2002 for a statistics class I was taking as part of my doctoral program. For the paper, I systematically examined the betting on horses to see if it was consistent with the efficient market hypothesis.

Just as the price of a stock reflects the opinion of people who have a vested interest in the outcome, the odds on a horse reflect the opinions of those who have a vested interest in the outcome. The odds are adjusted in real time as bets are placed. If more money is placed on a particular horse, the track offers less payout if that horse wins. If few people bet on a horse, the track offers a larger payout. The track doesn’t care which horse wins—it always gets its share.

I was taking my doctorate at Anderson University in Anderson, Indiana. The town is also home to a horse track, Hoosier Park. For each of the 770 races during the most recent season, I was able to find the final odds of each horse, the horse which won and the amount paid for a winning bet.

My results were the exact opposite of what I expected. For betting on horses, the best results were obtained by betting on the favorite. People had a worse outcome if they bet on the least favorite horse, the long shot.

Since a track pays out 80% of the amount bet, a $2 bet on each horse in each race will provide an average payoff of $1.60. If I had placed a $2 bet on the most favored horse in each race, meaning the horse with the smallest odds, I would have won an average of $1.70. A long-shot horse didn’t win very often, but—when it did—it paid a huge amount. But on average, a $2 bet on a long shot yielded just $1.38.

My analysis was more than 20 years ago, and I analyzed only one track and one season. Are similar results typical today? If so, perhaps horse betting is less efficient than the stock market—though making money would still be tough, given the track’s 20% take.

By the way, my wife still thinks gambling is a waste of good money.

Larry Sayler is the only person with a Wharton MBA who also graduated from Ringling Bros. and Barnum & Bailey’s Clown College. Earlier in his career, he served as CFO for three manufacturing and service organizations. For 16 years before his retirement, Larry taught accounting at a small Christian college in the Midwest. His brother Kenyon also writes for HumbleDollar. Check out Larry's earlier articles.

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Running in Place

A WHILE BACK, I WAS speaking with a mutual fund manager. In describing one of his fund’s stocks, he noted, “I owned it for a while, then I sold it, but then I bought it back.” It was a surprising comment since frequent trading is, in most cases, unproductive. Indeed, Warren Buffett has often said that his preferred holding period for an investment is “forever,” and many see that long-term mindset as crucial to his success.

At the same time, Buffett’s “forever” strategy hasn’t always worked out. He acknowledged making a mistake in owning IBM, which has seen its stock flatline for 10 years. Buffett’s Berkshire Hathaway also owned big positions in Wells Fargo and Tesco before corporate malfeasance took both of these companies’ stocks down. In all three cases, Buffett chose not to hold forever and finally exited these stocks.

Buffett’s experience indicates that holding any investment indefinitely can pose problems. On the other hand, there’s data showing that trading too frequently can also be detrimental. Brad Barber and Terrance Odean, for example, wrote a well-known paper titled “Trading Is Hazardous to Your Wealth.”

As an individual investor, what should you conclude from these seemingly contradictory findings? In a recent set of studies, researchers at Morningstar looked at this question.

In one study, Morningstar’s team analyzed 400 actively managed large-cap mutual funds. The researchers compared the funds’ performance over a 10-year period to an alternative scenario in which the funds’ holdings had been held static for those 10 years. They referred to these alternatives as the “do-nothing portfolios.”

The result? Some funds would have done worse if their holdings had been frozen in time, while others would have done better. On average, though, the difference would have been negligible: Before factoring in costs, the actual funds gained 12.1% a year over the 10 years ending March 31, while the do-nothing alternatives would have notched 12%. The difference was almost immaterial—but that was before fees.

Since actively managed funds carry annual fees of nearly 1%, the net effect was that these funds’ managers detracted more from their funds’ performance than they contributed. As Morningstar put it, these fund managers would have been better off taking a vacation—"a long one.”

In another study, Morningstar examined tactical asset-allocation funds. Unlike funds that pursue a single investment strategy, such as sticking with large-cap growth stocks or intermediate-term corporate bonds, tactical funds have the latitude to switch among asset classes as their managers see fit. If they see a recession coming, for example, they might switch more of the funds’ assets into bonds. For these funds, Morningstar asked the same question: How would these funds have fared if their holdings hadn’t changed at all over 10 years—in other words, if their managers had gone on vacation?

The result: Over the same 10-year period referenced above, tactical funds earned a modest 2.3% a year, on average. But had the managers done nothing at all for 10 years, their funds would have gained twice as much. As Morningstar put it, “They came. They saw. They incinerated half their funds’ potential returns.”

I see two lessons in these results. First, when in doubt, be like Buffett. Yes, you can make a mistake by hanging onto an investment for too long. But on balance, it’s better to maintain a long-term mindset toward your investments. That means, of course, hanging on through the market’s usual ups and downs, and I’ll acknowledge that isn’t always easy. But as the tactical fund managers proved, the alternative can be much worse. It’s virtually impossible to make successful trades based on economic or market predictions. This risks “incinerating” returns. Instead, in my view, investors are better served by choosing an asset allocation that they can live with through the market’s ups and downs.

The second lesson we can learn from these studies: Fees really matter. The late Jack Bogle, founder of Vanguard Group and an index fund pioneer, often said that he didn’t see active management as a problem per se. Rather, the problem was the high fees that most active managers charge. That’s the fundamental reason investors are, in my opinion, better off avoiding actively managed funds and instead opting for very low-cost funds, which usually means index funds.

What if an active fund manager has a solid long-term track record? Should you still avoid it? Certain funds, such as Fidelity Contrafund (symbol: FCNTX) and Dodge & Cox Stock Fund (DODGX), have enviable records and reputations to match. Are they the exception to the rule and worth a portion of your savings? It’s on this question that Morningstar’s new research is most helpful.

Look at the performance over the past decade of the 10 largest domestic stock funds compared to their do-nothing alternatives, and you’ll see that the results are nearly evenly split. Six underperformed the do-nothing alternatives. But the other four added value—even after fees in some cases. That might lead investors to conclude that it’s worth owning a few actively managed funds. At first, that might seem logical. The challenge, though, is that fund performance isn’t static. Yes, some funds do have streaks of excellent performance, but no fund has exhibited permanent outperformance.

Standard & Poor’s tracks the mutual fund industry closely and can quantify this. In its most recent Persistence Scorecard, fewer than half of mutual funds that had above-average performance over one five-year period were able to maintain those above-average results in the following five-year period. Funds with really exceptional performance—in the top quartile—demonstrated even less of an ability to maintain that top-tier performance.

Why is it so hard for fund managers to do better than their indexes? It doesn’t seem very hard to spot up-and-coming winners like Google and Apple. As it turns out, it isn’t very hard. Fund managers actually do a great job picking stocks. The problem is on the other side of the transaction, and that’s what drives their underperformance.

In a 2021 paper titled “Selling Fast and Buying Slow,” researchers looked at the track records of professional fund investors and made this discovery: “While there is clear evidence of skill in buying, selling decisions underperform substantially.” In other words, investment managers can spot winners. But they don’t do a good job in choosing when to sell those stocks. Sometimes, they sell too soon and miss out on future gains. Other times, they sell too late, after a stock has dropped. That’s why, according to the data, it’s best for investors to keep things simple—and steer clear of actively managed funds.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.

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Slicing the Apple

THE DOUBLE-DIGIT recovery by the S&P 500-stock index this year has been driven almost entirely by seven mega-cap stocks: Apple, Google, Microsoft, Amazon, Meta, Tesla and Nvidia. In fact, these seven stocks now comprise more than 25% of the index.

Since our family is heavily invested in a mix of the S&P 500, U.S. technology and growth funds, plus some individual tech stocks, I began to worry about our portfolio’s investment concentration. I tallied our positions in these seven stocks across all our accounts.

For decades, our largest fund position has been various S&P 500 index funds (symbols: VOO, VFIAX and FXAIX). The index’s allocation is now 7% Apple, 7% Microsoft, 3% Google and 3% Amazon. We also have a large sum invested in two U.S. information-technology index funds (VGT and FTEC), which taken together give us highly concentrated holdings of 23.5% Apple, 19% Microsoft and 6% Nvidia. In addition, we have small stakes in two U.S. large-cap growth funds (VUG and FSPGX), which give us exposure of roughly 13% Apple, 12% Microsoft, 6% Google, 5% Amazon and 3.5% Nvidia. On top of that, we own some Apple and Google shares directly.

So, how concentrated had our portfolio become as a result of the market’s recent artificial-intelligence bubbling? My tally showed that our Apple holdings had crept up to nearly 7% of our total financial assets. Both Microsoft and Google holdings were just over 3% of financial assets. For perspective, one rule of thumb says you shouldn’t have more than 5% of your stock portfolio—as opposed to your total financial assets—in any one company.

We now owned too much Apple stock when all the bits and pieces were added together. Unlike Warren Buffett, whose Apple shares comprise nearly half of Berkshire’s stock portfolio, though a much smaller percentage of Berkshire’s total assets, we can’t afford the risk of being too concentrated in any one stock.

The upshot: We lightened up on Apple by selling all our directly owned shares held within tax-deferred accounts. This reduced our holdings to just under 6% of total assets. Our remaining Apple shares are owned within a taxable account, which we’re reluctant to sell because of the resulting capital-gains tax bill.

To further reduce our Apple exposure, we also rebalanced some fund holdings within our tax-deferred accounts. We sold a bit of our information-technology funds and moved this money to our growth-stock funds. This rebalancing almost hurts: The information-technology funds have been our best-performing funds since we retired in 2017.

Still, we felt it prudent to lower our Apple holdings by another 0.5% of assets, and we’re considering selling even more. Our other stock concentrations are at more comfortable levels, with Microsoft and Google at 3% of financial assets and all other companies at 1% or less.

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Begging to Differ

DON'T ASSUME YOUR PATH up the mountain is one that everybody else should also follow.

I don’t budget, I earmark 80% of my retirement savings for stocks and I'm currently well above that level, I don’t have a separate emergency fund, I expect to live comfortably in retirement on half of what I currently earn, I plan to delay Social Security until age 70 and my stock market money is entirely in index funds, with roughly half allocated to foreign shares.

Should you blindly mimic what I do? Absolutely not.

It’s called personal finance for a reason: Everyone’s approach to managing money should reflect their personal goals, circumstances and emotional makeup. Yes, it’s interesting to get a glimpse into the financial life of others—a glimpse that’s regularly offered by HumbleDollar’s articles and by readers’ comments. Those glimpses give us a chance to reassess what we do and why, and we might pick up some useful ideas that’ll help us to better manage our money.

But make no mistake: When it comes to handling money, nobody has a monopoly on truth. Yes, logic and evidence favor certain courses of action, such as buying stocks if you have a long time horizon, holding down investment costs, diversifying, indexing, saving diligently, insuring against big financial risks and so on. But in the end, each of us has to tailor such advice to our individual financial life.

That’s why I grow concerned whenever I see folks insisting that their approach is not just right for them, but right for everybody else. Where does that unwavering conviction come from? Often, it seems to rest on one or more of the following six arguments:

1. “You should do this—because it’s what I did.” I see this phenomenon all the time. Those who claimed Social Security early insist it’s wrong to delay—and those who claimed late believe it’s wrong to claim early. Ditto for those who do or don’t budget, or do or don’t own individual stocks, or do or don’t have long-term-care insurance.

I view this as a form of anchoring. Many folks find it hard to set aside what they’ve done or currently do, and imagine that a different path might work just fine for others. I don’t budget and never have. But if others find it useful or comforting, what’s the harm? I avoid actively managed funds and individual stocks. But if others actively manage their portfolio, their returns are okay and it makes them more tenacious investors, who am I to object?

Want to know what really impresses me? When I read about folks who took one course of action—and now concede they were wrong. It’s easy to protect our psyche by pounding our chest and proclaiming we’re right. It’s much harder to humbly concede our error.

2. “It worked well for me.” I’ve never had a separate emergency fund. Early on, sitting on a big pile of cash simply didn’t seem like a possibility when I was raising a family on a junior reporter’s salary, while trying to save for retirement, the kids’ college and a house down payment.

As it turns out, my nonexistent emergency fund was never a problem. But that doesn’t mean it was prudent. It means I was lucky. To use the term popularized by professional poker player and author Annie Duke, we shouldn’t engage in “resulting”—imagining a decision was good simply because it turned out well.

Today, I still don’t have a separate emergency fund. But at this juncture, I think that’s just fine. I have ample money in my retirement portfolio and could easily use some of those dollars to cover an emergency expense without imperiling my financial future, so I see no need to keep a separate stash of rainy-day money. But that doesn’t mean my failure to have an emergency fund in my 20s and 30s was a smart strategy.

3. “I heard this incredible story.” I think the case for indexing is unassailable. But if your goal is to appeal to the heart not the head, you’ll likely fare far better by sharing that anecdote about your neighbors, who claim to have beaten the stock market averages every year with ease.

Make no mistake: Stories are more powerful than logic or statistics. But I would also encourage you to be skeptical of the stories you hear. Take those market-beating neighbors. Are they including all their investments in their calculation, or are they conveniently ignoring the duds that they’ve since sold? How much risk did they take? What benchmark are they comparing themselves to? Are they counting the savings they added to their nest egg as part of their portfolio’s gain? Have they even made a calculation and have they done it properly—or do they simply believe they’ve beaten the market because their wealth has grown over time?

4. “But what if that idiot wins the next election?” I’ve heard of folks who bailed out of stocks because Barack Obama won the presidency—and others who fled stocks because Donald Trump was elected. More recently, investors are getting hot and bothered over whether a money manager does or doesn’t use environmental, social and governance criteria.

I’m skeptical of any financial advice that comes with the taint of heated political rhetoric. I think our political views should play almost no role in the investments we own. One exception: Over the years, I’ve grown sympathetic with those who avoid investing in countries with authoritarian regimes, notably China, where property rights are far less secure.

5. “Everybody's doing it.” We’re social creatures whose spending and investing is heavily influenced by others, including our parents, neighbors, colleagues and—increasingly these days—those we follow on social media.

Indeed, the internet in general, and social media in particular, seem to be megaphones that promote all kinds of dubious information and bad behavior. How many people have made financial decisions in recent years that they now regret because of the online frenzy generated over meme stocks, cryptocurrencies, special purpose acquisition companies, real estate and even Series I savings bonds?

6. “Trust me, I’m successful.” Sure, you’ve led a life marked by career accomplishments. But that doesn’t automatically make you a whiz at managing money. Think of this as the “doctor phenomenon.” Just because you can save lives—or started a successful small business or became CEO—doesn’t mean you can pick the next hot stock or know which way the financial markets are headed.

Yet such folks often have abundant, unjustified confidence in their own investment abilities. Worse still, others often hang on their financial pronouncements. This is not a good idea. I once had the chance to view the feverish trading activity of a retired CEO. It was almost as if his goal was to violate the wash-sale rule. The number of buys and sells was impressive. The results weren’t.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.

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