Jonathan Clements's Blog, page 157

Riding the Rails

"HOW MUCH CAN I withdraw from my portfolio each year?" It’s one of the most common questions that retirees ask.

In the past, I’ve talked about the 4% rule, a popular tool for addressing this question. Among the reasons it’s so popular is its simplicity: In the first year of retirement, a retiree withdraws 4% of his or her portfolio, and then that amount increases each year with inflation. If you have a $1 million portfolio, for example, you can withdraw $40,000 in the first year. It couldn’t be easier.

There is, however, a fair amount of debate about the rule. Some contend that 4% is overly generous, while others argue that it’s unnecessarily stingy. And many question the assumptions used in the original research.

Perhaps the most fundamental criticism is that the 4% rule defies human nature. Suppose you had retired in 2009, in the middle of a recession, when the stock market was depressed. If you’d set your initial withdrawal based on the value of your portfolio at that time, it would have been an artificially low number, even though that’s what the 4% rule would have dictated.

Indeed, in the 14 years since, the stock market, as measured by the S&P 500, has risen from a low of 666 to above 4,000. As a result, many retirees’ portfolios have grown substantially over the past decade. But if you’d been following the 4% rule, your withdrawals would have grown much more slowly—because withdrawals under this rule are permitted to increase only at the rate of inflation and, with the exception of the past few years, inflation has averaged some 2%.

Because of that, many view the 4% rule as more theoretical than useful. That’s why an alternative spending methodology has been gaining in popularity. It’s commonly known as the “guardrails” method.

In simple terms, guardrails are designed to be more responsive to market returns than the 4% rule, which pays no attention to market movements. Using guardrails, retirees can withdraw more from their portfolio in years when the market is strong. But in exchange for that, retirees must accept a spending cut in years when the market is particularly weak.

Because guardrails-driven spending rates are responsive to market conditions, this approach has intuitive appeal. Guardrails-based spending also typically allows for a higher initial withdrawal rate than the 4% rule.

In their research, guardrails creators Jonathan Guyton and William Klinger concluded that much higher withdrawal rates—between 5.2% and 5.6%—would be sustainable over a 40-year retirement. Instead of $40,000, or 4%, on a $1 million portfolio, guardrails would allow for between $52,000 and $56,000. This aspect of guardrails also has intuitive appeal. If retirees are willing to accept a pay cut when the market is down, they should be allowed to start out at a somewhat higher rate.

At first glance, it might seem impractical to ask retirees to cut their spending during market downturns. But proponents make two points. First, these pay cuts aren’t significant. In the standard guardrails formula, withdrawals are cut by just 10% during market downturns. Second, those who use guardrails know how the strategy works—and they know which discretionary expenses they’d trim if it’s necessary.

Another appeal of guardrails: They offer a sort of built-in early warning system. In years when the market is weak, retirees can see how close they’re getting to a potential pay cut. Assuming a $1 million starting portfolio, the lower guardrail, which would necessitate a spending cut, might be set at $800,000. If that were the case, an investor could keep his eye on the market and begin preparing for a cut if he saw his portfolio drop below, say, $900,000.

Despite these benefits, guardrails have their downsides. For starters, unlike the 4% rule, the guardrails approach is complicated. If the 4% rule is like riding a bicycle, guardrails are like a 747. To determine each year’s withdrawal rate, investors must work through a five-part framework, which includes these rules: the portfolio management rule, the inflation rule, the withdrawal rule, the capital preservation rule and the prosperity rule.

To get a sense of the complexity of guardrails, you can try this online calculator. Just set the strategy to “Guyton-Klinger.” As you’ll see, even though the calculator does the hard part, there are still about a dozen inputs.

Another downside: Retirees have to contend with much more unpredictable spending from year to year. As I noted above, guardrails will generally only require a 10% pay cut in years when the market is down. But if the market declines for multiple years in a row, as it did in 2000, 2001 and 2002, guardrails would require multiple pay cuts in a row. It’s for this reason that one critic calls guardrails a “scam” and a “horror show.”

A final criticism—one that applies to both the 4% rule and guardrails—is that they ignore an important reality: Spending isn’t linear. Research has found that most retirees’ spending follows a common pattern, with spending higher during the initial post-retirement years but generally lower later in life, as travel and other activities become harder. That’s one reason it doesn’t make sense to simply extrapolate spending from the first year of retirement. Also, retirees might have one-time expenses—a home in Florida, an RV or maybe a gift to their children—that don’t fit neatly into either of these simple spending formulas.

Where does that leave retirees? If neither the 4% rule nor the guardrails approach provides a complete solution—and the alternative, Monte Carlo analysis, is even worse—how should retirees decide on a spending rate? I have three suggestions.

First, try to build a multi-year model that incorporates both regular spending and the one-time expenses referenced above. You could do this in a spreadsheet, though I recommend financial planning software because it does a better job of estimating taxes.

Second, after building an initial model, explore variations. For example, if it looks feasible to spend $70,000 per year and to buy a $400,000 vacation home, see what it would look like if your spending were instead $100,000 or the home more expensive. This would allow you to see what general range of spending is advisable over time, making it easier to vary it from year to year within that range.

My third suggestion: Don’t accept any of these spending strategies as gospel—but don’t entirely reject them, either. William Sharpe, a recipient of the Nobel Prize in economics, has described the retirement spending puzzle as “the nastiest, hardest problem in finance.” It’s not easy, so it’s wise to attack the problem with as many tools as you can.

Each strategy has some merit. The 4% rule is a great shorthand tool because you can often do the math in your head. Guardrails, on the other hand, may be more complex, but the way it responds to changes in the market makes it more realistic. Many school endowments, it’s worth noting, use a hybrid approach: They withdraw a fixed percentage of their endowments, but that fixed percentage is often set in relation to a three-year moving average of the endowment’s value.

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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What I Don’t Own

WE BUY ALL KINDS of investments and financial products. But what is it that you haven’t bought, do you have a good reason for not buying—or is there a gaping hole in your finances?

Below are some of the investments and financial products I’ve chosen not to own. The list, of course, isn’t comprehensive—and I didn’t bother to touch on financial products that are beyond the pale. Equity-indexed annuities, anyone? How about leveraged exchange-traded funds? Yeah, I didn’t think so.

Savings bonds. I’ve never bought a savings bond—though I once won a $75 EE bond, since cashed in, for finishing second in a local 5K. Series I bonds have enjoyed a heap of buzz over the past year or so. But I haven’t joined the buying stampede. Simply matching inflation or earning slightly more doesn’t strike me as terribly compelling, especially given the restrictions on buying and selling savings bonds, as well as the need to set up a TreasuryDirect account.

Longer-term bonds. When I covered mutual funds for Forbes magazine, I remember a Neuberger Berman bond manager telling me that, with five-year bonds, you get most of the yield of longer-term bonds with a fraction of the risk. That insight has always stayed with me, and it’s one reason I keep almost all my bond-market money in short-term government bond funds.

High-yield “junk” bonds. At various times, I’ve owned junk-bond funds, but I’ve come to view them as an unhappy compromise between stocks and bonds. When junk bonds are on sale—meaning they offer a hefty yield premium over Treasury bonds—stocks are typically also in the tank, and the latter should deliver much better performance when there are glimmers of economic improvement and markets come roaring back.

Municipal bonds. A dozen years ago, I owned a muni fund, which I sold to buy an apartment. I never repurchased the fund. Why not? Instead of owning munis in a taxable account, it strikes me as smarter to buy higher-yielding taxable bonds in my IRA, while using my taxable account to own stock-index funds. What if I suddenly need cash and it’s a bad time to sell stocks? It’s easy enough to sidestep that problem, as you can learn here.

Foreign bonds. I’ve never liked the idea of owning foreign bonds because you introduce currency fluctuations into the conservative part of a portfolio. What if the bonds are currency hedged? The folks at Vanguard Group believe hedged foreign bonds add portfolio diversification and, indeed, such bonds make up a small but significant part of the firm’s target-date funds. I’m not inclined to argue with Vanguard. Still, in the name of simplicity, I don’t own an international bond fund—hedged or unhedged—and I’m not sure I’m missing much.

Individual stocks. Over my lifetime, I’ve owned a dozen individual stocks, but only two in the past two decades—both were shares of my employer—and I haven’t owned any individual stocks since 2014. Those dozen stocks were enough to teach me I have no ability to pick market winners. That’s why all my stock-market money is in index funds. Indeed, I think my only investment superpower—other than a willingness to buy fearlessly when the stock market plunges—is my enduring humility about my own investment abilities.

Immediate fixed annuities. I intend to delay claiming Social Security until age 70, so I get the largest possible monthly check. But I’d like some additional guaranteed lifetime income on top of that, which is why I plan to sink some money into immediate fixed annuities. But I don’t need that income right now—I still earn enough to cover my living expenses—so I’ve held off buying. That means I should get more income when I do finally pull the trigger.

Deferred income annuities. Also known as longevity insurance, I think deferred income annuities are an intriguing idea. The notion: You pony up money at, say, age 65 to lock in a stream of income that starts at perhaps age 85. This can be a relatively low-cost way to hedge against the risk of a surprisingly long life. Still, I prefer the idea of getting income from the get-go, which would then allow me to keep less money in bonds and more in stocks, and that’s why I favor immediate-fixed annuities.

Gold. I think gold stocks have the potential to be a good diversifier for the broad stock market, with the chance to earn a performance bonus by rebalancing between the two. That’s why I owned Vanguard’s precious metals fund for a few years. But Vanguard kept changing the fund’s investment objective, so I dumped the fund and no longer bother with precious metals. Among folks I admire who still like gold stocks, their favored fund is VanEck Gold Miners ETF (symbol: GDX).

Commodities. Two decades ago, there was much buzz about commodity futures, which had delivered long-run returns that rivaled stocks but whose performance was uncorrelated with either the stock or bond market. I briefly owned a commodity fund in my 401(k), but quickly concluded that past performance was a rotten guide to the future and I dumped the fund—which was just as well. The iShares S&P GSCI Commodity-Indexed Trust (GSG) sports a -5.1% average annual return since its 2006 launch.

Real estate investment trusts. I owned a U.S. and an international REIT fund for many years, but I ditched both funds in 2020. Interest rates had reached rock-bottom levels and I figured any rise in rates would hurt REITs, which many folks buy for their yield. On top of that, I was on a campaign to simplify my portfolio, and I figured my total U.S. and international stock market index funds already gave me some REIT exposure.

Rental properties. Like many folks, I’ve toyed with buying rental properties. Who doesn’t like the idea of owning an asset that seems to scream stability and permanence? But I’ve never followed through—because I didn’t want to take on extra debt, deal with the hassles of another home and face the possibility that tenants might trash the place.

Long-term-care insurance. At age 60, if I were to buy LTC insurance, now is the time. But I’m confident I have enough saved to pay LTC costs out of pocket. On top of that, I hear too many horror stories about insurers both jacking up premiums and denying claims. As I mentioned in an earlier article, I have no desire to end up in any form of senior housing, let alone a nursing home. But if my thinking changes as I grow older, I’d lean toward a continuing care retirement community, a form of risk-pooling that strikes me as preferable to LTC insurance.

Life insurance. When my youngest child was perhaps seven or eight years old, I realized I had enough socked away to cover both kids’ expenses through college graduation. That’s when I dropped my term-life insurance. What about cash-value life insurance instead? Despite the praise heaped on these policies by self-interested insurance salespeople, I see scant reason to buy a cash-value policy. If you need life-insurance coverage, you’ll likely fare far better if you buy a term policy and then stash the premium savings, relative to cash-value insurance, in a retirement account.

Disability insurance. When I left my last fulltime job nine years ago, I lost my employer-provided disability coverage and didn’t bother replacing it with an individual policy. As with dropping my life insurance and avoiding LTC coverage, it all came down to my nest egg’s size: I figured that, if I never earned another dime, I’d have enough to cover my living costs for the rest of my life.

Flood insurance. In 2021, a year after I moved to Philadelphia, the Schuylkill River overflowed its banks and flooded some nearby homes. My nonagenarian neighbor, who has lived in the area her entire life, said the river had also badly flooded in the 1970s but, on that occasion, the water also didn’t reach our street. Still, in this era of climate change and extreme weather, I’m a tad concerned—and my to-do list includes calling Travelers to find out what it would cost to add flood insurance to my homeowner’s policy.

Powers of attorney. Okay, this doesn’t really count as a financial product. But I’m embarrassed to say I haven’t drawn up either a health-care or a financial power of attorney. With this admission, I’m hoping to shame myself into action. I do have an up-to-date will, the correct beneficiary designations on all retirement accounts and a letter of last instruction. But the powers of attorney are missing. Feel free to throw rotten tomatoes.

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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Opportunity Knocks

YOU’VE SOCKED AWAY some cash, waiting for the chance to snap up a small rental property. Property prices are down. Meanwhile, interest rates are up and many folks can’t qualify for a loan, but you’ve already been preapproved. It’s time to strike.

Now comes the hard part. Much literature is available on how to buy and sell residential income units. But there’s much less written on how to manage them. What follows is a primer for first-time landlords. Keep in mind that the best approach will vary based on factors such as region, taxes and local regulations.

What’s the minimum annual return you’ll accept? Because of the high price of real estate in California, we often have to settle for a lackluster 4% to 5%. This percentage is the estimated annual net income, or rents minus expenses, divided by the property’s purchase price. You can set the bar higher in the Midwest and South.

If even a moderate single-digit return doesn’t seem worth all the time and trouble of owning real estate directly, there’s an alternative. Many funds owning real estate investment trusts trade on the stock market. For instance, you might look at the popular Vanguard Real Estate ETF (symbol: VNQ). Like private ownership of real estate, it offers not just income, but also the opportunity for capital appreciation. You’ll have no hassle and no liability, but you will have the gyrations of the stock market.

I know it seems like the easiest way to wade in, but I’d stay away from free-standing single-family homes. In our part of California, you almost surely won’t get a positive cash flow and your estimate of potential capital gains is probably a pipe dream. Instead, I’d start with a duplex. Why? A duplex produces more rent than a comparable rental home and benefits from economies of scale. For instance, its fire insurance doesn't cost twice as much.

Now, let’s consider capital appreciation. Yes, there’ll be years you’ll be up 20%. But residential real estate can be risky, as evidenced by the current environment. We’re down 15% across our 11 investment properties since the Federal Reserve began ratcheting up interest rates. Ignore the real estate industry’s propaganda. The average annual total return on a residential income investment is about 10%, very similar to the stock market, though with a slightly less bumpy ride.

Some choice words on expenses: Be real and be exhaustive. Don’t forget to factor in those one-time big hits. Like rents, costs of insurance, utilities, taxes and most incidental items trend up slowly over time. Payments on a fixed-rate mortgage, of course, don’t change.

The wild card for your cash flow is maintenance and repairs, which fluctuate widely from month to month and year to year. To insure yourself against a ruinous expense like a new roof, HVAC failure or water heater dysfunction, set aside a few hundred dollars each month. You must do that, painful as it is and despite the temptation to cheat. You’re a step ahead if you’re a hands-on type. Handyman costs can add up and those for major jobs are subject to the integrity of the repair people.

Ready to rent? Check for comps in the neighborhood, preferably on the same street. You’ll want a reference from the previous landlord and a signed lease. Size up the applicant’s character. If a prospect asks where she should send the check, you’ve learned she’s conscientious. If she demurs because the rent is high, I might negotiate. You want to avoid picky tenants and nuisance phone calls. If a person you’re showing around the unit grouses about a couple of hairline scratches on the refrigerator, you can stop the music right there.

The credit score is the landlord’s reliable speedometer. It’s a snapshot of payment history, untarnished by outside opinions and first impressions. An applicant’s score should preferably be above 670, the sign of a good payment record. Ignore the credit score at your peril. It has often saved me from my tendency as a psychologist to overinterpret.

What will your rental strategy be? Many owners want to see their rents take flight, and they’re willing to tolerate unpleasant confrontations and frequent renter changes to make that happen. I’m a longevity guy because I believe the macho approach has major drawbacks. It wreaks havoc on a landlord's lifestyle and is financially shortsighted. While my brother spends hours pressing his aggressive agenda, my rental properties are far less of a time drain.

Painting one side of a duplex after the departure of a long-term renter recently cost me $4,800, the cheapest of three bids. Even refreshing only the most offending rooms would have cost more than $1,000. Add to that outlays for a new carpet, landscape enhancement and electrical rewiring, and you’ve racked up a turnover cost of more than $10,000.

On top of that, if you chase out a responsible tenant with a stinging rent increase, you’re doomed to an unknown commodity. And don’t forget a very substantial and often overlooked debit: two months of lost rent due to all the primping and searching for a newbie. There goes another few thousand.

To offset those costs, the revolving-door owner must raise rents close to the limit imposed by local authorities. Okay, let’s start new recruit Tanya at 10% above the previous occupant’s rent, say $150, or $1,800 a year. How many years will it take to recapture the cost of prepping the unit for Tanya? Two years? Three? Maybe four. My brother calls me Mr. Softee. Frankly, I think it should be Mr. Shrewdie.

Want a readable introduction to managing residential income properties? You might pick up a copy of The Book on Managing Rental Properties by Heather and Brandon Turner.

Steve Abramowitz is a psychologist in Sacramento, California. Earlier in his career, Steve was a university professor, including serving as research director for the psychiatry department at the University of California, Davis. He also ran his own investment advisory firm. Check out Steve's earlier articles.

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Frugal or Miserly?

MANY OF THE WEALTHY people I’ve studied were extremely frugal—to the point of eccentricity. Why is it that when rich folks are tightfisted, people call them eccentric, but—if you aren’t rich—people tag you as cheap?

New Jersey Bell Telephone Co., now called Verizon, used to have small inserts with its bills that highlighted persons of note who had a connection to the state, whether they were natives or had resided there at some point, such as Thomas Edison. One of the inserts told of Henrietta “Hetty” Green, better known as “The Witch of Wall Street.”

Green was a familiar figure on Wall Street, with her all-black garb, including dress, cape, bonnet and well-worn black satchel, which was how she earned that epithet. She was America’s first female tycoon, although today not many people have heard of her. Green was a successful financial speculator, quite unusual for a woman at the turn of the 20th century. She stood alone against the titans of industry.

A woman with a brilliant mind, her fortune was made by shrewd investments in real estate, railroads and government bonds. She was the richest woman in America during the Gilded Age, but frugal to the extreme. They say she wore the same black dress until it turned green.

Green lived a life of mean miserliness, to the extent of causing permanent injury to her son because of her reluctance to spend money on his health care. She was so obsessed with money that, it is said, she spent an entire night looking for a two-cent stamp she’d misplaced.

If there’s a term for those who are beyond miserly, it might be miserly madness. Nevertheless, the story of how Green amassed great wealth is fascinating. She turned an inheritance into a fortune.

Another woman who achieved great wealth through investing was Anne Scheiber, an auditor for the IRS. She retired in 1944 at age 51. After poring over numerous income tax returns, she’d decided that the way to wealth in America was achieved by owning stocks, so she started investing.

She, too, was an inveterate miser, often going to shareholder meetings with a capacious bag. She would fill it with enough food, available at the meeting, to last her for days. Her broker said that at the time you could get a hot dog lunch for 15 cents at Nedick’s, a chain of fast-food restaurants. But thanks to shareholder meetings, Scheiber had found a cheaper place.

She accumulated a $5,000 nest egg and then turned it into a $22 million fortune, even though she never made more than $4,000 a year and, in retirement, received a yearly pension of $3,150. She lived a reclusive life in a rent-controlled apartment in Manhattan and would walk miles just to save on bus fares.

Like Green, Scheiber never bought new clothing or furniture. Everything she owned was in various stages of disrepair or decrepitude.

My purpose in touching on the lives of these two women is to point out that they never enjoyed spending their wealth. Scheiber’s only pleasure was trips to the vault at Merrill Lynch near Wall Street to visit her stock certificates. Green’s enjoyment was besting other investors with her business acumen—and the rapacious accumulation of money.

Many people get ahead in life by living beneath their means. But by the time they achieve financial stability, the frugal habits of a lifetime are hard to temper. On top of that, the point of reference we have for the price of everything is usually rooted in our younger years, making current prices seem excessive. We recoil from what we perceive to be a shocking increase, forgetting how quickly time passes.

There is a fine line between being frugal and being miserly. Scheiber and Green were certainly extreme. When we reach a certain point where “enough is enough,” loosening the purse strings just makes sense.

We all have to find that balance in our own way, and lead our lives the way we see fit. While we may not wish to spend money on ourselves—buying things we don’t really need or indulging in luxury vacations or flashy cars—generosity to those less fortunate can be a meaningful way to give purpose to our lives. Some call it giving back.

I’ve heard of people being buried in their cars. I’m sure we’ve all read similar bizarre stories. But as far as worldly possessions go, there’s no U-Haul to heaven.

Marjorie Kondrack loves music, dancing and the arts, and is a former amateur ice dancer accredited by the United States Figure Skating Association. In retirement, she worked for eight years as a tax preparer for the IRS’s VITA and TCE programs. Check out Marjorie's earlier articles.

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Lost Property

OUR COMMUNITY HAS a Facebook-like online forum called Nextdoor. I tend to ignore the posts, which usually involve things like items for sale and new restaurant openings. But a recent post caught my eye—because it was from the Montgomery County Recorder of Deeds.

The article said Pennsylvania’s Attorney General had initiated a lawsuit against a realty company for deceptive practices targeting elderly, low-income and minority homeowners. The realty company was offering a “Homeowner Benefit Program” that gives homeowners anywhere from $400 to $1,000 upfront to lock into a contract. The contract is for 40 years and is recorded as a mortgage, often unbeknownst to homeowners. When they go to sell their home, they’re sued and forced to pay a termination fee of between 3% and 6% of the property’s value because they attempted to sell their home through another broker.

I’d grown curious about such things because of an earlier mailing we’d received, which had pitched a “home title lock” service that would protect us against home title fraud. I couldn’t believe that was even a thing. Home title fraud is the transfer of ownership of your home title to a criminal, who files the proper documents with the local authority to assume legal ownership of your property. How could that happen? Apparently, the county clerk who verifies that documents are filled out correctly doesn’t verify that the property sale is accurate.

Criminals seeking to perpetrate this fraud typically focus on vacant homes, rental properties and vacation properties. Some are so brazen that they’ll even target properties with the homeowners still in them. The criminals forge documents to transfer legal ownership to themselves. They then sell the property to unassuming third parties or take out equity lines of credit against the property with no intent of paying back the money borrowed.

What recourse do homeowners have? They’ll typically have to pay huge legal fees to clear up the crime with the parties involved, which might include a title company, lender, and a buyer or seller. They’ll probably also have their credit score negatively affected. How common is this theft? Not very, but senior citizens and property owners who have had their identities stolen are most vulnerable.

Real estate fraud is a growing phenomenon. Figures from the FBI report 11,578 cases in 2021 totaling $350 million, up from 9,654 cases in 2017 at a loss of $56 million. So far, title fraud is a small portion of that.

Having read about home title fraud, I was half-tempted to sign up for HomeTitleLock.com’s service, which costs “only” $19.95 a month. The site says it has an alert system and would work with customers to resolve the matter if they’re victims. Thanks to the Nextdoor article, I found a free service offered to Montgomery County, Pa., homeowners. FraudSleuth is a free property alert tool provided by our Recorder of Deeds Office. It will send out an email alert if something is recorded against your property.

If you aren’t fortunate enough to live in a state with such a service and don’t want to pay for one, the FBI suggests the following: Be sure to open all mail from your mortgage company. Follow up on any information and periodically check information related to your property through your county deed office. Checking may be free or you might have to pay a fee. Don’t recognize something? Be sure to look into it.

Sonja Haggert is the author of Invest, Reinvest, Rest. You can learn more at SonjaHaggert.com. Follow her on Twitter @SonjaHaggert and check out her earlier articles.

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About That Fine Print

CAR LEASING WILL likely make a comeback in 2023. But is leasing a good idea?

Before the pandemic, leases represented about 30% of new car sales and as much as 70% or 80% for some luxury vehicles. But during the pandemic, with new vehicles in short supply, manufacturers reduced their generous lease subsidies. This, combined with low interest rates, reduced payment differences between financing and leasing, making leasing less attractive.

But that may be about to change. With the average new car price exceeding $48,000, according to Cox Automotive, and interest rates significantly higher than a year ago, leasing could become a more attractive option.

Why take the time to learn the math of leasing? It’s important to be a knowledgeable consumer. When a dealer quotes you a lease payment, how do you know that the price you negotiated for the car is the price on which the payment is based? Some dealers try to negotiate a lease based on the monthly payment and avoid a conversation about the purchase price.

How does leasing work? For a specific term, which is typically 36 months, consumers make a monthly payment and then, at the end of the lease, they return the vehicle to the dealership. Alternatively, at the end of the lease, they can choose to buy the car based on the contracted residual value.

The math behind a lease is fairly simple. It’s the vehicle’s projected monthly depreciation plus the monthly interest. The depreciation varies by make, model and trim. To make the depreciation calculation scalable based on a car’s price, the financing arm of car manufacturers express a vehicle’s residual value at the end of a lease as a percentage of the MSRP, or manufacturer suggested retail price. It’s frequently in the 50% range for a 36-month term.

Cars with good resale values have higher residual values. That translates to less depreciation and hence lower lease payments. Say a vehicle with a $44,000 MSRP has a 55% residual value. That works out to $24,200. If you subtract the $24,200 residual value from the $44,000 negotiated sales price, which I’m assuming is the same as the MSRP, you get $19,800 in projected depreciation. Divide the projected depreciation by the 36-month lease term, and you get $550 in monthly depreciation.

Next, we need to calculate the monthly interest charge. This starts with the capitalized cost, which is basically the amount being financed. Capitalized cost is the negotiated sale price, plus the lender’s lease acquisition fee and any dealer fees, minus the down payment. For instance, in our example, if it’s a zero-down-payment lease, the capitalized cost would be the $44,000 negotiated price, plus perhaps a $650 lease acquisition fee, plus maybe $400 in dealer fees, for a total of $45,050.

The capitalized cost is added to the residual value, and then multiplied by the money factor. The money factor is the interest rate for a lease. Using our example, you’d add the $45,050 to the $24,200, and then multiply by the 0.0025 money factor.  That results in $173.13 in monthly interest. (It might seem like you’re charged interest twice on the car’s residual value—after all, that residual value is also included in the negotiated price—but the money factor adjusts for this perceived double counting.)

If you add the monthly interest payment to the monthly depreciation, you get the lease payment, which in this case would be $550 plus $173.13, or $723.13 total. Want to convert the money factor into an interest rate? You multiply the money factor by 2,400. Thus, a money factor of 0.0025 is equal to a 6% interest rate.

For simplicity, I have left taxes out of the equation. In most states, the sales tax is calculated on the monthly payment and not on the sales price of the vehicle at the time of leasing. This tax deferral is seen as another advantage of leasing.

According to a study done by CNW Marketing, the top three reasons consumers lease are lower monthly payments, smaller down payments and the chance to drive a nicer car for the same monthly payment. Meanwhile, the top complaints about leasing are the penalties at the end of a lease for exceeding mileage allowances and for wear and tear, the fact that you don’t build any equity, and the cost to exit a lease prior to the lease’s scheduled maturity.

Meanwhile, why do car manufacturers like leases? There are three main reasons:

By subsidizing leases, car companies can boost sales volume.
Leases allow car makers to maintain a relationship with consumers, with the potential to sell them vehicles every three years. By contrast, buyers typically go longer between car purchases.
As cars come off lease, they provide a steady supply of three-year-old cars for dealer’s used car operations and create a more affordable alternative for entry-level buyers.

Is leasing a wise move? It depends on your circumstance. If you buy cars and keep them for a decade, leasing is not the right route. But if you plan on getting a new set of wheels every three years, it might be worth considering.

Darwin Beloate spent 35 years in the automotive industry. He started working at an Isuzu dealer in Marietta, Georgia, while in high school and worked for car dealers in parts, service and sales throughout college. In 1990, he graduated from Northwood University with a degree in automotive marketing and worked for Nissan North America in marketing and sales positions for 30 years. He’s been a real estate investor since 2015 and, in his spare time, enjoys track days in his 1994 Mazda Miata R type.

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February’s Hits

READERS CAST AN EYE over more HumbleDollar pages last month than they did in any prior month in the site's six-year history. Much of the credit goes to the first article listed below, which accounted for almost a fifth of February's pageviews. Here are last month's 10 most popular articles and blog posts:

"Know your strongest needs—the things that really turn you on—and then find activities that will satisfy them on a regular basis," advises Mike Drak. "That’s the key to a happy, fulfilling retirement."
The old three-legged retirement stool was built on savings, Social Security and pension income. But Dennis Friedman is focused on the new three-legged stool—which stresses the need for money, health and friends.
In the final installment of our series devoted to the favorite articles penned by HumbleDollar's most prolific writers, I offer my 10 picks.
How'd you like to amass $10 million? John Yeigh shows how a young couple could hit that magic number by age 75 simply by funding their 401(k) or 403(b).
"If you’re in a career you don’t love, consider your investments as the foundation for your next life phase," writes Craig Stephens. "You may not have saved enough to retire—but it may be enough to launch a second act."
Don't have kids. Don't have a dog. Don't get divorced. Don't own a house. Don't get sick. Don't have fun. Want to retire at 38? Jim Kerr tells readers what they shouldn't do.
Want to assess the robustness of your retirement plan? Adam Grossman offers nine strategies.
While 2019's SECURE Act was a mixed bag for taxpayers, 2022's SECURE 2.0 offers far more goodies. Adam Grossman details the most significant planning opportunities for folks of various ages and life stages.
Some folks insist the Social Security trust fund was stolen and that Social Security is a ripoff—and Dick Quinn keeps trying to squash these and other myths.
"What good is money if we don’t spend it on the wonderful things this world has to offer?" asks James Kerr. "A slavish pursuit of value can turn a pleasant walk down Easy Street into a bleak stop at the dollar store."

What about our twice weekly newsletters? The four most popular were The Poor Millionaire by Sanjib Saha, and Helpful in Theory, The Long Game and Got Change. These last three were all written by me.

The post February’s Hits appeared first on HumbleDollar.

My Superpower

NOW THAT I'M RETIRED, I have more time to reflect on the larger shape of my life—a tendency that’s lately been strengthened by the fairly common impulse to ponder what to accomplish in the new year.

The disturbing truth: An objective assessment of my life suggests I’m pretty boring. Of course, I’d long known that most other people were boring. But until recently, I hadn’t realized I was one of them.

I also didn’t realize that my capacity to enjoy what looked from the outside like a boring life is, in fact, my financial superpower. A minor superpower maybe, but it’s mine.

My boring life has been full of boring middle-class acts. I worked. I raised kids. I steadily but unspectacularly saved for my kids’ college education, saved for a vague and distant thing called retirement, saved for nearer-term costs.

Decisions to save sound like they require discipline. But in my case, they involved a few upfront choices, and then a long period where I was too lazy and boring to do anything different. I find it easier to be lazy than disciplined.

My investment decisions were also boring. I would decide how much to save and then dump most of it in diversified mutual funds. Most long-term savings were automatic and tax-advantaged. I didn’t think too much about them on a daily basis.

My theory of long-term investing is also boring. It comes in three parts.

First, everyone who has bet against the capacity of the U.S. economy to grow in the long run has lost that bet. It’s been a losing bet for 250 years. The same is true for long-term global growth. There’s only a small chance that some apocalypse will occur in my lifetime that will change that and, if something that catastrophic does happen, I don’t think my portfolio balance is going to be uppermost in my mind.

Second, long-term growth in the economy is correlated with long-term growth in publicly traded companies. I have no idea which companies will grow the most or which will fail, but a diversified mix of such companies will always get more valuable over long investment time horizons.

Third, I’m too boring to outperform the market, but it seems to me I don’t have to beat the market. In fact, the development of transparency in financial markets in my lifetime, along with easier access to those markets for small investors and innovations such as low-fee index funds, have made my lifetime a very good time to be boring. Bet on a diversified portfolio, hold on for a while and you win. It’s easier than working for a living and you don’t have to be smart or exciting.

One day, after a few decades of being boring—but sooner than I’d imagined—I realized with some surprise that I could retire if I wanted. I wish I could say that all of this was because I had a highly paid skill that earned me a substantially higher-than-average salary. But no, the most I ever earned was about $65,000 a year. My happy financial outcomes have mostly resulted from the accident of enjoying a boring life over a long period of time.

Having enough to retire isn’t just a matter of boring saving and investing; the other side of the coin is spending. Here again, being boring helps. I like to read. I like to write. I like to garden. I like to cook. I like to fish, hike and camp. Most important, I like to hang out with my family.

Anyone watching me do these things would be bored silly, but these activities bring me satisfaction and, at their core, are surprisingly inexpensive. Your list won’t be my list. But you do need to know what your list is. In your quest to be boring, consider the possibility that the purpose of money is not to buy toys, but rather to use money as a lever to make your life and that of others better.

I firmly believe that people should spend as much of their limited time as they can doing what brings them deep satisfaction. Don’t worry about what other people want. Pretend you’re a good person, and look to what you—as well as others you care about—need to lead an even better life.

No, you won’t be able to surrender to hedonism or get rid of all unpleasant tasks. The boring truth is, to do what you want, you have to spend some time doing things you don’t like. Nobody likes going to the dentist, for example, but life is better if your teeth don’t rot and fall out of your head.

To pursue the important, you need to have at least some money. For most of us, that means we have to spend a fair chunk of our life working. Figuring out how to use the money we get from work in service of the important, rather than the trivial, is a critical step. Budgeting, though boring, is vital in this process.

Most of us think budgeting mainly involves staring at unpleasant numbers that tell us we can’t have things we want. There is a bit of that. But a critical part of “doing a budget” should involve making a list of the things, people and actions we most value. Next make a list of how we actually spend not just our money, but also our time. Then see how much of our time is spent on what’s important to us.

If, like the vast majority of us, you find the two lists don’t match up very well, change your life for the boring. And for the better.

David Johnson retired in 2021 from editing hunting and fishing magazines. He spends his time reading, cooking, gardening, fishing, freelancing and hanging out with his family in Oregon. David's previous article was What Is Retirement?

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Only You Can Answer

HOW MUCH DO I NEED to save for retirement? How much will I spend in retirement? Can I live comfortably in retirement? Can I even afford to retire?

I can answer all these questions, but most likely none of my answers will be exactly right—for you. Experts tackle these questions, too, but provide inconsistent answers. Google any of them and you’ll get a range of results. Without knowing your situation, such shotgun advice is pretty meaningless.

I submit that you can’t plan your retirement based on the general assumptions and guidance that proliferate in all forms of media. The important questions—which I’ll pose in a moment—you need to answer for yourself.

How much do I need to save to retire? Fidelity Investments suggests that, by age 67, you need to have saved 10 times your annual income, but maybe only eight times if you intend to "downsize and live frugally in retirement."

Can you retire with $1 million? To some people, this would be a dream. In theory, $1 million will generate about $40,000 a year in income—or is it $38,000, or maybe just $35,000? It depends who you ask.

Most people can add Social Security to this income. If you’re earning $80,000 a year, at 67, your Social Security income as a couple could be some $38,000. If you lived on $80,000 before retirement and have $1 million saved, can you retire on $78,000 a year? Yes, no or maybe? It depends on your circumstances and expectations.

The relatively few of us who earned a pension have it easy compared with most Americans. We have a steady income stream—just like when we worked—on top of Social Security and income from savings.

In retirement planning projections, I often see the words “frugal,” “comfortable” and sometimes “getting by.” While these words are subject to interpretation, isn’t the desired goal to at least maintain the same standard of living we had throughout our lives? Who would plan for a future where they’ll just “get by”?

Here’s another puzzler I’ve heard: There’s no need to save during retirement, right? Not in my experience. Over the past few years, like most people, I’ve paid thousands in unplanned expenses—dental care, car repairs, a child in need of assistance, even a dead tree. That cash came from emergency savings, which I contribute to each month. Yes, I’m saving in retirement. Absent that saving, I would have sold investments.

Everyone needs a saving, investing and spending strategy for retirement. As part of your deliberations, try to answer these questions for yourself:

Do you really want to retire? Not everyone does.
Do you and your spouse have the same vision for retirement?
Do you want to relocate—or will it be a financial necessity?
Will you actually change your way of life in retirement? Do you want to?
Do you want to spend money beyond the necessities without worrying?
Can you live the way you desire on 70% to 80% of your preretirement income?
Are you currently saving the most you can?
Have you seriously thought about how you invest your savings?

In answering these questions, I’d caution against using general assumptions—or planning to just “get by.” Aim higher. Perhaps a quick reality check using HumbleDollar’s Two-Minute Checkup will help.

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Not Bonding

I'VE SPENT THE PAST 10 years or so without any bonds or bond funds in my portfolio. What am I missing? And why did this happen?

Investing in bonds directly was always confusing to me. There are coupon rates, bond ladders, bond ratings and so much more. In the beginning, I just found it easier to ignore all the confusion. I know that bonds, in aggregate, represent a greater investment pool than stocks, but I just kept putting it off.

Somewhere between 2010 and 2015, I finally had time to learn more, but what I learned put me off further. The facts didn’t compel me. At that time, bonds didn’t provide an attractive return, and there was little prospect of things improving. In fact, they got worse.

Aggregate bond indexes have been slightly negative for the past three calendar years, and they’ve averaged just a 1.1% average annual return over the past 10 years. That’s less than the 2.6% average inflation rate over the same period. With bonds, I’d have been investing to lose money, since I view the inflation rate as my breakeven point. And so, I kept putting off bond investing.

Meanwhile, most financial advisors continue to push a balanced portfolio, with a default setting of 60% stocks and 40% bonds. Faced with this advice, I do have fear of missing out, or FOMO, given the relative safety that bonds can provide. The stock market could collapse at any time, after all.

People consider a market correction to be a drop of 10%, and a bear market to be at least twice that—20% or more. Since my returns in the stock market have averaged more than 10% a year for the past 10 years, my bond-free portfolio would still be quite a bit ahead, even if there was another stock bear market. Your experience may differ and, as they say, past returns are no guarantee of future results.

That leaves me still wondering: What about adding some bonds?

These days, bond exchange-traded funds (ETFs) will comfortably eliminate all those educational hurdles I had with bond ladders, ratings, coupon rates and the like. And, just like stocks, total market bond index funds, which are passively managed, compare quite favorably to actively managed bond funds, especially given their lower management fees.

What’s more, it doesn’t take long to find the biggest, cheapest and broadest-based bond ETFs by using search engines and fund screeners. Here are four of the biggest bond ETFs on the market today:

Vanguard Total Bond Market ETF (symbol: BND)
iShares Core U.S. Aggregate Bond ETF (AGG)
SPDR Portfolio Aggregate Bond ETF (SPAB)
Schwab U.S. Aggregate Bond ETF (SCHZ)

If I wanted to own bonds tomorrow, I’d buy one of these. If I was in doubt, I’d probably buy the biggest—Vanguard’s bond ETF—or maybe the fourth one, which is Schwab’s offering, since Schwab is my primary broker.

They would all perform about equally well and, if it helped me sleep better at night, bonds would be worth buying. If you’ve found some other good bond funds, your recommendations are welcome in the comments section.

For now, though, I’m going to stick to stocks, with a tilt toward large, stable, dividend-paying companies. I’ll completely avoid all debt securities—not just bond funds, but also loaning money to family or trusted friends. But that’s another story.

For the moment, I’m content with my bond-free portfolio. With inflation running hot, the gap between inflation and the current yield on bonds, whether government or corporate debt, remains uncompelling. I don’t mind missing out on these safe—but negative—returns, relative to inflation.

Right now, my bond FOMO is comfortably low. Though I may not sleep well tonight, it won’t be a lack of bonds that keeps me awake.

Steve Spinella is an international Christian ministry worker. He and his wife Laura have been married for more than 40 years. For more of Steve’s writing, check out his blog . His previous article was Trial by Fire.

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