Jonathan Clements's Blog, page 203

Learning by Erring

IMAGINE AN AGE long ago, before the internet. Not only that, it was so long ago that it was before most Americans cared about the stock market. Unimaginable? Well, it isn��t to me.

When I came of age in 1987, the stock market was a fantasyland. It was a place inhabited by your dentist, a friend��s father who was a lawyer, or that banker your dad knew from the Knights of Columbus. People like my parents, a janitor and a secretary, lived in a different world of passbook savings accounts, certificates of deposit and��if they were lucky��pensions. It was so long ago that if, for some bizarre reason, you wanted to know the price of an individual stock, you had to look it up in the newspaper��s business section��one that was printed on paper.

Most people��s knowledge of the stock market was limited to hearing that ��the Dow closed up 12 points in light trading�� on the 11 o��clock news. The market was such a non-story that when, on Oct. 19, 1987, the S&P 500 dropped 20.5% in the largest one-day percentage decline in its history, it passed me by nearly unnoticed. The only vague recollection I have is a fellow student asking if I��d ��heard what was happening with the stock market.�� I hadn��t and went back to studying or, more likely, watching General Hospital.

All that changed in the spring semester of my senior year, when I took engineering economics, an elective taught by Dr. Joe McNeill, P.E. I give his name this way because I remember him walking into the classroom and writing his name on the chalkboard in exactly that way. I think the good doctor was proud of his P.E.��professional engineer��license. When my fellow students subsequently spoke about him, we always called him ��Dr. Joe McNeill, P.E.��

Dr. Joe McNeill, P.E., taught a course that consisted of three parts:

Economic fundamentals, which included terms like net present value, internal rate of return and weighted average cost of capital. He taught us how to calculate the value of today��s dollar at some future date. Like most people, I realized that time was money, but the theory was eye-opening.
Saving and budgeting, because setting aside a significant portion of your income could lead to wealth, career options and early retirement.
Stock market basics, because this was where you needed to invest your savings. By doing so, you could become rich. It all seems so commonplace now��invest and grow rich��but back then, to the son of blue-collar parents, it was a revelation.

Using a special student rate, he made us subscribe to The Wall Street Journal. In a way, the Journal��was better than the internet because, while it contained a wealth of information, it left out much of the nonsense that the internet now reports as news.

You also have to realize that the Journal had a very different look and feel than it does today. First, the news stories did not contain any photos. If you were born in this millennium, this may blow your mind. No photos? Instead, the Journal used stylized black and white drawings that it called hedcuts. Second, it was only published on days when the stock market was open, not holidays or weekends. The idea was that whatever happened didn��t really matter��until the stock market opened.

The front page had a very regimented look, with six vertical columns. Each one covered a specific topic like global news, story summaries, human interest and weekly reports. I can still recall Dr. Joe McNeill, P.E., teaching us how to read the Journal, highlighting what to read first and where to focus our time. He also mentioned that the fourth column was about human interest, adding, ��You don��t need to waste your time on this.��

I have two distinct memories of my time with Dr. Joe McNeill, P.E. One was that, as a reward for having the highest grade in the course, I received a six-month subscription to The Journal and a plaque. This was given to me with my proud parents in attendance. The second was the realization that I needed to start saving as much as possible and invest it in the stock market.

Buying past performance.��The course required that I research a specific mutual fund. The one I picked was the hottest mutual fund then in existence, Fidelity Magellan Fund, managed by the hottest mutual fund manager then in existence, Peter Lynch. At that time, Lynch was possibly the most famous investor in the world due to the outsized returns he produced at Magellan, averaging 29.2% annually over the 13 years he managed the fund.

His secret, as he explained in his bestselling investment books, was working long hours, rigorous fundamental analysis and following his wife to the store. For example, he bought shares of HanesBrands based on the recommendation of his wife, who��while food shopping��came across the company��s egg-shaped plastic containers, called L��eggs, which held women��s stockings.

She purchased a pair and raved about them to her husband, who promptly bought shares in Hanes for Magellan. It was among those investments that increased 1,000% in share price, or ��10-baggers�� as Lynch called them. He had plenty of 10-baggers��over 100��and he made successful investing seem like the easiest thing in the world.

As soon as I graduated, I started investing in Magellan and quickly learned a valuable lesson about active mutual funds, namely that ��past performance does not guarantee future results.�� In this case, Lynch retired soon after I��d invested, as the stress of trying to beat the market was becoming an issue��another drawback of active investing.

His replacements didn��t have the magic touch of their predecessor. I soon realized that, while I didn��t mind paying Lynch an outsized expense ratio for his outsized returns, I didn��t see the benefit of paying his successors the same expense ratio for their underperformance. I started to look around for other places to invest my savings.

Fool��s gold. In the mid-1990s, while living in Hawaii, I attended an investment seminar in a hotel conference room given by a man named Harry Bellefontaine. The whole affair lasted about an hour and it was quite obvious that this was not the first presentation Mr. B had given. He mentioned that he thought both the stock market and Hawaiian real estate were overvalued. Indeed, he��d sold most of his stocks and his house. Because inflation was coming, he said that gold and silver were the way forward. Not just any gold and silver, though, but collectible coins��which he sold.

It was most likely the historic allure of gold coins, along with greed, but I bit and bit hard. Among other coins, I bought 20 half-ounce uncirculated 1991 American Gold Eagles. I can still remember leaving Mr. B's offices slightly paranoid, carrying my treasure in a special case that he gave me free of charge. I immediately took the coins to my bank, where now I had the added benefit of paying $100 a year to rent a safe deposit box.

Everything went along swimmingly, with Mr. B sending me monthly statements indicating the steady Madoff-like rise in the value of my collection. Then, one day, I was watching TV and heard a teaser for the local nightly news that went something like, ��Local financial advisor scams gold investors, news at 11.�� Well, that had my attention.

When I tuned in at 11, I almost cried. There was the station��s investigative reporter saying numerous locals may have been scammed by investing in rare coins. In the background, they ran grainy undercover footage of guess who? Mr. B. It appears they couldn��t interview him, as he had fled Hawaii on a boat to parts unknown. I almost crapped my pants.

A few weeks later, I was contacted by a different coin dealer, who offered a complimentary review of my collection. He was a nice enough guy and appeared to be a straight shooter. He informed me that, while my collection was genuine, I had overpaid for each coin and, for some pieces, grossly. He tried to let me down easy. But my mood wasn��t helped when, at the conclusion of the consultation, he asked if I��d ever considered investing in U.S. Mint commemorative coins, as they were sure to increase in value.

Built to last��maybe. Soon after my Gold Eagle gambit ended, I read a fascinating book titled Built to Last by Jim Collins��and Jerry I. Porras. It was the must-read business book of the 1990s and detailed an exhaustive study proving that some companies were just plain better than others.

The idea was that these select companies were ��built to last�� because they all followed similar paradigms, such as setting ��big hairy audacious goals��called BHAGs��like Boeing betting the company on the 747. Or by creating ��cult-like cultures��like Nordstrom providing dazzling customer service. Or by promoting ��homegrown management��like Procter & Gamble, which developed such a deep bench of talent that it never went outside to hire its CEO.

I thought it obviously followed that, since these were great companies, they would be great investments, too, and make a perfect recipe for a stock portfolio. That worked fine for a few years. But it turned out my recipe also included a few unappetizing ingredients��once-great companies that soon fell on hard times. Like Citibank, a penny stock amid the Great Recession of 2008-09. And Fannie Mae, mentioned in the follow-up book titled Good to Great, which was placed in conservatorship in 2008. And GE, whose long slide ended in near-bankruptcy in 2008. And Motorola, which was deemed irrelevant by the market in the late 2000s after the introduction of smartphones.

Master investor��briefly. In 1999, I read an article written by Paul Sturm in the��much-missed��SmartMoney��magazine. It was a comprehensive review of a security I��d never heard of before called a master limited partnership (MLP).

An MLP is a publicly traded company that has the tax benefits of a private partnership. Its income is taxed but not its distributions. That meant investors like me could defer taxes owed, sometimes almost indefinitely. Due to the vagaries of the tax code, MLPs are mostly limited to oil and gas pipeline companies.

To me, they seemed like the perfect security: tax-deferred distributions, rich cash flow, inflation-protected and high-yielding. We��re talking companies like Suburban Propane, NuStar Energy, Kinder Morgan and TEPPCO Partners. I felt like Yankees�� manager Miller Huggins reviewing his lineup card for the 1927 World Series: every player a heavy-hitter and reliable. Would you say no to investing in Babe Ruth and Lou Gehrig��on a tax-deferred basis to boot?

I bought my fill of MLPs and was rewarded richly, even though the K-1 partnership forms were a pain when it came time to file my taxes. But who am I to complain? For 10 golden years, I felt like a youthful Warren Buffett, consistently outperforming the S&P 500 with less volatility.

But alas poor Yorick, no security is perfect. I came to realize in time��that every��publicly traded company will borrow to the limit of its cash flows. I won��t bore you with the details of the painful deleveraging and subsequent MLP selloff by retail investors, but it was death by a thousand cuts. Since the Great Recession of 2008-09, my MLP lineup has reliably underperformed the S&P 500. Worse, one of my beloved ��Babe Ruth�� investments was restructured, sticking me with a Ruthian-sized tax bill, plus its distributions were reduced and the share price cut in half. As Job said, ��The Lord giveth, and the Lord taketh away��and then some.

Wait, there��s more. In 2000, I bought stock in a company that used the latest technologies to revolutionize the way multiple business lines did their business. A company that only hired the smartest people to work on cutting-edge projects that would change the world. Led by an even smarter CEO who claimed that many existing businesses were dinosaurs and would soon be extinct.

Unfortunately for me, this company wasn��t named Amazon. It was called Enron. Soon after I made my investment, then-CEO Jeff Skilling resigned to ��spend more time with family.�� Within months, Enron declared bankruptcy��the largest in U.S. history until then. I hung on for a little while because, as my mother used to say, ��hope springs eternal.�� But I eventually sold to harvest some very large tax losses.

The subsequent fraud convictions of Enron��s CEO, CFO and the chairman of the board��along with the collapse of its complacent auditor, Arthur Andersen LLP��were of little consolation. Enron not only shook my faith in the decency of man, but also in the wisdom of picking individual stocks.

This mood only grew on me with the subsequent significant devaluation of other ��can��t miss�� investments that I owned. Like Thornburg Mortgage, which went bankrupt in 2009. Or Medallion Financial Corp., which was such a stinker that it changed its ticker symbol from TAXI to MFC to hide. And International Business Machine��but at least I wasn��t alone in that gradual meltdown.

All the lemons that I��d chosen made me start to doubt my stock-picking ability and realize that maybe it was impossible to beat the market. The outperformance of my MLPs early on had made me believe that I possessed superior analytical skills. The subsequent underperformance by the same MLPs��plus all the other lemons I��d picked��disabused me of this notion.

While losing money on my clunkers was bad enough, it also filled me with an amount of anxiety and shame that wasn��t offset by my few-and-far-between winners. Because there were some in my portfolio, even if I eventually realized they might be due more to good luck than financial acumen. These included:

I purchased shares based on my wife��s orthopedic analysis, which was in turn based on the injection of a Genzyme-produced drug called Synvisc into her bad knee. Synvisc is a natural joint lubricant and cushion, synthesized from the cockscomb of a��rooster��the feathers on the top of his head. Chicken feathers, I thought. I knew that Peter Lynch would approve, so some shares were purchased. A few months later Sanofi bought out Genzyme and I received a 37% annualized return.
Monarch Cement. I purchased 100 shares at $28.50 based on a reverse stock split arbitrage opportunity offered to owners of record. The stratagem had the company buying back stock at $30 a share for a quick $1.50 gain. But it turned out that, due to a grammatical issue, I was not an ��owner of record,�� so the company didn��t buy back my shares. It all worked out in my favor, though, as my unsold shares subsequently tripled in value, leading to an annualized return of more than 20%.
In 2009, my mother gave me some money for Christmas. I used it to buy stock. I decided to invest it in a company she would be able to understand, so I picked the food distributor Sysco. I thought it could be a way we could share my interest in the stock market. I wrote her a ��thank you�� note, including specifics about the company, and mentioned I would update her now and then on its performance.

She may not have completely understood what I said, as she subsequently informed me that she ��didn��t need any stock tips.�� Since purchasing it in early 2010, Sysco has easily outperformed the S&P 500. Unfortunately, my mother had only given me $25.

The road to indexing. Over time, I started to lose interest in doing the deep research that was required to invest in individual stocks. I found I would rather spend my time working out, reading about World War II and traveling. Since it was obvious that I previously hadn��t spent enough time researching, common sense told me that reduced research would not lead to better results.

All this led me, slowly but surely, to shift my investments from hand-picked stocks to low-cost index funds like the Schwab Total Stock Market Index Fund, iShares Select Dividend ETF and Fidelity 500 Index Fund. These were added to a portfolio that already contained a fair amount of low-cost index funds as, thankfully, my 401(k) didn��t give me any other options. While low-cost index funds weren��t as sexy as Amazon or Apple, they were easier on my blood pressure and, more important, my ego.

When I retired a few years ago, I looked back at how I did. What kind of grade, I wondered, would Dr. Joe McNeill, P.E., give me? I think he��d be proud of my ability to save. As I tell fellow investors, the size of my portfolio is proportional to the size of my frugality.

He��d probably be disappointed, though, in many of the clunkers I��d invested in. How could I explain away Enron? He might, however, be proud that I��d learned from my mistakes and subsequently invested enough in low-cost index funds to allow for my early retirement.

Dr. Joe McNeill, P.E., was a tough grader. Still, I think he��d give me a ��B.�� But maybe not a plaque.

Michael Flack blogs at��AfterActionReport.info. He��s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.

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Published on July 01, 2022 22:00

Change Is Coming

WHETHER FOR GOOD luck or because I��m thrifty, I still stoop down to pick up pennies. But there might not be any in the future.

Thanks to their copper content, pennies now cost twice as much to produce as they��re worth��and skyrocketing inflation is only exacerbating the problem. There are even rumors that the government will stop producing pennies, but so far the U.S. Mint has made no such announcement.

Instead of using my debit card for groceries, gas and so on, I��ll occasionally do an all-cash budget for a week. Spending seems less abstract when you��re pulling dollars from your wallet and coins from your pocket. For example, if I'm paying cash, I��ll pause before buying that extra snack from Trader Joe��s.

My millennial children can identify a penny, but I don't think they pay for much of anything with cash. My son, who favors his American Express card, touts the credit card rewards he gets for his purchases. Debit cards are my usual method. They��re a vast improvement on checks. I write just one check a month, to my condo��s homeowners�� association.

According to a 2021 analysis, debit cards are used for 67% of card payments. Four out of five consumers prefer to use debit or credit cards for purchases. Only 10% use cash for all their spending, but 88% of consumers use cash at least sometimes. That��s not surprising: Some places won��t allow card use for very small purchases.

At some point, coins and paper currency are likely to become unneeded and irrelevant, and pennies might be the first to go. But without pennies, future generations will never understand expressions such as ��penny wise and pound foolish�� or ��a penny for your thoughts.�� Will they forget one of our greatest presidents if they don��t see his profile on a shiny coin? He��ll still be on the $5 bill, of course. But how long will paper currency be around?

Seeing Lincoln, Washington or Hamilton on our currency is a subtle reminder of how much we revere these leaders and how important they were in making our country great. The symbolism reaches much further into our society than a monument some will never see. It��s sad to think that eventually we��ll have just sterile transactions with plastic cards or with our cellphones.

I can��t say I think about Lincoln every time I pick up a penny or get change, but I am reminded of the respect we have for him and others when I use actual money. Shifting to a cashless society may be inevitable, but I won��t stop picking up those lost and neglected copper coins. Who knows, maybe they do bring good luck?

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Published on July 01, 2022 21:22

Home Rich Cash Poor

ACCORDING TO MY local newspaper, the average home price in my town rose 450% over the past 25 years. That made me ponder how I could use my home equity to fund my desired retirement lifestyle. I��m certainly not alone in thinking this way.

There are three ways you can access home equity. You can sell your home and downsize, you can take out a home equity line of credit or you can take out a reverse mortgage.

The first option isn��t attractive to many retirees. These folks want to maintain their current lifestyle, and remaining in their home can be a big part of that. The stories of COVID-19 outbreaks in nursing and retirement homes only reinforce the desire to stay put. Meanwhile, with a home equity line of credit, you��ll be compelled to make repayments during your lifetime.

What about the third option? I find reverse mortgages quite attractive. They allow you to unlock the equity you��ve accumulated in your home while still living there. That sounds great. Why be house rich and cash poor when you don��t have to be? Yes, reverse mortgages come with steep upfront and ongoing costs. Still, they can play an important role in a retirement income strategy, offering the following features:

They give you the choice to receive your home equity as a lump sum, as annuity payments or as a line of credit.
There are usually no repayments required until the home is sold��typically after your death.
They��re nonrecourse loans. That means that neither you nor your estate will ever owe more than the property��s market value, even if the sum borrowed plus accrued interest is greater.

There are other reasons I like reverse mortgages. For example, they can significantly increase your liquidity in retirement. You can use the extra cash they provide to fund your adventures, make large purchases, give money to family or make home improvements. All the while, you retain possession of a valuable, appreciating asset.

A reverse mortgage can also help you manage sequence-of-return risk by serving as a source of funds during market corrections. When the market drops, you can live off your reverse mortgage instead of selling investments.

In addition, a reverse mortgage can provide income that allows you to defer Social Security retirement benefits. Those benefits increase by roughly 8% for each year you delay claiming. This increased payout continues for life and rises every year with inflation.

With so many benefits, I��m surprised more folks don��t take advantage of reverse mortgages. I believe it��s because there��s an unfortunate stigma attached to them. Many people view a reverse mortgage as the option of last resort for impoverished retirees.

I would argue otherwise. There��s nothing wrong with spending your home��s equity to support your retirement lifestyle. Why choose to live on a tight budget when you have untapped wealth at your disposal?

Consider two couples. The first buys a home and then gradually pays off their mortgage, while the second couple rents an apartment and invests in a stock portfolio. After 30 years, the first couple owns a $1 million home outright, but has little in the way of retirement savings. Instead, the couple��s wealth is tied up in their home, and they lack the cash flow to support their desired lifestyle.

Meanwhile, the second couple has amassed a $1 million investment portfolio.��In all likelihood, the second couple would feel more comfortable drawing down their portfolio than the first couple would be taking out a reverse mortgage. I worry that the stigma of a reverse mortgage would force the first couple to struggle financially for no good reason. The first couple made a smart decision by buying a home. They should feel free to make another smart move��tapping their home��s equity to support their lifestyle.

I believe another reason people don��t use reverse mortgages is they worry about robbing their children of an inheritance. Some parents feel shame at not bequeathing a substantial sum. I��m not one of them. My wife and I worked hard to give our kids a good start in life. Now that they��re well-established, I don��t believe they need a further financial boost from us. Leaving them a sizable estate is the least of my concerns.

If the goal is to live your best life in retirement, you should be willing to use all the tools at your disposal. The reverse mortgage can be an effective tool, and more people should feel comfortable using it.

Of course, taking out a reverse mortgage is a major decision. Also, the money that you unlock still needs to be managed wisely. If you burn through it too quickly, you could find yourself in a tight budget situation all over again.

Want to learn more about reverse mortgages? I highly recommend the book Reverse Mortgages by Wade Pfau.

Mike Drak is a 38-year veteran of the financial services industry. He��s the author of Retirement Heaven or Hell , published in 2021, as well as an earlier book, 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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Published on July 01, 2022 00:00

June’s Hits

NOT SURPRISINGLY, many of last month's most popular articles and blog posts were devoted to the financial markets. Here were June's six best-read articles:

Donnie Mattox has had a perfect credit score in eight of the past 12 months. He explains how he does it.
Why is managing money so maddening? Because what seems true often isn't. John Goodell lists his top 12 financial paradoxes.
"You might want to check your mailbox," writes��Jim Kerr.��"Mr. Market has been sending around a book of discount coupons on some great index funds and individual stocks."
"I still believe emerging markets are an important element for investors�� portfolios," says Adam Grossman. "But I no longer recommend the standard capitalization-weighted index approach."
Don't own cryptocurrencies? There are still six useful lessons to be learned from the collapse of the crypto market, says Adam Grossman.
"The price of admission to this stock game is emotional pain and suffering," writes Tanvir Alam. "We need to stay in the game. Always. If we cannot, we will lose our money quickly and often."

Meanwhile, among the site's blog posts, the most popular were my pieces on check washing, financial slimming, why I'm optimistic��about stocks and income allocation, along with Mike Zaccardi on profiting from the bear market, Dick Quinn on feeling his age, Dennis Friedman on his��medication and John Lim on second-level thinking.

What about our twice-weekly newsletters? The three most popular were my article titled Like Edith Sang, Jim Wasserman's Course Correction and Matt Trogdon's Learning to Get By.

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Published on June 30, 2022 23:20

Contain Yourself

MANY YEARS AGO, I read an article that posited that U.S. income inequality is due, in part, to the unwillingness of unemployed and underemployed Americans to move to a new state or city to take a better job.

It mentioned three reasons for this reluctance. First, folks didn��t want to sell their home, which may have decreased in value due to the recession that caused the bad job market in the first place. Second, the other spouse might have a job that, even if it didn��t pay well, still provided some income. Third, people didn��t want to lose their connections to family, friends, schools and church.

While the above three reasons are the main ones, I think many people also don��t want to move for two other reasons: the anxiety and cost of moving. As an adult, I��ve moved numerous times. The initial two moves occurred while I was in the Navy. I knew going in that I��d be moving often, so that may have softened the impact. Probably more important, the Navy provided a free, white-glove moving service, plus my possessions were few and of little value.

Things were different in 2017, when my wife and I decided to sell our home, put our stuff in storage and travel the world. I knew that packing up would be stressful and costly. I therefore used a technique I��d learned as a nuclear submarine officer: I delegated the responsibility to my wife.

I told her that she had ��extraordinary and plenipotentiary power to negotiate and execute this move.�� I based this authorization on a scene from The West Wing and felt it was quite witty. I guess my wife��s not a fan, as she immediately recognized it for the screw job that it was.

Still, with the boldness of President Bartlet, she called a few full-service moving companies and just as quickly received egregious quotes for moving what was essentially a very nice Noguchi knockoff coffee table and a slew of boxes filled with pure gold, otherwise known as our personal possessions. To spare me a fit of apoplexy, she didn��t share the quotes, but instead looked at other options. The best was PODS, short for Portable on Demand Storage.

PODS is the company that owns the eponymous and ubiquitous containers that sit on streets, driveways and the back of flatbed trucks throughout the U.S., Canada and Australia. A flatbed truck with a hydraulic lift system lands an empty storage container uncomfortably close to your residence. You then pack it with your stuff and, a few days later, it��s hauled away.

In our case, a 12-foot by eight-foot by eight-foot PODS container was landed inches away from our townhome. Delivery and pickup were free. Over the next three days, we packed it with all our worldly goods, locked it with our own sturdy podlock, and then it was hauled away to be stored in a nearby secure climate-controlled storage facility. The hardest part��and, by that, I mean blood, sweat and tears hard��was packing our stuff in the container.

Two years earlier, my wife had made friends with the subcontractor who had collected the empty boxes after our prior move. She had chatted with him over a couple of the most economical Bud Lights she ever bought. She subsequently subcontracted with him for $500 in cash to help us pack up our gold and stash it in our PODS container. We also paid him in items that we couldn��t fit in the container, which included a very nice Costco-pedic mattress. Without Stanley��s assistance, I��m not sure the PODS option would have worked out so well.

During the ensuing four years, whenever I saw the monthly storage charge of $194.84, which surprisingly never increased, I always wondered how our stuff was doing, if it really was in a secure climate-controlled storage facility and, more important, if it was undamaged.

Well, four years later, we finally stopped traveling and, for $2.46 per mile, had our PODS container shipped to our new home, with an additional $139 required to have the container placed on the street in front of our new home. We emptied it ourselves and the container was removed three days later. After unpacking all the boxes, we were thankful that the only damage was one cracked wine glass. We were also confused as to why we��d put so much crap into storage in the first place.

PODS isn��t necessarily the option for everyone, as the emotional and physical cost may not be offset by the financial savings. My wife and I were both in good shape and retired at the time, so body aches and time were not an issue. Now that we��re a few years older and slightly wiser, it might not be an option next time.

Michael Flack blogs at��AfterActionReport.info. He��s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.

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Published on June 30, 2022 00:00

Fashion Statement

I'VE PREVIOUSLY written about the dramatic turn my life took when I went from carefree bachelor to husband and proud father of four. With multiple college educations looming, I drastically curtailed my spending, including on my professional wardrobe.

Initially, instead of the Hickey Freeman suits in which I��d previously indulged, I was happy with the latest sale at Jos. A. Bank. But eventually, I dipped my toe in uncharted waters��buying clothes on eBay.

This comes with risks. It��s difficult to judge how something fits until you try it on. A safer option is a men��s consignment store where you can try before you buy. But while women��s consignment stores are plentiful, men��s tend to be scarce and, when you do find one, the selection can be limited. By contrast, the selection on eBay is vast, and there are ways to mitigate the risk.

First, many eBay clothes sellers offer returns, with the buyer only paying for shipping. Better still, some sellers pick up the shipping costs on returns.

In addition, reputable eBay clothes sellers will offer not only extensive photos of their wares from every angle, but also the exact measurements. What if you��re buying a suit? That��ll require alterations, but so will a retail suit off the rack. Either way, you��ll be paying for tailoring.

There are other ways to mitigate the risk. If there��s a particular brand and model of shoe that you��ve previously owned, you know that��if you find the same one in your size��you��ll probably be fine. I like boat shoes. One of the high-quality brands is Sperry. When my current pair is wearing out, I know that if I can find the same or similar model in an 8��, I��m likely going to have a great fit. I��ve had similar experiences with pricey Alden and Johnston & Murphy dress shoes.

With eBay, it��s easy to keep tabs on specific items. The ��saved searches�� function will email you any time an item fitting the description you entered is newly listed.

The great joy of shopping for clothes on eBay is the incredible prices. Because folks are hesitant to buy clothes online, sellers discount even the finest brands substantially and often drastically. In addition, many eBay clothes sellers include the ��make an offer�� option. Even if they don��t, you can send them a message with an offer. When it comes to clothes, even lowball bids are often accepted.

I��ve gotten quite a few memorable bargains, including a couple of top-quality business suits in mint condition for a fraction of the retail price. And those Sperry boat shoes I mentioned? They��re currently retailing for up to $90. But I recently picked up a brand new pair on eBay for $15, including taxes and shipping.

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Published on June 29, 2022 22:55

Self-Inflicted

I��M NOT IN THE HABIT of celebrating half-birthdays, but my next one has me thinking. In a few days, I'll turn age 59��.

That, of course, is the age at which you can tap your retirement accounts without paying the 10% early withdrawal penalty. Though I don��t currently need to pull spending money from my retirement accounts, I like the feeling that I can now do so penalty-free.

Even without that 10% penalty, however, there��s still the small issue of income taxes. The good news: More than a fifth of my investment portfolio is in tax-free Roth accounts, with another tenth in a regular taxable account. The bad news: The other two-thirds are in a traditional IRA. Every dollar coming out of that traditional IRA will be dunned at ordinary income-tax rates.

That prompted me to do a quick, back-of-the-envelope calculation. If I put off all traditional IRA withdrawals until they��re required at age 72, and I assume modest investment gains, and I add in Social Security benefits and other income, I��ll likely find myself near the top of the 24% federal income-tax bracket when I'm in my 70s. A reliable estimate? Given all the variables involved, I consider it more of a rough guess.

Indeed, based on current tax law, there��s a possibility I could end up paying a 32% marginal rate��and there��s a decent chance tax laws will be different a dozen years from now, especially with parts of 2017��s tax law scheduled to sunset at year-end 2025. On top of that, I��ll most likely have to pay higher premiums for Medicare Part B and Part D, thanks to so-called IRMAA surcharges. For me, those surcharges could amount to an extra tax equal to 2% or 3% of income.

Meanwhile, this year, it looks like I��ll land in the lower part of the 24% marginal federal tax bracket. The upshot: I figure there��s some incentive to shrink my traditional IRA over the next few years, so there��s less risk I��ll end up paying higher taxes��and heftier Medicare premiums��later on. To be sure, by opting to draw down my traditional IRA before I'm compelled to, I��ll be inflicting large tax bills on myself. That's hardly a pleasant prospect.

Still, it strikes me as the rational thing to do. To that end, now that I��m turning age 59��, I could start pulling money penalty-free from my traditional IRA, and continue to do so throughout my 60s.��But given that I don��t need the spending money right now, it makes more sense to convert chunks of my traditional IRA to a Roth each year, where the money will then grow tax-free. Keep in mind that you don't have to be age��59�� to do a Roth conversion. Indeed, I've done a few over the years, including a big one in 2010, when I converted my��nondeductible IRA.

With the Roth conversions I'm currently planning, my goal is to make the most of the 24% income-tax bracket, but try mightily to avoid generating so much extra income that some of it gets dunned at 32%.��The incentive to shrink my traditional IRA is especially great this year and in the three years that follow.

Why? There are two reasons. First, in 2026, I turn age 63, meaning I��ll be two years from claiming Medicare. At that point, any extra income I generate has the potential to boost my Medicare premiums, because the IRMAA surcharges are based on your tax return from two years earlier. Second, in 2026, parts of today��s tax law sunset and, at that juncture, it may take far less income to land in a high tax bracket.

My plan: I��ll convert $60,000 now. Later in the year, when I have a better handle on my 2022 income and how close I am to the top of the 24% tax bracket, I might convert another $10,000 or so. Why not just wait until late 2022 and do a big conversion then? I don��t know whether the stock market will be depressed later in the year��but I know it��s depressed right now. I like the idea that the $60,000 I convert might bounce back with the broad stock market, and that those gains would be tax-free.

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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Published on June 28, 2022 22:00

Back on Target

AS A COLLEGE professor, there are a few times during the year when things quiet down. During these lulls, I take on tasks that have moved to the bottom of the to-do list. The items include things like doctor��s appointments, home repairs and portfolio rebalancing. I can hear my students�� reaction: ��But professor, you teach us about investing in companies and you write about investing. Why do you drop your portfolio review to the bottom of the list?�� Valid question.

I find reviewing our portfolio to be tedious. Also, the ultimate output of the process��shift some percent of our portfolio from investment A to investment B��doesn��t get my juices flowing. I��d rather read company financial statements and debate valuations. But I know that regular rebalancing is necessary, so I do it a few times a year. Here��s the process I follow.

We have almost all our money at a single brokerage firm, Schwab, but it��s still a manual process to summarize our positions across our nine accounts. This may sound like too many accounts, but all of them have a specific purpose. Beyond our standard brokerage account, my wife and I both have rollover and Roth IRA accounts. We also have custodial and 529 accounts for our two children. I haven��t found a way on Schwab.com to generate a report on our combined accounts, given the different Social Security numbers involved. Instead, I lean on my Excel skills to summarize the data.

To our Schwab data, I add the positions from our employer-sponsored defined contribution plans. Once I��ve got all the information downloaded, I categorize each investment as U.S. stocks, international stocks, bonds and cash. Once I do this, I use a ��SUMIF�� formula in Excel to determine the market value for each category.

The final step is to calculate our total investment portfolio��s percentage allocation to each category and compare those allocations to our targets. Based on our investing experience and age, we use the following targets: 55% to 60% U.S. stocks, 20% to 25% international stocks, 15% to 20% bonds and less than 5% cash.

How are things looking? Our allocations to international stocks and bonds were spot on. The main issue was that, at 9%, we had too much cash, and we were low on our allocation to U.S. stocks.

To rectify the situation, we shifted about half the extra cash to a few U.S. stock index funds. To get the rest of the cash invested, I increased our semi-monthly automatic U.S. stock investments. Thanks to that increase, our remaining excess cash will be invested by the end of the summer.

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Published on June 28, 2022 21:19

Options in Disguise

DO YOU INVEST in options? Think twice before saying that you��d rather go to Vegas. My bold claim: Options investing has a lot in common with investing in stocks and corporate bonds.

Intrigued? Let��s recap a European style call option. It��s a discretionary contract that allows someone to buy an underlying asset at a set strike price at a future date. Let��s say the buyer of the call, Bob, has an option on a stock with a strike price of $100. Bob will only exercise the contract if it��s profitable. If the stock price rises to $150 by the time the option expires, Bob can acquire the shares for $100 and immediately sell them for a $50 profit.

On the other hand, if the stock price drops to $80, Bob has no obligation to exercise the option. His call option will simply expire worthless. Bob��s only chance at profit comes if the underlying asset clears the strike price.

That brings us to the option seller, Shelly. She owns the underlying stock and is participating in a covered call, meaning she��s selling a call option on an asset she already owns. In return, Shelly receives a call premium from Bob. Selling covered calls is a popular strategy for generating extra income.

In exchange for the income she receives from selling the covered call, Shelly risks having to sell the stock at the strike price. If the shares rise to $150, Shelly must still sell for $100. The covered call limits her payoff. If the asset doesn��t exceed the strike price, Shelly keeps her shares and pockets the income. What if the stock falls? Shelly still has her option premium, but that may be more than offset by the share price decline.

Now, let��s consider the positions of stock and bond investors in a hypothetical company called Contoso. You��ll see that their interests and chances for profit are quite similar to those of Bob and Shelly.

Contoso has just two investors: conservative Connie and risky Ricky. Contoso borrowed money from Connie, issuing her a bond with a $100 face value and a maturity date 10 years in the future. Similar to the premium income earned by Shelly, Connie will receive income while she holds the bond.

On top of the $100 from Connie, Contoso raised $100 in additional capital by issuing stock to Ricky, so the company now has total assets of $200. Ricky hopes that the company��s shareholder equity��which is the value of its initial $200 in assets minus its $100 in liabilities, as represented by Connie��s bond��will rise over time.

Fast forward 10 years to when Contoso��s $100 bond matures. The outcomes for Connie and Ricky hinge on how successful Contoso was in increasing its assets. If the company did well and its assets grew to $250, it can return $100 to Connie, leaving it debt-free, and its shareholder equity will have increased to $150. Result: Ricky��s stock would be worth $50 more than his purchase price.

Conversely, if Contoso struggled so badly that its asset base shrank below the value of its liabilities, the company might have to default on its debt. Its assets would be liquidated and Connie would keep the proceeds of the liquidation. If the assets are valued at $80, that��s what Connie would receive. Ricky, as a stockholder, would get nothing. There would be no shareholder equity left after the assets were sold off.

The financial position of Ricky and Connie resemble those of our options investors, with the face value of Contoso��s debt acting as the strike price. The value of Bob��s call option depends on the value of an underlying asset. Ditto for Ricky��s stock investment in Contoso. If certain hurdles aren��t cleared, both investors could come away with nothing.

Similarly, Shelly��s covered call position mirrors Connie��s experience as a bondholder. Both investors receive income and have limited upside. But their ultimate outcome also hinges on what happens to the value of an underlying asset.

Sanjib Saha is a software engineer by profession, but he's now transitioning to early retirement. Self-taught in investments, he passed the Series 65 licensing exam as a non-industry candidate. Sanjib is��passionate about raising financial literacy and��enjoys helping others with their finances. Check out his earlier articles.

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Published on June 28, 2022 00:00

Options In Disguise