Jonathan Clements's Blog, page 221
March 29, 2022
Who’s on First?
IS IT JUST ME OR HAS��dealing with health insurance companies become more confusing and frustrating? Trying to figure out who to speak to feels like that classic Abbott and Costello comedy routine, ���Who���s on first?���
My wife retired last July. For the previous four years, we���d used her employer-provided medical benefits and now we needed to shop for coverage. Under my old employer���s pension plan, pension-eligible employees like me���who retired prior to beginning Medicare���were eligible to sign up for one of the company���s medical plans. You paid full price, less a subsidy that depended on your years of service.
I had more than 30 years of service, so I was eligible for the maximum subsidy of $735 a month. After the subsidy, a high-deductible health plan for my wife and me cost about $900 a month. This seemed like our best option for medical insurance when we enrolled in August 2021 and renewed for 2022.
I started my pension in August 2017. In the four years since, the company I had retired from merged with a larger company, went public in an initial public offering, and then merged with another, even larger company. This final merger brought the company back into private ownership, so its stock was delisted. Needless to say, human resources (HR) and benefits providers have changed many times.
I was a senior manager for the last 20 years of my career. I always made it a point to build strong relationships with HR. It was important to know who the experts were, in case you needed support. This was especially true for employee benefits.
Over the years, more and more of the benefit functions were outsourced. Benefit plans changed frequently, especially as my old company changed hands. As far as I can ascertain, my current health insurance requires five different companies to manage the process. Figuring out who to call if you have a question is getting harder all the time. Here���s my simplistic view of the five companies involved and the roles they play:
Company No. 1 is the one I worked for and retired from. It owns the pension plan and contracts with the other four companies to provide the entire menu of health insurance services to employees and retirees.
Company No. 2 is a full-service benefits administrator. It administers the benefit plans for company No. 1. This includes health plans, retirement plans and a menu of other offerings. Company No. 2 created and manages the web portal that employees use to sign up for benefits. This website is also used for annual enrollment, as well as any changes due to life events. Company No. 2 also handles the billing and payment of premiums.
Company No. 3 is a third-party administrator that processes claims. I looked the company up���it administers benefit plans for more than 100 companies. I think it interprets the insurance company���s plans and makes determinations of what���s covered. Company No. 3 keeps track of claims, deductibles and out-of-pocket totals. I also believe it sends out the explanation-of-benefits statements.
Company No. 4 is supposed to make health care personal. It���s the company you actually speak to when you call company No. 2 or 3. It administers wellness plans and can provide limited information about your health coverage.
Company No. 5 is the actual insurer, one of the Blue Cross Blue Shield companies. It doesn���t appear to interact with the insured���me���in any way. I remember speaking directly with Blue Cross 15 years ago, advocating for my mother when she was ill and the company was denying her rehabilitation care. It was a challenge, but I kept working my way up the ladder until I spoke with a supervisor who agreed with me and got the services approved. I have no idea how, or if, I could do that now.
Last year, my doctor recommended an outpatient diagnostic procedure for me. I scheduled it for late December. The doctor prescribed two procedures at once. He presumed the results of the first would justify the second procedure based on his examination and discussions with me. Before I had the procedure done, however, the outpatient facility contacted me to say the procedure had not been approved. That came from company No. 4, which communicates with you about your insurance coverage.
The outpatient facility worked with my doctor to get a new prescription for the first procedure only. Company No. 4 approved the new request. Its response said that the procedure was medically necessary and appropriate. But it specifically stated that this approval did not imply that the procedure was covered by my insurance. That one really confused me.
Later, I received notice that it would be covered. Since we have a high-deductible plan, and my rescheduled procedure would now be early in the new year, I suspected we would pay most and perhaps all of the cost. I called the outpatient facility���s business office to get an estimate. The employee there was able to give me the amount the facility would charge the insurance company, but not what the negotiated price would be under my insurance plan.
The business office recommended that I contact my insurance company to find out what the negotiated cost would be. I called the number on my insurance card and got someone from company No. 4. The representative had trouble understanding my question. He could tell me what our family deductible was, and how much we had used to date. He recommended I call company No. 3, the one that processes claims.
I called company No. 3, using the number on its website. A representative of company No. 4 answered. She thought only company No. 5 could know the answer to my question and recommended that I call company No. 2, the benefits administrator. I���m sure you���ve guessed by now that company No. 2 had no idea of what I might be billed.
That���s when I gave up. It will be what it will be, and we will pay the bill.
Richard Connor is��a semi-retired aerospace engineer with a keen interest in finance. He��enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter��@RConnor609��and check out his earlier articles.
My wife retired last July. For the previous four years, we���d used her employer-provided medical benefits and now we needed to shop for coverage. Under my old employer���s pension plan, pension-eligible employees like me���who retired prior to beginning Medicare���were eligible to sign up for one of the company���s medical plans. You paid full price, less a subsidy that depended on your years of service.
I had more than 30 years of service, so I was eligible for the maximum subsidy of $735 a month. After the subsidy, a high-deductible health plan for my wife and me cost about $900 a month. This seemed like our best option for medical insurance when we enrolled in August 2021 and renewed for 2022.
I started my pension in August 2017. In the four years since, the company I had retired from merged with a larger company, went public in an initial public offering, and then merged with another, even larger company. This final merger brought the company back into private ownership, so its stock was delisted. Needless to say, human resources (HR) and benefits providers have changed many times.
I was a senior manager for the last 20 years of my career. I always made it a point to build strong relationships with HR. It was important to know who the experts were, in case you needed support. This was especially true for employee benefits.
Over the years, more and more of the benefit functions were outsourced. Benefit plans changed frequently, especially as my old company changed hands. As far as I can ascertain, my current health insurance requires five different companies to manage the process. Figuring out who to call if you have a question is getting harder all the time. Here���s my simplistic view of the five companies involved and the roles they play:
Company No. 1 is the one I worked for and retired from. It owns the pension plan and contracts with the other four companies to provide the entire menu of health insurance services to employees and retirees.
Company No. 2 is a full-service benefits administrator. It administers the benefit plans for company No. 1. This includes health plans, retirement plans and a menu of other offerings. Company No. 2 created and manages the web portal that employees use to sign up for benefits. This website is also used for annual enrollment, as well as any changes due to life events. Company No. 2 also handles the billing and payment of premiums.
Company No. 3 is a third-party administrator that processes claims. I looked the company up���it administers benefit plans for more than 100 companies. I think it interprets the insurance company���s plans and makes determinations of what���s covered. Company No. 3 keeps track of claims, deductibles and out-of-pocket totals. I also believe it sends out the explanation-of-benefits statements.
Company No. 4 is supposed to make health care personal. It���s the company you actually speak to when you call company No. 2 or 3. It administers wellness plans and can provide limited information about your health coverage.
Company No. 5 is the actual insurer, one of the Blue Cross Blue Shield companies. It doesn���t appear to interact with the insured���me���in any way. I remember speaking directly with Blue Cross 15 years ago, advocating for my mother when she was ill and the company was denying her rehabilitation care. It was a challenge, but I kept working my way up the ladder until I spoke with a supervisor who agreed with me and got the services approved. I have no idea how, or if, I could do that now.
Last year, my doctor recommended an outpatient diagnostic procedure for me. I scheduled it for late December. The doctor prescribed two procedures at once. He presumed the results of the first would justify the second procedure based on his examination and discussions with me. Before I had the procedure done, however, the outpatient facility contacted me to say the procedure had not been approved. That came from company No. 4, which communicates with you about your insurance coverage.
The outpatient facility worked with my doctor to get a new prescription for the first procedure only. Company No. 4 approved the new request. Its response said that the procedure was medically necessary and appropriate. But it specifically stated that this approval did not imply that the procedure was covered by my insurance. That one really confused me.
Later, I received notice that it would be covered. Since we have a high-deductible plan, and my rescheduled procedure would now be early in the new year, I suspected we would pay most and perhaps all of the cost. I called the outpatient facility���s business office to get an estimate. The employee there was able to give me the amount the facility would charge the insurance company, but not what the negotiated price would be under my insurance plan.
The business office recommended that I contact my insurance company to find out what the negotiated cost would be. I called the number on my insurance card and got someone from company No. 4. The representative had trouble understanding my question. He could tell me what our family deductible was, and how much we had used to date. He recommended I call company No. 3, the one that processes claims.
I called company No. 3, using the number on its website. A representative of company No. 4 answered. She thought only company No. 5 could know the answer to my question and recommended that I call company No. 2, the benefits administrator. I���m sure you���ve guessed by now that company No. 2 had no idea of what I might be billed.
That���s when I gave up. It will be what it will be, and we will pay the bill.
Richard Connor is��a semi-retired aerospace engineer with a keen interest in finance. He��enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter��@RConnor609��and check out his earlier articles.The post Who’s on First? appeared first on HumbleDollar.
March 28, 2022
Matters of Maturity
KNOWING WHAT RETURN��you can reasonably expect from stocks, bonds and other asset classes is valuable because it can help you make more educated asset allocation choices. It also helps you decide how much you need to be saving. If expected returns are low, you���ll need to save more.
Such estimates don���t require extraordinary clairvoyance. In fact, when it comes to bonds, estimating returns is quite straightforward. The expected return from a bond is very close to something called the bond���s yield to maturity, which is the return you would expect if you held the bond until it matures.
Many investors don���t hold individual bonds, nor should they. Instead, they ought to invest in bond mutual funds or exchange-traded funds. Fortunately, the expected return from a bond fund also closely approximates the fund���s average yield to maturity. If you know that number, you have a good handle on what return you can expect from the fund.
In the short run, the return could be higher or lower than the fund���s yield to maturity. That���s because bond prices are subject to market volatility, just like stocks. This year is a good example. The U.S. bond market���using the Bloomberg Aggregate Bond Index, or ���the Agg,��� as a proxy���is down almost 7% in 2022, even with interest included.
But when bond prices fall, their yields rise. The total return that an investor receives is always a combination of capital gains (or losses) and income. When the price of a bond falls, bond income can be reinvested at higher yields. These two effects���lower bond prices and higher yields���offset each other. That���s why the starting yield to maturity is a very good estimate of the total return that bond fund investors will receive over, say, six or seven years if they own an intermediate-term bond fund.
As an example, one of the largest bond funds in the world is the Vanguard Total Bond Market Index Fund (symbol: VBTLX. The exchange-traded alternative is��BND). Its yield to maturity is currently 2.3%. If you���re an investor in this fund, 2.3% is close to the long-term return you can expect. It���s that simple.
Such estimates don���t require extraordinary clairvoyance. In fact, when it comes to bonds, estimating returns is quite straightforward. The expected return from a bond is very close to something called the bond���s yield to maturity, which is the return you would expect if you held the bond until it matures.
Many investors don���t hold individual bonds, nor should they. Instead, they ought to invest in bond mutual funds or exchange-traded funds. Fortunately, the expected return from a bond fund also closely approximates the fund���s average yield to maturity. If you know that number, you have a good handle on what return you can expect from the fund.
In the short run, the return could be higher or lower than the fund���s yield to maturity. That���s because bond prices are subject to market volatility, just like stocks. This year is a good example. The U.S. bond market���using the Bloomberg Aggregate Bond Index, or ���the Agg,��� as a proxy���is down almost 7% in 2022, even with interest included.
But when bond prices fall, their yields rise. The total return that an investor receives is always a combination of capital gains (or losses) and income. When the price of a bond falls, bond income can be reinvested at higher yields. These two effects���lower bond prices and higher yields���offset each other. That���s why the starting yield to maturity is a very good estimate of the total return that bond fund investors will receive over, say, six or seven years if they own an intermediate-term bond fund.
As an example, one of the largest bond funds in the world is the Vanguard Total Bond Market Index Fund (symbol: VBTLX. The exchange-traded alternative is��BND). Its yield to maturity is currently 2.3%. If you���re an investor in this fund, 2.3% is close to the long-term return you can expect. It���s that simple.
The post Matters of Maturity appeared first on HumbleDollar.
Rattled by Rates
IT���S BEEN A STUNNING quarter for the bond market. According to Bloomberg, short-term interest rates have seen their biggest jump since 1984, as measured by the yield on two-year Treasury notes, which now stands at around 2.3%.
The rise this time around seems especially sharp, considering how low yields were at the start of 2022. Back in the early 1980s, the two-year Treasury yielded north of 10%, versus barely above 0% at times last year. We could see yet more bond market volatility, with key data points such as final fourth-quarter gross domestic product and March���s employment report hitting later in the week.
One consequence of rising yields has been higher mortgage rates. Consumers can get updates on conventional loans each afternoon. Friday���s update was particularly jarring: The 30-year conventional fixed-rate mortgage nearly touched 5% and is now at its highest level since late 2018. Freddie Mac also publishes a weekly report on Thursdays. Should mortgage rates climb much above 5%, that would mark the highest borrowing costs in more than a decade.
For potential home buyers, soaring property prices are adding to their misery. We���ll get the latest reading on the S&P Case-Shiller U.S. National Home Price Index on Tuesday morning. The consensus estimate says home values rose 18.3% over the 12 months through January.
Consumers aren���t exactly taking the rising interest-rate environment, triggered by high inflation, in stride. February���s University of Michigan consumer sentiment reading of 59.4 was the bleakest since August 2011���s 55.8. That���s when the U.S. debt downgrade occurred and the European sovereign debt crisis was ongoing. Despite low unemployment and somewhat resilient stock prices, rising consumer prices and unstable geopolitical conditions continue to weigh on consumers.
The first quarter has been no cakewalk for stock investors, either. The good news is that the volatility index is close to its lowest reading since January. That means daily stock market swings should be calmer in the coming weeks. Maybe stocks are beginning to price in better times ahead.
The rise this time around seems especially sharp, considering how low yields were at the start of 2022. Back in the early 1980s, the two-year Treasury yielded north of 10%, versus barely above 0% at times last year. We could see yet more bond market volatility, with key data points such as final fourth-quarter gross domestic product and March���s employment report hitting later in the week.
One consequence of rising yields has been higher mortgage rates. Consumers can get updates on conventional loans each afternoon. Friday���s update was particularly jarring: The 30-year conventional fixed-rate mortgage nearly touched 5% and is now at its highest level since late 2018. Freddie Mac also publishes a weekly report on Thursdays. Should mortgage rates climb much above 5%, that would mark the highest borrowing costs in more than a decade.
For potential home buyers, soaring property prices are adding to their misery. We���ll get the latest reading on the S&P Case-Shiller U.S. National Home Price Index on Tuesday morning. The consensus estimate says home values rose 18.3% over the 12 months through January.
Consumers aren���t exactly taking the rising interest-rate environment, triggered by high inflation, in stride. February���s University of Michigan consumer sentiment reading of 59.4 was the bleakest since August 2011���s 55.8. That���s when the U.S. debt downgrade occurred and the European sovereign debt crisis was ongoing. Despite low unemployment and somewhat resilient stock prices, rising consumer prices and unstable geopolitical conditions continue to weigh on consumers.
The first quarter has been no cakewalk for stock investors, either. The good news is that the volatility index is close to its lowest reading since January. That means daily stock market swings should be calmer in the coming weeks. Maybe stocks are beginning to price in better times ahead.
The post Rattled by Rates appeared first on HumbleDollar.
Ready to Retire
IF THERE WAS ANYONE who should have been emotionally unprepared to retire, it was me. In the years immediately before, I was at the top of my career. I���d been promoted to vice president. I had virtual total control over my job. I was recognized by nearly every employee because of my extensive employee benefits communications and the fact that I���d negotiated benefits for decades. I was among the few who routinely met with the company���s chairman. In short, I enjoyed my job, typically working from 6 a.m. to 6 p.m.
But when the chairman retired, the overall corporate environment changed. I knew it was time to go. A good pension, 401(k) and Social Security took care of financial security.
The thing is, I never gave a moment���s thought to what I���d do with my time after I retired. That was a bit ironic, given that I conducted retirement planning sessions for employees and admonished them to think about their life after work.
Surveys show that nearly a quarter of retirees don���t like their life in retirement because they feel isolated and a loss of direction. Thinking about what you���ll do with your time in retirement is important. But I suspect people who end up unhappy aren���t inclined to plan.
Some of the things that keep retirees busy and engaged cost money, but others are free or low cost. Chances are you aren���t going to start doing things you didn���t do before retirement or didn���t have any interest in.
If you���ve never fished, you probably won���t be booking a fishing trip to Alaska. If, as in my case, you aren���t the do-it-yourself type, renovating the bathroom won���t be a good retirement project. On the other hand, I know retirees who greatly enjoy long-term hobbies, even starting money-making ventures.
Have you ever visited a McDonald���s or a coffee shop in the morning and noticed a group of older folks chatting? For some, that simple daily routine is enjoyable and allows them to stay connected. Volunteering is another opportunity enjoyed by many retirees. It fills their days, and provides a sense of self-worth and recognition. Former President Jimmy Carter, who is often seen helping others, is an excellent role model for retirees. There are even volunteering vacations.
Others move to places like The Villages in Florida, where they find endless activities���and people. If you���ve never been a joiner or tend toward introvert, you probably won���t change upon retirement. Your activities in retirement may be affected by your relocation plans. Starting over can create opportunities for new friends and activities, but also challenges. After all, you are starting over.
Great expectations may not work out. I know a retiree who spent $100,000 on a grand RV, planning to see the country. But the cost of operating the RV and the difficulty of driving it soon led to its sale.
I took up drawing again after ignoring it for 50 years. I even took a few lessons. While working, I enjoyed preparing employee benefit communications. I was able to transfer that interest to my own blog and later to HumbleDollar. I also joined several Facebook groups for employees and retirees of my former employer. It���s more than a decade since I retired, but I���m still asked questions.
I started playing golf at age 57, but���other than employer-sponsored outings���I didn���t play much. When I retired, I lost contact with former associates who played. But after moving to our condo, I made new friends. We have a group that plays twice a week. Travel also keeps me busy, as do our grandchildren, especially on weekends.
The days are filled or, if I choose, they aren���t. I may ���waste��� time some mornings watching Hazel or Dennis the Menace���shows that brings back memories. I don���t think a detailed plan for retired life is necessary, though it���s still something worth thinking about in advance. For me, it all worked out, and I suspect that���s the case for most retirees.
Richard Quinn blogs at QuinnsCommentary.net. Before retiring in 2010, Dick was a compensation and benefits executive.��Follow him on Twitter��@QuinnsComments��and check out his earlier��articles.
The post Ready to Retire appeared first on HumbleDollar.
March 27, 2022
Following Through
THERE ARE MANY virtues, but one of the rarest is persistence in following through. In our complicated world, often you can���t get something done on the first go. Instead, you have to revisit the task, sometimes more than once. This is true not just of financial decisions but also many other aspects of our lives.
In fact, if you���re trying to get folks to do something, often their first defense is to stall���because they know that, after a while, most people will simply give up.
I���ve given up on tasks because I became convinced it couldn���t be done, or the costs outweighed the benefits, or I had a change in my thinking. But I try to make it a rare case to abandon something because I���m not willing to put in the effort needed to follow through.
For me, one key to this is a calendar and to-do lists. I���m a bit of a fanatic about both. There���s been a calendar on my desk for the past half-century���and, to my wife���s great amusement, I still have them all. What about to-do lists? I have multiple versions on my desk at any given time: long term, medium term, this week and so on.
If a task is on the calendar or on a list, it has to be addressed. Before it���s crossed off, I���ve got to get it done, or made a conscious decision not to do it, or have it relisted for a future date on the calendar or on a new to-do list. No task ever simply disappears.
There are certain rewards for this obsessive behavior. For one, you get a lot of things done. Second, if you have repeated dealings with the same folks, they learn that you won���t give up, so maybe it���s easier to just resolve the issue quickly and spare themselves the ongoing headache. Finally, for the obsessive among us, it allows us to relax a bit, happy in the knowledge that the task has been dealt with.
I still remember when our youngest daughter came home one weekend after starting college. She was taking an introductory course on psychology, where she learned, among other things, about various mental disorders. She related how, when the professor got to the section on obsessive compulsive disorder, she���d almost shouted out loud, ���Oh my god, that���s Dad.���
I���m not arguing that staying on-task is always good. In fact, I���ve known numerous people who have a lot of bad ideas but who often fail to follow through. The latter usually saves them from the consequences of the former.
In fact, if you���re trying to get folks to do something, often their first defense is to stall���because they know that, after a while, most people will simply give up.
I���ve given up on tasks because I became convinced it couldn���t be done, or the costs outweighed the benefits, or I had a change in my thinking. But I try to make it a rare case to abandon something because I���m not willing to put in the effort needed to follow through.
For me, one key to this is a calendar and to-do lists. I���m a bit of a fanatic about both. There���s been a calendar on my desk for the past half-century���and, to my wife���s great amusement, I still have them all. What about to-do lists? I have multiple versions on my desk at any given time: long term, medium term, this week and so on.
If a task is on the calendar or on a list, it has to be addressed. Before it���s crossed off, I���ve got to get it done, or made a conscious decision not to do it, or have it relisted for a future date on the calendar or on a new to-do list. No task ever simply disappears.
There are certain rewards for this obsessive behavior. For one, you get a lot of things done. Second, if you have repeated dealings with the same folks, they learn that you won���t give up, so maybe it���s easier to just resolve the issue quickly and spare themselves the ongoing headache. Finally, for the obsessive among us, it allows us to relax a bit, happy in the knowledge that the task has been dealt with.
I still remember when our youngest daughter came home one weekend after starting college. She was taking an introductory course on psychology, where she learned, among other things, about various mental disorders. She related how, when the professor got to the section on obsessive compulsive disorder, she���d almost shouted out loud, ���Oh my god, that���s Dad.���
I���m not arguing that staying on-task is always good. In fact, I���ve known numerous people who have a lot of bad ideas but who often fail to follow through. The latter usually saves them from the consequences of the former.
The post Following Through appeared first on HumbleDollar.
Wasted Effort
AS YOU MIGHT GUESS, my favorite��Seinfeld��episode is ���The Stock Tip.��� It starts with a conversation between George and Jerry.
���My friend Simons knows this guy Wilkenson,��� George says. ���He made a fortune in the stock market. Now he���s got this new thing.��� George goes on to explain that Wilkenson has millions invested in a company called Centrax.
He urges Jerry to invest along with him, though the details are thin. ���It���s an electronic thingy,��� George says. But to underscore the opportunity, he tells Jerry that, ���It���s gone up three points since I���ve been watching it.��� He promises that Wilkenson will let them know ���the exact right minute to sell.���
Jerry is skeptical but goes along. Almost as soon as he invests, however, the plan falls apart. The stock drops 50%, and Wilkenson disappears. As Jerry becomes increasingly agitated, his friends are no help.
George encourages Jerry to hang on but betrays his own fears. ���I���m keeping it,��� he says. ���I���m going down with the ship!��� Meanwhile, Kramer taunts Jerry with his usual nonsense: ���It���s all manipulated, with junk bonds. You can't win.��� Then, raising his voice, ���Get rid of that stock now!���
Unable to handle the stress, Jerry sells. That, needless to say, is when the stock turns around. As the episode wraps up, George gloats,��cigar in hand. ���I told you not to sell,��� he tells Jerry. ���Simons made money, Wilkenson cleaned up.��� Meanwhile, Seinfeld is depressed. ���I'm not an investor,��� he says.
This episode aired more than 30 years ago. But according to the research, it���s remarkably close to reality. University of California at Berkeley professor Terrance Odean has been studying investment markets���and individual investors, in particular���his entire career. In a recent��interview, he shared a set of useful observations and recommendations.
By way of background, Odean���s best-known study, co-authored with Brad Barber, was titled ���Trading Is Hazardous to Your Wealth.��� Today, it���s generally accepted that stock-picking is, for the most part, unproductive. But Odean and Barber were able to quantify it. Looking at actual client trades at an (undisclosed) brokerage firm, they found that investors who traded most frequently underperformed the overall market by more than six percentage points��per year.
Why do active traders underperform? You might assume it���s because stock-picking is difficult. But that���s just one reason. Another factor is transaction costs. While trading commissions have largely dropped to zero, Odean points out that, ���Zero commissions doesn���t mean zero profits to the brokerage firms.��� Instead,��he says, ���They���re just getting paid by someone else.���
You may have heard the term ���payment for order flow.��� Wall Street market makers pay brokers to route trades through them. This gives them advance visibility into trades and thus potential price movements. This, in turn, gives market makers the opportunity to profit by placing their own trades a split-second before clients. For that privilege, market makers pay brokers substantial fees. In short, market makers are paying brokers for the ability to trade against the brokers��� clients. This comes out of individual investors��� pockets a penny or two at a time.
In addition, there���s what���s known as the bid-ask spread, the difference between the lower price at which you can currently sell a stock and the higher price at which you can buy. That too subtracts a fractional amount from each trade. This has always been a factor. But today, now that stocks no longer trade in��eighths, most people view it as less of a concern.
Odean, however, points out that high-speed traders have swung the pendulum back. He cautions that individual investors should always ask themselves, ���Who���s on the other side of this trade?��� Most often, he says, the answer is a high-speed trading firm���s algorithm, designed to outwit individual investors. This is virtually impossible to observe with the naked eye, but��research��has proven that individual investors are jumping into a proverbial shark tank whenever they cross paths with Wall Street. This further contributes to the underperformance of those who trade most frequently.
This leads to another valuable insight. In his work, Odean has found that women, on average, achieve better investment results than men. No, it isn���t because women are better than men at picking stocks. Both underperform the market to the same degree with their picks. But women are more patient���they trade less. To the extent that each trade just makes things worse, women achieve results that are less bad.
Odean���s research has also explored the dynamics behind Robinhood���a new brokerage firm which pioneered the zero-commission model and which was closely associated with the meme stock craze we saw during the depths of the pandemic. Among other things, Odean and his coauthors��found��that Robinhood���s ���gamification��� of investing was both very successful and also very damaging. By simplifying the investing experience and making it more exciting���with��confetti��blanketing the screen after a trade, for example���Robinhood was remarkably successful. Starting from zero in 2013, it claimed 22 million customers by the end of 2021.
While Robinhood has done well as a firm, Odean found that its customers were especially susceptible to ���herding events��� and, as a result, experienced underperformance, on average. Odean connects the dots here in a way that provides an important lesson. Robinhood���s user interface gave customers the illusion that investing is a game. It was then natural for users to assume that, like any other game, practice would lead to greater skill and improved results. But as his earlier research had found, this is the opposite of what���s good for investors.
If you and I wake up every day and practice tennis or Tetris or Wordle or anything else, we���ll undoubtedly improve. But if we wake up every day and ���practice��� investing by trading, the opposite will likely occur. Investment returns will get��worse. This reveals a key���and frustrating���reality about investing: Unlike pretty much every other activity in life, when it comes to investing, effort and results are inversely correlated. The harder we try, the worse our results. Effort has a negative payoff.
What does all this mean in practice? In my view, Odean���s research helps underscore a view I���ve emphasized before: For your long-term savings, stick with a simple set of broadly diversified index funds. By doing this, you���ll insulate yourself from the angst of watching individual stocks, and you won���t be tempted into��buying and��selling those stocks at inopportune times. A further advantage: Because good index funds are buy-and-hold investors themselves, they also help limit both transaction costs and taxes.
Despite these advantages, I know that when I recommend index funds, I run the risk of sounding like a killjoy. Picking stocks��can��be fun. And as I���ve��noted��before, it���s incontrovertible that all of the world���s great fortunes���from Carnegie and Rockefeller to Gates and Buffett��� have been earned not with index funds but by owning one stock, albeit a very good one.
What���s the solution? In my work with clients, several maintain separate accounts in which they have placed more speculative bets���on individual stocks, on cryptocurrency and on startup companies. These accounts are limited in size and sit alongside their core index fund portfolios. Sometimes, they produce great profits and sometimes losses. But in all cases, they���re small enough to not disrupt the investor���s overall plan. Odean endorses this approach and perfectly summarizes the advantage: A small trading account like this offers investors ���90% of the thrills for 10% of the cost.���
At the end of the ���Stock Tip��� episode, George leans in and lowers his voice: ���Wilkenson���s got a bite on a new one,��� he says. ���Petramco Corporation... If you want to get in, there's very little time.��� This is funny and, of course, exaggerated. But if you find yourself in this situation, a side account may be the perfect solution.
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.
���My friend Simons knows this guy Wilkenson,��� George says. ���He made a fortune in the stock market. Now he���s got this new thing.��� George goes on to explain that Wilkenson has millions invested in a company called Centrax.
He urges Jerry to invest along with him, though the details are thin. ���It���s an electronic thingy,��� George says. But to underscore the opportunity, he tells Jerry that, ���It���s gone up three points since I���ve been watching it.��� He promises that Wilkenson will let them know ���the exact right minute to sell.���
Jerry is skeptical but goes along. Almost as soon as he invests, however, the plan falls apart. The stock drops 50%, and Wilkenson disappears. As Jerry becomes increasingly agitated, his friends are no help.
George encourages Jerry to hang on but betrays his own fears. ���I���m keeping it,��� he says. ���I���m going down with the ship!��� Meanwhile, Kramer taunts Jerry with his usual nonsense: ���It���s all manipulated, with junk bonds. You can't win.��� Then, raising his voice, ���Get rid of that stock now!���
Unable to handle the stress, Jerry sells. That, needless to say, is when the stock turns around. As the episode wraps up, George gloats,��cigar in hand. ���I told you not to sell,��� he tells Jerry. ���Simons made money, Wilkenson cleaned up.��� Meanwhile, Seinfeld is depressed. ���I'm not an investor,��� he says.
This episode aired more than 30 years ago. But according to the research, it���s remarkably close to reality. University of California at Berkeley professor Terrance Odean has been studying investment markets���and individual investors, in particular���his entire career. In a recent��interview, he shared a set of useful observations and recommendations.
By way of background, Odean���s best-known study, co-authored with Brad Barber, was titled ���Trading Is Hazardous to Your Wealth.��� Today, it���s generally accepted that stock-picking is, for the most part, unproductive. But Odean and Barber were able to quantify it. Looking at actual client trades at an (undisclosed) brokerage firm, they found that investors who traded most frequently underperformed the overall market by more than six percentage points��per year.
Why do active traders underperform? You might assume it���s because stock-picking is difficult. But that���s just one reason. Another factor is transaction costs. While trading commissions have largely dropped to zero, Odean points out that, ���Zero commissions doesn���t mean zero profits to the brokerage firms.��� Instead,��he says, ���They���re just getting paid by someone else.���
You may have heard the term ���payment for order flow.��� Wall Street market makers pay brokers to route trades through them. This gives them advance visibility into trades and thus potential price movements. This, in turn, gives market makers the opportunity to profit by placing their own trades a split-second before clients. For that privilege, market makers pay brokers substantial fees. In short, market makers are paying brokers for the ability to trade against the brokers��� clients. This comes out of individual investors��� pockets a penny or two at a time.
In addition, there���s what���s known as the bid-ask spread, the difference between the lower price at which you can currently sell a stock and the higher price at which you can buy. That too subtracts a fractional amount from each trade. This has always been a factor. But today, now that stocks no longer trade in��eighths, most people view it as less of a concern.
Odean, however, points out that high-speed traders have swung the pendulum back. He cautions that individual investors should always ask themselves, ���Who���s on the other side of this trade?��� Most often, he says, the answer is a high-speed trading firm���s algorithm, designed to outwit individual investors. This is virtually impossible to observe with the naked eye, but��research��has proven that individual investors are jumping into a proverbial shark tank whenever they cross paths with Wall Street. This further contributes to the underperformance of those who trade most frequently.
This leads to another valuable insight. In his work, Odean has found that women, on average, achieve better investment results than men. No, it isn���t because women are better than men at picking stocks. Both underperform the market to the same degree with their picks. But women are more patient���they trade less. To the extent that each trade just makes things worse, women achieve results that are less bad.
Odean���s research has also explored the dynamics behind Robinhood���a new brokerage firm which pioneered the zero-commission model and which was closely associated with the meme stock craze we saw during the depths of the pandemic. Among other things, Odean and his coauthors��found��that Robinhood���s ���gamification��� of investing was both very successful and also very damaging. By simplifying the investing experience and making it more exciting���with��confetti��blanketing the screen after a trade, for example���Robinhood was remarkably successful. Starting from zero in 2013, it claimed 22 million customers by the end of 2021.
While Robinhood has done well as a firm, Odean found that its customers were especially susceptible to ���herding events��� and, as a result, experienced underperformance, on average. Odean connects the dots here in a way that provides an important lesson. Robinhood���s user interface gave customers the illusion that investing is a game. It was then natural for users to assume that, like any other game, practice would lead to greater skill and improved results. But as his earlier research had found, this is the opposite of what���s good for investors.
If you and I wake up every day and practice tennis or Tetris or Wordle or anything else, we���ll undoubtedly improve. But if we wake up every day and ���practice��� investing by trading, the opposite will likely occur. Investment returns will get��worse. This reveals a key���and frustrating���reality about investing: Unlike pretty much every other activity in life, when it comes to investing, effort and results are inversely correlated. The harder we try, the worse our results. Effort has a negative payoff.
What does all this mean in practice? In my view, Odean���s research helps underscore a view I���ve emphasized before: For your long-term savings, stick with a simple set of broadly diversified index funds. By doing this, you���ll insulate yourself from the angst of watching individual stocks, and you won���t be tempted into��buying and��selling those stocks at inopportune times. A further advantage: Because good index funds are buy-and-hold investors themselves, they also help limit both transaction costs and taxes.
Despite these advantages, I know that when I recommend index funds, I run the risk of sounding like a killjoy. Picking stocks��can��be fun. And as I���ve��noted��before, it���s incontrovertible that all of the world���s great fortunes���from Carnegie and Rockefeller to Gates and Buffett��� have been earned not with index funds but by owning one stock, albeit a very good one.
What���s the solution? In my work with clients, several maintain separate accounts in which they have placed more speculative bets���on individual stocks, on cryptocurrency and on startup companies. These accounts are limited in size and sit alongside their core index fund portfolios. Sometimes, they produce great profits and sometimes losses. But in all cases, they���re small enough to not disrupt the investor���s overall plan. Odean endorses this approach and perfectly summarizes the advantage: A small trading account like this offers investors ���90% of the thrills for 10% of the cost.���
At the end of the ���Stock Tip��� episode, George leans in and lowers his voice: ���Wilkenson���s got a bite on a new one,��� he says. ���Petramco Corporation... If you want to get in, there's very little time.��� This is funny and, of course, exaggerated. But if you find yourself in this situation, a side account may be the perfect solution.
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.The post Wasted Effort appeared first on HumbleDollar.
March 25, 2022
Winding Down
I LET MY EMPLOYER know last week that I'm leaving. It���s a strange feeling to think I���ll soon be saying goodbye to the daily routine I���ve followed for more than two decades.
When I began working at the college, I was 31 years old. If I wore my blonde hair up in a ponytail, I was often mistaken for a student. But working at a college provides a unique perspective on aging. Every year, I grew older but the students surrounding me stayed the same age.
I still remember the shock I felt���just a few years into the job���when I realized the incoming freshman class had been born the year I graduated from high school. Now, as I prepare to leave, I���m keenly aware that almost none of the students who wander around campus was born when I began working there.
It���s been 24 years, 48 semesters, almost 8,800 days.
To be honest, I never expected to stay that long. I took a $5,000-a-year pay cut when I started working as the biology department manager. But since the job came with some excellent benefits���including a generous early retiree perk���I decided to take a chance on it.
My predecessor had left the job abruptly, apparently disillusioned with department politics. She left behind a letter for me to read that described, in great detail, the turmoil that existed. She predicted I wouldn���t last six months.
I took it as a personal challenge.
To be sure, it���s never been a dream job. Most of what I do involves solving problems other people don���t want to deal with. I make sure broken equipment gets repaired. I ensure the various lab exercises being taught each week run smoothly. I order supplies and I pay bills. It���s not glamorous or particularly challenging. It does, however, allow me to work independently, making it an ideal match for my introverted personality.
And the benefits have been generous. The college has made regular contributions to my retirement account since the day I started. I���ve had good health care coverage and plenty of paid time off. And even though it has no monetary value, the fact that I���ve been able to bring my dogs to work with me every day for 24 years is, perhaps, the benefit I���ve valued the most.
For sure, I���ll miss seeing some of the people I���ve worked with over the years. But new adventures and challenges are ahead. Leaving behind a steady paycheck isn���t an easy decision, but it���s one I���m slowly becoming comfortable with.
When I began working at the college, I was 31 years old. If I wore my blonde hair up in a ponytail, I was often mistaken for a student. But working at a college provides a unique perspective on aging. Every year, I grew older but the students surrounding me stayed the same age.
I still remember the shock I felt���just a few years into the job���when I realized the incoming freshman class had been born the year I graduated from high school. Now, as I prepare to leave, I���m keenly aware that almost none of the students who wander around campus was born when I began working there.
It���s been 24 years, 48 semesters, almost 8,800 days.
To be honest, I never expected to stay that long. I took a $5,000-a-year pay cut when I started working as the biology department manager. But since the job came with some excellent benefits���including a generous early retiree perk���I decided to take a chance on it.
My predecessor had left the job abruptly, apparently disillusioned with department politics. She left behind a letter for me to read that described, in great detail, the turmoil that existed. She predicted I wouldn���t last six months.
I took it as a personal challenge.
To be sure, it���s never been a dream job. Most of what I do involves solving problems other people don���t want to deal with. I make sure broken equipment gets repaired. I ensure the various lab exercises being taught each week run smoothly. I order supplies and I pay bills. It���s not glamorous or particularly challenging. It does, however, allow me to work independently, making it an ideal match for my introverted personality.
And the benefits have been generous. The college has made regular contributions to my retirement account since the day I started. I���ve had good health care coverage and plenty of paid time off. And even though it has no monetary value, the fact that I���ve been able to bring my dogs to work with me every day for 24 years is, perhaps, the benefit I���ve valued the most.
For sure, I���ll miss seeing some of the people I���ve worked with over the years. But new adventures and challenges are ahead. Leaving behind a steady paycheck isn���t an easy decision, but it���s one I���m slowly becoming comfortable with.
The post Winding Down appeared first on HumbleDollar.
Freed by Frugality
WHEN I TOOK A JOB with a U.S.-based software company and moved to the States in 2000, I wasn���t planning to live here permanently. I came under the H-1B visa program, which allows nonimmigrant foreigners to obtain temporary employment. I figured I might work in the U.S. for a few years and then return to India, where I grew up.
Things didn���t quite turn out that way.
I started my career as a software engineer in Kolkata, my hometown. But as a lover of travel, I seized opportunities to work abroad and get to know new cultures. My plan was to work in other countries while I was young, before heading back to Kolkata with my wife to settle down. America was on my bucket list. An opportunity came almost by accident.
While working in Ireland in the late 1990s, I returned to Kolkata to visit my parents. I bumped into an acquaintance who lived in the U.S. and worked for a software company. In those days, many software engineers regarded his employer as the premier software company. Sensing my envy, he asked for my resume. I was skeptical about my prospects but, on his insistence, I typed up a CV.
After returning to Ireland, I forgot about the whole thing, but he didn���t. A recruiter called me weeks later to set up a few phone calls to check my technical knowledge. Once I had cleared that hurdle, the recruiter offered to bring me to the U.S. headquarters for interviews. An expense-paid trip across the Atlantic sounded like a great deal, and I was soon on a plane heading to the Pacific Northwest.
The dozen or so interviews over two days were grueling. I was bombarded with all sorts of questions, including brainteaser puzzles and bizarre algorithmic problems. By the end, I felt I had wasted everyone���s time. Demoralized, I returned to Ireland.
When the recruiter called back the next week, I was almost certain that I hadn���t made the grade. But to my surprise, she offered words of congratulation: I had made it.
My coworkers and supervisor at my Irish employer advised me to accept the position. I leaned toward doing so, but there was a downside: taking another foreign job in my early 30s would delay my eventual return to India.
On the other hand, the upsides were too attractive to ignore. The chance to be part of a transformative company might never come my way again, I���d get to explore a beautiful country full of natural wonders, and the job might be my ticket to financial freedom���for two reasons.
First was the promising math of working in a high-income country before returning to one that has a low cost of living. Even modest savings would go far in my hometown. I���d already saved a bit from my previous overseas jobs. A few years of saving in U.S. dollars would mean increased financial security.
Second, my pay package included stock options���a benefit I���d never before heard of. The recruiter explained that, when the options vested, I���d reap the profit from any rise in the company���s share price since my starting date. The stock had been on a tear for nearly a decade. If history was any guide, she said jokingly, the options would make me a lot of money. Little did I know that all my options would expire worthless and that the stock wouldn���t recover for 15 years, thanks to the bursting of the dot-com bubble. So much for getting rich quick.
Because I was na��ve enough to extrapolate past performance of the company���s stock into the future, the overall compensation package looked unbelievably attractive. Great work, beautiful place, generous pay. What more could I ask for? I accepted the job offer and moved to the U.S. in early 2000.
Coming to America. The new chapter of my life started well. That summer, I visited a close friend of many years who was also now living in the U.S. It was refreshing to catch up with him and spend time with his family. His wife suggested that I buy a house. When I replied that I planned to go back to India in a few years, my friend laughed and made three predictions: I���d soon gain at least 20 pounds, I���d have no time to connect with friends and I���d live in the U.S. permanently. I made a friendly bet that he was wrong.
Over the next few years, we lost touch���until tragedy struck. My friend suffered a cerebral stroke and was put on life support. I flew to see him as soon as I could but, alas, he never awoke from the coma. I didn���t get a chance to say goodbye, let alone treat him to something as payment for the three bets I���d lost.
My friend���s premature death shook me. He wasn���t even 40. I felt that my life also was ticking away. I started to picture my future self and the family who depended on me financially. What would happen to them if I died? Who would attend my funeral and what would they say about me? My midlife crisis set in early.
Meanwhile, I, too, had a few ups and downs. I went through a divorce in 2003. What followed was a period of ultra-frugality while I put my financial house back in order. I said goodbye to every hint of luxury���the almost new car, the spacious rental apartment, vacation trips, cellphone, even going out with friends. To save on rent, I bought a poorly lit townhouse in a not-so-great location. I rarely bought anything beyond groceries and essentials. I cooked all my meals and limited my socializing to occasional get-togethers with close friends over homecooked food. The local library became my only source of books and videos. With a four-figure cost of living and my six-figure income, it didn't take long before I was back on track financially and able to resume a less thrifty lifestyle.
A few years later, I remarried. I abandoned my plan to return to India and decided to settle permanently in the U.S. This last decision nixed my plan for financial freedom. I could no longer count on a lower cost of living later in life. I was 38 and effectively starting my financial journey from scratch.
My friend���s demise was also a wakeup call. I needed to stop procrastinating and get serious about my financial responsibilities, especially now that I was not only remarried, but also had a stepdaughter. I bumped up the coverage amounts on my life- and disability-insurance policies. I named beneficiaries on my financial accounts. I figured that I needed to do more than just save aimlessly���I needed to plan. That was when I realized my biggest money blunder.
I was clueless about the stock market and its indispensable role in building wealth over the long term. I had wasted the first 15 years of my career, taking shelter in bank certificates of deposit and savings accounts. I had, unfortunately, missed out on years of stock market compounding. No, I wasn���t sitting on the sideline with cash, waiting for a better time to invest. Rather, I simply mistook the sideline for the playground.
Thankfully, I also possessed a valuable asset���my income-earning potential���and that offset my many financial mistakes, big and small. I was fortunate that software engineering turned out to be a dependable career for my generation, providing not only abundant job opportunities and high pay, but also enjoyment and satisfaction. The steady income, and the security it provided, was my greatest financial strength.
Fixing my money mistakes was easy once I took the time to learn about investments and personal finance. I maxed out my 401(k) contributions, putting the money in diversified stock funds. I got into the habit of investing my savings in inexpensive index funds. Because of the demands of work and family, and the pursuit of various hobbies, I was too busy to pay much attention to market noise. That was a blessing in disguise.
Wrestling with readiness. The 2000s went by swiftly. My wife went back to work, and the extra income bolstered our household balance sheet. My stepdaughter started elementary school and���seemingly before we knew it���was off to an in-state university. As empty nesters, our daily life slowed, and I had time to focus on something that had been bothering me.
A brief interaction with a stranger, whom I���ll call Ted, left me anxious about our finances. Ted was a part-time driver for a shuttle service that my employer used for local commutes. One day, I was feeling unwell at work and needed a ride home. Ted showed up with a car.
Ted appeared to be in his late 60s or early 70s. He was eager to strike up a conversation and, from his remarks at stoplights and amid the rush-hour traffic, I figured he was disgruntled with his job. I was curious as to why he was still working at his age, especially if he disliked his job so much.
Ted didn���t mind my inquisitiveness. He had retired several years ago after working for 35-plus years. The first few years of retirement went well���until the 2008 financial crisis. His nest egg had shrunk, and he was too afraid to dip into it. Instead, he needed ongoing income to supplement his investment earnings. He didn���t think he could ���re-retire��� anytime soon.
I found his story hard to believe. How could a citizen of the world���s wealthiest country be unable to afford retirement after a multi-decade career? Did he lose money flipping houses or in some other crazy get-rich-quick scheme? I didn���t know what had happened, but I got a clue later when I learned about the effect of the financial crisis on new retirees. Ted was probably one of the many investors who had responded to the market plunge by panicking and cashing out their investments, vowing never to own stocks again.
Ted���s story made me worried. Was I going to end up in the same boat when my paychecks stopped? How much money would I need for retirement, and how much longer would I have to work to get there? With my daughter in college, it was a good time to research my retirement readiness.
The exercise was overwhelming. As I navigated through the retirement planning maze, my spreadsheet got overly complicated, with dozens of parameters and macros. I didn���t expect so many moving parts and so many unknowns. I was getting nowhere in figuring out a target size for my retirement nest egg. The number varied widely depending on my assumptions and inputs.
It then dawned on me that I was asking the wrong question. It wasn���t about how much money I���d need to retire comfortably. Rather, the question was whether my personal time and independence were more valuable than financial comfort. It was about finding the courage to set a retirement date.
Buying time. With this changed mindset, my spreadsheet appeared to tilt in my favor. Unless catastrophe struck, I wasn���t too far from financial freedom. On my 47th birthday, I made a resolution to retire in three years, by the end of 2017. I wrote down the number 1,095���the number of days until my 50th birthday���and pinned it on our kitchen wall.
My daughter was amused. My wife was more surprised than anxious. Could I really afford to walk away from a golden-egg-laying career so soon, especially after a late start? Truth be told, I was a little puzzled, too, until I analyzed our cash flow. The secret wasn���t an oversized gain on smartly picked stocks, nor was it financial windfalls. Instead, it was that we lived far below our means.
Frugality was ingrained in me, thanks to my parents. They also imparted many other sound money habits that have paid off bigtime throughout my life. I had been able to handle money responsibly and keep expenses in check since my schooldays. Growing up in a middle-class family in India, I also learned to abhor debt. Paying off a loan always felt like an accomplishment.
Our low expenses helped in two ways. First, we didn���t need a large nest egg to support our modest lifestyle. Second, our supercharged savings rate, which typically ran at least 60% of our household���s after-tax income, quickly got us to our number���what we needed for financial security. The compound growth of our dollar-cost-averaged investments did its magic.
To be clear, our financial situation was far from rock-solid, especially for an early retiree. The plan could���ve backfired. But I wanted to take my chances, knowing that I could reverse course if things didn���t work out. My wife didn���t intend to stop working in the near future. That, and the flexibility of my plan, made things easier.
As I approached my 50th birthday, I broached the subject of retirement with my supervisor. His brilliant suggestion turned out to be the best financial guidance I���ve ever received: He advised me to gradually reduce my work hours rather than stop abruptly. I took him up on his offer.
Switching to a part-time role at age 50 has worked out well, and I still love it. I get the extra time for my personal interests. Without the pressure of a high-powered career or the feeling that I���m dependent on a paycheck, I enjoy my work more. My modest spending habits may not appeal to others���but they���ve bought me one of life���s greatest luxuries, which is financial freedom.
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.
Things didn���t quite turn out that way.
I started my career as a software engineer in Kolkata, my hometown. But as a lover of travel, I seized opportunities to work abroad and get to know new cultures. My plan was to work in other countries while I was young, before heading back to Kolkata with my wife to settle down. America was on my bucket list. An opportunity came almost by accident.
While working in Ireland in the late 1990s, I returned to Kolkata to visit my parents. I bumped into an acquaintance who lived in the U.S. and worked for a software company. In those days, many software engineers regarded his employer as the premier software company. Sensing my envy, he asked for my resume. I was skeptical about my prospects but, on his insistence, I typed up a CV.After returning to Ireland, I forgot about the whole thing, but he didn���t. A recruiter called me weeks later to set up a few phone calls to check my technical knowledge. Once I had cleared that hurdle, the recruiter offered to bring me to the U.S. headquarters for interviews. An expense-paid trip across the Atlantic sounded like a great deal, and I was soon on a plane heading to the Pacific Northwest.
The dozen or so interviews over two days were grueling. I was bombarded with all sorts of questions, including brainteaser puzzles and bizarre algorithmic problems. By the end, I felt I had wasted everyone���s time. Demoralized, I returned to Ireland.
When the recruiter called back the next week, I was almost certain that I hadn���t made the grade. But to my surprise, she offered words of congratulation: I had made it.
My coworkers and supervisor at my Irish employer advised me to accept the position. I leaned toward doing so, but there was a downside: taking another foreign job in my early 30s would delay my eventual return to India.
On the other hand, the upsides were too attractive to ignore. The chance to be part of a transformative company might never come my way again, I���d get to explore a beautiful country full of natural wonders, and the job might be my ticket to financial freedom���for two reasons.
First was the promising math of working in a high-income country before returning to one that has a low cost of living. Even modest savings would go far in my hometown. I���d already saved a bit from my previous overseas jobs. A few years of saving in U.S. dollars would mean increased financial security.
Second, my pay package included stock options���a benefit I���d never before heard of. The recruiter explained that, when the options vested, I���d reap the profit from any rise in the company���s share price since my starting date. The stock had been on a tear for nearly a decade. If history was any guide, she said jokingly, the options would make me a lot of money. Little did I know that all my options would expire worthless and that the stock wouldn���t recover for 15 years, thanks to the bursting of the dot-com bubble. So much for getting rich quick.
Because I was na��ve enough to extrapolate past performance of the company���s stock into the future, the overall compensation package looked unbelievably attractive. Great work, beautiful place, generous pay. What more could I ask for? I accepted the job offer and moved to the U.S. in early 2000.
Coming to America. The new chapter of my life started well. That summer, I visited a close friend of many years who was also now living in the U.S. It was refreshing to catch up with him and spend time with his family. His wife suggested that I buy a house. When I replied that I planned to go back to India in a few years, my friend laughed and made three predictions: I���d soon gain at least 20 pounds, I���d have no time to connect with friends and I���d live in the U.S. permanently. I made a friendly bet that he was wrong.
Over the next few years, we lost touch���until tragedy struck. My friend suffered a cerebral stroke and was put on life support. I flew to see him as soon as I could but, alas, he never awoke from the coma. I didn���t get a chance to say goodbye, let alone treat him to something as payment for the three bets I���d lost.
My friend���s premature death shook me. He wasn���t even 40. I felt that my life also was ticking away. I started to picture my future self and the family who depended on me financially. What would happen to them if I died? Who would attend my funeral and what would they say about me? My midlife crisis set in early.
Meanwhile, I, too, had a few ups and downs. I went through a divorce in 2003. What followed was a period of ultra-frugality while I put my financial house back in order. I said goodbye to every hint of luxury���the almost new car, the spacious rental apartment, vacation trips, cellphone, even going out with friends. To save on rent, I bought a poorly lit townhouse in a not-so-great location. I rarely bought anything beyond groceries and essentials. I cooked all my meals and limited my socializing to occasional get-togethers with close friends over homecooked food. The local library became my only source of books and videos. With a four-figure cost of living and my six-figure income, it didn't take long before I was back on track financially and able to resume a less thrifty lifestyle.
A few years later, I remarried. I abandoned my plan to return to India and decided to settle permanently in the U.S. This last decision nixed my plan for financial freedom. I could no longer count on a lower cost of living later in life. I was 38 and effectively starting my financial journey from scratch.
My friend���s demise was also a wakeup call. I needed to stop procrastinating and get serious about my financial responsibilities, especially now that I was not only remarried, but also had a stepdaughter. I bumped up the coverage amounts on my life- and disability-insurance policies. I named beneficiaries on my financial accounts. I figured that I needed to do more than just save aimlessly���I needed to plan. That was when I realized my biggest money blunder.
I was clueless about the stock market and its indispensable role in building wealth over the long term. I had wasted the first 15 years of my career, taking shelter in bank certificates of deposit and savings accounts. I had, unfortunately, missed out on years of stock market compounding. No, I wasn���t sitting on the sideline with cash, waiting for a better time to invest. Rather, I simply mistook the sideline for the playground.
Thankfully, I also possessed a valuable asset���my income-earning potential���and that offset my many financial mistakes, big and small. I was fortunate that software engineering turned out to be a dependable career for my generation, providing not only abundant job opportunities and high pay, but also enjoyment and satisfaction. The steady income, and the security it provided, was my greatest financial strength.
Fixing my money mistakes was easy once I took the time to learn about investments and personal finance. I maxed out my 401(k) contributions, putting the money in diversified stock funds. I got into the habit of investing my savings in inexpensive index funds. Because of the demands of work and family, and the pursuit of various hobbies, I was too busy to pay much attention to market noise. That was a blessing in disguise.
Wrestling with readiness. The 2000s went by swiftly. My wife went back to work, and the extra income bolstered our household balance sheet. My stepdaughter started elementary school and���seemingly before we knew it���was off to an in-state university. As empty nesters, our daily life slowed, and I had time to focus on something that had been bothering me.
A brief interaction with a stranger, whom I���ll call Ted, left me anxious about our finances. Ted was a part-time driver for a shuttle service that my employer used for local commutes. One day, I was feeling unwell at work and needed a ride home. Ted showed up with a car.
Ted appeared to be in his late 60s or early 70s. He was eager to strike up a conversation and, from his remarks at stoplights and amid the rush-hour traffic, I figured he was disgruntled with his job. I was curious as to why he was still working at his age, especially if he disliked his job so much.
Ted didn���t mind my inquisitiveness. He had retired several years ago after working for 35-plus years. The first few years of retirement went well���until the 2008 financial crisis. His nest egg had shrunk, and he was too afraid to dip into it. Instead, he needed ongoing income to supplement his investment earnings. He didn���t think he could ���re-retire��� anytime soon.
I found his story hard to believe. How could a citizen of the world���s wealthiest country be unable to afford retirement after a multi-decade career? Did he lose money flipping houses or in some other crazy get-rich-quick scheme? I didn���t know what had happened, but I got a clue later when I learned about the effect of the financial crisis on new retirees. Ted was probably one of the many investors who had responded to the market plunge by panicking and cashing out their investments, vowing never to own stocks again.
Ted���s story made me worried. Was I going to end up in the same boat when my paychecks stopped? How much money would I need for retirement, and how much longer would I have to work to get there? With my daughter in college, it was a good time to research my retirement readiness.
The exercise was overwhelming. As I navigated through the retirement planning maze, my spreadsheet got overly complicated, with dozens of parameters and macros. I didn���t expect so many moving parts and so many unknowns. I was getting nowhere in figuring out a target size for my retirement nest egg. The number varied widely depending on my assumptions and inputs.
It then dawned on me that I was asking the wrong question. It wasn���t about how much money I���d need to retire comfortably. Rather, the question was whether my personal time and independence were more valuable than financial comfort. It was about finding the courage to set a retirement date.
Buying time. With this changed mindset, my spreadsheet appeared to tilt in my favor. Unless catastrophe struck, I wasn���t too far from financial freedom. On my 47th birthday, I made a resolution to retire in three years, by the end of 2017. I wrote down the number 1,095���the number of days until my 50th birthday���and pinned it on our kitchen wall.
My daughter was amused. My wife was more surprised than anxious. Could I really afford to walk away from a golden-egg-laying career so soon, especially after a late start? Truth be told, I was a little puzzled, too, until I analyzed our cash flow. The secret wasn���t an oversized gain on smartly picked stocks, nor was it financial windfalls. Instead, it was that we lived far below our means.
Frugality was ingrained in me, thanks to my parents. They also imparted many other sound money habits that have paid off bigtime throughout my life. I had been able to handle money responsibly and keep expenses in check since my schooldays. Growing up in a middle-class family in India, I also learned to abhor debt. Paying off a loan always felt like an accomplishment.
Our low expenses helped in two ways. First, we didn���t need a large nest egg to support our modest lifestyle. Second, our supercharged savings rate, which typically ran at least 60% of our household���s after-tax income, quickly got us to our number���what we needed for financial security. The compound growth of our dollar-cost-averaged investments did its magic.
To be clear, our financial situation was far from rock-solid, especially for an early retiree. The plan could���ve backfired. But I wanted to take my chances, knowing that I could reverse course if things didn���t work out. My wife didn���t intend to stop working in the near future. That, and the flexibility of my plan, made things easier.
As I approached my 50th birthday, I broached the subject of retirement with my supervisor. His brilliant suggestion turned out to be the best financial guidance I���ve ever received: He advised me to gradually reduce my work hours rather than stop abruptly. I took him up on his offer.
Switching to a part-time role at age 50 has worked out well, and I still love it. I get the extra time for my personal interests. Without the pressure of a high-powered career or the feeling that I���m dependent on a paycheck, I enjoy my work more. My modest spending habits may not appeal to others���but they���ve bought me one of life���s greatest luxuries, which is financial freedom.
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.The post Freed by Frugality appeared first on HumbleDollar.
Treading Gingerly
AS INTEREST RATES head higher, where should bond investors turn?
A lot of ink has been devoted to Series I savings bonds���for good reason. The initial yield, which applies to bonds bought through April, is north of 7%. Come May 1, it might go even higher if the inflation rate continues to climb. The recent energy price surge wasn���t fully reflected in February���s Consumer Price Index, so the coming months��� reports could be even more alarming.
Problem is, there���s a limit to how much you can invest in Series I bonds, which are sold through TreasuryDirect. The annual purchase cap is $10,000. You can also put up to $5,000 of your federal income-tax refund into I bonds, though you must take delivery of physical bonds. You then have the option of converting them to electronic form.
What if you have even more money to stash in bonds? Check out short-term Treasury exchange-traded funds (ETFs). Right now, you can buy iShares iBonds Dec 2024 Term Treasury ETF (symbol: IBTE) and earn a respectable, safe yield to maturity of around 2.2% a year over the next two-plus years. That beats the pants off a high-yield online savings account, which might offer a measly 0.5%. Other choices include the iShares 1-3 Year Treasury Bond ETF (SHY) and Vanguard Short-Term Treasury ETF (VGSH).
Why is there such a large yield gap between savings accounts and very low-risk Treasury funds? Short-term Treasury rates have jumped recently as the Federal Reserve starts to raise rates. The two-year Treasury rate, which was 0.2% six months ago, has vaulted above 2.1%. Another reason for the surge in near-dated maturities is the rapid rise in two-year inflation expectations. They were near 3.3% in mid-February and are now just shy of 5%.
Rates on the long end of the Treasury curve haven���t seen that kind of volatility. They also don���t offer much of a yield premium. The iShares 25+ Year Treasury STRIPS Bond ETF (GOVZ) yields just 0.3 percentage point more than the low-duration iShares 2024 fund mentioned above. A lower duration means you���ll suffer less should market yields rise. The effective durations are 2.2 years for the iShares 2024 fund and 27 years for the iShares 25+ fund. That means that, for every one percentage point rise in market interest rates, the 2024 fund will lose about 2.2%, while the more rate-sensitive iShares 25+ fund will decline by a whopping 27%.
As rates rise from here, investors should keep reviewing their bond and cash investments. Owning a short-term Treasury ETF strikes me as a good choice right now, but that may change if yields spike higher across the bond market.
Some investors believe that owning bond ETFs and mutual funds, rather than individual bonds, is a mistake. I take issue with that. There���s a fallacy out there that bond funds are extra risky since a bond fund typically never matures, unlike an individual bond, which can be redeemed at maturity for its par value.
But consider this: A bond fund is comprised of individual bonds. Whether you own a basket of individual bonds or a bond fund, it���s essentially the same thing. Sure, when interest rates rise, a bond fund���s price drops���but so, too, does the price of an individual bond. In both cases, you���re looking at a potential loss if you need to sell right away. But when market interest rates rise, the bond fund offers a key advantage: It automatically invests proceeds from maturing bonds into new, higher-yielding bonds, plus it���s easy for shareholders to reinvest the interest they receive in additional fund shares.
Looking to invest in today's bond market? Keep these four pointers in mind:
Think about shifting from savings accounts to a short-term Treasury fund now that rates have perked up.
Find out the yield to maturity for the bond funds you���re interested in. That���s a good guide to your likely return.
Check a fund���s duration. If a fund has a high duration, it���ll be roughed up by rising interest rates. Today���s low yields will likely provide scant compensation.
Tempted to buy corporate bonds, with their higher yields? Remember, you���re taking credit risk. You���ll receive extra interest for assuming that risk���but those bonds will also fall harder than Treasurys if the economy starts to slow.
Mike Zaccardi is a freelance writer for financial advisors and investment firms. He's a CFA�� charterholder and Chartered Market Technician��, and has passed the coursework for the Certified Financial Planner program. Mike is also a finance instructor at the University of North Florida. Follow him on Twitter @MikeZaccardi, connect with him via LinkedIn, email him at MikeCZaccardi@gmail.com��and check out his earlier articles.
A lot of ink has been devoted to Series I savings bonds���for good reason. The initial yield, which applies to bonds bought through April, is north of 7%. Come May 1, it might go even higher if the inflation rate continues to climb. The recent energy price surge wasn���t fully reflected in February���s Consumer Price Index, so the coming months��� reports could be even more alarming.
Problem is, there���s a limit to how much you can invest in Series I bonds, which are sold through TreasuryDirect. The annual purchase cap is $10,000. You can also put up to $5,000 of your federal income-tax refund into I bonds, though you must take delivery of physical bonds. You then have the option of converting them to electronic form.
What if you have even more money to stash in bonds? Check out short-term Treasury exchange-traded funds (ETFs). Right now, you can buy iShares iBonds Dec 2024 Term Treasury ETF (symbol: IBTE) and earn a respectable, safe yield to maturity of around 2.2% a year over the next two-plus years. That beats the pants off a high-yield online savings account, which might offer a measly 0.5%. Other choices include the iShares 1-3 Year Treasury Bond ETF (SHY) and Vanguard Short-Term Treasury ETF (VGSH).
Why is there such a large yield gap between savings accounts and very low-risk Treasury funds? Short-term Treasury rates have jumped recently as the Federal Reserve starts to raise rates. The two-year Treasury rate, which was 0.2% six months ago, has vaulted above 2.1%. Another reason for the surge in near-dated maturities is the rapid rise in two-year inflation expectations. They were near 3.3% in mid-February and are now just shy of 5%.
Rates on the long end of the Treasury curve haven���t seen that kind of volatility. They also don���t offer much of a yield premium. The iShares 25+ Year Treasury STRIPS Bond ETF (GOVZ) yields just 0.3 percentage point more than the low-duration iShares 2024 fund mentioned above. A lower duration means you���ll suffer less should market yields rise. The effective durations are 2.2 years for the iShares 2024 fund and 27 years for the iShares 25+ fund. That means that, for every one percentage point rise in market interest rates, the 2024 fund will lose about 2.2%, while the more rate-sensitive iShares 25+ fund will decline by a whopping 27%.
As rates rise from here, investors should keep reviewing their bond and cash investments. Owning a short-term Treasury ETF strikes me as a good choice right now, but that may change if yields spike higher across the bond market.
Some investors believe that owning bond ETFs and mutual funds, rather than individual bonds, is a mistake. I take issue with that. There���s a fallacy out there that bond funds are extra risky since a bond fund typically never matures, unlike an individual bond, which can be redeemed at maturity for its par value.
But consider this: A bond fund is comprised of individual bonds. Whether you own a basket of individual bonds or a bond fund, it���s essentially the same thing. Sure, when interest rates rise, a bond fund���s price drops���but so, too, does the price of an individual bond. In both cases, you���re looking at a potential loss if you need to sell right away. But when market interest rates rise, the bond fund offers a key advantage: It automatically invests proceeds from maturing bonds into new, higher-yielding bonds, plus it���s easy for shareholders to reinvest the interest they receive in additional fund shares.
Looking to invest in today's bond market? Keep these four pointers in mind:
Think about shifting from savings accounts to a short-term Treasury fund now that rates have perked up.
Find out the yield to maturity for the bond funds you���re interested in. That���s a good guide to your likely return.
Check a fund���s duration. If a fund has a high duration, it���ll be roughed up by rising interest rates. Today���s low yields will likely provide scant compensation.
Tempted to buy corporate bonds, with their higher yields? Remember, you���re taking credit risk. You���ll receive extra interest for assuming that risk���but those bonds will also fall harder than Treasurys if the economy starts to slow.
Mike Zaccardi is a freelance writer for financial advisors and investment firms. He's a CFA�� charterholder and Chartered Market Technician��, and has passed the coursework for the Certified Financial Planner program. Mike is also a finance instructor at the University of North Florida. Follow him on Twitter @MikeZaccardi, connect with him via LinkedIn, email him at MikeCZaccardi@gmail.com��and check out his earlier articles.
The post Treading Gingerly appeared first on HumbleDollar.
March 24, 2022
Nice Problem to Have
THERE ARE TWO THINGS that Americans loathe paying: taxes and health care costs. When those two come together, watch out.
That brings us to IRMAA, short for income-related monthly adjustment amount, the steeper Medicare premiums paid by retirees with high incomes. Those who pay IRMAA are often livid about the extra cost.
I looked up my Social Security records. Over my working career, I paid $98,062 in Medicare taxes and my employer paid $97,735, for a total of $195,797. Yes, that���s a lot of money. But my wife, who didn���t have any earned income after 1970 and thus paid minimal Medicare taxes, has incurred bills paid by Medicare well in excess of $300,000.
Many retirees can say the same and most paid far less in Medicare taxes than I did. Keep in mind that the current taxes funding the Medicare hospital trust are inadequate. The trust will run out of money in about four years. The standard Medicare Part B premiums only fund about 25% of the program���s costs. The balance comes from general federal government revenue.
In that context, the IRMAA surcharges don���t seem so terrible. Yet, when I pointed out to a group of retirees that the income-based premiums affected only 7% of retirees, many weren���t impressed. Many also discounted the fact the premiums start at $91,000 for individuals and $182,000 for couples, well above the typical U.S. household income.
Here are some of the replies I received from various Facebook groups:
���I think Medicare and IRMAA are a scam.���
���Considering that all those years I paid the maximum into Social Security and Medicare and now am having Social Security taxed but also having Social Security income increasing my IRMAA, it just wasn���t worth it to me.���
���I consider it a federal fine for being successful.���
Affluent current and future retirees seek ways to avoid or limit IRMAA. One strategy is to fund Roth accounts or to make Roth conversions two years in advance of Medicare. Tax-free distributions from Roths aren���t counted when determining income for IRMAA purposes, but tax-free municipal bond interest is. Go figure.
I think keeping your income low to avoid paying $816 a year more in Part B premiums���that���s the sum if you breach the first IRMAA income threshold���is a losing proposition. But this Facebook commenter didn���t think so: ���The last thing you want is to make $1 more than the [IRMAA] bracket. That's really feeling screwed.���
Yes, IRMAA is a so-called cliff penalty. Even if you���re just $1 above the threshold amount, you get charged the full extra premium for that income level. The premium surcharges could have been better designed. Still, is it so unreasonable for high-income retirees to pay more for Medicare?
That brings us to IRMAA, short for income-related monthly adjustment amount, the steeper Medicare premiums paid by retirees with high incomes. Those who pay IRMAA are often livid about the extra cost.
I looked up my Social Security records. Over my working career, I paid $98,062 in Medicare taxes and my employer paid $97,735, for a total of $195,797. Yes, that���s a lot of money. But my wife, who didn���t have any earned income after 1970 and thus paid minimal Medicare taxes, has incurred bills paid by Medicare well in excess of $300,000.
Many retirees can say the same and most paid far less in Medicare taxes than I did. Keep in mind that the current taxes funding the Medicare hospital trust are inadequate. The trust will run out of money in about four years. The standard Medicare Part B premiums only fund about 25% of the program���s costs. The balance comes from general federal government revenue.
In that context, the IRMAA surcharges don���t seem so terrible. Yet, when I pointed out to a group of retirees that the income-based premiums affected only 7% of retirees, many weren���t impressed. Many also discounted the fact the premiums start at $91,000 for individuals and $182,000 for couples, well above the typical U.S. household income.
Here are some of the replies I received from various Facebook groups:
���I think Medicare and IRMAA are a scam.���
���Considering that all those years I paid the maximum into Social Security and Medicare and now am having Social Security taxed but also having Social Security income increasing my IRMAA, it just wasn���t worth it to me.���
���I consider it a federal fine for being successful.���
Affluent current and future retirees seek ways to avoid or limit IRMAA. One strategy is to fund Roth accounts or to make Roth conversions two years in advance of Medicare. Tax-free distributions from Roths aren���t counted when determining income for IRMAA purposes, but tax-free municipal bond interest is. Go figure.
I think keeping your income low to avoid paying $816 a year more in Part B premiums���that���s the sum if you breach the first IRMAA income threshold���is a losing proposition. But this Facebook commenter didn���t think so: ���The last thing you want is to make $1 more than the [IRMAA] bracket. That's really feeling screwed.���
Yes, IRMAA is a so-called cliff penalty. Even if you���re just $1 above the threshold amount, you get charged the full extra premium for that income level. The premium surcharges could have been better designed. Still, is it so unreasonable for high-income retirees to pay more for Medicare?
The post Nice Problem to Have appeared first on HumbleDollar.
