Jonathan Clements's Blog, page 228
February 24, 2022
Cheap Talk
I���M FASCINATED by frugality. Being frugal is not the same as being cheap, though���based on what I read about some people who claim frugality���it sounds to me like they are indeed being cheap.
We���re told frugality adds to the quality of life, that it creates a less stressful, less materialistic existence. Being frugal is fine, but living frugally because it���s a necessity���especially in retirement���not so much. Is a minimalist lifestyle all that satisfying?
I think being frugal is a misnomer. What we actually mean is being prudent with our money, living within our means, and not being extravagant or wasteful. In the end, the money we claim to be saving as a result of our frugality is going to be spent in some way. If you choose to live frugally, should there be a purpose, a long-term goal? If not, why do it in the absence of financial necessity?
It all boils down to my simple formula: Take your after-tax income, save what you need for a secure future, never carry a credit card balance and spend what���s left of your pay in any way you like.
When I shop for coffee K-cups, I only buy those on sale, even if they aren���t my favorite brand. I���m not paying $10 for 10 cups of coffee. Am I frugal? I rarely buy from Omaha Steaks. But if there's a so-called sale, I might. Is that frugal?
I���m thinking neither is frugal. Why buy K-cups except for convenience? Similarly, I could buy beef less expensively if it wasn���t shipped from Nebraska.
My grandfather removed every piece of tinsel from the Christmas tree, placed it in a box, and used it year after year. I never heard him use the word frugal. It was more like, don���t waste anything. In my grandparents��� day, that���s how most people lived���waste not, want not.
There's a no-name, cash-only gas station near me. It always has a line of cars waiting for gas. Sometimes, they call the police for traffic control. What amazes me is that the line of cars includes many BMWs, Mercedes, Porsches and similar cars. Do we call that frugality���saving 20 cents a gallon when you own a car that requires premium gas? Not in my book.
I recently read a discussion about a leather chair that had torn arms and seat, so the stuffing was falling out. The question was, have it repaired, throw it out or simply use a slipcover? Slipcover was the frugal choice. I can just hear that discussion in my house. ���It���s not that bad, hon, just put a slipcover on it.��� My wife���s response: ���Get the car, we���re going shopping.���
There are those who see frugality as a challenge, even if it isn���t a necessary one. Others see it as some kind of badge of honor���I can live more cheaply than you can. That���s fun?
Some people retire really early, expecting to live on their investments for the next 40 or 50 years. To do so, they apply the frugality strategy. Is it worth the tradeoff? Others see frugality as a way to slow down, to live simply on less money. Or are they simply living within their means?
Buying used toys and clothes for your kids��� presents seems extreme to me. My preference would be buying fewer but new gifts. Shopping in thrift shops, cutting your own hair and spending hours looking for deals to save a few dollars may be acceptable to some. But I���ll pass on the Dollar Store canned tuna from a country I���ve never heard of.
On the other hand, I have purchased brand name���and not out of date���snacks for $1 at the Dollar Store. Why not? Why was I in the Dollar Store? It has greeting cards for a dollar. Now, that���s a bargain.
True, when I���m walking down the supermarket aisles, I keep an eye out for sales. But that also means I buy stuff I don���t really need. I have frequent shopper apps on my phone that I use, but I���m not spending hours clipping coupons.
I received an e-mail from a frugal aficionado. In part it read, ���You spend less money, so you have more money and you don���t have to stress about money because you don���t need very much of it in order to live the good life, but hey, you have more of it anyway!��� There���s a logic in there, I suppose���but I���m still looking. I���m thinking the good life is in the eye of the beholder.
It all boils down to balance. Neither extreme frugality nor extravagance is desirable. Neither brings true happiness in my book.
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.
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February 22, 2022
Chewing It Over
I had forgotten my own story of enough, until I was reminded about it recently by my old boss.
Twenty-four years ago, my boss asked me to move to a different state to run a portion of a manufacturing plant. This was the time-honored step necessary to be considered for promotion to director or vice president of manufacturing. Without that plant leadership experience, my career would be severely limited.
I politely turned down the offer to move. My boss reminded me that my career would probably plateau without this additional experience. He wanted to know how I could turn down this wonderful opportunity.
I replied that I love real maple syrup. We seldom had it growing up. But now, every weekend, I made pancakes or waffles and ate them with real maple syrup.
My boss asked me what maple syrup had to do with the job offer. I replied that I was now sufficiently well off that I could afford real maple syrup for the rest of my life—and so, while I appreciated his confidence in my abilities, I was happy with my current career path.
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22 Tax Season Tips
WILL YOU BE WORKING with a CPA to file your tax return? For eight years, I was one of the folks on the other side of this annual ordeal. Want to make life easier both for yourself and for us green-shade types? Here are 22 insights:
1. Time is money. CPAs sell expertise by the hour. They track everything they do, all day long, in six-minute increments—or perhaps 15. For the business to survive, it must convert time into revenue. It helps to look at the next 21 insights through that lens.
2. Buying insurance. CPAs envy investment advisors, who get paid by drawing a fee right out of your investment account, with no action required on your part. It hurts more to open a bill and write a check. Working with a CPA is like carrying insurance. Most of the time, it won’t feel like it’s worth it—until it does, and then it’ll feel like a steal.
3. Go team. At least two people will likely work on your account—a signer with more experience and a preparer with less. It’s necessary for the propagation of the profession. Embrace the team approach and consider yourself a part of it.
4. Help wanted. Don’t forget there’s another member of the team—the IRS. A lack of funds and staff, antiquated technology and too many responsibilities have left the IRS heading into the 2022 tax season with a backlog of 24 million returns. You will feel this, and your CPA will, too.
5. Working the papers. Your CPA wants to use your tax documents to create workpapers. A complete set should coherently tell the tax return’s story to someone with no prior knowledge—like an IRS auditor, for instance. Provide clear documentation, and you can help your team reach the workpaper promised land sooner.
6. Email etiquette. When your CPA emails a list of questions, remember that he or she is just trying to speed the progress to the promised land. If you can reply with complete answers, you help create the workpapers—saving your CPA time and saving you money. Hint: It takes more time to transcribe phone messages.
7. Call when it’s complicated. It’s better to discuss complex matters on the phone. Your CPA’s tax season challenge is balancing communication time with enough quiet, focused time to get the job done by the deadline. Scheduled phone calls are more efficient than impromptu calls.
8. It’s a marathon—and a sprint. We’re talking 60-hour weeks, tracked in six-minute increments, that last for three consecutive months. Humans can’t do that with a uniform level of focus and production. You may notice fluctuations.
9. Get organized. Group and order your tax documents when submitting them to your CPA. For example, try something like this: W-2s, brokerage account 1099s, retirement account withdrawal 1099-Rs, summary of rental income and expenses, mortgage interest 1098, charitable donation letters.
10. Provide a summary. Create a simple lead sheet that summarizes all documents. Keep the same format each year and highlight any new or unusual items. For accountants, it’s incredibly helpful to see the big picture at a glance, so they can compare it to the prior year and check the tax return for completeness.
11. Send everything. Include every page of the tax documents you receive—even the pages that might seem unnecessary. If you leave one out, your CPA will have to ask you for it.
12. Answer the questions. Complete your CPA’s pesky questionnaire the best you can. Even though you’re already sending all the tax documents you know about, this list is designed to catch those easily overlooked details that are pertinent for tax compliance. Besides, the firm’s professional liability carrier makes the firm do it.
13. One and done. Don’t send in your tax documents until you have everything—or, at least, almost everything. Multiple piecemeal submissions take up extra time and increase the chances of leaving something off the return by mistake.
14. No oversharing. Yes, supply complete tax information, but use discretion and don’t overshare. Do you really want to pay your CPA to do the sorting and summations that you can do on your own? Use the deduction categories from Schedule C or E to create summaries of business or rental income and expenses.
15. Favor simplicity. If you have brokerage accounts with multiple investment custodians, consider consolidating everything at one firm. It’ll reduce the volume of 1099s, making tax compliance more efficient and, as an added bonus, simplifying your portfolio management.
16. Extending the agony. You can request a six-month tax-filing extension, but that doesn’t change the payment deadline. That means your CPA must do enough work before the April deadline to calculate an accurate tax liability.
17. Schedule K-1. If you own an interest in a partnership, limited liability company or S corporation, you can’t file your tax return until you have the K-1 that reports your share of the flow-through income, deductions and other tax info. If the entity extends, then you must, too—and, in the meantime, use the best available estimates to calculate your tax liability. When the K-1 eventually arrives, your CPA will have to revisit the work that resulted in the initial tax estimate and integrate the new details.
18. Private pain. Over the past decade, private equity firms have made a push downstream from institutional investors to individuals. If there weren’t enough reasons to be wary already, don’t invest unless you’re willing to accept the extra complication and cost of tax compliance for these limited partnership interests.
Compared to the straightforward 1099 reporting of a mutual fund or exchange-traded fund, your CPA must parse far greater detail to properly report the multiple types of income, deductions, gains, losses, and supplemental information included in these private equity K-1s. Extra compliance tasks include applying passive loss limitations, preparing tax basis schedules, calculating the qualified business income deduction, evaluating potential state filing requirements, and working through onerous foreign informational reporting mandates which ramp up to a new level of scrutiny in 2022 with the introduction of the Schedule K-3.
19. Master limited partnerships. Energy infrastructure MLPs are often touted as a great source of yield. Just know they’re also a great source of tax headaches. Yes, they’re traded on an exchange, but they are classified as publicly traded partnerships. That means they report on a K-1, triggering most of the same issues as private equity, but with even more restrictive passive loss limitations.
20. In them you trust. Do your homework to choose a CPA you can trust—and then trust him or her. Questions asked in a spirit of collaboration will enhance the relationship. But if you constantly press your CPA to defend his or her decisions, your accountant won’t enjoy working with you.
21. Matters of judgment. Your CPA signs his or her name to your tax return—putting professional credibility on the line. The tax code is complicated and sometimes gray. Expect your CPA to exercise professional judgment and take this responsibility seriously.
22. Be kind. Enjoy getting to know your CPA. Ask about family and interests. He or she will want to know about yours. Any self-respecting CPA won’t charge you for this chat time. And you’ll get better service. We all want to look after our friends.
Matt Christopher White is a CPA and CFP® who writes about money and apprenticeship to Jesus. You can get his book “How to Love Money: Four Paradoxes that Breathe Life Into Your Finances” at MattChristopherWhite.com. Follow Matt on Twitter @WriteMattWhite and check out his earlier articles.The post 22 Tax Season Tips appeared first on HumbleDollar.
How It Happens
THERE���S A SCENE in Three Days of the Condor, that very ���70s, America-in-decline movie, where the CIA is the bad guy and Robert Redford���s character is in danger of imminent extinction.
Max von Sydow���s character Joubert���the Alsatian assassin���warns him that he has ���not much future.��� Then he calmly describes how the CIA will come for him.
���It will happen this way,��� Joubert says. ���You may be walking. Maybe the first sunny day of the spring. And a car will slow beside you, and a door will open, and someone you know, maybe even trust, will get out of the car. And he will smile, a becoming smile. But he will leave open the door of the car and offer to give you a lift.���
Let me paraphrase Joubert and tell you from experience how Mr. Market will occasionally come for you and try to kill your financial future.
First, the market will fall far enough that investors start to be concerned. Not you necessarily, but some chatter begins. Worries are expressed. Theories are floated explaining why the market is down, and going to fall further. ��
Today, that might be the inflation narrative. Both stocks and bonds are down in 2022. At one point in January, the S&P 500 was off 10% from its high. But you know that happens to stocks every other year, on average. You buy the dip.
Less frequently, the market will fall 15%. Now those predictions of big trouble get louder and more convincing. Still, you���ve seen this before. You buy more. Like Redford���s character���codenamed Condor���you���re still one step ahead.
But once in a while, the market will drop 20%, then 30%. And at least once in your investment career, the bottom will seem to fall out. In mine, I���ve lived through:
2000-02, when the shares in the S&P 500 fell 49%. The index is now more than 700% higher, including dividends.
2007-09, down 57%. It���s again more than 700% higher.
February-March 2020, down 34%. It���s now 100% higher.
The further the market falls, the more prescient the doomsayers look. What are they saying now?��That your past gains were based on easy money. It���s all a house of cards. America was living on borrowed money and borrowed time. Twenty-five-year-old crypto billionaires? Meme stock millionaires? You should have seen our comeuppance coming.
��
Hedge fund billionaire and author Ray Dalio contributes a doomsday scenario: America could collapse within 10 years because of populism, inflation and war. This time, the market won���t recover.
Maybe those close to you start sounding the alarm, too. How will we ever retire? You feel like you better get this right. You may be ready to accept a ride from a friendly face and drive away from trouble.
Maybe you���ll listen to a friend who sold everything when the news turned scary. Why didn���t you? Or perhaps a familiar Wall Street strategist or TV commentator will suggest bailing out. Or a legendary hedge fund manager in the high-brow financial press.
They���ll say you can sidestep further declines, that buy-and-hold is dead. They���ll say you need to be in Chinese shares, gold, commodities���all the usual suspects. Maybe crypto is the future after all. Your own ego begins to convince you that you can call the next move.
Stocks are obviously headed lower. It���s time to sell, to get a ride out of Dodge, even if just for a little while. This is exactly where Mr. Market wants you.
Everything you think you know about what���s coming next was planted in your head: It took root because it seemed to explain the recent past. This is how Mr. Market, with all his multiple personalities at cross-purposes, weeds out the weak and the wrongfooted.
Yes, Mr. Market can be your best friend, compounding your wealth over decades. But he���s also a remorseless assassin, occasionally���inevitably���destroying fortunes large and small, destroying the financial futures of the greedy and the innocent alike.
But just like Three Days of the Condor, this is a movie we���ve seen before. The lessons of market history: Betting on a worst-case scenario is a bad bet. The market has always come back. Don���t risk selling near the lows, the point of maximum fear.
In all likelihood, you will suffer a permanent loss of capital as you miss the rebound because the market is never going to seem safe until a new bull market is well underway. Then you may hear Joubert���s words: ���You were quite good, Condor, until this. This move was predictable.���
William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart��and check out his earlier articles.
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February 21, 2022
No I for Me
Sure, at first glance, 7% sounds enticing. But after a detailed review, it all sounds like a marketing pitch worthy of Uncle Ron Popeil rather than Uncle Sam.
Series I savings bonds purchased before May 1 are guaranteed to yield 7% for the first six months. But after that, they reset to a combination of a fixed rate, which applies for the 30-year life of the bond, and the semiannual inflation rate. The fixed rate is 0% for the current offering period, so���if you hold the bonds for 30 years���you���ll merely keep up with inflation.
Annual purchases of Series I bonds are limited to $10,000 (plus up to an additional $5,000 if you use a federal tax refund to make a purchase). Since you can���t buy savings bonds through your brokerage account, you have to create a separate financial account for your investment���or two if you want to ���max out��� this proposition by including your spouse.
And oh, by the way, if you die prior to collecting, make sure your heirs know about your latest investment scheme. Since one of the benefits of Series I bonds is that no interest is paid and therefore no taxes are owed until you redeem them, there���s no 1099 to alert your heirs to their windfall. Think you���re too savvy to let that happen? Well, there���s $29 billion in paper savings bonds that have matured but which the owners haven���t bothered to cash in. We may live in a digital age, but I wouldn���t count on the Treasury tracking down your heirs.
I guess there���s safety in knowing that your $10,000 will keep up with inflation. But to me, it all seems like a giant pain in the neck. I already have too many accounts to keep tabs on. Do I really need one more that has only $10,000 in it? Also, why does the Treasury limit your investment to $10,000? Is it to prevent you from taking advantage of the Treasury or is it to prevent the Treasury from taking advantage of you? It reminds me of those commercials touting the Ronco Pocket Fisherman���"only one to a customer."
Whoever thought this up at the Treasury should be given a raise: offer an introductory teaser rate, then pay interest equal to the rate of inflation for 30 years, pay this interest on the back end and, if the owner dies in the meantime, maybe never pay it at all.
That���s all��I have to say about that. Instead, I���d rather spend my time talking about something a little more lucrative. Still willing to open a new account to put that $10,000 to work? I recommend depositing your $10,000 at tastyworks brokerage for three months. You���ll be rewarded with $500, easily outpacing inflation.
I opened an account a month ago. In two months, I���ll be $500 richer. But in the meantime, maybe I should let my wife know the details���just in case.
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Foreign Affairs
A sore spot for international investors has been small-cap stocks. Vanguard FTSE All-World ex-U.S. Small-Cap ETF (VSS) is down 7%. The fund holds both developed and emerging markets stocks.
Developed foreign market indexes are dominated by countries from Europe and the Pacific region, with Canadian shares sometimes also included. I like to geek-out on the sector composition of various exchange-traded funds (ETFs). The Vanguard FTSE Developed Markets ETF has an 18% weight in the financial sector and 15% in industrials stocks. Growth sectors like information technology and consumer discretionary make up about 20% of the fund. By contrast, the U.S. stock market has 38% in those two sectors.
Looking for exposure to value stocks, such as those in the financials and industrials sectors? You might be well served by owning an international developed markets fund.
What does Vanguard FTSE Emerging Markets ETF look like under the hood? It���s not that much different from the foreign developed markets fund, though it does have more exposure to the information technology and consumer discretionary sectors, thanks to its large 53% exposure to China and Taiwan. The Vanguard emerging markets fund offers a relatively top-heavy portfolio, with more than 14% in its top three positions: Taiwan Semiconductor, Tencent and Alibaba. By comparison, the largest holding of Vanguard Developed Markets ETF is Nestle at just 1.5%.
As for valuations, the developed markets fund sports a 14.3 price-earnings (P/E) ratio, while the emerging markets fund is even cheaper at just 12.3. The U.S. market is much pricier right now, with a P/E ratio of 21.8. You can dive into these figures yourself on sites like Vanguard.com and Fidelity.com. Forward��valuations also indicate foreign markets are cheap.
Most of us have a home bias, but the numbers say we shouldn���t ignore overseas stocks. The global stock market, valued at more than $100 trillion, is about 40% foreign markets. While a 100% U.S. allocation worked well in the 2010s, this year offers a warning���that perhaps that sort of one-sided portfolio won���t always look so smart.
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View From the Top
By all objective criteria, this high-income crowd should be thrilled with their financial gains over the past three years. But instead, it seems they���re nervous about everything from an extremely tight labor market to rising inflation, both of which are contributing to rising business costs. How nervous? A recent American Association of Individual Investors��� survey of investor confidence found that sentiment was the most bearish it���s been since 2013.
I know, I know, you���re reading this and thinking, ���Poor little rich girl���or boy.��� But we need to monitor this group���s economic temperature. A downturn in confidence among the top decile of wealth in the U.S. could cause damaging economic ripples.
Let me first explain who I���m talking about. The new aristocracy is made up of corporate management, physicians, small business owners, partners at professional firms, tech developers, digital media mavens, dentists, police and fire veterans, architects, contractors (I see you, plumbers) and engineers. Full disclosure: I belong to this tribe. I suspect many���and perhaps most���HumbleDollar readers do, too.
Household gross income for this top decile begins at approximately $130,000, based on the Census Bureau���s ASEC survey, as compiled by the site DQYDJ. The value of their assets has exploded. According to Federal Reserve data, the top 10% of American households now own 89% of all stocks, the highest share on record.
Credit Suisse releases a global wealth report every year. According to the report, ���The contrast is most evident in the wealth share of the top 10% of wealth holders, which has risen substantially in the United States since 2007���from 71.6% to 75.7%.��� Galloping home-price appreciation has contributed to this group���s rising share of total wealth.
Soaring share prices have been another major contributor. The U.S. stock market has been nothing short of a rocket for the past three calendar years, with the S&P 500 clocking gains of 29%, 18% and 31%, including reinvested dividends, before retreating a little in 2022. Since 89% of the stock market is owned by the top 10% of Americans, presumably the upper class are seeing their net worth grow by leaps and bounds.
But has it? While that may be true in aggregate, my sense is that not everybody in the top 10% is feeling fat and happy. For instance, I spoke with a physician who told his broker to dump all of his stocks in February 2020. I haven���t asked him whether he���s gone back into the market. I suspect he hasn���t because he���s deeply skeptical of the stock market���and he isn���t alone. Many other affluent workers have listened to financial quacks on YouTube, or even widely quoted investment strategists like Jeremy Grantham, who say an apocalyptic crash is right around the bend. For the record, Grantham���s investment firm, GMO, has been bearish since 2013.
Even if folks own stocks, there���s a good chance their results don���t look like the S&P 500 because they had substantial money in other market sectors. Most of the affluent I���ve spoken to have financial advisors who���ve done exactly what their clients have asked: put them in conservative, well-diversified portfolios. The result has been relatively paltry gains.
Meanwhile, some have gone in the opposite direction. Perhaps they piled into exchange-traded funds from ARK Invest after the huge run-up in tech, arriving just in time for the decline. Maybe they chased performance in cryptocurrencies, only to suffer hefty losses. As Warren Buffett has noted, emotional steadiness���not intelligence���is a better predictor of an investor���s performance.
On top of that, while we assume that high income correlates with wealth building, it may instead be associated not just with foolish investments, but also with high spending. Fear of missing out and fear of losing it all are emotions that don���t discriminate based on income.
What���s my advice for those who find themselves in the ���new aristocracy,��� but feel like they aren���t enjoying the prosperity they should? First, take a step back and be grateful. Pew Research shows that the global middle class lives on $10 to $20��a day. We have access to running water, electricity, plenty of food, shelter and sanitation, things my parents never took for granted when they lived in Bangladesh before emigrating to the U.S.
Second, understand that loss aversion is a powerful heuristic that plays tricks on the mind and can leave us feeling miserable in the short term. Don���t fall for it. Embrace your inner Buffett���both Warren and Jimmy���and keep calm. A balanced portfolio won���t sail the fastest in calm waters, but fares well during stormy markets. This year appears to be stormy.
Third, if you���re middle-aged, you may be in the trough of overall happiness. As Scott Galloway notes in his book, The Algebra of Happiness, satisfaction with life bottoms some time in our 50s and then skyrockets up as we approach our 60s and 70s. Happier days may lie ahead.
Tanvir Alam has been practicing corporate law for more than two decades, but you shouldn���t hold that against him. He lives in New York���s Hudson Valley with his patient wife and two skeptical teenagers. Tanvir is interested in personal finance and travel, and is trying desperately to become a runner. Follow him on Twitter @Docket75. Tanvir's previous article was Measuring Up.The post View From the Top appeared first on HumbleDollar.
February 20, 2022
After You Leave
All this information relates to the retiree. Rarely���actually never���have I seen a discussion about survivor benefits. Even the 4% rule uses an assumed 30-year retirement period, apparently ignoring the possibility that retirement income needs to last over two lifetimes that may extend beyond 30 years, a distinct possibility if one partner is several years younger.
I���m sensitive to this issue because, during my working years, I received many calls from new widows asking about their survivor pension. Often, there was none because their husbands had selected to receive income only over their life, with no survivor benefit. Times have changed, of course. There are new laws to protect spouses, plus many couples have dual incomes. But at the same time, retirement is more the individual���s responsibility than ever before.
Given the reported dismal state ��of retirement planning, I wonder if people are thinking about dual lifetimes. Couples should have detailed discussions about how much income there will be after the first spouse dies.
Does each spouse have their own income source? Are they drawing from a single pool of retirement assets? To what extent do they count on Social Security? What���s the age difference between the couple?
I have both a qualified and nonqualified pension. I selected a 50% joint-and-survivor annuity for one and 75% for the other, meaning my wife will receive half and three-quarters of these two pensions, should I die first. Opting for the survivor annuities reduced the monthly payout on the two pensions, but the reduction was worth the peace of mind. On top of that���and contrary to conventional wisdom about dropping coverage as you grow older���I maintain life insurance equal to about two years of expenses. My wife will also have access to our investments.
It���s all a bit conservative, I admit, but I don���t want my wife worrying about money, even if she should require long-term care, and I don���t want to create a financial burden for our children. Want to make sure a surviving spouse has enough money? Here are five pointers:
Plan on Social Security survivor benefits, but remember that���upon the death of the first spouse���your household���s total Social Security benefits could drop by a third or more.
Ensure accumulated assets are sufficient for two lifetimes, and perhaps longer than the often-assumed 30-year retirement.
When selecting pension coverage, choose the survivor option.
For additional lifetime income, consider using part of your retirement nest egg to purchase an immediate annuity that pays income over both of your lifetimes.
Purchase life insurance so the surviving spouse receives a lump sum upon the other spouse���s death.
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Await the All-Clear?
As you might guess, the reason these statistics are cited so frequently is to caution investors against trying to time the market���jumping in and out in an effort to sidestep downturns. It���s an important message because market timing can be so tempting, especially in a year like we���re currently experiencing. Both stocks and bonds have lost money, and many are worried that it could get worse. Folks are warily eyeing the Federal Reserve, on the one hand, and Vladimir Putin, on the other. Investors could be forgiven for entertaining the idea of a little market timing.
That���s why I think it���s useful to understand the stock market���s behavior in as much detail as possible. Coming back to the question I received���about the impact of missing a few of the market���s best days���I realize that these statistics are counterintuitive. Five days out of 30 years translates to less than 0.1% of trading days. How could such a tiny fraction of days have such an outsized effect on long-term returns? It helps to examine the dynamics that underlie these statistics.
Maybe the most important dynamic: In the stock market, it���s often at the point when things look most discouraging that they begin to improve, sometimes rapidly. Veteran investor Jeremy Grantham��cites��the Great Depression as an example. In 1933, when unemployment was still rising and the economy was by no means out of the woods, the S&P 500 rose 105% in just five months. A similar move occurred during the doldrums of the 1970s.
Also consider 2020. The stock market began to recover in the spring, even when it was virtually impossible to see any light at the end of the tunnel. Schools and businesses were still shuttered, and vaccines were many months away. Yet on March 23, 2020, the S&P 500 hit bottom and, from there, gained 68% through the end of the year.
This is a pattern that���s been repeated many times over the years, and why it���s so tricky to time the market. But why exactly does this occur���what causes the market���s mood to shift from pessimistic to optimistic so quickly? In most cases, it's one of two factors.
The first is government action. This can take two forms. Fiscal policy refers to tax and spending action taken by Congress, while monetary policy describes action taken by the Federal Reserve. In 2020, we saw a combination of both. On the fiscal side, Congress issued a series of stimulus payments to individuals, and it helped businesses stay afloat with programs like the Paycheck Protection Program.
On the monetary side, the Fed took even more dramatic action. On a single day, it��announced��a long list of new and expanded programs to support the economy. What day was that? March 23, 2020���not coincidentally, the day when the stock market began its turnaround. The very next day, the market jumped 9%. To put that in perspective, the standard deviation of the U.S. stock market���s daily return is about 1%, meaning returns are within 1% on the vast majority of trading days. A 9% move is almost unheard of. But when the Fed marches in with its bazooka, that���s what can happen.
In March 2020, no reasonable person could have guessed that the stock market was about to stage its fastest rally on record. In fact, I distinctly remember one person worrying out loud that we might be heading into a period not unlike the Great Depression. No question, it was scary. But this episode perfectly illustrates why market timing is so difficult. An investor who had chosen to stand aside until the dust settled would have missed significant gains.
The second factor that can drive the market: Wall Street research departments. Every day, brokerage firms' analysts publish their views on the market and on individual stocks. In ordinary times, these reports don���t have great predictive accuracy. Analysts have a hard time forecasting where the market is headed next. But when the market hits extreme lows, their forecasts can be more useful. That���s because there definitely is a correlation���at a very high level���between market valuations and future returns.
Consider a stock that normally trades at a price-earnings (P/E) ratio of 20. If the stock drops to a P/E of 18, it���s debatable whether it should be considered undervalued. It might or might not rise back to a 20 P/E. But if that stock were to drop to a P/E of, say, 12, it would be a lot easier for an analyst to make a credible argument that it���s undervalued. At a point like that, the analyst doesn���t need to be too accurate. He or she would just need to observe that the stock is near the bottom end of its historical range and therefore more likely to rise than fall. Even if the stock only recovered back to a P/E of 15 or 17, an investor would do quite well.
No single analyst can move the market too much. But collectively, analysts and other market observers do have an impact. When enough market observers start to read from the same song sheet���that the market is undervalued���that can spur the market higher. Warren Buffett offers a case in point. On Oct. 16, 2008, when the market was in the midst of a steep drop, he wrote an��opinion piece��in��The New York Times.��He started by acknowledging that no one can forecast where the market will go in the short term: ���I haven���t the faintest idea as to whether stocks will be higher or lower a month or a year from now.��� In fact, a month later, stocks were quite a bit lower.
But he continued, ���What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up.��� He cautioned, ���If you wait for the robins, spring will be over.��� That was the key point, and that���s exactly what happened. Unemployment continued to rise for another 12 months, but the stock market hit bottom less than six months later. An investor who had waited for clear signs that the economy was improving would have missed out on significant gains.
Where does this leave investors today? As in 2008 and 2020, no one can say whether the market will continue to deteriorate or when it will recover. But as the statistics show���and as the historical examples confirm���it���s best to stay invested through thick and thin. Investors who wait for an all-clear signal may be disappointed.
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 Await the All-Clear? appeared first on HumbleDollar.
February 18, 2022
Building a Bridge
Last year, I wrote about a study from Boston College���s Center for Retirement Research (CRR) that detailed the value in claiming Social Security later. A new CRR paper examines the topic further.
The paper describes a survey of those nearing retirement. The goal: to gauge interest in using a 401(k) "bridge��� to generate income while folks delayed claiming Social Security. The bridge was pitched as a new feature of 401(k) plans. A portion of participants��� 401(k) savings would be dedicated to paying regular monthly income until they started their Social Security benefit. In essence, they���d be using 401(k) dollars to buy a higher Social Security payment. For each year folks delay, those benefits increase by some eight percentage points above the inflation rate.
The idea that retirees might use savings to pay living costs, while allowing their Social Security benefit to grow, isn���t new. What���s new about the 401(k) bridge is that it would be an additional, automated option within 401(k) plans.
The paper provides a simple example. Assume you���re eligible for a $1,500-a-month Social Security benefit at age 62. Waiting until 65 to claim would provide an increased benefit of about $1,900. If you elected a 401(k) bridge, you���d receive $1,900 a month at age 62, or $23,000 per year, from your 401(k). At 65, that monthly payment would stop and you���d claim your $1,900 Social Security benefit.
The research was structured to gauge people���s interest in this unfamiliar option, if the way the option was framed made a difference, and how much of their 401(k) they���d be willing to allocate. In general, no more than a third of respondents showed interest in the bridge option. The authors cite TIAA data showing that this share is consistent with the number of people who choose annuities when retirement plans offer lifetime-income options.
In the CRR study, when the 401(k) bridge was framed as ���income insurance,��� there was a small but significant increase in interest. The other framing technique that increased interest: making the bridge the default option. Having to opt out, as opposed to opting in, increased enrollment.
The post Building a Bridge appeared first on HumbleDollar.
