Jonathan Clements's Blog, page 229
February 18, 2022
Saving Myself
I LIKE TO THINK that what happened to me in my mid-40s wasn���t a midlife crisis, but instead a midlife reinvention.
I transformed myself physically and mentally. I lost 20 pounds. I took up CrossFit. I learned how to shoot guns and began participating in���and winning���pistol competitions. I spent a considerable amount of time evaluating every aspect of my life. I thought long and hard about what made me happy and what didn���t. I pledged to purge everything that no longer provided me joy. My beloved Welsh Corgis made the cut. My husband didn���t.
Getting divorced after nearly 20 years of marriage wasn���t as traumatic as I expected. I���d felt trapped in a loveless relationship for years. For more than a decade, my husband and I had lived like college roommates rather than life partners. We went on separate vacations. We kept our finances separate. We had few friends in common. Everything, from our taste in music to the hobbies we pursued, was completely different.
As part of the divorce settlement, we agreed to sell our home, along with almost everything we���d acquired over the previous two decades. In a matter of a few days, I went from living in a 3,000-square-foot, completely remodeled home to inhabiting a 600-square-foot apartment that hadn���t been updated in at least 30 years. The few pieces of furniture I needed were purchased off Craigslist.
Even though nearly every aspect of my life had been disrupted, I found myself happier than I���d been in years. But one stress weighed heavily on my mind. Financially, I had no idea how I would negotiate the second half of my life.
In 2013, when my divorce was finalized, I���d been working for the same employer for 15 years. I was making $57,000 a year while residing in an area of the country where the cost of living was 30% higher than the national average. I knew almost nothing about managing money or investing.
I walked away from my divorce with a used car, two dogs and about $80,000 in cash from the sale of our home. I���d managed to retain the full balance of my 403(b). I did, however, forfeit half of a small state pension-plan benefit that I���d become vested in decades earlier.
I spent the better part of the next year getting comfortable juggling my day-to-day finances. I started tracking every dollar I spent, a habit that remains with me to this day. I keep a small notebook detailing my income, as well as every expenditure, no matter the size. By late 2014, I was comfortable that my income and spending habits were in equilibrium. I had more than enough each month to cover rent, utilities, insurance and food. I was able to cover any discretionary expenses that arose. I decided it was time to start educating myself about investing and retirement planning to ensure I���d continue to have a financially stable life.
I soon found myself spending all my spare time learning about personal finance. My reading list included Women and Money by Suze Orman and The Millionaire Next Door by Thomas Stanley and William Danko, as well as the annual financial guide that morphed into HumbleDollar.com. I listened to Dave Ramsey podcasts every night before bed. I read blog posts by Mr. Money Mustache. I poured over the vast amount of information posted on the Bogleheads.org forum.
It wasn���t always easy to decipher the information I was taking in. I often felt overwhelmed and risked analysis paralysis. I knew I needed to develop a plan to make small, systematic changes in how I managed my finances.
My journey begins. I started 2015 with a resolution to put my financial house in order. The first step was to calculate my net worth. With no debts, the calculation wasn���t difficult. The total value of my retirement accounts, my cash savings and my car came to just over $250,000. I felt good knowing that, at age 47, that figure meant that I���d exceeded the median net worth for my age group.
Next, I reviewed how my retirement funds were invested. I was vested in a Teachers Insurance and Annuity Association of America (TIAA) 403(b) plan. Every month, my employer contributed an amount equal to 10% of my salary to the plan. Between 1998 and 2004, all my contributions were directed into a guaranteed return account. I assumed that investing my funds safely���the account was guaranteed to earn a minimum 3% annually���was the best way to ensure that I���d build a sizable nest egg.
In 2005, a TIAA representative convinced me that I was invested far too conservatively for my age. The rep suggested that I consider contributing to a mutual fund account. Starting later that year, I chose to direct new contributions into a stock index fund.
When I reviewed the performance of my 403(b) account in 2015, I wasn���t unhappy with the rate of return I had been earning. My money had been growing, albeit at a slow pace, for 17 years. I was, however, convinced that I needed to invest in accounts that would deliver higher returns over the long run. I also knew I needed to start contributing a larger percentage of my salary toward my retirement savings, so my nest egg would grow faster.
The final component of my financial roadmap was to establish a specific goal. I knew that, without a target to strive for, I���d be more likely to fail. I decided to aim to have my retirement account on its own reach $250,000. I planned to get there by steadily contributing a portion of my salary to a stock-based mutual fund. Starting in 2015, I set aside $500 a month from my paycheck and invested it in a growth-stock index fund. The money my employer contributed to my account was split between a 2035 target-date retirement fund and an international growth fund.
As my account balance grew, I was motivated to save even more. Soon, I was contributing $1,000 a month. By 2016, I was setting aside almost 50% of my paycheck each month. Living frugally became a game���one I enjoyed playing. I borrowed books from the library rather than buying them from Amazon. I made my lunch every day so I wouldn���t be tempted to eat out. My entertainment was limited to those shows and movies I could watch for free using my Amazon Prime membership.
I also began taking on freelance writing assignments as a way to supplement my income. The amount I earned varied wildly. Some months I brought in nothing, while other months I earned an extra $400 or $500. By late 2016, I���d achieved my first financial goal. My retirement account hit the $250,000 mark for the first time.
Eyeing retirement. When I turned 50 years old, in May 2017, I began thinking seriously about how much longer I wanted to work fulltime. In the course of my personal finance education, I���d been introduced to the financial independence-retire early (FIRE) movement. I���d read stories of people who stopped working long before their 60s.
I began to think it might be possible for me to leave behind fulltime employment when I turned 55. At that time, I���d be eligible to receive an early retiree health insurance plan through my employer. That benefit meant I���d have the freedom to take a part-time job without worrying about having access to health care coverage.
I felt confident I could continue the pace of my savings for another five years. Even though I didn���t particularly enjoy living in an apartment, I was resigned to staying there a few more years. I didn���t foresee any large expenses that would hinder my ability to keep saving a large portion of my salary. I decided my second major financial goal would be to have enough financial stability to shift to part-time work at age 55.
For the first time in my adult life, I felt like I had a solid financial plan and a lofty goal to go along with it. I took comfort in knowing that, when I turned 55, I could always reevaluate my situation. If I needed to, I could continue to work fulltime until I reached financial security.
A change in plans. Life throws everyone curves and, for me, 2018 was a year of major upheaval. Unlike 2012���when I���d purged my life of everything that left me feeling empty���2018 was a year overflowing with happiness. I brought home a new puppy. I moved out of my rundown apartment and became a homeowner again. And the change that brought me the most happiness? I got remarried.
The financial plans I���d put in place as a single woman were suddenly no longer applicable. The flow of money previously directed to my retirement account was rerouted to a mortgage company. Overnight, I went from being a one-person, two-dog household to a member of a two-person, four-dog family. I questioned whether my goal of early retirement was still achievable.
My husband, who is 13 years older, was already retired when we married. We both looked forward to the day I could stop working. We were eager to relocate to a different part of the country, since both of us were growing weary of Pacific Northwest weather and politics.
In 2019, we visited two locations we were considering for retirement. We were priced out of the housing market at our first pick. Our second choice, a 55-plus community just outside Phoenix, still had homes available in our price range. We put in offers on three houses before landing one. The community had everything we were looking for: multiple recreational facilities, easy access to medical care, and a thriving group of active retirees. I also felt good knowing that, if I later needed a part-time job, there were employment opportunities available in the community.
Purchasing two homes in less than a year put a serious strain on my limbic system. I took some comfort in knowing that both of our homes were modest structures. Each had been built in the 1980s. Neither had been significantly updated or renovated since being constructed. As a capable do-it-yourselfer, I wasn���t put off by the prospect of investing a bit of time and energy into fixing up the houses.
Buying two homes just a few months before housing values began increasing at a record pace turned out to be one of the most beneficial���and luckiest���financial moves I ever made. Both homes have appreciated between 25% and 30% since 2020. It remains to be seen how much we���ll walk away with when we sell our Portland home. But we���ll easily recoup the down payment and likely pocket a tidy profit.
Where I stand. In late 2021, I transferred 40% of my total retirement portfolio into the TIAA Traditional account. Because of the way the account is structured, some of my money is guaranteed to earn just 1%. But most of it is set at a guaranteed return of 3%. The actual crediting rates are consistently higher than these minimum levels. The remainder of my TIAA account balance is invested in a couple of stock index funds. My state pension fund is guaranteed to earn 7.5% annually.
Should I choose to annuitize my TIAA Traditional account, I���ll have numerous options when it comes time to draw money out. I can take interest-only payments or monthly lifetime payouts, or I could systematically withdraw all the money over 10 years. While the annuity option doesn���t come with a guaranteed annual cost-of-living increase, the fund has typically increased the payouts it makes to recipients, including a 5% increase for 2022.
I���m hoping I won���t have to touch any of my money prior to age 65. When I stop working, my husband and I plan on living on his retirement income. We���ll also have the proceeds from the sale of our Oregon home. Should we need it, I can claim my Social Security benefit at age 62. My husband is delaying his benefit until age 70.
When I reflect on my personal finance journey, I ponder the things I would have done differently. I wish I had fought to retain my state pension rather than forfeiting half to my ex-husband. I wish I had started contributing a portion of my paycheck to my retirement plan when I was in my 20s, instead of waiting until I was in my 40s. I wish I had invested in more aggressive mutual funds at a younger age.
But I can't change the past. The roadmap that led to where I am now is filled with twists and turns I never saw coming. I also know I can���t put a price on happiness. At this moment in my life, as I sit at my kitchen table writing and watching our four dogs frolic in the backyard, I���m as content as I���ve ever been.
Kristine Hayes is a departmental manager at a small, liberal arts college. She��enjoys competitive pistol shooting and hanging out with her husband and their dogs. Check out Kristine's earlier articles.
I transformed myself physically and mentally. I lost 20 pounds. I took up CrossFit. I learned how to shoot guns and began participating in���and winning���pistol competitions. I spent a considerable amount of time evaluating every aspect of my life. I thought long and hard about what made me happy and what didn���t. I pledged to purge everything that no longer provided me joy. My beloved Welsh Corgis made the cut. My husband didn���t.
Getting divorced after nearly 20 years of marriage wasn���t as traumatic as I expected. I���d felt trapped in a loveless relationship for years. For more than a decade, my husband and I had lived like college roommates rather than life partners. We went on separate vacations. We kept our finances separate. We had few friends in common. Everything, from our taste in music to the hobbies we pursued, was completely different.As part of the divorce settlement, we agreed to sell our home, along with almost everything we���d acquired over the previous two decades. In a matter of a few days, I went from living in a 3,000-square-foot, completely remodeled home to inhabiting a 600-square-foot apartment that hadn���t been updated in at least 30 years. The few pieces of furniture I needed were purchased off Craigslist.
Even though nearly every aspect of my life had been disrupted, I found myself happier than I���d been in years. But one stress weighed heavily on my mind. Financially, I had no idea how I would negotiate the second half of my life.
In 2013, when my divorce was finalized, I���d been working for the same employer for 15 years. I was making $57,000 a year while residing in an area of the country where the cost of living was 30% higher than the national average. I knew almost nothing about managing money or investing.
I walked away from my divorce with a used car, two dogs and about $80,000 in cash from the sale of our home. I���d managed to retain the full balance of my 403(b). I did, however, forfeit half of a small state pension-plan benefit that I���d become vested in decades earlier.
I spent the better part of the next year getting comfortable juggling my day-to-day finances. I started tracking every dollar I spent, a habit that remains with me to this day. I keep a small notebook detailing my income, as well as every expenditure, no matter the size. By late 2014, I was comfortable that my income and spending habits were in equilibrium. I had more than enough each month to cover rent, utilities, insurance and food. I was able to cover any discretionary expenses that arose. I decided it was time to start educating myself about investing and retirement planning to ensure I���d continue to have a financially stable life.
I soon found myself spending all my spare time learning about personal finance. My reading list included Women and Money by Suze Orman and The Millionaire Next Door by Thomas Stanley and William Danko, as well as the annual financial guide that morphed into HumbleDollar.com. I listened to Dave Ramsey podcasts every night before bed. I read blog posts by Mr. Money Mustache. I poured over the vast amount of information posted on the Bogleheads.org forum.
It wasn���t always easy to decipher the information I was taking in. I often felt overwhelmed and risked analysis paralysis. I knew I needed to develop a plan to make small, systematic changes in how I managed my finances.
My journey begins. I started 2015 with a resolution to put my financial house in order. The first step was to calculate my net worth. With no debts, the calculation wasn���t difficult. The total value of my retirement accounts, my cash savings and my car came to just over $250,000. I felt good knowing that, at age 47, that figure meant that I���d exceeded the median net worth for my age group.
Next, I reviewed how my retirement funds were invested. I was vested in a Teachers Insurance and Annuity Association of America (TIAA) 403(b) plan. Every month, my employer contributed an amount equal to 10% of my salary to the plan. Between 1998 and 2004, all my contributions were directed into a guaranteed return account. I assumed that investing my funds safely���the account was guaranteed to earn a minimum 3% annually���was the best way to ensure that I���d build a sizable nest egg.
In 2005, a TIAA representative convinced me that I was invested far too conservatively for my age. The rep suggested that I consider contributing to a mutual fund account. Starting later that year, I chose to direct new contributions into a stock index fund.
When I reviewed the performance of my 403(b) account in 2015, I wasn���t unhappy with the rate of return I had been earning. My money had been growing, albeit at a slow pace, for 17 years. I was, however, convinced that I needed to invest in accounts that would deliver higher returns over the long run. I also knew I needed to start contributing a larger percentage of my salary toward my retirement savings, so my nest egg would grow faster.
The final component of my financial roadmap was to establish a specific goal. I knew that, without a target to strive for, I���d be more likely to fail. I decided to aim to have my retirement account on its own reach $250,000. I planned to get there by steadily contributing a portion of my salary to a stock-based mutual fund. Starting in 2015, I set aside $500 a month from my paycheck and invested it in a growth-stock index fund. The money my employer contributed to my account was split between a 2035 target-date retirement fund and an international growth fund.
As my account balance grew, I was motivated to save even more. Soon, I was contributing $1,000 a month. By 2016, I was setting aside almost 50% of my paycheck each month. Living frugally became a game���one I enjoyed playing. I borrowed books from the library rather than buying them from Amazon. I made my lunch every day so I wouldn���t be tempted to eat out. My entertainment was limited to those shows and movies I could watch for free using my Amazon Prime membership.
I also began taking on freelance writing assignments as a way to supplement my income. The amount I earned varied wildly. Some months I brought in nothing, while other months I earned an extra $400 or $500. By late 2016, I���d achieved my first financial goal. My retirement account hit the $250,000 mark for the first time.
Eyeing retirement. When I turned 50 years old, in May 2017, I began thinking seriously about how much longer I wanted to work fulltime. In the course of my personal finance education, I���d been introduced to the financial independence-retire early (FIRE) movement. I���d read stories of people who stopped working long before their 60s.
I began to think it might be possible for me to leave behind fulltime employment when I turned 55. At that time, I���d be eligible to receive an early retiree health insurance plan through my employer. That benefit meant I���d have the freedom to take a part-time job without worrying about having access to health care coverage.
I felt confident I could continue the pace of my savings for another five years. Even though I didn���t particularly enjoy living in an apartment, I was resigned to staying there a few more years. I didn���t foresee any large expenses that would hinder my ability to keep saving a large portion of my salary. I decided my second major financial goal would be to have enough financial stability to shift to part-time work at age 55.
For the first time in my adult life, I felt like I had a solid financial plan and a lofty goal to go along with it. I took comfort in knowing that, when I turned 55, I could always reevaluate my situation. If I needed to, I could continue to work fulltime until I reached financial security.
A change in plans. Life throws everyone curves and, for me, 2018 was a year of major upheaval. Unlike 2012���when I���d purged my life of everything that left me feeling empty���2018 was a year overflowing with happiness. I brought home a new puppy. I moved out of my rundown apartment and became a homeowner again. And the change that brought me the most happiness? I got remarried.
The financial plans I���d put in place as a single woman were suddenly no longer applicable. The flow of money previously directed to my retirement account was rerouted to a mortgage company. Overnight, I went from being a one-person, two-dog household to a member of a two-person, four-dog family. I questioned whether my goal of early retirement was still achievable.
My husband, who is 13 years older, was already retired when we married. We both looked forward to the day I could stop working. We were eager to relocate to a different part of the country, since both of us were growing weary of Pacific Northwest weather and politics.
In 2019, we visited two locations we were considering for retirement. We were priced out of the housing market at our first pick. Our second choice, a 55-plus community just outside Phoenix, still had homes available in our price range. We put in offers on three houses before landing one. The community had everything we were looking for: multiple recreational facilities, easy access to medical care, and a thriving group of active retirees. I also felt good knowing that, if I later needed a part-time job, there were employment opportunities available in the community.
Purchasing two homes in less than a year put a serious strain on my limbic system. I took some comfort in knowing that both of our homes were modest structures. Each had been built in the 1980s. Neither had been significantly updated or renovated since being constructed. As a capable do-it-yourselfer, I wasn���t put off by the prospect of investing a bit of time and energy into fixing up the houses.
Buying two homes just a few months before housing values began increasing at a record pace turned out to be one of the most beneficial���and luckiest���financial moves I ever made. Both homes have appreciated between 25% and 30% since 2020. It remains to be seen how much we���ll walk away with when we sell our Portland home. But we���ll easily recoup the down payment and likely pocket a tidy profit.
Where I stand. In late 2021, I transferred 40% of my total retirement portfolio into the TIAA Traditional account. Because of the way the account is structured, some of my money is guaranteed to earn just 1%. But most of it is set at a guaranteed return of 3%. The actual crediting rates are consistently higher than these minimum levels. The remainder of my TIAA account balance is invested in a couple of stock index funds. My state pension fund is guaranteed to earn 7.5% annually.
Should I choose to annuitize my TIAA Traditional account, I���ll have numerous options when it comes time to draw money out. I can take interest-only payments or monthly lifetime payouts, or I could systematically withdraw all the money over 10 years. While the annuity option doesn���t come with a guaranteed annual cost-of-living increase, the fund has typically increased the payouts it makes to recipients, including a 5% increase for 2022.
I���m hoping I won���t have to touch any of my money prior to age 65. When I stop working, my husband and I plan on living on his retirement income. We���ll also have the proceeds from the sale of our Oregon home. Should we need it, I can claim my Social Security benefit at age 62. My husband is delaying his benefit until age 70.
When I reflect on my personal finance journey, I ponder the things I would have done differently. I wish I had fought to retain my state pension rather than forfeiting half to my ex-husband. I wish I had started contributing a portion of my paycheck to my retirement plan when I was in my 20s, instead of waiting until I was in my 40s. I wish I had invested in more aggressive mutual funds at a younger age.
But I can't change the past. The roadmap that led to where I am now is filled with twists and turns I never saw coming. I also know I can���t put a price on happiness. At this moment in my life, as I sit at my kitchen table writing and watching our four dogs frolic in the backyard, I���m as content as I���ve ever been.
Kristine Hayes is a departmental manager at a small, liberal arts college. She��enjoys competitive pistol shooting and hanging out with her husband and their dogs. Check out Kristine's earlier articles.The post Saving Myself appeared first on HumbleDollar.
Over Active?
CATHIE WOOD'S ARK Innovation ETF was the toast of the investing town in 2020 and early 2021. The star portfolio manager picked one winning stock after another���stocks that benefited as much of the world shifted to work-from-anywhere.
Like so many other hot funds, her time in the sun didn���t last. After Wood���s flagship ARK fund returned more than 150% in 2020, plus another 25% to start 2021, the bubble finally popped last February. The peak-to-trough decline was 57.6% through Jan. 31.
ARK Innovation (symbol: ARKK) is an actively managed exchange-traded fund (ETF). Most ETFs passively track a market index. But as ETFs ballooned in popularity, some portfolio managers got crafty and opened active ETFs. An active ETF works like an actively managed mutual fund, with portfolio managers betting on stocks they think will outperform the market.
Active ETFs have some notable advantages over regular mutual funds, including potentially lower fees, effectively no investment minimum, and the ability for investors to buy and sell them throughout the trading day rather than waiting for the 4 p.m. ET market close, as happens with mutual funds. But perhaps the biggest benefit is the favorable tax treatment that the ETF wrapper offers. By contrast, regular actively managed mutual funds often make large taxable distributions to shareholders.
Still, relatively little money is allocated to active ETFs. According to Morningstar, they account for just 3.5% of the $6.6 trillion ETF market. As we���re now discovering with ARK Innovation ETF, maybe that���s a good thing.
How do active ETFs work? As with index ETFs, each active ETF has both a share price and a net asset value (NAV), which is the value of the fund���s portfolio figured on a per-share basis. To keep those two in line, there���s a mechanism whereby ���authorized participants������designated institutional investors���can exchange shares of the ETF itself for the underlying securities owned by the ETF and vice versa.
Everybody knows what an index ETF owns���it���s the securities in the fund���s target index���but active ETFs use more complicated systems to avoid immediately disclosing their holdings and thereby running the risk that investors will front-run their trades. Still, in essence, all ETFs allow an arbitrage process that keeps an ETF���s shares close to its NAV. This arbitrage process leads authorized participants to buy ETF shares on the open market when they���re at a discount to NAV and sell when they���re at a premium, thus closing the gap between the two. Still, even with this mechanism, during volatile times, wide gaps can open up between an active ETF���s share price and its NAV.
Maybe more important, there���s a major flaw with active ETFs. Nothing stops a massive influx of new dollars into a recently hot fund. In fact, because ETFs can be bought and sold throughout the day, it���s almost too easy for performance-chasing investors to pile into a hot fund. By contrast, regular mutual funds have the option of closing to new investors should their asset base grow too large.
Why would a mutual fund company���which makes money if it manages more assets���turn away investors? The bigger a fund gets, the harder it becomes to generate good performance. A $50 billion portfolio might have an average position size of $1 billion. That means that, even if a manager identifies, say, a $200 million market-cap company with great prospects, owning that stock just won���t make much difference to the fund���s performance, even if the manager buys 5% of the company���s shares.
Right now, mutual funds like Fidelity Growth Company Fund (symbol: FDGRX) and Vanguard Capital Opportunity Fund (VHCAX) are closed. Analysts argue that even more mutual funds should be shuttered to new investors.
But when it comes to ETFs, closing isn���t an option. New shares are created on demand, whether a fund wants that or not. That���s a problem because an active ETF���like Wood���s ARK���almost inevitably attracts performance-chasing investors if it posts stellar returns. And all too often, those investors turn up just as performance is peaking.
Result: You get what���s called a behavior gap���a sharp difference between a fund���s time-weighted returns and its dollar-weighted results. ARK���s time-weighted returns were off the charts in the years leading up to its early 2021 peak. But many investors in ARK have endured sharp losses because they piled in just as the fund���s share price was topping out, and the result has been rotten dollar-weighted returns.
Performance chasing can, of course, happen with index ETFs and mutual funds, especially those that track more narrow market sectors. Don���t want to suffer a behavior gap of your own? Stick with index mutual funds and ETFs���those that offer broad market exposure.
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.
Like so many other hot funds, her time in the sun didn���t last. After Wood���s flagship ARK fund returned more than 150% in 2020, plus another 25% to start 2021, the bubble finally popped last February. The peak-to-trough decline was 57.6% through Jan. 31.
ARK Innovation (symbol: ARKK) is an actively managed exchange-traded fund (ETF). Most ETFs passively track a market index. But as ETFs ballooned in popularity, some portfolio managers got crafty and opened active ETFs. An active ETF works like an actively managed mutual fund, with portfolio managers betting on stocks they think will outperform the market.
Active ETFs have some notable advantages over regular mutual funds, including potentially lower fees, effectively no investment minimum, and the ability for investors to buy and sell them throughout the trading day rather than waiting for the 4 p.m. ET market close, as happens with mutual funds. But perhaps the biggest benefit is the favorable tax treatment that the ETF wrapper offers. By contrast, regular actively managed mutual funds often make large taxable distributions to shareholders.
Still, relatively little money is allocated to active ETFs. According to Morningstar, they account for just 3.5% of the $6.6 trillion ETF market. As we���re now discovering with ARK Innovation ETF, maybe that���s a good thing.
How do active ETFs work? As with index ETFs, each active ETF has both a share price and a net asset value (NAV), which is the value of the fund���s portfolio figured on a per-share basis. To keep those two in line, there���s a mechanism whereby ���authorized participants������designated institutional investors���can exchange shares of the ETF itself for the underlying securities owned by the ETF and vice versa.
Everybody knows what an index ETF owns���it���s the securities in the fund���s target index���but active ETFs use more complicated systems to avoid immediately disclosing their holdings and thereby running the risk that investors will front-run their trades. Still, in essence, all ETFs allow an arbitrage process that keeps an ETF���s shares close to its NAV. This arbitrage process leads authorized participants to buy ETF shares on the open market when they���re at a discount to NAV and sell when they���re at a premium, thus closing the gap between the two. Still, even with this mechanism, during volatile times, wide gaps can open up between an active ETF���s share price and its NAV.
Maybe more important, there���s a major flaw with active ETFs. Nothing stops a massive influx of new dollars into a recently hot fund. In fact, because ETFs can be bought and sold throughout the day, it���s almost too easy for performance-chasing investors to pile into a hot fund. By contrast, regular mutual funds have the option of closing to new investors should their asset base grow too large.
Why would a mutual fund company���which makes money if it manages more assets���turn away investors? The bigger a fund gets, the harder it becomes to generate good performance. A $50 billion portfolio might have an average position size of $1 billion. That means that, even if a manager identifies, say, a $200 million market-cap company with great prospects, owning that stock just won���t make much difference to the fund���s performance, even if the manager buys 5% of the company���s shares.
Right now, mutual funds like Fidelity Growth Company Fund (symbol: FDGRX) and Vanguard Capital Opportunity Fund (VHCAX) are closed. Analysts argue that even more mutual funds should be shuttered to new investors.
But when it comes to ETFs, closing isn���t an option. New shares are created on demand, whether a fund wants that or not. That���s a problem because an active ETF���like Wood���s ARK���almost inevitably attracts performance-chasing investors if it posts stellar returns. And all too often, those investors turn up just as performance is peaking.
Result: You get what���s called a behavior gap���a sharp difference between a fund���s time-weighted returns and its dollar-weighted results. ARK���s time-weighted returns were off the charts in the years leading up to its early 2021 peak. But many investors in ARK have endured sharp losses because they piled in just as the fund���s share price was topping out, and the result has been rotten dollar-weighted returns.
Performance chasing can, of course, happen with index ETFs and mutual funds, especially those that track more narrow market sectors. Don���t want to suffer a behavior gap of your own? Stick with index mutual funds and ETFs���those that offer broad market exposure.
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 Over Active? appeared first on HumbleDollar.
February 17, 2022
Saving Their Souls
EVERY FALL AT LAW schools across America, a process occurs called on-campus interviewing, or OCI, as it���s commonly known. The more elite the law school, the more prestigious the crop of law firms that visit, each offering the promise of large salaries to brilliant, mostly young minds. Only students with excellent grades or editorial positions on the school���s law review are selected to interview for summer internships.
Like nearly all graduate schools, law school comes with an expensive price tag, leaving many students with large amounts of debt. Because law students are nearly always type-A personalities and because law firm recruiting is a zero-sum game���there are many more applicants than spots, with even fewer spots at prestigious, well-paying firms���law school tends to engender extreme competitiveness and jealousy. In the pre-internet era, there were legendary stories of pages torn from books to thwart other students��� success.
In the 15 years since I graduated from law school, I���ve noticed an interesting trend. Very few of my peers who began as law firm associates stayed to make partner. Many left to become in-house counsel at corporations. Others became law professors, government attorneys and judges. Long hours, high pressure and unfulfilling work lead many attorneys to tap out of the law firm life, and opt instead for careers that are much less stressful and arguably more rewarding.
Law school is by no means the only graduate school where the most intelligent alumni chase prestige and money, only to end up mired in soul-sucking work. Many top-tier business school graduates head to Wall Street. The best medical students often become plastic surgeons. Some of our brightest computer science minds create technology that negatively impacts countless lives.
A lot of attention is paid to where someone goes to graduate school and what they do after graduation. Not nearly enough emphasis is placed on whether that career will bring them the type of happiness that can���t come from money or titles. For those students approaching these life choices, it���s worth remembering the words of the philosopher Lao Tzu, who centuries ago in the Tao Te Ching wrote the following words:
Better stop short than fill to the brim.
Over-sharpen the blade, and the edge will soon blunt.
Amass a store of gold and jade, and no one can protect it.
Claim wealth and titles, and disaster will follow.
Retire when the work is done.
This is the way of heaven.
Like nearly all graduate schools, law school comes with an expensive price tag, leaving many students with large amounts of debt. Because law students are nearly always type-A personalities and because law firm recruiting is a zero-sum game���there are many more applicants than spots, with even fewer spots at prestigious, well-paying firms���law school tends to engender extreme competitiveness and jealousy. In the pre-internet era, there were legendary stories of pages torn from books to thwart other students��� success.
In the 15 years since I graduated from law school, I���ve noticed an interesting trend. Very few of my peers who began as law firm associates stayed to make partner. Many left to become in-house counsel at corporations. Others became law professors, government attorneys and judges. Long hours, high pressure and unfulfilling work lead many attorneys to tap out of the law firm life, and opt instead for careers that are much less stressful and arguably more rewarding.
Law school is by no means the only graduate school where the most intelligent alumni chase prestige and money, only to end up mired in soul-sucking work. Many top-tier business school graduates head to Wall Street. The best medical students often become plastic surgeons. Some of our brightest computer science minds create technology that negatively impacts countless lives.
A lot of attention is paid to where someone goes to graduate school and what they do after graduation. Not nearly enough emphasis is placed on whether that career will bring them the type of happiness that can���t come from money or titles. For those students approaching these life choices, it���s worth remembering the words of the philosopher Lao Tzu, who centuries ago in the Tao Te Ching wrote the following words:
Better stop short than fill to the brim.
Over-sharpen the blade, and the edge will soon blunt.
Amass a store of gold and jade, and no one can protect it.
Claim wealth and titles, and disaster will follow.
Retire when the work is done.
This is the way of heaven.
The post Saving Their Souls appeared first on HumbleDollar.
Rite of Spring
TAX SEASON IS HERE. You���ve probably received your W-2 and, if they haven���t arrived already, your investment tax forms may be just days away. If you���re like me, your email inbox has been inundated with tax-filing services pitching their latest deal. I���m no expert on which tax-prep provider is best, but each year I check this page for reviews of the major sites.
I have two other tips that might save you a few bucks. First, see if your brokerage firm offers a discount on sites like TurboTax and TaxAct. Second, your credit card might have a cashback offer if you use one of those sites. It���s not much, but those small savings can help shave your tax-prep fee.
I���m curious to see how this tax season goes, given 2021���s frustrations���including refund delays���that resulted from IRS staff shortages and a slow postal service. Ally Bank Consumer Research performed a survey late last month that suggests filers have low expectations.
The survey says 51% of consumers expect another season of delays. To speed things along, the IRS recommends Americans submit returns electronically���but 81% of folks already do. Ally���s survey of more than 1,000 consumers also found that half of respondents expect a refund. Among that group, 63% planned to file in January or February.
The average refund was $2,827 last year, according to the National Taxpayer Advocate. Two-thirds of those Ally surveyed expect refunds of $3,000 or less. What will recipients do with their windfall? Among those expecting a refund, 55% plan to save it, 33% will use it to pay down debt and 30% will invest part or all of it. Of those planning to invest, 57% are looking to traditional financial markets, while 28% are considering rolling the dice with cryptocurrencies.
I have two other tips that might save you a few bucks. First, see if your brokerage firm offers a discount on sites like TurboTax and TaxAct. Second, your credit card might have a cashback offer if you use one of those sites. It���s not much, but those small savings can help shave your tax-prep fee.
I���m curious to see how this tax season goes, given 2021���s frustrations���including refund delays���that resulted from IRS staff shortages and a slow postal service. Ally Bank Consumer Research performed a survey late last month that suggests filers have low expectations.
The survey says 51% of consumers expect another season of delays. To speed things along, the IRS recommends Americans submit returns electronically���but 81% of folks already do. Ally���s survey of more than 1,000 consumers also found that half of respondents expect a refund. Among that group, 63% planned to file in January or February.
The average refund was $2,827 last year, according to the National Taxpayer Advocate. Two-thirds of those Ally surveyed expect refunds of $3,000 or less. What will recipients do with their windfall? Among those expecting a refund, 55% plan to save it, 33% will use it to pay down debt and 30% will invest part or all of it. Of those planning to invest, 57% are looking to traditional financial markets, while 28% are considering rolling the dice with cryptocurrencies.
The post Rite of Spring appeared first on HumbleDollar.
Check Mate
WHEN I WAS IN the Navy, the checklist was a way of life. Everything from a radiation leak to starting an air compressor required one. In emergency situations like flooding, you were expected to take memorized ���immediate actions,��� and then use a checklist to ensure all the actions were accomplished. For more routine procedures, you would follow the checklist line by line���deviations were not allowed.
While this wasn���t conducive to a creative working environment, it was a safe and efficient one. It���s important to note that these checklists were not followed blindly. Everyone involved needed to completely understand the theory behind each step.
If a step didn���t make sense in the current situation, work was stopped until the issue could be resolved. Ever��since the Navy acquired the USS��Holland��in 1900, this process has allowed the experience, training and knowledge of every submariner to be reflected in every checklist���and therefore to be accessible to even the most junior personnel. My worth as an officer was judged in large part by how well I understood the checklists and how well I used them.
When I joined Exxon Mobil, I quickly found out that my experience using checklists was not particularly valued. For many years, I worked in an operations role, coordinating the transportation of petroleum products throughout the world. I developed numerous checklists to help track vessels, create schedules and provide training to new personnel.
When mistakes were made and we learned from the experience, I would revise my checklists. They were also useful when I went on vacation, as I could easily get my replacement up to speed on every vessel, shipment and schedule by reviewing the appropriate checklist.
I also annotated each checklist to help track unusual requirements and to provide a hard copy of all the great things I did. This came in handy during annual performance reviews.
I tried to get colleagues and managers to embrace the checklist philosophy, but I completely failed. As soon as they saw one, I could see the glaze appear in their eyes or���worse���the smirk appear on their faces.
Generally, when I returned from vacation, the checklists I had reviewed with my relief were on my desk exactly where I left them, unchanged and unread. Now retired, I think about what I might have done better to get buy-in.
This all came back to me recently while reading the book The Checklist Manifesto: How to Get Things Right by��Atul Gawande. The author is a surgeon who created basic checklists used worldwide that drastically reduced surgical complications and deaths. He did extensive research on checklists from the aviation, construction and even finance industry.
One of the more compelling stories in the book details how a checklist played a critical role in Captain Chesley ���Sully��� Sullenberger���s successful ditching of Flight 1549 in the Hudson River in 2009. Dr. Gawande also reveals the difficulties he had getting surgeons to understand the benefits of checklists���and then to actually use them. That made me feel much better about my failure at Exxon Mobil.
I have used a checklist in the past when doing my taxes. It ensured that I reviewed certain items that directly affected my specific tax situation���like that darn foreign��tax credit. It also allowed me a place to make notes for the following year. After I filed my taxes, I would update the checklist with what I learned and anything I needed to review the next year.
Over the past few years, I stopped using my tax checklist. I have no idea why. This year, I resolved to get my old tax checklist out of mothballs, update it well before tax time and put it back into use. I���ve also created a list of other potential checklists: prepping the house prior to long-term travel, annual auto maintenance, annual home maintenance, annual financial review and annual health care.
Still not convinced of the value of checklists? Don���t take my word for it. As Charlie Munger, the longtime vice chairman of Berkshire Hathaway, notes, ���No wise pilot, no matter how great his talent and experience, fails to use a checklist.���
Michael Flack blogs at��AfterActionReport.info. He���s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.
While this wasn���t conducive to a creative working environment, it was a safe and efficient one. It���s important to note that these checklists were not followed blindly. Everyone involved needed to completely understand the theory behind each step.
If a step didn���t make sense in the current situation, work was stopped until the issue could be resolved. Ever��since the Navy acquired the USS��Holland��in 1900, this process has allowed the experience, training and knowledge of every submariner to be reflected in every checklist���and therefore to be accessible to even the most junior personnel. My worth as an officer was judged in large part by how well I understood the checklists and how well I used them.
When I joined Exxon Mobil, I quickly found out that my experience using checklists was not particularly valued. For many years, I worked in an operations role, coordinating the transportation of petroleum products throughout the world. I developed numerous checklists to help track vessels, create schedules and provide training to new personnel.
When mistakes were made and we learned from the experience, I would revise my checklists. They were also useful when I went on vacation, as I could easily get my replacement up to speed on every vessel, shipment and schedule by reviewing the appropriate checklist.
I also annotated each checklist to help track unusual requirements and to provide a hard copy of all the great things I did. This came in handy during annual performance reviews.
I tried to get colleagues and managers to embrace the checklist philosophy, but I completely failed. As soon as they saw one, I could see the glaze appear in their eyes or���worse���the smirk appear on their faces.
Generally, when I returned from vacation, the checklists I had reviewed with my relief were on my desk exactly where I left them, unchanged and unread. Now retired, I think about what I might have done better to get buy-in.
This all came back to me recently while reading the book The Checklist Manifesto: How to Get Things Right by��Atul Gawande. The author is a surgeon who created basic checklists used worldwide that drastically reduced surgical complications and deaths. He did extensive research on checklists from the aviation, construction and even finance industry.
One of the more compelling stories in the book details how a checklist played a critical role in Captain Chesley ���Sully��� Sullenberger���s successful ditching of Flight 1549 in the Hudson River in 2009. Dr. Gawande also reveals the difficulties he had getting surgeons to understand the benefits of checklists���and then to actually use them. That made me feel much better about my failure at Exxon Mobil.
I have used a checklist in the past when doing my taxes. It ensured that I reviewed certain items that directly affected my specific tax situation���like that darn foreign��tax credit. It also allowed me a place to make notes for the following year. After I filed my taxes, I would update the checklist with what I learned and anything I needed to review the next year.
Over the past few years, I stopped using my tax checklist. I have no idea why. This year, I resolved to get my old tax checklist out of mothballs, update it well before tax time and put it back into use. I���ve also created a list of other potential checklists: prepping the house prior to long-term travel, annual auto maintenance, annual home maintenance, annual financial review and annual health care.
Still not convinced of the value of checklists? Don���t take my word for it. As Charlie Munger, the longtime vice chairman of Berkshire Hathaway, notes, ���No wise pilot, no matter how great his talent and experience, fails to use a checklist.���
Michael Flack blogs at��AfterActionReport.info. He���s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.The post Check Mate appeared first on HumbleDollar.
February 15, 2022
Paid to Play
IT SEEMS LIKE EVERY month or so, one of our kids—and, for the married ones, that includes spouse and little ones—is on vacation. A week or two in Cabo or Cozumel, a road trip out west, or a jaunt to some other interesting destination is commonplace. How is this possible? One of the reasons, I believe, is because they don’t work for themselves.
Instead, they work for big institutions, such as corporations, universities, school districts and large nonprofits.
I left my position as a prosecutor with the district attorney’s office in 1983, when I got a job offer from a two-man law firm. I happily remained there until I retired in 2017. I took a lot of pride in our firm and enjoyed the independence that came with being our own bosses. But the burdens of running a small business were significant.
While my partners and I helped each other in numerous ways, we had an “eat what you kill” system. My income came only from the clients I signed up and personally represented. There was no sharing among the partners. This meant that if I wasn’t working, I wasn’t earning. As I often explained to my dear wife, if we took a vacation, it was a double whammy. Not only did we have the cost of the vacation itself, but also for those days when I was away from the office and not hustling, there was less income—and no new clients. With four kids to get through college, we didn’t take many vacations.
Moreover, since my partners and I each did our own work, there was no one to keep up with it while we were gone. Upon return, there were always several hectic days of catchup.
But our kids and their spouses enjoy a different life. They have paid vacation time every year, so there’s no loss of income. In their large organizations, there’s a whole structure which can, at least to some extent, pick up the work slack while they’re away.
Another advantage is that, with their jobs, the administrative stuff is handled by their employers. As the compulsive organizer in our small firm, most of that fell on my shoulders. Added to the legal work were tasks like hiring a new secretary or runner, buying supplies and dealing with our vendors.
As for retirement plans, we had none until one day, many years ago, I stumbled on SIMPLE plans. But as for any “free money” employer matches, the only employer making the modest matches to our plan was us.
And then there was health insurance. We weren’t big enough to qualify for any group health plans, so for us it was the endless hassle and expense of dealing with the individual health insurance market. I could tell some nightmare stories.
In The Millionaire Next Door, one of the first finance books I ever read and one that influenced me greatly, the point was made that many millionaires are entrepreneurs. I don’t doubt it. But these days, I think a little more about all the sacrifices those driven individuals must have made to get to that point.
I take a lot of pride in what I accomplished in my career, including the fact that our kids all made it through college and graduated debt-free. But I’m also gratified that they seem to have found a different path, and quite likely a better one.
Instead, they work for big institutions, such as corporations, universities, school districts and large nonprofits.
I left my position as a prosecutor with the district attorney’s office in 1983, when I got a job offer from a two-man law firm. I happily remained there until I retired in 2017. I took a lot of pride in our firm and enjoyed the independence that came with being our own bosses. But the burdens of running a small business were significant.
While my partners and I helped each other in numerous ways, we had an “eat what you kill” system. My income came only from the clients I signed up and personally represented. There was no sharing among the partners. This meant that if I wasn’t working, I wasn’t earning. As I often explained to my dear wife, if we took a vacation, it was a double whammy. Not only did we have the cost of the vacation itself, but also for those days when I was away from the office and not hustling, there was less income—and no new clients. With four kids to get through college, we didn’t take many vacations.
Moreover, since my partners and I each did our own work, there was no one to keep up with it while we were gone. Upon return, there were always several hectic days of catchup.
But our kids and their spouses enjoy a different life. They have paid vacation time every year, so there’s no loss of income. In their large organizations, there’s a whole structure which can, at least to some extent, pick up the work slack while they’re away.
Another advantage is that, with their jobs, the administrative stuff is handled by their employers. As the compulsive organizer in our small firm, most of that fell on my shoulders. Added to the legal work were tasks like hiring a new secretary or runner, buying supplies and dealing with our vendors.
As for retirement plans, we had none until one day, many years ago, I stumbled on SIMPLE plans. But as for any “free money” employer matches, the only employer making the modest matches to our plan was us.
And then there was health insurance. We weren’t big enough to qualify for any group health plans, so for us it was the endless hassle and expense of dealing with the individual health insurance market. I could tell some nightmare stories.
In The Millionaire Next Door, one of the first finance books I ever read and one that influenced me greatly, the point was made that many millionaires are entrepreneurs. I don’t doubt it. But these days, I think a little more about all the sacrifices those driven individuals must have made to get to that point.
I take a lot of pride in what I accomplished in my career, including the fact that our kids all made it through college and graduated debt-free. But I’m also gratified that they seem to have found a different path, and quite likely a better one.
The post Paid to Play appeared first on HumbleDollar.
Making Your Claim
THE SOCIAL SECURITY claiming decision is one of the most complex—and contentious—choices that retirees have to make.
I was reminded of that in December, while at a Christmas party. Two former colleagues were discussing their Social Security decision. Both are male, single, childless, retired engineers. Each has a traditional pension, a paid-off home and significant retirement savings. Ted is age 77. Fred is 66.
Ted took his Social Security at 62. His reason was longevity or, rather, the lack thereof. He had been a smoker for many years. He calculated his breakeven age as 77, at which point he would get back as much as he’d paid into the system. He decided to collect a lower benefit as early as allowed and then invest the money. Ted lives frugally, and will leave a handsome legacy to his nieces and nephews.
Fred is waiting until age 70 to collect. He’s in generally good health, and family history suggests he could live a long life. Although retired, he does some consulting for his former employer. It provides mental stimulation, while covering the extras—travel, electronics, cigars, wine—in his budget. If you're younger than your full Social Security retirement age, which is 66 or 67, depending on the year you were born, Social Security has rules limiting how much you can receive if you're also earning an income. Since Fred hasn’t yet reached his full retirement age, his benefit would be reduced if he claimed early. That was another reason he decided to wait.
In short, here we have two retirees in fairly similar situations who made entirely different choices based on their circumstances. Still, unlike many retirees, they’re fortunate: Both have the financial wherewithal to make taking Social Security an option, not a necessity.
Many retirees have no choice but to start Social Security as soon as possible. My parents fit that description. Serious health problems prevented them from accumulating any retirement assets, other than minimal equity in their home. Once they stopped working, their Social Security checks were their only income.
I’ve studied this topic from half-a-dozen different angles, and I’m still not 100% sure what my wife and I will do. I turn age 65 in September. My wife will be 64 in March. Although my lifetime earnings were higher, my wife’s benefit is 86% of mine. I’ve tried to build a logical framework to help us make the right choice. If you’re facing a similar decision, here are some key considerations:
Marital status. If you’re married, upon the death of the first spouse, the surviving spouse typically continues to receive the larger of the couple's two benefit checks. One strategy we’re considering: Have my wife claim her lower benefit at her full retirement age, while I delay until 70, when I’d get my maximum benefit. That way, my wife would receive my higher benefit as a survivor benefit, should I predecease her.
This is a strategy that could help many married women, who typically have lower lifetime earnings but often live longer than their husbands. According to the Social Security Administration, women reaching age 65 in 2019 typically outlive men by 2½ years. In 2019, the average annual benefit received by women 65 and older was $13,505, compared to $17,374 for men.
Spousal benefit. A spouse may be eligible to receive up to 50% of the other spouse’s benefit, even without a work history. The tricky part: The spouse who was the main breadwinner must begin benefits before the other spouse can claim spousal benefits. This creates an incentive for the higher earner to claim benefits no later than when the lower-earning spouse reaches his or her full retirement age. If the lower-earning spouse delays receiving benefits beyond his or her full retirement age, there’s no further increase in the spousal benefit.
Longevity. Singles have a simpler choice. If you have health issues, or your family hasn’t been blessed with long lives, you may want to claim your retirement benefit as soon as eligible.
For married couples, it’s more complicated. If the higher-earning spouse is also the spouse with lower expected longevity, there’s still an argument for delaying benefits—because the other spouse could receive that larger benefit as a survivor benefit.
Nest egg. If you have no other sources of income, you may be compelled to start benefits earlier. Fortunately, my wife and I have the necessary savings, along with my pension, to cover the five-plus years until I reach age 70. Thereafter, our combined Social Security benefits and my pension should cover our expenses, and allow our portfolio to continue to grow.
There are tools available to help you with the choice. The Social Security Administration provides a portal where you can create your own Social Security account. It will show what you’d receive at your full retirement age, plus estimate your benefit at 62 and 70.
Another useful tool is financial writer Mike Piper’s Open Social Security. It’s a sophisticated calculator that allows you to investigate a variety of scenarios and options. Open Social Security scores each scenario by calculating the lifetime benefits it would produce. The tool generates a heat map that lets you easily compare each scenario to the optimal payout. I found this useful in understanding our situation. It showed the value of my waiting to claim until 70, and that my wife’s claiming choice had much less impact.
For example, the optimal scenario recommended that I claim at age 70, and my wife at 65 and four months. That produced a present value average of $1.4 million in benefits over our lifetimes. If my wife claimed a year earlier, it would reduce our total benefits by only 0.1%. If she waited until she was 70, the total is reduced by 1.3%.
On the other hand, if I claimed at my full retirement age of 66 and six months, and she waited until 70, our lifetime total was reduced by 5.2%. If we both claimed at our full retirement ages, the total is reduced by 7.2%. These numbers support our plan to leave my benefit to grow until age 70. Meanwhile, we have about 18 months until we reach the optimum claiming date for my wife. A lot, of course, could happen between now and then—and that could prompt us to change our plans.
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.
I was reminded of that in December, while at a Christmas party. Two former colleagues were discussing their Social Security decision. Both are male, single, childless, retired engineers. Each has a traditional pension, a paid-off home and significant retirement savings. Ted is age 77. Fred is 66.
Ted took his Social Security at 62. His reason was longevity or, rather, the lack thereof. He had been a smoker for many years. He calculated his breakeven age as 77, at which point he would get back as much as he’d paid into the system. He decided to collect a lower benefit as early as allowed and then invest the money. Ted lives frugally, and will leave a handsome legacy to his nieces and nephews.
Fred is waiting until age 70 to collect. He’s in generally good health, and family history suggests he could live a long life. Although retired, he does some consulting for his former employer. It provides mental stimulation, while covering the extras—travel, electronics, cigars, wine—in his budget. If you're younger than your full Social Security retirement age, which is 66 or 67, depending on the year you were born, Social Security has rules limiting how much you can receive if you're also earning an income. Since Fred hasn’t yet reached his full retirement age, his benefit would be reduced if he claimed early. That was another reason he decided to wait.
In short, here we have two retirees in fairly similar situations who made entirely different choices based on their circumstances. Still, unlike many retirees, they’re fortunate: Both have the financial wherewithal to make taking Social Security an option, not a necessity.
Many retirees have no choice but to start Social Security as soon as possible. My parents fit that description. Serious health problems prevented them from accumulating any retirement assets, other than minimal equity in their home. Once they stopped working, their Social Security checks were their only income.
I’ve studied this topic from half-a-dozen different angles, and I’m still not 100% sure what my wife and I will do. I turn age 65 in September. My wife will be 64 in March. Although my lifetime earnings were higher, my wife’s benefit is 86% of mine. I’ve tried to build a logical framework to help us make the right choice. If you’re facing a similar decision, here are some key considerations:
Marital status. If you’re married, upon the death of the first spouse, the surviving spouse typically continues to receive the larger of the couple's two benefit checks. One strategy we’re considering: Have my wife claim her lower benefit at her full retirement age, while I delay until 70, when I’d get my maximum benefit. That way, my wife would receive my higher benefit as a survivor benefit, should I predecease her.
This is a strategy that could help many married women, who typically have lower lifetime earnings but often live longer than their husbands. According to the Social Security Administration, women reaching age 65 in 2019 typically outlive men by 2½ years. In 2019, the average annual benefit received by women 65 and older was $13,505, compared to $17,374 for men.
Spousal benefit. A spouse may be eligible to receive up to 50% of the other spouse’s benefit, even without a work history. The tricky part: The spouse who was the main breadwinner must begin benefits before the other spouse can claim spousal benefits. This creates an incentive for the higher earner to claim benefits no later than when the lower-earning spouse reaches his or her full retirement age. If the lower-earning spouse delays receiving benefits beyond his or her full retirement age, there’s no further increase in the spousal benefit.
Longevity. Singles have a simpler choice. If you have health issues, or your family hasn’t been blessed with long lives, you may want to claim your retirement benefit as soon as eligible.
For married couples, it’s more complicated. If the higher-earning spouse is also the spouse with lower expected longevity, there’s still an argument for delaying benefits—because the other spouse could receive that larger benefit as a survivor benefit.
Nest egg. If you have no other sources of income, you may be compelled to start benefits earlier. Fortunately, my wife and I have the necessary savings, along with my pension, to cover the five-plus years until I reach age 70. Thereafter, our combined Social Security benefits and my pension should cover our expenses, and allow our portfolio to continue to grow.
There are tools available to help you with the choice. The Social Security Administration provides a portal where you can create your own Social Security account. It will show what you’d receive at your full retirement age, plus estimate your benefit at 62 and 70.
Another useful tool is financial writer Mike Piper’s Open Social Security. It’s a sophisticated calculator that allows you to investigate a variety of scenarios and options. Open Social Security scores each scenario by calculating the lifetime benefits it would produce. The tool generates a heat map that lets you easily compare each scenario to the optimal payout. I found this useful in understanding our situation. It showed the value of my waiting to claim until 70, and that my wife’s claiming choice had much less impact.
For example, the optimal scenario recommended that I claim at age 70, and my wife at 65 and four months. That produced a present value average of $1.4 million in benefits over our lifetimes. If my wife claimed a year earlier, it would reduce our total benefits by only 0.1%. If she waited until she was 70, the total is reduced by 1.3%.
On the other hand, if I claimed at my full retirement age of 66 and six months, and she waited until 70, our lifetime total was reduced by 5.2%. If we both claimed at our full retirement ages, the total is reduced by 7.2%. These numbers support our plan to leave my benefit to grow until age 70. Meanwhile, we have about 18 months until we reach the optimum claiming date for my wife. A lot, of course, could happen between now and then—and that could prompt us to change our plans.
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 Making Your Claim appeared first on HumbleDollar.
Marked Absent
THE NATIONAL STUDENT Clearinghouse Research Center recently published a report on postsecondary enrollment for fall 2021, including enrollment at community colleges, undergraduate institutions and graduate schools.
If you���re a believer in postsecondary education, the headline numbers weren���t encouraging. Enrollment fell by 2.7%, or 476,100 students. Over the two years since the start of the pandemic, it���s declined by 5.1%, or 937,500 students.
While the report offers no reasons for these declines, my view is that colleges are struggling to justify their value proposition to students and their families, especially during a pandemic that���s disrupted in-person learning. As I���ve noted before, college costs are extremely high, creating a significant financial burden for just about any family.
Why should a family take on six figures of debt when a student can earn a good wage at age 18? A manufacturing company near me is offering entry-level workers more than $20 an hour, plus training and benefits. Only a high school degree���or its equivalent���is required. With opportunities like that available, it can be hard to justify the cost of college.
This may be the reason behind the big drop in liberal arts majors. The number of liberal arts majors at four-year institutions fell by 78,774 students, or 7.6%, in fall 2021. By contrast, those majoring in computer and information sciences increased 1.3%, and that followed gains of 5.6% and 4.5% in the prior two years.
It appears some students have decided they need to graduate with solid technical skills to justify their tuition bill. Over the next several years, I believe we���ll continue to see students shift to majors that should lead them to lucrative careers. I also suspect many universities���especially private ones���will revise their pricing and course offerings to make themselves more compelling to students.
If you���re a believer in postsecondary education, the headline numbers weren���t encouraging. Enrollment fell by 2.7%, or 476,100 students. Over the two years since the start of the pandemic, it���s declined by 5.1%, or 937,500 students.
While the report offers no reasons for these declines, my view is that colleges are struggling to justify their value proposition to students and their families, especially during a pandemic that���s disrupted in-person learning. As I���ve noted before, college costs are extremely high, creating a significant financial burden for just about any family.
Why should a family take on six figures of debt when a student can earn a good wage at age 18? A manufacturing company near me is offering entry-level workers more than $20 an hour, plus training and benefits. Only a high school degree���or its equivalent���is required. With opportunities like that available, it can be hard to justify the cost of college.
This may be the reason behind the big drop in liberal arts majors. The number of liberal arts majors at four-year institutions fell by 78,774 students, or 7.6%, in fall 2021. By contrast, those majoring in computer and information sciences increased 1.3%, and that followed gains of 5.6% and 4.5% in the prior two years.
It appears some students have decided they need to graduate with solid technical skills to justify their tuition bill. Over the next several years, I believe we���ll continue to see students shift to majors that should lead them to lucrative careers. I also suspect many universities���especially private ones���will revise their pricing and course offerings to make themselves more compelling to students.
The post Marked Absent appeared first on HumbleDollar.
Retirement Revamp
I RECENTLY RETIRED and have a lump sum from my former employer to invest. For months now, I���ve presumed that I would just add it to our existing investments in the same proportions, easy-peasy. In practice, however, one consideration has led to another, so I���ve made no firm decisions.
Within our 70% stock-30% bond portfolio, I���ve long had a soft rule of keeping well over a third of our stocks in broad market index funds. I see now that this was a rule of convenience, made after I was forced into compliance. As my 401(k) offered only index funds, I invested in them, and then took credit for the wise decision to index.
With the new lump sum rolled into my IRA, I now have a universe of possibilities���for good or ill. Adding to the impasse: At some point, I���ll roll my index-hugging 401(k) assets into an IRA, as well. How should I invest this money?
At the end of December, I took advantage of earlier capital losses to sell down some winning positions in our taxable account, parting with some actively managed funds that I really like, but with the goal of making our portfolio more tax-efficient. Must I say goodbye to these funds completely, I wondered, or should I ease my ���one-third index��� rule and reacquire them in my now-larger IRA? We���d still have some money in index funds, just less.
Alternatively, I���ve considered investing the lump sum in an index-based balanced fund or target-date fund. Although my retirement year has arrived, I���d choose a target year in the future to gain a higher stock allocation.
An index-based target fund would keep up my index holdings. And while it adds a new fund to the mix, it might also add some simplicity. I���d give no more thought to my asset mix for that portion of the portfolio, plus a target-date fund would add exposure to assets that we don���t own as individual positions, such as Treasury Inflation-Protected Securities.
I notice that Fidelity Investments��� target-date funds, both the indexed and active versions, continue to hold more than 40% of their stock allocation in international shares even after their target dates. I like that, and I���m inclined to raise our allocation to foreign stocks and also to venture a bit beyond indexes. Research has shown that active management may have some advantages overseas, particularly among small-company stocks and emerging markets.
One argument has kept me from acting. Since a retiree like me will be spending U.S. dollars, perhaps we need higher U.S. stock holdings in retirement. Still, after a decade of foreign-stock underperformance relative to the U.S. market, I���m thinking about taking our allocation from somewhere around a third of our stocks now to 40%, closer to the market weight for foreign shares as a portion of global stock market value.
What about bonds? Part of the lump sum will be invested there. This is another area in which research indicates some benefits to active management. My default would be to add to our already significant position in Fidelity Total Bond, an actively managed fund. Another option would be to add a short-term bond fund, which would be less sensitive to interest rate hikes that the Fed has assured us are coming. As it is, much of our bond allocation is already in certificates of deposit and my 401(k) plan���s stable value fund, so we stand to benefit from a rate increase and avoid the volatility now afflicting the bond market.
A third bond option would be to add money to a U.S. total bond market index fund. This would offer the usual cost advantage of indexing, plus that index focuses on higher-quality bonds, which could provide better ballast in a stock market drop.
Decisions about bonds would be more important if we were to shift from our current 70% stock-30% bond allocation toward the traditional 60% stock-40% bond mix. Yet this is a move that I���m not as inclined to make. While it feels right to reduce stock risk at this stage, market risk isn���t the only danger. What we regard as ���safe assets��� now are threatened by inflation. A greater stock allocation could give us more protection there.
In thinking through all these considerations, I find that I���ve come full circle. A traditional allocation using index funds would be good should we suffer cognitive decline. Perhaps then we���d be less likely to go down ill-advised investing paths, failing to recognize the risks involved. This basic approach might also benefit a surviving spouse who is less interested in investing.
As William Bernstein says, if you���ve won the game, why keep playing? As in sports, our task is to do the best we can without hurting ourselves. My conclusion: A well-balanced allocation���with a significant share given to indexing���should give us a reasonable chance of accomplishing that.
Michael Perry is a former career Army��officer and external��affairs executive��for a Fortune 100��company. In addition to personal finance and investing, his interests include reading, traveling,��being outdoors,��strength training and coaching, and cocktails. Check out his earlier articles.
Within our 70% stock-30% bond portfolio, I���ve long had a soft rule of keeping well over a third of our stocks in broad market index funds. I see now that this was a rule of convenience, made after I was forced into compliance. As my 401(k) offered only index funds, I invested in them, and then took credit for the wise decision to index.
With the new lump sum rolled into my IRA, I now have a universe of possibilities���for good or ill. Adding to the impasse: At some point, I���ll roll my index-hugging 401(k) assets into an IRA, as well. How should I invest this money?
At the end of December, I took advantage of earlier capital losses to sell down some winning positions in our taxable account, parting with some actively managed funds that I really like, but with the goal of making our portfolio more tax-efficient. Must I say goodbye to these funds completely, I wondered, or should I ease my ���one-third index��� rule and reacquire them in my now-larger IRA? We���d still have some money in index funds, just less.
Alternatively, I���ve considered investing the lump sum in an index-based balanced fund or target-date fund. Although my retirement year has arrived, I���d choose a target year in the future to gain a higher stock allocation.
An index-based target fund would keep up my index holdings. And while it adds a new fund to the mix, it might also add some simplicity. I���d give no more thought to my asset mix for that portion of the portfolio, plus a target-date fund would add exposure to assets that we don���t own as individual positions, such as Treasury Inflation-Protected Securities.
I notice that Fidelity Investments��� target-date funds, both the indexed and active versions, continue to hold more than 40% of their stock allocation in international shares even after their target dates. I like that, and I���m inclined to raise our allocation to foreign stocks and also to venture a bit beyond indexes. Research has shown that active management may have some advantages overseas, particularly among small-company stocks and emerging markets.
One argument has kept me from acting. Since a retiree like me will be spending U.S. dollars, perhaps we need higher U.S. stock holdings in retirement. Still, after a decade of foreign-stock underperformance relative to the U.S. market, I���m thinking about taking our allocation from somewhere around a third of our stocks now to 40%, closer to the market weight for foreign shares as a portion of global stock market value.
What about bonds? Part of the lump sum will be invested there. This is another area in which research indicates some benefits to active management. My default would be to add to our already significant position in Fidelity Total Bond, an actively managed fund. Another option would be to add a short-term bond fund, which would be less sensitive to interest rate hikes that the Fed has assured us are coming. As it is, much of our bond allocation is already in certificates of deposit and my 401(k) plan���s stable value fund, so we stand to benefit from a rate increase and avoid the volatility now afflicting the bond market.
A third bond option would be to add money to a U.S. total bond market index fund. This would offer the usual cost advantage of indexing, plus that index focuses on higher-quality bonds, which could provide better ballast in a stock market drop.
Decisions about bonds would be more important if we were to shift from our current 70% stock-30% bond allocation toward the traditional 60% stock-40% bond mix. Yet this is a move that I���m not as inclined to make. While it feels right to reduce stock risk at this stage, market risk isn���t the only danger. What we regard as ���safe assets��� now are threatened by inflation. A greater stock allocation could give us more protection there.
In thinking through all these considerations, I find that I���ve come full circle. A traditional allocation using index funds would be good should we suffer cognitive decline. Perhaps then we���d be less likely to go down ill-advised investing paths, failing to recognize the risks involved. This basic approach might also benefit a surviving spouse who is less interested in investing.
As William Bernstein says, if you���ve won the game, why keep playing? As in sports, our task is to do the best we can without hurting ourselves. My conclusion: A well-balanced allocation���with a significant share given to indexing���should give us a reasonable chance of accomplishing that.
Michael Perry is a former career Army��officer and external��affairs executive��for a Fortune 100��company. In addition to personal finance and investing, his interests include reading, traveling,��being outdoors,��strength training and coaching, and cocktails. Check out his earlier articles.The post Retirement Revamp appeared first on HumbleDollar.
February 14, 2022
Not So Terrible
THERE WAS MUCH hoopla last week about high inflation, surging interest rates and geopolitical turmoil. Sure, these are important macro conditions. Still, stocks took things in stride. If you only pay attention to once-highflying growth companies, especially tech stocks, the market appears dire. Broaden your perspective, though, and things haven���t been all that terrible of late.
Yes, the S&P 500 lost 1.8% last week. Small-caps, however, were up 1.5%. Foreign shares were about unchanged. The U.S. bond market, despite one of its worst days of the past decade on Thursday, was down just 0.4%.
Traders' heads are still spinning after a wild earnings season. From company-specific volatility to U.S. economic headlines to the Russia-Ukraine crisis, investors might be on edge. But there are some encouraging signs.
Most stocks remain above their Jan. 27 lows. Diversified investors���who likely underperformed last year���have benefited from international exposure in 2022. Vanguard FTSE Emerging Markets ETF (symbol: VWO) is positive year-to-date, while foreign developed market stocks have beaten the S&P 500 by 3.5 percentage points in 2022.
Another green shoot: Small-cap stocks have turned up versus large-caps. The iShares Russell 2000 ETF (IWM) has outpaced the S&P 500 by almost four percentage points since Feb. 2. While a short timeframe, that could be a sign that not everyone is risk-averse right now.
Many small speculative stocks have endured a tough year. While the iShares Russell 2000 ETF has lately held up well, it���s down more than 10% over the trailing 52 weeks. Given the extended duration and magnitude of the decline among small company stocks, now might be a decent time to buy.
It���s humbling how quickly financial markets can turn from optimism to fear. There���s no shortage of risks to worry about right now. But that often means opportunity for those investors who focus on the long run.
Yes, the S&P 500 lost 1.8% last week. Small-caps, however, were up 1.5%. Foreign shares were about unchanged. The U.S. bond market, despite one of its worst days of the past decade on Thursday, was down just 0.4%.
Traders' heads are still spinning after a wild earnings season. From company-specific volatility to U.S. economic headlines to the Russia-Ukraine crisis, investors might be on edge. But there are some encouraging signs.
Most stocks remain above their Jan. 27 lows. Diversified investors���who likely underperformed last year���have benefited from international exposure in 2022. Vanguard FTSE Emerging Markets ETF (symbol: VWO) is positive year-to-date, while foreign developed market stocks have beaten the S&P 500 by 3.5 percentage points in 2022.
Another green shoot: Small-cap stocks have turned up versus large-caps. The iShares Russell 2000 ETF (IWM) has outpaced the S&P 500 by almost four percentage points since Feb. 2. While a short timeframe, that could be a sign that not everyone is risk-averse right now.
Many small speculative stocks have endured a tough year. While the iShares Russell 2000 ETF has lately held up well, it���s down more than 10% over the trailing 52 weeks. Given the extended duration and magnitude of the decline among small company stocks, now might be a decent time to buy.
It���s humbling how quickly financial markets can turn from optimism to fear. There���s no shortage of risks to worry about right now. But that often means opportunity for those investors who focus on the long run.
The post Not So Terrible appeared first on HumbleDollar.
