Jonathan Clements's Blog, page 233
January 28, 2022
Not That We’d Brag
MANY OF THE WORLD’S religions view humility as an admirable trait to which we should all aspire. It’s frequently associated with poverty, as practiced by devout orders like Buddhist monks and the Sisters of Mercy. But when it comes to investing, humility can—ironically—make you significantly wealthier.
As documented by the behavioral finance research, overconfidence can lead to worse investment returns when investors presume, without justification, that they’re skilled at, say, picking market-beating stocks. The research on indexing versus active stock fund management overwhelmingly shows that, for long holding periods, actively managed funds perform worse than index funds, on average. That doesn’t mean active management never succeeds, but the odds are heavily stacked against those who try.
The superior return history of indexing can strike folks as counterintuitive. It seems as though investors are just settling for average. But research shows that investors who choose low-cost indexing can end up with fund results that outpace 80% or 90% of active managers.
In addition to feeling counterintuitive, indexing flies in the face of our inherent belief in our own abilities. In opting for index funds, it can feel like we’re surrendering to the poverty of a religious order by not aiming to outperform. But in fact, it does just the opposite, making investors on average wealthier than if they’d pursued active strategies. Want to avoid the negative financial consequences of overconfidence? Let humility be your antidote.
The post Not That We’d Brag appeared first on HumbleDollar.
Not That We���d Brag
MANY OF THE WORLD���S religions view humility as an admirable trait to which we should all aspire. It���s frequently associated with poverty, as practiced by devout orders like Buddhist monks and the Sisters of Mercy. But when it comes to investing, humility can���ironically���make you significantly wealthier.
As documented by the behavioral finance research, overconfidence can lead to worse investment returns when investors presume, without justification, that they���re skilled at, say, picking market-beating stocks. The research on indexing versus active stock fund management overwhelmingly shows that, for long holding periods, actively managed funds perform worse than index funds, on average. That doesn���t mean active management never succeeds, but the odds are heavily stacked against those who try.
The superior return history of indexing can strike folks as counterintuitive. It seems as though investors are just settling for average. But research shows that investors who choose low-cost indexing can end up with fund results that outpace 80% or 90% of active managers.
In addition to feeling counterintuitive, indexing flies in the face of our inherent belief in our own abilities. In opting for index funds, it can feel like we���re surrendering to the poverty of a religious order by not aiming to outperform. But in fact, it does just the opposite, making investors on average wealthier than if they���d pursued active strategies. Want to avoid the negative financial consequences of overconfidence? Let humility be your antidote.
The post Not That We���d Brag appeared first on HumbleDollar.
Five Times Lucky
LUCK HAS BEEN A KEY element in my financial journey. My good fortune has come in stages, beginning with my parents teaching me the lessons of saving and moderate spending. They valued education, supporting me as I attended first Yale for my undergraduate degree and then Harvard Business School.
After business school, I was fortunate to be hired as a junior analyst by the Rockefeller family office. This got me into the investment world, that most interesting line of work. In the early 1960s, there were no courses on investing at Harvard Business School. Obviously needing to get educated on investing, I was delighted that my employer would pay the cost of courses at New York University night school.
Over the next several years, I worked on my PhD. My timing was fortunate. Older professors taught traditional securities analysis, while younger faculty taught modern portfolio theory and efficient markets. I also studied to become a Chartered Financial Analyst. This three-way education gave me a unique opportunity to learn advanced best practices in investment management.
Meanwhile, I had moved on to Wall Street, taking a job with Donaldson, Lufkin & Jenrette, a leading research-based stockbroker. I was assigned to cover major clients in Boston, New York and Philadelphia. Each client had a stellar team of bright, hard-working, highly competitive analysts and portfolio managers, and each of these teams had its own concept and process for winning the battle for superior investment performance.
With several dozen clients, I was blessed with an extraordinary opportunity to learn from each. I was also able to see that as smart and hard-working as each group was, they were competing against each other. They all read the same research coming out of Wall Street and they all had access to the New York Stock Exchange, where corporate filings required by the Securities and Exchange Commission were available.
Two things seemed clear: Not all could win every year, and those who won this year seldom won again next year. As performance measurement firms were soon able to document, over the long term, many investment managers were falling short.
Case closed. The next phase of my good fortune was a series of annual three-day seminars I was privileged to lead, eventually for 30 years, in which the leading portfolio managers came together to discuss investing. This ���best of the best��� assemblage made it even more clear that the competition in The Money Game���as George Goodman, writing under the pen name ���Adam Smith,��� dubbed it in his bestselling book���was superb and intense.
During a break in one of the seminar���s sessions, my friend Jay Sherrerd, co-founder of the investment firm Miller, Anderson & Sherrerd, said, ���Did you know you can get Neff at a significant discount?���
John Neff, widely recognized as one of the all-time best mutual fund managers, had recently launched a dual-purpose closed-end fund named Gemini, after the mythological twins. Half the money in Gemini got all the dividends and half got all the capital gains���and all the losses. A severe bear market was particularly punishing to the value stocks in which John specialized, so Gemini���s capital shares had taken a terrific beating. Because Gemini was a closed-end fund rather than a regular mutual fund, its shares traded on the stock market. At that time���1974���the capital shares were selling at a steep discount to the value of the fund���s already-depressed portfolio.
Lucky me, I knew John well. He had a strong record of outperforming the market, and was unusually focused on understanding and managing risk. This presented me with a special opportunity. Believing the market was seriously oversold, particularly for the value stocks that John specialized in, I made an assumption that the market would not go down more than an additional 20%. Then, with maximum margin, I put all I had into Gemini���s capital shares. In a few months, the bear market turned into a bull market, and value stocks outperformed the overall market. John���s picks beat value stocks generally, and the double leverage of the duo-fund structure���and my hefty use of margin���multiplied one another in a most wonderful way. It was my first notable investment win.
My second winning experience came with Greenwich Associates, the consulting firm I founded in 1972. The firm had a profit-sharing retirement plan. Each year, the firm contributed 15% of each person���s earned income. Added to this was the 2% to 3% left behind by those employees who didn���t stay five years and so missed full vesting. And added to this was our early years��� practice of investing in closed-end mutual funds that were likely to go open-ended. These open-endings���or conversions to regular mutual fund status���had the effect of eliminating the gap between the fund���s share price and its higher underlying portfolio value. As Senator Dirksen once said, ���Pretty soon, it can add up to real money.���
Meal ticket. My third winning experience was the best. I was pleased to be invited to lunch by Sandy Gottesman, the much-admired senior partner of First Manhattan and one of Greenwich Associates��� clients. I hoped this would give me an opportunity to get him to adopt our recommendations for the firm���s stockbrokerage business.
As we sat down at his regular table at his club, Sandy said, ���We are not going to renew our engagement with you in stockbrokerage this year and I���d like to tell you why. Our research is focused on creative investment ideas, but your research shows that institutions want us to organize around coverage of whole industries. We don���t want to do that. You also show that clients want us to get into block trading, which we also do not want to do. It���s too risky for us.���
I was about to offer Sandy our program on investment management for large corporate pension funds, but he said, ���I know you have a great program on big pension funds, but that���s not our market. We focus on smaller funds.���
The conversation was effectively over and our lunch orders hadn���t yet come. To fill the void, I said, ���Sandy, thank you for being so open and courteous with me about your decision.��� Then, knowing Sandy was a very successful investor, I asked him to share his experiences with great investments.
He replied with one word: ���Berkshire.���
I had heard about Warren Buffett and the Buffett Partnership, so I asked, ���How long have you invested in Berkshire Hathaway?���
���A long time.���
���How long would you expect to continue owning it?���
���Forever.���
While we ate our lunch, Sandy told me the Berkshire story, about how Buffett took control of an ailing New England textile company in 1965 and turned it into the vehicle he used to make a slew of extraordinarily successful investments, with an early focus on insurance. He then used the insurance company ���float��� to make further investments, eventually building what today is one of the world���s largest companies.
Lucky as Sandy���s recommendation was, it was actually perfectly matched by a fortunate situation. My partners and I had agreed to create a reserve fund in case our small firm ran into a bad earnings situation, so we wouldn���t have to each scramble to put up more capital if we had an operating loss. The fund was only $100,000, but we thought that would be enough, if and when an emergency developed. The money was raised by simply slow-paying our year-end bonuses by a few months. We had agreed that the money would be invested in safe stocks and that I would recommend the portfolio. By the time Sandy had finished his reasoning for holding Berkshire Hathaway forever, the obvious move was to invest the whole fund in Berkshire. The result over nearly five decades has been superb���more than 300 times our cost.
Embracing average. My fourth winning experience in investing: not losing the money I had made. I accomplished this by investing in index funds at Vanguard Group. Over the past 20 years, nearly 90% of actively managed stock mutual funds have fallen short of the market averages, often by large amounts. I believe indexing has saved me from considerable grief and losses. Indexing has also saved me time and concern. Other than Berkshire, my investment program is and has been simple: index.
I was so convinced by indexing���s virtues that I became a proponent even before I could invest that way. In 1975, for the Financial Analysts Journal, I wrote an article entitled ���The Loser���s Game,��� where I argued, ���The investment management business (it should be a profession but is not) is built upon a simple and basic belief: Professional money managers can beat the market. That premise appears to be false.��� More than a decade later, that article turned into a book that���s now entitled Winning the Loser���s Game and which has gone on to sell more than 650,000 copies.
My fifth winning experience in investing may surprise readers, but it���s the one part of my experience that others might enjoy including in their overall financial strategy. I certainly recommend each person give it careful consideration. It���s been a big win for me.
Scholarships for talented young people, that enable them to get first-rate educations and make the most of their talents, are a wonderful way to strengthen our society. It can also lead to unmatchable personal satisfaction. For me, providing scholarships for exceptional young people has been a joy. The importance that my parents put on education, and the steps they took to ensure I got the best available, has been a huge part of my success. It���s a gift that I am more than happy to share with others. What a wonderful investment!
Charles D. Ellis is the author of 18 books, including Winning the Loser���s Game,��which is now in its 8th edition, with 650,000 copies sold. Charley has taught investing courses at both Yale and Harvard business schools, and he served for 17 years on Yale���s investment committee. Check out his earlier articles.
After business school, I was fortunate to be hired as a junior analyst by the Rockefeller family office. This got me into the investment world, that most interesting line of work. In the early 1960s, there were no courses on investing at Harvard Business School. Obviously needing to get educated on investing, I was delighted that my employer would pay the cost of courses at New York University night school.
Over the next several years, I worked on my PhD. My timing was fortunate. Older professors taught traditional securities analysis, while younger faculty taught modern portfolio theory and efficient markets. I also studied to become a Chartered Financial Analyst. This three-way education gave me a unique opportunity to learn advanced best practices in investment management.Meanwhile, I had moved on to Wall Street, taking a job with Donaldson, Lufkin & Jenrette, a leading research-based stockbroker. I was assigned to cover major clients in Boston, New York and Philadelphia. Each client had a stellar team of bright, hard-working, highly competitive analysts and portfolio managers, and each of these teams had its own concept and process for winning the battle for superior investment performance.
With several dozen clients, I was blessed with an extraordinary opportunity to learn from each. I was also able to see that as smart and hard-working as each group was, they were competing against each other. They all read the same research coming out of Wall Street and they all had access to the New York Stock Exchange, where corporate filings required by the Securities and Exchange Commission were available.
Two things seemed clear: Not all could win every year, and those who won this year seldom won again next year. As performance measurement firms were soon able to document, over the long term, many investment managers were falling short.
Case closed. The next phase of my good fortune was a series of annual three-day seminars I was privileged to lead, eventually for 30 years, in which the leading portfolio managers came together to discuss investing. This ���best of the best��� assemblage made it even more clear that the competition in The Money Game���as George Goodman, writing under the pen name ���Adam Smith,��� dubbed it in his bestselling book���was superb and intense.
During a break in one of the seminar���s sessions, my friend Jay Sherrerd, co-founder of the investment firm Miller, Anderson & Sherrerd, said, ���Did you know you can get Neff at a significant discount?���
John Neff, widely recognized as one of the all-time best mutual fund managers, had recently launched a dual-purpose closed-end fund named Gemini, after the mythological twins. Half the money in Gemini got all the dividends and half got all the capital gains���and all the losses. A severe bear market was particularly punishing to the value stocks in which John specialized, so Gemini���s capital shares had taken a terrific beating. Because Gemini was a closed-end fund rather than a regular mutual fund, its shares traded on the stock market. At that time���1974���the capital shares were selling at a steep discount to the value of the fund���s already-depressed portfolio.
Lucky me, I knew John well. He had a strong record of outperforming the market, and was unusually focused on understanding and managing risk. This presented me with a special opportunity. Believing the market was seriously oversold, particularly for the value stocks that John specialized in, I made an assumption that the market would not go down more than an additional 20%. Then, with maximum margin, I put all I had into Gemini���s capital shares. In a few months, the bear market turned into a bull market, and value stocks outperformed the overall market. John���s picks beat value stocks generally, and the double leverage of the duo-fund structure���and my hefty use of margin���multiplied one another in a most wonderful way. It was my first notable investment win.
My second winning experience came with Greenwich Associates, the consulting firm I founded in 1972. The firm had a profit-sharing retirement plan. Each year, the firm contributed 15% of each person���s earned income. Added to this was the 2% to 3% left behind by those employees who didn���t stay five years and so missed full vesting. And added to this was our early years��� practice of investing in closed-end mutual funds that were likely to go open-ended. These open-endings���or conversions to regular mutual fund status���had the effect of eliminating the gap between the fund���s share price and its higher underlying portfolio value. As Senator Dirksen once said, ���Pretty soon, it can add up to real money.���
Meal ticket. My third winning experience was the best. I was pleased to be invited to lunch by Sandy Gottesman, the much-admired senior partner of First Manhattan and one of Greenwich Associates��� clients. I hoped this would give me an opportunity to get him to adopt our recommendations for the firm���s stockbrokerage business.
As we sat down at his regular table at his club, Sandy said, ���We are not going to renew our engagement with you in stockbrokerage this year and I���d like to tell you why. Our research is focused on creative investment ideas, but your research shows that institutions want us to organize around coverage of whole industries. We don���t want to do that. You also show that clients want us to get into block trading, which we also do not want to do. It���s too risky for us.���
I was about to offer Sandy our program on investment management for large corporate pension funds, but he said, ���I know you have a great program on big pension funds, but that���s not our market. We focus on smaller funds.���
The conversation was effectively over and our lunch orders hadn���t yet come. To fill the void, I said, ���Sandy, thank you for being so open and courteous with me about your decision.��� Then, knowing Sandy was a very successful investor, I asked him to share his experiences with great investments.
He replied with one word: ���Berkshire.���
I had heard about Warren Buffett and the Buffett Partnership, so I asked, ���How long have you invested in Berkshire Hathaway?���
���A long time.���
���How long would you expect to continue owning it?���
���Forever.���
While we ate our lunch, Sandy told me the Berkshire story, about how Buffett took control of an ailing New England textile company in 1965 and turned it into the vehicle he used to make a slew of extraordinarily successful investments, with an early focus on insurance. He then used the insurance company ���float��� to make further investments, eventually building what today is one of the world���s largest companies.
Lucky as Sandy���s recommendation was, it was actually perfectly matched by a fortunate situation. My partners and I had agreed to create a reserve fund in case our small firm ran into a bad earnings situation, so we wouldn���t have to each scramble to put up more capital if we had an operating loss. The fund was only $100,000, but we thought that would be enough, if and when an emergency developed. The money was raised by simply slow-paying our year-end bonuses by a few months. We had agreed that the money would be invested in safe stocks and that I would recommend the portfolio. By the time Sandy had finished his reasoning for holding Berkshire Hathaway forever, the obvious move was to invest the whole fund in Berkshire. The result over nearly five decades has been superb���more than 300 times our cost.
Embracing average. My fourth winning experience in investing: not losing the money I had made. I accomplished this by investing in index funds at Vanguard Group. Over the past 20 years, nearly 90% of actively managed stock mutual funds have fallen short of the market averages, often by large amounts. I believe indexing has saved me from considerable grief and losses. Indexing has also saved me time and concern. Other than Berkshire, my investment program is and has been simple: index.
I was so convinced by indexing���s virtues that I became a proponent even before I could invest that way. In 1975, for the Financial Analysts Journal, I wrote an article entitled ���The Loser���s Game,��� where I argued, ���The investment management business (it should be a profession but is not) is built upon a simple and basic belief: Professional money managers can beat the market. That premise appears to be false.��� More than a decade later, that article turned into a book that���s now entitled Winning the Loser���s Game and which has gone on to sell more than 650,000 copies.
My fifth winning experience in investing may surprise readers, but it���s the one part of my experience that others might enjoy including in their overall financial strategy. I certainly recommend each person give it careful consideration. It���s been a big win for me.
Scholarships for talented young people, that enable them to get first-rate educations and make the most of their talents, are a wonderful way to strengthen our society. It can also lead to unmatchable personal satisfaction. For me, providing scholarships for exceptional young people has been a joy. The importance that my parents put on education, and the steps they took to ensure I got the best available, has been a huge part of my success. It���s a gift that I am more than happy to share with others. What a wonderful investment!
Charles D. Ellis is the author of 18 books, including Winning the Loser���s Game,��which is now in its 8th edition, with 650,000 copies sold. Charley has taught investing courses at both Yale and Harvard business schools, and he served for 17 years on Yale���s investment committee. Check out his earlier articles.The post Five Times Lucky appeared first on HumbleDollar.
AAA Is for Apple
TO BE AWARDED a triple-A credit rating was once a priority for some of the biggest and best-known U.S. companies. Only the financially strongest companies, organizations and governments can earn a triple-A rating.
The triple-A rating typically bestows the lowest borrowing rates and suggests the highest ability to repay bondholders. But the triple-A club has been shrinking over the past four decades. Apple recently became only the third current corporate member of this exclusive club.
The list of companies holding triple-A credit ratings was once much longer. In 1980, nearly 60 companies carried a triple-A rating. These companies prioritized solid balance sheets and enjoyed the lower borrowing costs that flowed to financially robust borrowers.
But starting in the 1980s, the U.S. business landscape began to change. Intense business competition, the buyout and acquisition binge, and evolving corporate financial policies conspired to create a willingness to take on more debt.
Business struggles forced Ford and General Motors from the triple-A club in 1980 and 1981, respectively. Growing competition from Japanese automakers, higher fuel prices and rising interest rates damaged the two automakers��� finances so much that they couldn't maintain their financial strength while also competing effectively.
In 1986, Coke lost its triple-A rating when it took on debt to create a new bottling network. Competitive issues led to Sears being downgraded in 1980, followed by AT&T in 1984, drug-maker Schering-Plough in 1985, Eastman Kodak in 1986 and IBM in 1993.
Buyouts and acquisitions also took their toll. They ushered in a dramatic rise in the use of debt to increase shareholder returns and fund takeovers. Companies with large cash balances became attractive targets for corporate raiders. After being acquired, many targets lost their triple-A rating, as the new owners used the acquired company���s cash plus more debt to pay for the deals. Getty Oil and Gulf Oil both experienced this in 1984, Sterling Drug in 1988 and Amoco in 1999.
Changes in financial policy were the final nail in the coffin for many triple-A-rated firms. Some companies decided to deemphasize building up large cash balances in favor of more debt, hoping that would lead to higher profits. DuPont lost its triple-A rating in 1981 following a change in financial policy. Macy's, Kraft Foods and General Foods also all lost theirs in 1981, Kellogg's and Chevron in 1984, and Procter & Gamble in 1987.
By 2011, the list of triple-A-rated companies had narrowed to just four companies after General Electric, Berkshire Hathaway and Pfizer lost their triple-A ratings following 2008���s Great Financial Crisis. But because monetary policy was so easy, interest rates so low and bond demand so great, interest costs for a triple-A-rated credit were hardly different from those for lower-rated companies.
Suddenly, the cost savings derived from a higher credit rating mattered less than ever. After taking on more debt, payroll processor ADP was downgraded in 2015, followed by Exxon in 2016. That left only Microsoft and Johnson & Johnson with AAA ratings, until Apple���s elevation last month.
Apple didn't sacrifice other business initiatives to prioritize credit strength, and it didn't achieve a triple-A credit rating because that was its goal. Rather, Apple's triple-A credit rating is the culmination of the company���s programming, design, production and marketing decisions that lead to billions in excess cash and a solid balance sheet.
Apple made loads of money by competing, executing and winning. Credit rating agencies are routinely late in realizing what markets have already seen. Eventually, Apple's business success made it impossible not to give it the top AAA rating.
Phil Kernen, CFA, is a portfolio manager and partner with
Mitchell Capital
, a financial planning and investment management firm in Leawood, Kansas. When he's not working, Phil enjoys spending time with his family and friends, reading, hiking and riding his bike. You can connect with Phil via
LinkedIn
. Check out his earlier articles.
The triple-A rating typically bestows the lowest borrowing rates and suggests the highest ability to repay bondholders. But the triple-A club has been shrinking over the past four decades. Apple recently became only the third current corporate member of this exclusive club.
The list of companies holding triple-A credit ratings was once much longer. In 1980, nearly 60 companies carried a triple-A rating. These companies prioritized solid balance sheets and enjoyed the lower borrowing costs that flowed to financially robust borrowers.
But starting in the 1980s, the U.S. business landscape began to change. Intense business competition, the buyout and acquisition binge, and evolving corporate financial policies conspired to create a willingness to take on more debt.
Business struggles forced Ford and General Motors from the triple-A club in 1980 and 1981, respectively. Growing competition from Japanese automakers, higher fuel prices and rising interest rates damaged the two automakers��� finances so much that they couldn't maintain their financial strength while also competing effectively.
In 1986, Coke lost its triple-A rating when it took on debt to create a new bottling network. Competitive issues led to Sears being downgraded in 1980, followed by AT&T in 1984, drug-maker Schering-Plough in 1985, Eastman Kodak in 1986 and IBM in 1993.
Buyouts and acquisitions also took their toll. They ushered in a dramatic rise in the use of debt to increase shareholder returns and fund takeovers. Companies with large cash balances became attractive targets for corporate raiders. After being acquired, many targets lost their triple-A rating, as the new owners used the acquired company���s cash plus more debt to pay for the deals. Getty Oil and Gulf Oil both experienced this in 1984, Sterling Drug in 1988 and Amoco in 1999.
Changes in financial policy were the final nail in the coffin for many triple-A-rated firms. Some companies decided to deemphasize building up large cash balances in favor of more debt, hoping that would lead to higher profits. DuPont lost its triple-A rating in 1981 following a change in financial policy. Macy's, Kraft Foods and General Foods also all lost theirs in 1981, Kellogg's and Chevron in 1984, and Procter & Gamble in 1987.
By 2011, the list of triple-A-rated companies had narrowed to just four companies after General Electric, Berkshire Hathaway and Pfizer lost their triple-A ratings following 2008���s Great Financial Crisis. But because monetary policy was so easy, interest rates so low and bond demand so great, interest costs for a triple-A-rated credit were hardly different from those for lower-rated companies.
Suddenly, the cost savings derived from a higher credit rating mattered less than ever. After taking on more debt, payroll processor ADP was downgraded in 2015, followed by Exxon in 2016. That left only Microsoft and Johnson & Johnson with AAA ratings, until Apple���s elevation last month.
Apple didn't sacrifice other business initiatives to prioritize credit strength, and it didn't achieve a triple-A credit rating because that was its goal. Rather, Apple's triple-A credit rating is the culmination of the company���s programming, design, production and marketing decisions that lead to billions in excess cash and a solid balance sheet.
Apple made loads of money by competing, executing and winning. Credit rating agencies are routinely late in realizing what markets have already seen. Eventually, Apple's business success made it impossible not to give it the top AAA rating.
Phil Kernen, CFA, is a portfolio manager and partner with
Mitchell Capital
, a financial planning and investment management firm in Leawood, Kansas. When he's not working, Phil enjoys spending time with his family and friends, reading, hiking and riding his bike. You can connect with Phil via
LinkedIn
. Check out his earlier articles.The post AAA Is for Apple appeared first on HumbleDollar.
January 27, 2022
Use It or Lose It
THERE���S AN EXPERIENCE I keep thinking about. I was visiting Italy pre-pandemic, enjoying a great dinner with a lovely family. I was introduced to two nonnas���grandmothers in Italian���who were in their 80s. Although fine physically, they were both suffering from dementia.
That got me thinking about how that could have happened. I���ve read plenty of research on how retiring to a simple lifestyle, and not being challenged mentally, accelerates cognitive decline. I wondered whether that���s what happened to the two nonnas. Their lives consisted of living the same day over and over, following the same basic routine for the last 60-plus years. They were rarely taxed mentally.
My contention: It���s a mistake to let the fire go out when we retire. Transitioning from a mentally challenging job to a sedentary lifestyle, where you spend a lot of time sitting around watching TV or on social media, is going to cost you.
I���m saddened when I see new retirees intentionally dumbing down their minds, trying to adjust to the slower pace of their new lives, because I fear that���ll only accelerate the decaying process. You can see it in their eyes, and in how they talk and act. They���re shells of their former selves. They���ve lost their spark, energy, inspiration and excitement about life, and it���s sad to see that happening.
When we stop growing intellectually, our memory fades, our cognitive ability diminishes and our brain physically shrinks. That is why it���s so important to create a retirement lifestyle that engages and challenges us, one that forces us to use our brain the same way we did while working. Don���t feel like you���re exerting yourself mentally? You might even consider going back to school.
That got me thinking about how that could have happened. I���ve read plenty of research on how retiring to a simple lifestyle, and not being challenged mentally, accelerates cognitive decline. I wondered whether that���s what happened to the two nonnas. Their lives consisted of living the same day over and over, following the same basic routine for the last 60-plus years. They were rarely taxed mentally.
My contention: It���s a mistake to let the fire go out when we retire. Transitioning from a mentally challenging job to a sedentary lifestyle, where you spend a lot of time sitting around watching TV or on social media, is going to cost you.
I���m saddened when I see new retirees intentionally dumbing down their minds, trying to adjust to the slower pace of their new lives, because I fear that���ll only accelerate the decaying process. You can see it in their eyes, and in how they talk and act. They���re shells of their former selves. They���ve lost their spark, energy, inspiration and excitement about life, and it���s sad to see that happening.
When we stop growing intellectually, our memory fades, our cognitive ability diminishes and our brain physically shrinks. That is why it���s so important to create a retirement lifestyle that engages and challenges us, one that forces us to use our brain the same way we did while working. Don���t feel like you���re exerting yourself mentally? You might even consider going back to school.
The post Use It or Lose It appeared first on HumbleDollar.
Up and Away
MY HUSBAND AND I purchased a home near Phoenix, Arizona, in 2019. It was the second house we���d bought in less than a year, so we were only able to come up with a 10% down payment. That���s meant paying $70 a month for the past 30 months to cover the cost of private mortgage��insurance (PMI).
With property values in the Phoenix area up 30% since 2020, I knew I should contact our mortgage company to see if we could get the PMI payment removed. I assumed an appraisal would show our home equity had increased to the point where we no longer needed to carry the coverage.
Still, I hesitated to make the phone call because I feared the entire process would be both time-consuming and costly. I expected a full appraisal to run at least $500. I also assumed that finding an appraiser and then having him or her evaluate our home, process the paperwork and report back to our mortgage lender would take months.
In December 2021, I finally contacted our mortgage company. I was directed to the PMI department and was immediately able to speak to a customer service representative. The rep told me I had two options. I could pay for a full appraisal, estimated to cost between $500 and $600. Or, for $150, I could opt to have a broker price opinion report created. This second option involved having a real estate agent evaluate photos of our home. After comparing the features of our home to those of houses in our neighborhood that had recently sold, the agent would compute our home���s estimated market value.
Within three days of my initial phone call, a mortgage company representative arrived at our doorstep. She spent no more than five minutes walking through our home snapping a few photos. Within a week, we had a full market comparison report from a real estate agent. The estimated market price for our home came in at nearly $120,000 more than what we���d paid. The mortgage company informed me two days later that our PMI payment would be removed starting February 2022.
With property values in the Phoenix area up 30% since 2020, I knew I should contact our mortgage company to see if we could get the PMI payment removed. I assumed an appraisal would show our home equity had increased to the point where we no longer needed to carry the coverage.
Still, I hesitated to make the phone call because I feared the entire process would be both time-consuming and costly. I expected a full appraisal to run at least $500. I also assumed that finding an appraiser and then having him or her evaluate our home, process the paperwork and report back to our mortgage lender would take months.
In December 2021, I finally contacted our mortgage company. I was directed to the PMI department and was immediately able to speak to a customer service representative. The rep told me I had two options. I could pay for a full appraisal, estimated to cost between $500 and $600. Or, for $150, I could opt to have a broker price opinion report created. This second option involved having a real estate agent evaluate photos of our home. After comparing the features of our home to those of houses in our neighborhood that had recently sold, the agent would compute our home���s estimated market value.
Within three days of my initial phone call, a mortgage company representative arrived at our doorstep. She spent no more than five minutes walking through our home snapping a few photos. Within a week, we had a full market comparison report from a real estate agent. The estimated market price for our home came in at nearly $120,000 more than what we���d paid. The mortgage company informed me two days later that our PMI payment would be removed starting February 2022.
The post Up and Away appeared first on HumbleDollar.
Answers About Life
I REALIZE MOST FOLKS don���t find personal finance as enthralling as I do, so I apologize in advance���this article���s topic is the least thrilling of all. It���s time to talk about life insurance.
I���ve been trying to come up with a good analogy for life insurance. The best I can think of: Life insurance is like the airbags in your car. No one ever gets excited about airbags. No one ever shows off the airbags in their new car. But if you ever need your airbags, you���ll be glad as heck you have them.
Life insurance can be tough to understand. There���s a boatload of different types. There are lots of weird terms. There are pushy salespeople whose incentives aren���t aligned with your best interests. And there���s a lack of unbiased guidance out there.
I���m writing in hopes of providing some basic understanding of how life insurance works, who needs it, how to estimate how much you need and how to understand the different types that are sold. To begin with, all types of insurance are designed to transfer the financial risk of something bad happening from you to the insurance company. With life insurance, you transfer the financial risk that comes from the possibility of untimely death.
If you die, you won���t be able to financially support your loved ones. By buying life insurance, you transfer part of that risk to the insurance company. You pay a small amount���the premium���to secure the coverage. In exchange, the insurance company guarantees to pay your beneficiaries if you die, reducing your family���s financial loss.
Each life insurance policy contains a death benefit. This is the amount that would be paid to the beneficiaries upon the death of the insured. Let���s use a hypothetical couple, Zack and Kelly. Let���s say Zack buys a life insurance policy with a $1 million death benefit. Zack lists himself as the insured and Kelly as the beneficiary. Zack pays $100 a month as his insurance premium. If Zack dies, the insurance company would pay Kelly $1 million.
If others depend on you financially, you should think about obtaining life insurance. There are many sorts of people who might need life insurance and, while some are obvious, some aren���t:
Parents with young children.
Married or partnered adults who own a home and have a mortgage.
Adults who financially support other adults.
Adults who have debts they don���t want to leave to their estate.
Small business owners who���d want to buy out a partner���s interest if she died.
Adults whose assets exceed the federal estate tax exemption, which is $12 million per person currently and is scheduled to drop to $5 million in 2026.
Although you might not get this impression from an insurance agent, not everyone needs life insurance. You don���t need coverage if your death wouldn���t cause anyone else financial distress. In other words, if you���re a child or a single adult with no debts or dependents, you probably don���t need life insurance.
If you do need insurance, however, there are two main types: term insurance and permanent insurance. Term insurance is the most basic kind and has the cheapest monthly premiums. Think of it as an insurance rental.
A term insurance policy pays out a death benefit if the insured dies within the specified period���the term���that���s listed when it���s purchased. The insurance coverage stops at the end of the term. This insurance is the most suitable and cost-effective form of insurance for most people.
Let���s say that Zack and Kelly have two children, ages four and two. They might each purchase a life insurance policy with a 20-year term. By the time their policies end, their children will be 24 and 22, respectively, and presumably won���t need financial support. If Zack or Kelly die during the 20-year period, their death benefit would replace the income they otherwise would have provided.
Permanent insurance is designed to cover someone forever, no matter how long he or she lives. In addition to paying out a death benefit, permanent insurance policies also contain a cash value component that allows policyholders to access some of the money they���ve paid in premiums over the years.
Permanent insurance is usually much more expensive than term insurance. Still, it can be useful for people who foresee the need for insurance for as long as they live. This can be those with large estates. Parents with children who need lifelong support could also be candidates for permanent insurance, which is sometimes called whole life.
There are numerous calculators to help determine how large a death benefit you might need. But here���s a back-of-the-napkin method you can use at home:
Figure out your annual take-home pay. That���s your gross salary minus deductions for things like taxes, Social Security, Medicare and retirement savings.
Subtract from your annual take-home pay how much you spend on yourself in any given year.
What���s left is the amount of support you provide your family annually. This is the sum your family will need to replace each year to maintain its standard of living.
Multiply this family support amount by the number of years you���d like the insurance to cover. That number is the death benefit you���d want from an insurance policy.
Let���s say Zack makes $100,000 in take-home salary and spends $25,000 on himself alone. His family would need to replace $75,000 in lost earnings each year to maintain its current lifestyle if Zack were to die. Over 20 years, Zack���s family would need to replace as much as $1.5 million of lost earnings. In this case, having Zack take out a $1.5 million term policy for 20 years might be a good idea.
Unfortunately, insurance is often sold rather than bought. The salesperson���s commission is tied to the size of the policy that gets sold and the type of coverage. For a policy of the same size, permanent insurance would pay a bigger commission than term. As a result, there is an incentive to oversell policies that clients don���t need.
Watch out for a salesperson who tells you that an insurance policy is a good investment or suggests that you can afford more insurance coverage by diverting savings from other areas. It���s also a red flag if someone uses scare tactics in the sales process, or tries to sell you permanent insurance right out of medical school or law school.
Rather than going through an insurance agent, you can now shop for insurance online through sites like Policy Genius, Nerd Wallet and Bestow. If you have questions, contact a fee-only financial planner. That���s a good way to get an unbiased opinion.
Matt Trogdon is a financial planner with Craftwork Capital, LLC. He's based in Washington, D.C., and has a special interest in helping Gen X and Gen Y families. He also serves as a workshop instructor for the Babson College Financial Literacy Project. Matt's previous articles were Preservation Mode and��What It Really Costs. Follow him on Twitter��@Matt_Trogdon.
I���ve been trying to come up with a good analogy for life insurance. The best I can think of: Life insurance is like the airbags in your car. No one ever gets excited about airbags. No one ever shows off the airbags in their new car. But if you ever need your airbags, you���ll be glad as heck you have them.
Life insurance can be tough to understand. There���s a boatload of different types. There are lots of weird terms. There are pushy salespeople whose incentives aren���t aligned with your best interests. And there���s a lack of unbiased guidance out there.
I���m writing in hopes of providing some basic understanding of how life insurance works, who needs it, how to estimate how much you need and how to understand the different types that are sold. To begin with, all types of insurance are designed to transfer the financial risk of something bad happening from you to the insurance company. With life insurance, you transfer the financial risk that comes from the possibility of untimely death.
If you die, you won���t be able to financially support your loved ones. By buying life insurance, you transfer part of that risk to the insurance company. You pay a small amount���the premium���to secure the coverage. In exchange, the insurance company guarantees to pay your beneficiaries if you die, reducing your family���s financial loss.
Each life insurance policy contains a death benefit. This is the amount that would be paid to the beneficiaries upon the death of the insured. Let���s use a hypothetical couple, Zack and Kelly. Let���s say Zack buys a life insurance policy with a $1 million death benefit. Zack lists himself as the insured and Kelly as the beneficiary. Zack pays $100 a month as his insurance premium. If Zack dies, the insurance company would pay Kelly $1 million.
If others depend on you financially, you should think about obtaining life insurance. There are many sorts of people who might need life insurance and, while some are obvious, some aren���t:
Parents with young children.
Married or partnered adults who own a home and have a mortgage.
Adults who financially support other adults.
Adults who have debts they don���t want to leave to their estate.
Small business owners who���d want to buy out a partner���s interest if she died.
Adults whose assets exceed the federal estate tax exemption, which is $12 million per person currently and is scheduled to drop to $5 million in 2026.
Although you might not get this impression from an insurance agent, not everyone needs life insurance. You don���t need coverage if your death wouldn���t cause anyone else financial distress. In other words, if you���re a child or a single adult with no debts or dependents, you probably don���t need life insurance.
If you do need insurance, however, there are two main types: term insurance and permanent insurance. Term insurance is the most basic kind and has the cheapest monthly premiums. Think of it as an insurance rental.
A term insurance policy pays out a death benefit if the insured dies within the specified period���the term���that���s listed when it���s purchased. The insurance coverage stops at the end of the term. This insurance is the most suitable and cost-effective form of insurance for most people.
Let���s say that Zack and Kelly have two children, ages four and two. They might each purchase a life insurance policy with a 20-year term. By the time their policies end, their children will be 24 and 22, respectively, and presumably won���t need financial support. If Zack or Kelly die during the 20-year period, their death benefit would replace the income they otherwise would have provided.
Permanent insurance is designed to cover someone forever, no matter how long he or she lives. In addition to paying out a death benefit, permanent insurance policies also contain a cash value component that allows policyholders to access some of the money they���ve paid in premiums over the years.
Permanent insurance is usually much more expensive than term insurance. Still, it can be useful for people who foresee the need for insurance for as long as they live. This can be those with large estates. Parents with children who need lifelong support could also be candidates for permanent insurance, which is sometimes called whole life.
There are numerous calculators to help determine how large a death benefit you might need. But here���s a back-of-the-napkin method you can use at home:
Figure out your annual take-home pay. That���s your gross salary minus deductions for things like taxes, Social Security, Medicare and retirement savings.
Subtract from your annual take-home pay how much you spend on yourself in any given year.
What���s left is the amount of support you provide your family annually. This is the sum your family will need to replace each year to maintain its standard of living.
Multiply this family support amount by the number of years you���d like the insurance to cover. That number is the death benefit you���d want from an insurance policy.
Let���s say Zack makes $100,000 in take-home salary and spends $25,000 on himself alone. His family would need to replace $75,000 in lost earnings each year to maintain its current lifestyle if Zack were to die. Over 20 years, Zack���s family would need to replace as much as $1.5 million of lost earnings. In this case, having Zack take out a $1.5 million term policy for 20 years might be a good idea.
Unfortunately, insurance is often sold rather than bought. The salesperson���s commission is tied to the size of the policy that gets sold and the type of coverage. For a policy of the same size, permanent insurance would pay a bigger commission than term. As a result, there is an incentive to oversell policies that clients don���t need.
Watch out for a salesperson who tells you that an insurance policy is a good investment or suggests that you can afford more insurance coverage by diverting savings from other areas. It���s also a red flag if someone uses scare tactics in the sales process, or tries to sell you permanent insurance right out of medical school or law school.
Rather than going through an insurance agent, you can now shop for insurance online through sites like Policy Genius, Nerd Wallet and Bestow. If you have questions, contact a fee-only financial planner. That���s a good way to get an unbiased opinion.
Matt Trogdon is a financial planner with Craftwork Capital, LLC. He's based in Washington, D.C., and has a special interest in helping Gen X and Gen Y families. He also serves as a workshop instructor for the Babson College Financial Literacy Project. Matt's previous articles were Preservation Mode and��What It Really Costs. Follow him on Twitter��@Matt_Trogdon.The post Answers About Life appeared first on HumbleDollar.
January 25, 2022
Better With Others
IN THE COMPUTER gaming world���and I���ll openly admit to occupying that realm often���one measure of a game���s value is its replayability. If you shell out $60 and play a game through to the end, how likely are you to do it again? Each time you replay, you���re getting more value from your initial outlay, making it a better decision.
I sometimes use that economic logic to try to persuade my wife it���s better for me to "shoot and loot" from my gaming chair than do household chores. I���m adding value to my spending, I���ll explain. She never buys it.
Replayability varies by genre and person. For fantasy quests and RPGs���role-playing games���replayability is often low. Once you���ve solved the puzzles and completed the quests, there���s little mystery left. To compensate, game makers create a vast world inside and fill it with lots of tasks.
On the other hand, strategy games have high replayability because the variables change with each game. My sons enjoy virtual card games. I���m a 30-year fan of the various incarnations of Civilization , where you develop a people economically, politically and militarily to conquer others.
The concept of added value from replayability applies in the real world as well, especially leisure spending. We recently rented a house on a lake. While immersing ourselves in relaxation, we discussed buying a lake house, or splitting the cost of one with family and taking turns visiting. We quickly realized, however, that the replayability for us would be low.
Many people enjoy returning to the same familiar place every year. But we get antsy sitting in one place too long. Investing in replaying a vacation home getaway wouldn���t be a good decision for us. It���s all a matter of personal preference.
There���s one other important factor to gaming, though: human interaction. No artificial intelligence, no matter how sophisticated, can truly replicate the feeling of having a shared experience with another person. Many gamers form communities online with those who share their interests. In many ways, the game itself, while entertaining, may be little more than a MacGuffin���irrelevant to the game���s real pleasure.
I like solo computer gaming as a personal getaway. It���s the sharing of experiences, however, that truly adds value to the replayability of an activity. It���s the side comment that my wife or I will throw out at dinner about sneaky castling in our latest chess game. My son and I have played cribbage together for more than 20 years. Talking about how his job is going, or the day���s news, or what���s that thing that seems to be on his mind���that���s what makes me still enjoy our games after all this time.
If anything has unlimited replayability, it���s relationships.
I sometimes use that economic logic to try to persuade my wife it���s better for me to "shoot and loot" from my gaming chair than do household chores. I���m adding value to my spending, I���ll explain. She never buys it.
Replayability varies by genre and person. For fantasy quests and RPGs���role-playing games���replayability is often low. Once you���ve solved the puzzles and completed the quests, there���s little mystery left. To compensate, game makers create a vast world inside and fill it with lots of tasks.
On the other hand, strategy games have high replayability because the variables change with each game. My sons enjoy virtual card games. I���m a 30-year fan of the various incarnations of Civilization , where you develop a people economically, politically and militarily to conquer others.
The concept of added value from replayability applies in the real world as well, especially leisure spending. We recently rented a house on a lake. While immersing ourselves in relaxation, we discussed buying a lake house, or splitting the cost of one with family and taking turns visiting. We quickly realized, however, that the replayability for us would be low.
Many people enjoy returning to the same familiar place every year. But we get antsy sitting in one place too long. Investing in replaying a vacation home getaway wouldn���t be a good decision for us. It���s all a matter of personal preference.
There���s one other important factor to gaming, though: human interaction. No artificial intelligence, no matter how sophisticated, can truly replicate the feeling of having a shared experience with another person. Many gamers form communities online with those who share their interests. In many ways, the game itself, while entertaining, may be little more than a MacGuffin���irrelevant to the game���s real pleasure.
I like solo computer gaming as a personal getaway. It���s the sharing of experiences, however, that truly adds value to the replayability of an activity. It���s the side comment that my wife or I will throw out at dinner about sneaky castling in our latest chess game. My son and I have played cribbage together for more than 20 years. Talking about how his job is going, or the day���s news, or what���s that thing that seems to be on his mind���that���s what makes me still enjoy our games after all this time.
If anything has unlimited replayability, it���s relationships.
The post Better With Others appeared first on HumbleDollar.
Inertia’s Rewards
I ONCE JOINED a book club led by an amazingly smart guy. We were reading a challenging book by Nassim Nicholas��Taleb, the philosopher, investor and probabilities expert. Our discussion leader was a Chartered Financial Analyst who had solved one of the most enduring riddles at Vanguard Group, where I worked at the time.
For many years���decades, really���Vanguard hadn���t offered an international bond fund. Our founder, Jack Bogle, wasn���t a fan of international investing in general. But he was retired by then, and we did offer several international stock funds.
But there was a big problem with international bonds���they were unreliable. We weren���t just being xenophobic. The issue was currency fluctuations. It could wipe out any gain an investor might make internationally when that gain was converted back into U.S. dollars. Exchange rates���luck, really���mattered more to returns than yield, credit quality or anything else we could analyze.
That���s when the leader of our book group made a brilliant suggestion to top management. Why not hedge international bonds against currency fluctuations, so that risk was taken out of the equation? He had cut the Gordian knot. Vanguard opened an international bond fund on that basis in 2013. It was a huge favorite with bond investors seeking diversification, the only free lunch in investing. The fund had $119 billion in assets by late 2021, in part because it���s a mainstay of Vanguard���s target-date funds.
But this isn���t a tale about bonds or international investing. One day at book club, our leader told us a story about his own investing. Because he was super-smart and a CFA, he was frequently tweaking his portfolio for optimal performance. He had the thing tuned up like a Ferrari. His wife, on the other hand, didn���t work in the investment world. She invested her money in index funds and never made a change.
One day, this smart guy was checking their accounts online and noticed something incredible. His wife���s do-nothing strategy had a higher average annual return than his souped-up portfolio. She was beating him at his own business. To say that he was surprised would be an understatement. Stunned is more like it.
What did he do? Simple. He followed the evidence and switched to an index portfolio and stopped fiddling around with his investment mix. He recommended that all of us do the same.
This is unquestionably great advice. But it���s incredibly hard to follow because we���re all so smart and well informed. The flow of information in the investment world is immense. It tends to suggest that you do something right now���this instant���or miss out on the next Tesla or watch huge sums vanish in the next market crash.
Just sitting there doing nothing has proved to be the smartest move 20 years down the line, providing you own at least some stocks. There���s never been a negative 20-year period for U.S. stocks in the last 150 years, Yale economist and Nobel laureate Robert Shiller has found. But it would help us immensely to be like Rip Van Winkle, asleep the whole time. Let me put it this way: I���m trying hard to do nothing, but it���s been a struggle.
I���ll give the last word to Taleb, whose book The Black Swan explains our problem. ���I noticed that very intelligent and informed persons were at no advantage to cabdrivers in their predictions, but there was a crucial difference. Cabdrivers did not believe that they understood as much as a learned person���they were not experts and they knew it. Nobody knew anything but elite thinkers thought they knew more than the rest because they were elite thinkers, and if you���re a member of the elite, you automatically know more than the nonelite.���
Greg Spears is HumbleDollar's��deputy editor.��Earlier in his career, he worked as a reporter for the Knight Ridder Washington Bureau and Kiplinger���s Personal Finance magazine. After leaving journalism, Greg spent 23 years as a senior editor at Vanguard Group on the 401(k) side, where he implored people to save more for retirement. He currently teaches behavioral economics at St. Joseph���s University in Philadelphia as an adjunct professor. The subject helps shed light on why so many Americans save less than they might. Greg is also a Certified Financial Planner certificate holder. Check out his earlier articles.
For many years���decades, really���Vanguard hadn���t offered an international bond fund. Our founder, Jack Bogle, wasn���t a fan of international investing in general. But he was retired by then, and we did offer several international stock funds.
But there was a big problem with international bonds���they were unreliable. We weren���t just being xenophobic. The issue was currency fluctuations. It could wipe out any gain an investor might make internationally when that gain was converted back into U.S. dollars. Exchange rates���luck, really���mattered more to returns than yield, credit quality or anything else we could analyze.
That���s when the leader of our book group made a brilliant suggestion to top management. Why not hedge international bonds against currency fluctuations, so that risk was taken out of the equation? He had cut the Gordian knot. Vanguard opened an international bond fund on that basis in 2013. It was a huge favorite with bond investors seeking diversification, the only free lunch in investing. The fund had $119 billion in assets by late 2021, in part because it���s a mainstay of Vanguard���s target-date funds.
But this isn���t a tale about bonds or international investing. One day at book club, our leader told us a story about his own investing. Because he was super-smart and a CFA, he was frequently tweaking his portfolio for optimal performance. He had the thing tuned up like a Ferrari. His wife, on the other hand, didn���t work in the investment world. She invested her money in index funds and never made a change.
One day, this smart guy was checking their accounts online and noticed something incredible. His wife���s do-nothing strategy had a higher average annual return than his souped-up portfolio. She was beating him at his own business. To say that he was surprised would be an understatement. Stunned is more like it.
What did he do? Simple. He followed the evidence and switched to an index portfolio and stopped fiddling around with his investment mix. He recommended that all of us do the same.
This is unquestionably great advice. But it���s incredibly hard to follow because we���re all so smart and well informed. The flow of information in the investment world is immense. It tends to suggest that you do something right now���this instant���or miss out on the next Tesla or watch huge sums vanish in the next market crash.
Just sitting there doing nothing has proved to be the smartest move 20 years down the line, providing you own at least some stocks. There���s never been a negative 20-year period for U.S. stocks in the last 150 years, Yale economist and Nobel laureate Robert Shiller has found. But it would help us immensely to be like Rip Van Winkle, asleep the whole time. Let me put it this way: I���m trying hard to do nothing, but it���s been a struggle.
I���ll give the last word to Taleb, whose book The Black Swan explains our problem. ���I noticed that very intelligent and informed persons were at no advantage to cabdrivers in their predictions, but there was a crucial difference. Cabdrivers did not believe that they understood as much as a learned person���they were not experts and they knew it. Nobody knew anything but elite thinkers thought they knew more than the rest because they were elite thinkers, and if you���re a member of the elite, you automatically know more than the nonelite.���
Greg Spears is HumbleDollar's��deputy editor.��Earlier in his career, he worked as a reporter for the Knight Ridder Washington Bureau and Kiplinger���s Personal Finance magazine. After leaving journalism, Greg spent 23 years as a senior editor at Vanguard Group on the 401(k) side, where he implored people to save more for retirement. He currently teaches behavioral economics at St. Joseph���s University in Philadelphia as an adjunct professor. The subject helps shed light on why so many Americans save less than they might. Greg is also a Certified Financial Planner certificate holder. Check out his earlier articles.The post Inertia’s Rewards appeared first on HumbleDollar.
Fire the 4% Rule
I DID ACHIEVE financial independence and retire early���if you count age 64 as early. My friend Jose, a true believer in FIRE, or financial independence-retire early, celebrated his retirement at 44. That took a steely nerve that I lacked, plus I had big college bills to pay before retiring.
One big challenge of FIRE, of course, is that your savings might need to last 40 or even 50 years. Vanguard Group recently published a��research paper to help FIRE followers go the distance. It includes major tinkering with the 4% rule, which was designed with only a 30-year retirement in mind.
Under the 4% rule, you withdraw 4% of your savings in the first year of retirement, then raise that dollar amount by the rate of inflation in the second year and so on thereafter. This approach worked 82% of the time over a 30-year period with a 50% stock-50% bond portfolio. If retirement gets stretched to 50 years, however, the success rate fell to a discouraging 36%, Vanguard���s researchers found.
To improve the odds, they suggest FIRE followers try these four steps:
Enter truly big numbers into your retirement planning calculations, by assuming, say, a 50-year retirement. The standard assumptions of a 20- or 30-year retirement could produce false positives for FIRE followers.
Slash investment costs. Even relatively modest annual costs of 0.2% cut the odds of 50-year success down to 29%. Index investments can cost one-third of that sum or less at Vanguard and, incredibly, nothing at all at Fidelity Investments.
See the world. The 36% success rate was based on an all-American portfolio. The odds of 50-year savings survival jumped to 56% when 40% of the stock allocation and 30% of the bond allocation were invested internationally.
Adjust the 4% rule to withdraw less money when account values are down. The chance of savings lasting 50 years leaped to 90% if retirees withdrew 1.5% less when their account balance fell below last year���s. Example: If you withdrew $40,000 in year one, 1.5% less works out to $39,400 in year two. Happily, the model also permits larger withdrawals if account balances are higher, such as $42,000 in year two.
There are no automatic inflation adjustments under this dynamic spending model, so the shoe would pinch if higher inflation turns out not to be ���transitory.��� Still, the concept follows human nature: Tighten your belt when balances are down and spend a bit more when they���re higher.
Does this mean the 4% rule is repealed? Not really. FIRE followers who adhere to all four steps could start with a 4% withdrawal rate, the researchers found, and have at least an 85% chance that their savings would last a full 50 years. Your results may vary, of course. Good luck, Jose.
One big challenge of FIRE, of course, is that your savings might need to last 40 or even 50 years. Vanguard Group recently published a��research paper to help FIRE followers go the distance. It includes major tinkering with the 4% rule, which was designed with only a 30-year retirement in mind.
Under the 4% rule, you withdraw 4% of your savings in the first year of retirement, then raise that dollar amount by the rate of inflation in the second year and so on thereafter. This approach worked 82% of the time over a 30-year period with a 50% stock-50% bond portfolio. If retirement gets stretched to 50 years, however, the success rate fell to a discouraging 36%, Vanguard���s researchers found.
To improve the odds, they suggest FIRE followers try these four steps:
Enter truly big numbers into your retirement planning calculations, by assuming, say, a 50-year retirement. The standard assumptions of a 20- or 30-year retirement could produce false positives for FIRE followers.
Slash investment costs. Even relatively modest annual costs of 0.2% cut the odds of 50-year success down to 29%. Index investments can cost one-third of that sum or less at Vanguard and, incredibly, nothing at all at Fidelity Investments.
See the world. The 36% success rate was based on an all-American portfolio. The odds of 50-year savings survival jumped to 56% when 40% of the stock allocation and 30% of the bond allocation were invested internationally.
Adjust the 4% rule to withdraw less money when account values are down. The chance of savings lasting 50 years leaped to 90% if retirees withdrew 1.5% less when their account balance fell below last year���s. Example: If you withdrew $40,000 in year one, 1.5% less works out to $39,400 in year two. Happily, the model also permits larger withdrawals if account balances are higher, such as $42,000 in year two.
There are no automatic inflation adjustments under this dynamic spending model, so the shoe would pinch if higher inflation turns out not to be ���transitory.��� Still, the concept follows human nature: Tighten your belt when balances are down and spend a bit more when they���re higher.
Does this mean the 4% rule is repealed? Not really. FIRE followers who adhere to all four steps could start with a 4% withdrawal rate, the researchers found, and have at least an 85% chance that their savings would last a full 50 years. Your results may vary, of course. Good luck, Jose.
The post Fire the 4% Rule appeared first on HumbleDollar.
