Jonathan Clements's Blog, page 261
September 27, 2021
Share What You Know
Another group of newcomers to the U.S. financial system who could use guidance are immigrants, particularly refugees. Jiab and I have been volunteering for a number of years to help refugees get acclimated to American life. We���ve learned how much ���common knowledge��� is actually not so common in many parts of the world. We once had to explain to a family from Myanmar that, if they put uncovered raw chicken in the freezer, it would end up with freezer burn.
The same is true for financial basics. Many refugees have never opened a bank account, let alone had a credit card or read a financial statement. Imagine how helpful it would be to them if someone like you, who���s familiar with the system, helped guide them through the basics.
To do so, you don���t need to be a financial expert, just someone who���s experienced in avoiding potholes on the road to success. There are many organizations that provide immigrant and refugee services, including introductory financial guidance. In Dallas, we have Refugee Services of Texas, which is currently processing many Afghan refugees, and Jewish Family Service, which isn���t limited to any one faith. There are also organizations and groups that serve low income and undereducated people in general that could use support and donations. I���d encourage you to check out homeless shelters, women���s shelters, community centers and public libraries to see what financial education services they offer���and whether you can help.
The post Share What You Know appeared first on HumbleDollar.
CDs and Cemeteries
���A YEAR TO LIVE.��� That���s the name of a class I���ve been teaching on and off for the past 20 years. My hope: Participants will gain more understanding, acceptance and peace about one of life���s few guarantees���death. This year���s class members have a little over five months left to live.
Every group is a little different. Some people resist the practicalities of preparing for death: putting things in writing, making medical and funeral arrangements, and divvying up their possessions. Others struggle with the spiritual and emotional preparations, such as making amends, letting go of control and telling those close to them how much they���ve meant.
Last month���s homework included visiting a local cemetery to reflect on how we���re doing. Less than half of this year���s class made time for the cemetery visit. Those who did reported little impact, saying that���since they plan on being cremated���the cemetery didn���t mean much to them.
I visited our local historical cemetery for the first time. I���ve loved cemeteries for as long as I can remember. I make a point of visiting them whenever I can. They���re one of the few public places where we acknowledge death.
Normally, I start by finding famous people���s plots, which are often a pilgrimage site. But this time, I couldn���t find the famous politicians��� or national championship coach���s resting places. I decided to find a shady spot, sit on a bench dedicated in memory to a loved one, and meditate. I was surrounded by the graves of Edward who died in 2017 at the age of 86, Nancy who died in 2013 at 77, and Titus Elijah who died at seven. Ken was born in 1942 and Jacqueline was born in 1947. No dates of death yet.
I was reminded, once again, that the rich and famous���like the rest of us���all end up in the same place. Some of us will have fresh flowers placed next to us once a year, some will have plastic year-round, and some will be strewn in a forest, an ocean or amongst the stars for eternity. I also thought about how much time and energy we spend making sure that our portfolios are just right, or that we have the best guaranteed rates on our annuities and certificates of deposit (CDs).
Planning and preparing for our financial future, and ensuring we have as much security as we can for ourselves and our loved ones, is a good thing. But so too is planning for, preparing for and, dare I say, embracing the one ultimate guarantee that comes with life���our death. We didn���t have much to do with how we came into this world. But we have a lot to do with how well we leave it���and how well we say goodbye to others.
If you haven���t visited a cemetery lately, I encourage you to do so. Fall is a lovely time to be outside and contemplate where we���re headed and will end up one day. Imagine the lives of those around you and think about what you have left to do before you say your last goodbyes. Maybe you have wills and medical directives to complete. Maybe you have some things to check off your ultimate to-do list. Maybe you have amends to make to yourself and to others. Spending a day remembering what ultimately awaits all of us has a way of clarifying our priorities and providing a sense of urgency for what we know we need to do.
Nobody can really predict where interest rates are going, or how much income our next CD ladder or dividend fund will produce. But we do our best to learn and study, so we achieve the best that we can get.
By contrast, everybody can predict where our life���s journey will end. Hopefully, we can all do our best to learn and study, so we get there with as much peace and preparation as possible.
Don Southworth is a semi-retired minister, consultant and tax preparer living in Chapel Hill, North Carolina. He recently completed his Certified Financial Planner education.��Don is passionate about the intersection between spirituality and money, and he encourages people to follow their callings wherever they lead.��Follow Don on Twitter @Calltrepreneur��and check out his earlier articles.
The post CDs and Cemeteries appeared first on HumbleDollar.
September 26, 2021
Growing Cheap
That would be considered high by historical standards, though it isn���t outrageous given today���s low interest rates. But what would it take for stocks to look like a compelling investment? A market crash would do the trick.
But consider an alternative scenario: Suppose stocks treaded water at current levels, while corporate earnings climbed 5% a year. Five years later, at year-end 2026, the S&P 500 would be at 18.8 times earnings, below the 19.9��average for the past 50 years. If earnings grew at 7% a year, the S&P 500 would end 2026 at 17.1 times earnings, which is the average for the past 100 years. In other words, it wouldn���t take many years for today���s richly valued stock market to start appearing cheap.
One other observation: The prospect of a big market crash likely terrifies many investors. But the idea of stocks treading water for five years probably wouldn���t unnerve many folks at all. Yet, over the next five years, a big market crash followed by a recovery to today���s level would likely leave investors wealthier���assuming that, during the intervening five years, they took advantage of lower share prices by reinvesting their dividends, rebalancing their investment mix and adding new savings to their portfolio.
The post Growing Cheap appeared first on HumbleDollar.
Epic Fail
I used to serve on a 401(k) committee. I���d keep an eye on the active funds included in our investment lineup. Returns looked good. The thing is, 401(k) plans tend to pluck the strongest recent performers to include in their lineup. Inevitably, some employees park retirement money in those hot funds, only to see future returns fail to live up to past glory. That���s why I advocated for fewer active funds and championed adding a series of target-date��funds, which most plans now offer.
While retirement plans sometimes offer options that aren���t investor-friendly or cost too much, individuals still control where to invest their money. The SPIVA report shows low-cost index funds are the smart choice���assuming they���re one of the options. According to S&P���s mid-year review, in 15 out of 18 U.S. stock fund categories, the majority of actively managed funds underperformed their benchmark over the 12 months through June 30.
Arguably, that���s short-term noise. Long-run underperformance trends are more revealing���and jaw-dropping when you see them for the first time. The report finds that 88% of U.S. stock mutual funds underperformed their benchmark over the past 20 years. It���s no better for international managers. The percentage of foreign stock funds underperforming S&P���s International 700 index stands at 91%. As for bond funds, it���s the same story. I���ll spare you the data.
Active fund managers talk a convincing game on TV and podcasts. But don���t be fooled by their narratives and ���best ideas��� lists. The evidence tells the true story���that sticking with low-cost index funds is our best bet for long-term success.
The post Epic Fail appeared first on HumbleDollar.
Costly Arguments
Is higher inflation inevitable? I see five possible answers to this question:
1. Yes, of course. Between 2010 and 2020, annual inflation averaged just 1.7%. But the three most recent readings—in June, July and August—have all topped 5%. For that reason, it seems obvious that the Fed’s actions have led to a sharp uptick in inflation. It’s just as the textbooks would have predicted.
2. No, because this time is different. I’ve heard more than one concerned investor compare the Fed’s actions today to those of Weimar-era Germany. During that period, the German government printed so much new money that it resulted in hyperinflation.
How bad did it get? To cite one example, the price of bread rose from 163 marks in December 1922 to more than 200 billion marks just 11 months later. The Weimar example certainly paints a dramatic picture. But it isn’t an accurate historical analog.
Eric Hilt, an economic historian at Wellesley College, provides this explanation: “The Fed's actions over the last 18 months have very little to do with what happened in Germany in the 1920s. The distinction is subtle but important. After World War I, Germany... printed currency (paper money) to pay the government's bills. As the amount of paper currency in circulation expanded, the value of the currency decreased, which meant that larger amounts needed to be printed to produce the same revenue, and the situation spiraled out of control into hyperinflation.”
He continues: “None of that has happened in the U.S. The Fed has acted to backstop markets in new ways and has expanded its balance sheet, but it has done so not by increasing paper currency in circulation (printing money), but by adding to the deposit accounts of financial institutions—their reserve accounts. This is different from money in circulation because it is not going to be spent quickly.”
That last point is key: Yes, the Fed has printed an enormous amount of money, but it hasn’t all gone directly into consumers’ pockets, where it could be spent and thus contribute to driving up prices.
To be sure, some of the new money has found its way indirectly to consumers. That’s because the Fed helps to finance the U.S. government’s deficits. During the pandemic, a large part of the deficit has resulted from programs like Paycheck Protection Program loans that have bolstered consumers’ spending power. Still, Hilt makes an important distinction between the Fed’s actions today and the actions of the German government in the 1920s. Upon casual observation, they might seem similar. But they're not the same—either in character or in magnitude.
3. No, though it’s natural to suspect fire when we see smoke. While the overall inflation rate has more than doubled in recent months, defenders of the Fed’s actions are quick to point out that there’s more than meets the eye. Foremost among these defenders: Fed Chair Jerome Powell, who has argued that the recent inflation spike will be temporary.
To support his view, Powell points to a breakdown of this year’s inflation figures, which reveals that prices have not accelerated across the board. Instead, inflation increases have been limited to specific sectors. In most cases, these are industries which have experienced COVID-related supply chain disruptions. The price of lumber, for instance, rose sharply last year, though it has moderated more recently. Car prices—particularly used car prices—have also jumped due to a global shortage of semiconductor chips. Modern cars, it turns out, require between 1,000 and 3,000 chips to manufacture.
In other words, the Fed acknowledges that inflation has been running hotter. But Powell contends it’ll cool off once the supply chain normalizes: “As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”
4. No, because the world economy has changed. More or less continuously since the 2008 financial crisis, the Fed has been engaged in “quantitative easing”—a technical term for printing money. Japan has similarly been expanding its monetary base. And yet, in both countries, observers have noted that inflation has remained quite low. In fact, for several years prior to the pandemic, the U.S. enjoyed both low inflation and low unemployment. This also defied textbook economics.
For these reasons, a group of academics and politicians have been making the case that today's economy is different and that the traditional rules no longer apply. Specifically, they believe the U.S. government can now, within reason, print as much money as it wishes and that new money can be used to finance much larger deficits than ever before. According to this line of argument, there's no reason to fear further inflation.
5. Maybe, but it depends on what Congress does next. It may be too early to tell. As recently as February, the monthly inflation reading was still below 2%. Perhaps today’s higher inflation will indeed prove to be transitory. Still, Washington is working on a new set of initiatives which will, on the one hand, impose higher taxes and, on the other, increase spending. It's difficult to know how this will all net out.
As an individual investor, where does this leave you? As the saying goes, it’s clear as mud. But that, I think, is precisely the conclusion to draw. You might find one of the above arguments to be convincing. But ultimately, there’s no way to know where all the crosscurrents will take us.
My view: In the absence of definitive data either way, investors’ best strategy is to diversify. In the past, I’ve argued that stocks provide effective inflation protection. That’s still my view. On the bond side, I recommend an allocation to inflation-indexed bonds—either Treasury Inflation-Protected Securities or Series I savings bonds. But you want to maintain balance. Even if you have strong views on the inflation question, take a moderate approach with your portfolio, so you aren’t unduly affected no matter who turns out to be right.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.The post Costly Arguments appeared first on HumbleDollar.
September 25, 2021
Clouds in My Coffee
I'M ON MY THIRD cup of coffee this morning and it dawned on me how much I’m spending on the stuff. I have one of those machines which use the little K-Cup pods, which may be the most expensive way to make coffee. I find it curious that someone who likes to think of himself as frugal makes coffee at home that can cost 70 cents or more per cup.
If I bought a pound bag of house brand—not designer—coffee, I could enjoy a cup for as little as 12 cents. Why not do that? In a word, convenience. Like many other people, I’ll pay more than five times as much for a cup of home-brewed coffee just to have it quickly and with no mess. Are we spoiled or what? There’s another advantage to the machines—variety. The cups provide an endless choice of coffee and flavors, including that fall delight known as pumpkin spice.
My machine also makes lattes and cappuccinos. The Starbucks standard price for a latte or cappuccino is $4.25. The price for a small—excuse me—“tall” coffee is $1.85. That means they’re charging an extra $2.40 for a little skim milk and perhaps some syrup to upgrade coffee into cappuccino. At that rate, my in-home convenience has a favorable price factor, though without the coffee shop ambiance.
Lattes and cappuccinos have always fascinated me. What’s the difference? Turns out there’s very little difference and it all comes down to foam. A cappuccino has more foam, while a latte has more steamed milk in the coffee and a little foam on top. The real discovery is that someone convinced us there’s a couple of dollars of value in making foamed milk. Probably the same critic who convinced us that modern abstract art was actually art.
There are many ways to make coffee. I’ve used a French press and cold brew. Both work, but they’re messy. I was in a specialty store with a large copper coffee machine on display that looked like a boiler. It was $15,000. I wonder what that amortizes to per cup?
I’m sticking with my machine, but I’m obsessed with not paying full price for my K-Cups. Fact is, every week or so, one brand is on sale, even Starbucks. I’ll buy whatever is a bargain. Every trip to the store requires a trip down the coffee aisle in my quest to save money—or is that to overspend less?
The post Clouds in My Coffee appeared first on HumbleDollar.
Dream Inflation
More likely, however, we’ll use the cash to help cover our living expenses until I’m eligible to receive Social Security. Even though I can access most of my retirement account money when I turn age 55, I’m hoping to hold off tapping my nest egg until I’m at least 65. Once I leave my job, we’ll still be eligible to receive health-care coverage through my employer. We will, however, have to pay premiums of about $7,000 a year for the two of us. The money from our Portland home would help cover that expense.
When we started making our plans, we assumed we’d get back little more than our down payment—$80,000—when we sold our Oregon house. But over the past year, the equity in our modest home has increased sharply. Our ideas for how best to use the money have also grown by leaps and bounds.
I started making a list of items we might want for our Arizona house, including new kitchen appliances and new flooring. A few new electronic gadgets also made the cut. Every day, as I checked the latest estimate for the value of our home on Zillow, the list grew longer and more diverse. Our latest idea: Using some of the money to start a small business—which might eventually create a stream of income for us during our retirement years.
The post Dream Inflation appeared first on HumbleDollar.
The Cardinal Sin
From 1926 to 2016, more than half of all U.S. stocks���57.4% to be exact���returned less than one-month Treasury bills. In other words, you were better off putting your money into risk-free T-bills than owning these stocks. In fact, more than half of common stocks delivered negative total returns. These stats come from an academic��paper by finance professor Hendrik Bessembinder.
Now here���s the real kicker: Bessembinder found that the best-performing shares, a mere 4% of all stocks, were responsible for the stock market���s entire gain over and above T-bills. The remaining 96% of companies collectively generated returns that simply matched one-month T-bills. These findings have profound implications for investors.
If just 4% of stocks���we'll call them the winners���account for the lion���s share of stock market returns, you had better own them or you���re doomed to underperform the market. If you invest in total market index funds, you will own these winners by default. On the other hand, if you���re picking individual stocks, your odds aren���t great.
But let���s say you���re really smart (or lucky) and happen to pick a fair share of the winners. You face another big hurdle. You must hold on to your winners and not sell them prematurely. Unfortunately, this is easier said than done. Most investors display a strong tendency to sell their winners and ride their losers. This has been termed the disposition��effect, first described by behavioral economists Hersh Shefrin and Meir Statman.
The disposition effect can be explained by mental accounting and loss aversion. When an investor buys a stock, a mental account is subconsciously created. The initial investment or cost basis is recorded in this account. If the position is subsequently sold for less than its cost basis, the mental account is closed at a loss. Since losses are painful���particularly to our egos���investors do everything in their power to avoid this from happening, hence the tendency for investors to cling to their losers and even double down on them.
Mental accounting also explains why investors are so quick to sell their winners. Selling a position for a gain closes the mental account in the black. This feels good and strokes the investor���s ego. It also serves as a salve for the pain caused by the losers in the portfolio. Prospect theory says that investors weigh losses more heavily than equal-sized gains. That means the mental anguish from a $1,000 loss must be counterbalanced by gains far in excess of $1,000, thus serving as further impetus for selling winners.
From a tax standpoint, the disposition effect is an anomaly that shouldn���t exist. After all, our tax code rewards us for taking capital losses and penalizes our capital gains. Despite these incentives, the disposition effect is alive and well. It appears that investors are willing to pay a heavy tax to preserve their self-esteem.
Taxes aside, consider the enormous damage done to a portfolio by selling winners too early. As demonstrated in Bessembinder���s paper, strip out the big winners from a portfolio and you are left with middling returns that are on par with T-bills. Why are the winners so vital to a portfolio? Because of the inherent asymmetry between losers and winners.
A losing stock has limited downside. At worst, it can go to zero. In fact, in Bessembinder���s study, a 100% loss was the single most frequent outcome for individual stocks over their lifetime. On the other hand, winners had virtually unlimited upside.
If you talk to seasoned investors, most will confess they struggle far more with the sell decision than the buy one. A recent study of institutional investors confirms this striking discrepancy. While the authors found clear evidence of skill in buying, selling decisions underperformed badly. In fact, they were worse than random selling strategies.
Given the data from Bessembinder���s paper and the behavioral biases plaguing the sell decision, perhaps the best strategy is the one espoused by Warren Buffett: "When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. [Celebrated fund manager] Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds."
The greatest investing sin may also explain why active managers find it so hard to beat mindless index funds. Notwithstanding lower fees, cap-weighted index funds have fundamental advantages over their actively managed brethren. As alluded to earlier, a total market index fund by definition will own all the winners. More important, it lets them ride. The manager of an index fund won���t be tempted to sell the winners, nor does he have an ego to preserve.
What���s my advice to active managers and stock pickers? As much as possible, ignore your cost basis and focus on the fundamentals. Remember that the market is right most of the time, so let your losers go and enjoy the tax loss harvest. Most important, fight the urge to cash in on your winners with every fiber of your being.
Latest Posts
HERE ARE THE SIX other articles published by HumbleDollar this week:
"I���m at peace with my inability to forecast technological innovation," writes John Goodell. "Because we index, we���ll capture the gains of whatever marvels the world���s brightest innovators create."
Congress may have killed off the stretch IRA. But as Kathleen Rehl explains, there's a way to bring it back���and help your favorite charity at the same time.
Are you planning to retire in the next few years? Howard Rohleder outlines some key financial steps to take in the period before and after you quit the workforce.
"When you deal with a company rep, the Holy Grail is someone who asks for time to resolve the issue, and then not only resolves it but also updates you," says Andrew Forsythe. "This doesn���t happen often."
As you build your retirement plan, don't just focus on your portfolio's withdrawal rate. Adam Grossman's advice: Also ponder taxes, family needs, your debts and how you'll use your time.
"Am I hoping for the next Berkshire Hathaway?" asks John Goodell. "No. It would be great if the destination proves lucrative���but I think the journey will be the truly fun part."
Also check out the past week's blog posts, including Don Southworth on found money,��Bill Ehart on being a contrarian, Sanjib Saha on diminished value auto claims, Mike Zaccardi on stock buybacks, Kyle McIntosh on inflation and Dennis Friedman on moving back home.
John Lim is a physician and author of "How to Raise Your Child's Financial IQ," which is available as both a free PDF and a Kindle edition.��Follow John on Twitter @JohnTLim��and check out his earlier articles.The post The Cardinal Sin appeared first on HumbleDollar.
September 24, 2021
Saturday All Week
Even though my own retirement was still many years away, I���d already started dreaming about it. To be honest, I felt a twinge of jealousy regarding this gent���s situation. I asked him, ���What���s retirement really like?��� He couldn���t help rubbing it in a bit: ���Andy, I���ll tell you what it���s like. Every day is Saturday.���
I love retirement and, although I miss many of the people I worked with, I don���t miss the work at all. Now I can do much more of what I enjoy during my days, and a lot less of what I don���t. That said, I maintain a similar rhythm for the week. Mondays are still the most stressful day, and I might be a little cranky. As the week progresses, I get into a more comfortable groove and work on accomplishing the various tasks I���d outlined for the week. Oh yes, there���s always a list.
And Friday is a happy day, just as it was during my working years, and the weekend still officially begins with the Friday edition of the PBS NewsHour. Saturday is likewise happy. Everything happens at a slower, more relaxed pace. Sunday is restful, but with the same touch of melancholy it���s had my entire life: Fun times are over���for now���and it's time to get serious about the upcoming week.
I���m wondering about my fellow retirees: Even if your activities are different and more enjoyable, is the week���s rhythm still the same?
The post Saturday All Week appeared first on HumbleDollar.
Feeling Insecure
Perhaps that isn���t surprising given the state of Social Security. Based on the program���s current financing, benefits would need to be cut after 2033. None of us wants to hear that, but we also aren���t surprised. The Natixis study reports that a whopping 77% of U.S. investors think rising government debt will lead to reduced Social Security benefits, with 46% of millennials saying it would ���take a miracle��� to live a financially secure retirement.
Allow me to offer a caveat to that seemingly grim outlook: It isn���t as if Social Security goes belly up a dozen years from now. The latest projection states 76% of scheduled benefits will be payable if we stay the course. There will almost certainly be changes to the current system. Perhaps we���ll see higher payroll taxes to fund Social Security, adjustments to the full retirement age or reduced benefits for wealthier individuals. Or perhaps the government will simply borrow more money. Whatever happens, sharp benefit cuts aren���t something the electorate will take kindly to.
There are also reasons to feel somewhat upbeat about the future. Employers are stepping up to the plate in significant ways. Wages are rising sharply for younger and low-wage workers. Some major corporations have announced they���ll pay employees��� college tuition costs.
On that note, Natixis found that 82% of U.S. investors believe employers have a responsibility to help their employees achieve a financially secure retirement. Taking advantage of your company 401(k) match is a common personal finance refrain. What if employers pay workers more and help alleviate student debt burdens? That could pave the way for employees to contribute even more to their 401(k).
The post Feeling Insecure appeared first on HumbleDollar.
