Jonathan Clements's Blog, page 271
August 26, 2021
Brave New World
I MAY BE THE POSTER child for the new retirement, switching back and forth between standard employment and side gigs, as I seek work that I find fulfilling. I���m not alone: It seems many people are retiring earlier than they planned and then working part-time, moving in and out of the workforce based on need and opportunity.
The annual Retirement Confidence Survey from the Employee Benefit Research Institute (EBRI) shows that���while workers expect to retire at age 65���the median retirement age is actually 62. Indeed, in the latest survey, a quarter of today���s workers said they expect never to retire or to work until they���re at least age 70, and yet only 6% of current retirees waited that long.
For some early retirees, a health crisis or disability forces them to quit work sooner than anticipated. Meanwhile, corporate restructurings force others out of the workforce. In the past 18 months, some lost their jobs as businesses closed or scaled back because of COVID-19. For others, a decade of rising financial markets has provided enough savings for them to contemplate retirement. On top of all that, workplace disruptions during the pandemic showed that technology can make consulting and remote work much easier to manage. A recent New York Times article showcased stories of people retiring earlier than expected due to economic changes.
It isn���t just people in their early 60s who are retiring early. EBRI reports that 15% of the retirees surveyed said they retired before turning 55. Another 28% retired between ages 55 and 61, and 39% retired between ages 62 and 65.
I view the increasing number of early retirees as a great thing. But I also believe many folks won���t be happy with a life of pure leisure and instead they���ll want to remain engaged in the world. That might come in the form of more consulting activity, part-time work or perhaps volunteering. Early retirement from the traditional nine-to-five world provides the flexibility for this sort of life. In the years ahead, I suspect even more people will seek some kind of fulfilling work after their main career draws to a close.
My contention: The traditional work-retirement distinction may be breaking down and a new retirement construct could be emerging. It will be fascinating to dive into the EBRI survey results in the coming years to see if the pandemic has indeed altered the retirement landscape.
My work landscape has certainly shifted. I���m in my early 30s, with a portfolio large enough to cover my (admittedly modest) living costs, making me financially independent. Still, I continue to seek traditional fulltime employment, while enjoying side hustles such as consulting in investments and financial planning, and also teaching finance here in Jacksonville, Florida.
There can be drawbacks to depending on these side gigs. For one, I might miss out on the typical compensation increases for people climbing the corporate ladder. Also, side hustles don���t provide valuable benefits like paid leave, employer retirement contributions and health insurance. Working independently also affects social connections. In my lonely office, there���s no shooting the breeze with coworkers at the coffee machine.
Here���s another thing about side hustles: You have to hustle. You���re your own salesperson. Assignments rarely are presented on a silver platter. In my ideal world, I���d have a meaningful traditional job, while also dabbling in a few consulting projects, including teaching.
Still, working only side gigs for most of 2021 has been interesting. I���ve probably learned more this year than in the prior six years of traditional fulltime work. It's paid the bills and kept me sharp for my next career endeavor���be it traditional employment or continuing down the independent road. And along the way, I���ve had a glimpse of what the new retirement���or perhaps the new work world���will look like.
Mike Zaccardi is an adjunct finance instructor at the University of North Florida, as well as an investment writer for financial advisors and investment firms. He's a CFA�� charterholder and Chartered Market Technician��, and has passed the coursework for the Certified Financial Planner program. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn, email him at MikeCZaccardi@gmail.com��and check out his earlier articles.
The annual Retirement Confidence Survey from the Employee Benefit Research Institute (EBRI) shows that���while workers expect to retire at age 65���the median retirement age is actually 62. Indeed, in the latest survey, a quarter of today���s workers said they expect never to retire or to work until they���re at least age 70, and yet only 6% of current retirees waited that long.
For some early retirees, a health crisis or disability forces them to quit work sooner than anticipated. Meanwhile, corporate restructurings force others out of the workforce. In the past 18 months, some lost their jobs as businesses closed or scaled back because of COVID-19. For others, a decade of rising financial markets has provided enough savings for them to contemplate retirement. On top of all that, workplace disruptions during the pandemic showed that technology can make consulting and remote work much easier to manage. A recent New York Times article showcased stories of people retiring earlier than expected due to economic changes.
It isn���t just people in their early 60s who are retiring early. EBRI reports that 15% of the retirees surveyed said they retired before turning 55. Another 28% retired between ages 55 and 61, and 39% retired between ages 62 and 65.
I view the increasing number of early retirees as a great thing. But I also believe many folks won���t be happy with a life of pure leisure and instead they���ll want to remain engaged in the world. That might come in the form of more consulting activity, part-time work or perhaps volunteering. Early retirement from the traditional nine-to-five world provides the flexibility for this sort of life. In the years ahead, I suspect even more people will seek some kind of fulfilling work after their main career draws to a close.
My contention: The traditional work-retirement distinction may be breaking down and a new retirement construct could be emerging. It will be fascinating to dive into the EBRI survey results in the coming years to see if the pandemic has indeed altered the retirement landscape.
My work landscape has certainly shifted. I���m in my early 30s, with a portfolio large enough to cover my (admittedly modest) living costs, making me financially independent. Still, I continue to seek traditional fulltime employment, while enjoying side hustles such as consulting in investments and financial planning, and also teaching finance here in Jacksonville, Florida.
There can be drawbacks to depending on these side gigs. For one, I might miss out on the typical compensation increases for people climbing the corporate ladder. Also, side hustles don���t provide valuable benefits like paid leave, employer retirement contributions and health insurance. Working independently also affects social connections. In my lonely office, there���s no shooting the breeze with coworkers at the coffee machine.
Here���s another thing about side hustles: You have to hustle. You���re your own salesperson. Assignments rarely are presented on a silver platter. In my ideal world, I���d have a meaningful traditional job, while also dabbling in a few consulting projects, including teaching.
Still, working only side gigs for most of 2021 has been interesting. I���ve probably learned more this year than in the prior six years of traditional fulltime work. It's paid the bills and kept me sharp for my next career endeavor���be it traditional employment or continuing down the independent road. And along the way, I���ve had a glimpse of what the new retirement���or perhaps the new work world���will look like.
Mike Zaccardi is an adjunct finance instructor at the University of North Florida, as well as an investment writer for financial advisors and investment firms. He's a CFA�� charterholder and Chartered Market Technician��, and has passed the coursework for the Certified Financial Planner program. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn, email him at MikeCZaccardi@gmail.com��and check out his earlier articles.
The post Brave New World appeared first on HumbleDollar.
August 25, 2021
Did It Myself���Almost
OVER THE PAST decade, my wife and I have hired others to handle most home improvement projects. It all came down to a lack of time: We had two young children and demanding jobs in the corporate world. But thanks to my recent switch to teaching, I have more free time, so I decided to tackle a few projects this summer. Here are three things I learned:
Painting is possible. For more than a year, my daughter has been asking to update her room���s color to something other than the ���moonlight yellow��� she���s had since birth. We didn���t know much about painting, so we took to the internet and found an instructive 10-minute video. After three days of prepping and painting, my daughter���s ���filmy green��� room looks good. I estimate we saved $300 by doing it ourselves.
Check for unused supplies. Before heading to the home improvement store, I checked with three neighbors to see if they had painting materials we could use. All three had unused supplies, so we got a running start with ample brushes, rollers and drop cloths. That saved us at least $50.
Doors are tough. While painting was doable, replacing an exterior door proved difficult. I made an error in placing the original door order. The measurements were only off by a quarter of an inch. Still, I needed to call a handyman to rework the door width. On top of that, while online videos make hanging a door look easy, the weight was such that I couldn���t do it on my own. Result? The handyman ended up hanging the door after he made the width adjustment. While the combined cost of the door and the handyman was reasonable, it would have been more efficient to have him handle it from the start.
Painting is possible. For more than a year, my daughter has been asking to update her room���s color to something other than the ���moonlight yellow��� she���s had since birth. We didn���t know much about painting, so we took to the internet and found an instructive 10-minute video. After three days of prepping and painting, my daughter���s ���filmy green��� room looks good. I estimate we saved $300 by doing it ourselves.
Check for unused supplies. Before heading to the home improvement store, I checked with three neighbors to see if they had painting materials we could use. All three had unused supplies, so we got a running start with ample brushes, rollers and drop cloths. That saved us at least $50.
Doors are tough. While painting was doable, replacing an exterior door proved difficult. I made an error in placing the original door order. The measurements were only off by a quarter of an inch. Still, I needed to call a handyman to rework the door width. On top of that, while online videos make hanging a door look easy, the weight was such that I couldn���t do it on my own. Result? The handyman ended up hanging the door after he made the width adjustment. While the combined cost of the door and the handyman was reasonable, it would have been more efficient to have him handle it from the start.
The post Did It Myself���Almost appeared first on HumbleDollar.
Rule Your World
I���VE NEVER BEEN a fan of financial planning rules of thumb. To understand why, consider a common shortcut for choosing an asset allocation: The allocation to bonds in a portfolio, according to this rule of thumb, should equal an investor���s age.
For example, if an investor is 65 years old, his or her allocation to bonds should be 65%. That sounds reasonable���until you realize that Microsoft founder Bill Gates is 65. Should he have the same asset allocation as everyone else his age? Perhaps he���s an extreme example. But how about a 65-year-old who is retired with a secure government pension? As you can see, rules of thumb can quicky break down.
It���s for this reason that I���m��skeptical��of rules of thumb. But in a recent��interview, behavioral scientist Sarah Newcomb cited the work of Gerd Gigerenzer. A professor and the author of�� Gut Feelings , Gigerenzer challenges the view that rules of thumb are a less-than-optimal way to make decisions. In some ways, he argues, they are��superior��to a strictly numbers-based, analytical approach.
To illustrate, Gigerenzer cites the collapse of the hedge fund firm Long-Term Capital Management. An entire��book��was written about it. But in short, what happened was that the fund���s managers relied too heavily on statistical models using historical data. They failed to consider the possibility that things might turn out differently���and worse���in the future than in the past. And that���s exactly what happened. In 1998, the fund suffered a spectacular failure, going to zero essentially overnight. Were it not for a bailout by the Federal Reserve, Long-Term Capital might have taken down its trading partners, including some of Wall Street���s biggest banks.
This was an extreme but hardly isolated case. It���s why Gigerenzer asserts that rules of thumb shouldn���t be dismissed as an inferior way to think about problems. On the contrary, Gigerenzer sees greater risk in trying to be overly analytical in situations that defy quantitative analysis. In the case of Long-Term Capital, the Nobel laureates who ran the fund were too brilliant for their own good. They were so wedded to their sophisticated math that it resulted in their undoing. If, instead, they had allowed more flexibility into their thinking���flexibility that wouldn���t necessarily have been supported by the numbers���they might have had more margin for error and might have survived.
I���m still wary of rules of thumb, but Gigerenzer makes a useful point. It���s good to be analytical where appropriate. But sometimes, employing a rule of thumb might be better. Below, for example, are five questions that might be better answered with a rule of thumb than a spreadsheet:
1. What's a safe portfolio withdrawal rate in retirement?��A few weeks ago, I��talked��about the famous 4% rule. I pointed out that even the rule���s inventor used a higher number���4.5%���and that today many prefer a lower number, closer to 3%. Ultimately, though, these numbers are all in the same ballpark. No one suggests, for example, that 10% is a safe withdrawal rate. For that reason, the 3% to 5% range is, in fact, a useful rule of thumb.
2. How much growth can we expect from the stock market?��Historically, the U.S. stock market has returned 10% a year, on average. But population growth today is much slower than in the past. For that reason, many advisors���myself included���build plans around a lower number, in the 7% range. Is that based on a mathematical model? No, it���s simply a rule of thumb, but one that recognizes that it���s far worse to under-save for retirement than over-save.
3. What will future stock market downturns look like?��On average, in past bear markets,��stocks have dropped 27% and taken 32 months to get back to even. In building a financial plan, is it safe to rely on these long-term averages? In my opinion, no���because averages can be misleading. Between 2000 and 2002, the market fell 45% and took six years to recover. Between 2007 and 2009, the market fell 51% and took four-and-a-half years to recover.
That���s why the rule of thumb I use is to assume a market downturn could last seven years���more than twice the long-term average and longer than any downturn since the Great Depression. Again, this isn't based on scientific analysis. Instead, it's designed to avoid making the mistake Long-Term Capital made, which was to put too much faith in statistics. It also acknowledges that things were quite a bit worse in the Great Depression. Though that was nearly 100 years ago, it can't be entirely ignored.
4. With all the negative headlines, will Social Security be there for tomorrow���s retirees?��The last time Congress overhauled Social Security���s retirement benefits was in 1983. But the changes didn���t negatively affect anyone older than age 46 at that time. Most of the impact fell on people who were younger than 30. The changes were justified by rising life expectancies.
That���s why I think a reasonable rule of thumb is to expect that Congress will make changes again in the future, since life expectancies have increased since 1983. But I also think it���s safe to assume Congress will take the same approach as last time, placing more of the burden on younger people. If you���re mid-career, you might see a small decrease in benefits, but not enough to worry about. What if you���re later in your career? I wouldn���t worry much at all.
5. What should I assume in terms of life expectancy?��If you want, you can consult��actuarial��tables online. But those are just averages. If you���re trying to build a retirement plan for yourself, a good rule of thumb is to assume you might make it to 100. There is, of course, no scientific basis for choosing 100 instead of 99 or 101 or any other age. But I think it���s far better than building a plan that���s tailored too tightly around your actuarial life expectancy, with no room for error. That again was the mistake made by Long-Term Capital.
How can you know when it's best to pull out your calculator and when it's okay to rely on a rule of thumb? Well, here's my rule of thumb on that: The more information you have on a given question, the more I would lean toward quantitative analysis. Asset allocation, for example, lends itself to careful analysis, because it's so personal and because so much of the relevant data is available. But if something is completely out of your hands���what the stock market will do, for example, or what Congress will do���then a rule of thumb may serve you better than trying to overanalyze to the point that you're really just guessing.
A final note: Gerd Gigerenzer is a serious academic. But he also has a sense of humor. If you have 30 seconds, I recommend this old VW��commercial. He���s the one on the right, with the banjo.
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.
For example, if an investor is 65 years old, his or her allocation to bonds should be 65%. That sounds reasonable���until you realize that Microsoft founder Bill Gates is 65. Should he have the same asset allocation as everyone else his age? Perhaps he���s an extreme example. But how about a 65-year-old who is retired with a secure government pension? As you can see, rules of thumb can quicky break down.
It���s for this reason that I���m��skeptical��of rules of thumb. But in a recent��interview, behavioral scientist Sarah Newcomb cited the work of Gerd Gigerenzer. A professor and the author of�� Gut Feelings , Gigerenzer challenges the view that rules of thumb are a less-than-optimal way to make decisions. In some ways, he argues, they are��superior��to a strictly numbers-based, analytical approach.
To illustrate, Gigerenzer cites the collapse of the hedge fund firm Long-Term Capital Management. An entire��book��was written about it. But in short, what happened was that the fund���s managers relied too heavily on statistical models using historical data. They failed to consider the possibility that things might turn out differently���and worse���in the future than in the past. And that���s exactly what happened. In 1998, the fund suffered a spectacular failure, going to zero essentially overnight. Were it not for a bailout by the Federal Reserve, Long-Term Capital might have taken down its trading partners, including some of Wall Street���s biggest banks.
This was an extreme but hardly isolated case. It���s why Gigerenzer asserts that rules of thumb shouldn���t be dismissed as an inferior way to think about problems. On the contrary, Gigerenzer sees greater risk in trying to be overly analytical in situations that defy quantitative analysis. In the case of Long-Term Capital, the Nobel laureates who ran the fund were too brilliant for their own good. They were so wedded to their sophisticated math that it resulted in their undoing. If, instead, they had allowed more flexibility into their thinking���flexibility that wouldn���t necessarily have been supported by the numbers���they might have had more margin for error and might have survived.
I���m still wary of rules of thumb, but Gigerenzer makes a useful point. It���s good to be analytical where appropriate. But sometimes, employing a rule of thumb might be better. Below, for example, are five questions that might be better answered with a rule of thumb than a spreadsheet:
1. What's a safe portfolio withdrawal rate in retirement?��A few weeks ago, I��talked��about the famous 4% rule. I pointed out that even the rule���s inventor used a higher number���4.5%���and that today many prefer a lower number, closer to 3%. Ultimately, though, these numbers are all in the same ballpark. No one suggests, for example, that 10% is a safe withdrawal rate. For that reason, the 3% to 5% range is, in fact, a useful rule of thumb.
2. How much growth can we expect from the stock market?��Historically, the U.S. stock market has returned 10% a year, on average. But population growth today is much slower than in the past. For that reason, many advisors���myself included���build plans around a lower number, in the 7% range. Is that based on a mathematical model? No, it���s simply a rule of thumb, but one that recognizes that it���s far worse to under-save for retirement than over-save.
3. What will future stock market downturns look like?��On average, in past bear markets,��stocks have dropped 27% and taken 32 months to get back to even. In building a financial plan, is it safe to rely on these long-term averages? In my opinion, no���because averages can be misleading. Between 2000 and 2002, the market fell 45% and took six years to recover. Between 2007 and 2009, the market fell 51% and took four-and-a-half years to recover.
That���s why the rule of thumb I use is to assume a market downturn could last seven years���more than twice the long-term average and longer than any downturn since the Great Depression. Again, this isn't based on scientific analysis. Instead, it's designed to avoid making the mistake Long-Term Capital made, which was to put too much faith in statistics. It also acknowledges that things were quite a bit worse in the Great Depression. Though that was nearly 100 years ago, it can't be entirely ignored.
4. With all the negative headlines, will Social Security be there for tomorrow���s retirees?��The last time Congress overhauled Social Security���s retirement benefits was in 1983. But the changes didn���t negatively affect anyone older than age 46 at that time. Most of the impact fell on people who were younger than 30. The changes were justified by rising life expectancies.
That���s why I think a reasonable rule of thumb is to expect that Congress will make changes again in the future, since life expectancies have increased since 1983. But I also think it���s safe to assume Congress will take the same approach as last time, placing more of the burden on younger people. If you���re mid-career, you might see a small decrease in benefits, but not enough to worry about. What if you���re later in your career? I wouldn���t worry much at all.
5. What should I assume in terms of life expectancy?��If you want, you can consult��actuarial��tables online. But those are just averages. If you���re trying to build a retirement plan for yourself, a good rule of thumb is to assume you might make it to 100. There is, of course, no scientific basis for choosing 100 instead of 99 or 101 or any other age. But I think it���s far better than building a plan that���s tailored too tightly around your actuarial life expectancy, with no room for error. That again was the mistake made by Long-Term Capital.
How can you know when it's best to pull out your calculator and when it's okay to rely on a rule of thumb? Well, here's my rule of thumb on that: The more information you have on a given question, the more I would lean toward quantitative analysis. Asset allocation, for example, lends itself to careful analysis, because it's so personal and because so much of the relevant data is available. But if something is completely out of your hands���what the stock market will do, for example, or what Congress will do���then a rule of thumb may serve you better than trying to overanalyze to the point that you're really just guessing.
A final note: Gerd Gigerenzer is a serious academic. But he also has a sense of humor. If you have 30 seconds, I recommend this old VW��commercial. He���s the one on the right, with the banjo.
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 Rule Your World appeared first on HumbleDollar.
August 24, 2021
���������������������
IN CASE YOU���RE wondering, that means, ���Where is my blog?���
In retirement, it���s important to keep busy doing things you enjoy. For me, that���s blogging. It���s fun and I learn from readers��� comments.
On Aug. 17, I received an email addressed to ���Karen��� saying my site���s domain was expiring. Who���s Karen? It must be a scam, so I ignored it. The next day, my blog couldn���t be found.
I logged on to the domain seller and paid the fee. The firm charged my American Express card���twice���but nothing happened. I called. The company���s voicemail was full. When I emailed, my message bounced back.
I clicked on the link in the original email to ���Karen.��� It was a Chinese site and, after I clicked to translate the site into English, I found my domain wasn���t listed. Turned out the nonexistent email address at the original domain company was for the same Karen named in the e-mail I'd received.
I contacted the company that hosts my blog. The folks there referred me to yet another organization, where I found my domain listed but with no way to activate anything. Who were they, what did they do, how were the Chinese involved? It seemed there was an international plot to shut me down.
The only thing to do was to call one of my sons. He tried the sites I gave him and concluded somebody sold my domain to somebody else, or turned it over to somebody else to manage, or something like that. In the meantime, my words of wisdom were missing from��the blogosphere.
���You need to get a new domain,��� my son advised. I did, but since my original domain was still out there, I had to swap to QuinnsCommentary.net from .com. To activate the new domain, I received instructions that weren���t in Chinese, but could have been as far as I was concerned.
This blogging looks easy, but once you slip into the abyss of what makes it all work, some of us are in deep trouble. It helps to have a son who���s a software engineer.
The post ��������������������� appeared first on HumbleDollar.
Game Changer
I FELL IN LOVE with baseball in 1965. My parents were in the midst of divorcing. I found sanctuary listening to San Francisco Giants��� games on the radio. I put on my batting helmet and pretended I was Willie Mays swinging at every pitch or diving on my bed catching imaginary lines drives. Willie had a magical year and, although the hated Dodgers nosed us out in the end, a lifelong passion was born.
I preached on miracles when I applied for fellowship as a minister. Jesus��� acts were nowhere to be found in baseball. Still, the story of the 1969 ���miracle��� New York Mets���and this 11-year-old���s awe���were central to my message. Baseball was an annual sermon then because, for fans like me, it is a magical, mystical game that has meaning far beyond runs, errors and base hits. The 1989 film Field of Dreams, a story about fathers, sons, baseball heroes and ghosts coming out of a cornfield in Iowa, highlighted the spirituality of the game.
Major League Baseball recently played its first game at the Iowa cornfield where the movie was made. The Yankees and White Sox entered the field through the corn and played before an intimate crowd of 8,000. Millions more watched on television. It was the highest-rated regular season game in years. The game ended dramatically when Tim Anderson of the White Sox hit a walk-off home run into the cornfield to win the game.
Ironically, Anderson has never seen Field of Dreams. He was born after the movie was made. Like many young ballplayers, especially those of color, the storyline of old-time white baseball players coming back to life doesn���t really resonate.
Baseball has become too slow and too boring for more and more people. It���s become an old man���s game. Players like Anderson and others are bringing a new swagger and excitement to baseball. Bat flips, trash talking and strutting after home runs are becoming more popular. Perhaps this new way of playing will bring more people back to baseball and especially those much younger than me.
As I watch these changes, I fight the curmudgeon in me who misses the old days. It reminds me of those in the financial world who complain about the ���gamification��� of investing and the changes that come with it. Bitcoin, Robinhood, short-selling and margin calls for average investors? To some, it���s blasphemy.
But the only constant in baseball, investing and life is change. How well we cope with it has a lot to do with our ability to adapt and succeed. IRAs and 401(k)s weren���t around 50 years ago, and neither were video replays nor launch angles. We have survived. So I���m struggling to understand WAR in baseball and ESG in investing. But don���t ever expect me to accept the designated hitter.
The post Game Changer appeared first on HumbleDollar.
Wealth at Work
ON THE NEWS the other day, they were discussing technological change. ���It happens gradually and then suddenly,��� said the guest commentator.
The commentator was borrowing a memorable phrase from a book written almost a century earlier, Ernest Hemingway���s 1926 novel The Sun Also Rises.
���How did you go bankrupt?��� Bill asked.
���Two ways,��� Mike said. ���Gradually and then suddenly.���
Although this fictional conversation refers to financial ruin, ���gradually and then suddenly��� is also how most financially successful people accumulate wealth. They reach their financial goals gradually by practicing good money habits over many years. Most people don���t get rich quick by earning a high six-figure income or owning a lucrative business. Instead, they spend decades saving and investing small amounts.
Meanwhile, the dollars invested compound. The investments are generating earnings that are reinvested and those earnings then generate their own earnings. Because of the way compounding works, money can grow exponentially over time. This is how our investment portfolios grow gradually and then suddenly.
Of course, it isn���t as easy as it sounds. It takes discipline to stay the course during good times and bad, so that we don���t disrupt this wealth-building process. That's why financial security isn���t just about the financial markets. It���s also about our behavior.
The commentator was borrowing a memorable phrase from a book written almost a century earlier, Ernest Hemingway���s 1926 novel The Sun Also Rises.
���How did you go bankrupt?��� Bill asked.
���Two ways,��� Mike said. ���Gradually and then suddenly.���
Although this fictional conversation refers to financial ruin, ���gradually and then suddenly��� is also how most financially successful people accumulate wealth. They reach their financial goals gradually by practicing good money habits over many years. Most people don���t get rich quick by earning a high six-figure income or owning a lucrative business. Instead, they spend decades saving and investing small amounts.
Meanwhile, the dollars invested compound. The investments are generating earnings that are reinvested and those earnings then generate their own earnings. Because of the way compounding works, money can grow exponentially over time. This is how our investment portfolios grow gradually and then suddenly.
Of course, it isn���t as easy as it sounds. It takes discipline to stay the course during good times and bad, so that we don���t disrupt this wealth-building process. That's why financial security isn���t just about the financial markets. It���s also about our behavior.
The post Wealth at Work appeared first on HumbleDollar.
Working My Losses
AT THE START of the pandemic, we picked up a nice chunk of capital losses. I say ���nice��� because these were intentional. When the market dropped significantly, we realized losses and immediately reinvested the proceeds in other fallen stocks.
What about capital gains? In 2020, some of our mutual funds distributed capital gains, but we didn���t intentionally realize any other gains. Some of our realized losses offset the distributed fund gains. Another $3,000 was applied against ordinary income. But our remaining capital losses were carried over for future years. We intend to put some of these losses to use in 2021, allowing us to harvest more tax-free gains.
Our taxable accounts have a combination of index funds, actively managed funds and individual stocks. Where should we realize gains? One approach would be to simplify our portfolio by selling individual stocks, which include some rather small positions. As we get closer to retirement, having fewer holdings would make managing our investment income and taxes simpler. It would also make the portfolio easier for my wife to manage should I not be around to help.
But I���m not 100% convinced this is the right strategy. Besides being tax-efficient and very low cost, some of the individual stocks are nice dividend payers. As I near retirement, I wonder if this is the right time to remove a source of income. Finally, some of our holdings are undervalued, according to Morningstar. Why sell these now if they may have room to run?
Another approach would be to realize gains in one or more of our actively managed funds. That would slightly improve our overall portfolio���s tax efficiency and slightly reduce our overall fees. None of these funds is highly tax-inefficient, judging by the tax cost ratio provided by Morningstar. But there���s undoubtedly room for improvement. One drawback: If our goal is to use up our tax losses while not ending up with a net realized capital gain, we couldn���t eliminate any of these fund positions entirely if we took capital gains���which means we wouldn���t do anything to simplify our portfolio.
Whatever we decide, we won���t take much action until our funds announce their year-end distributions. At that point, we can subtract those distributions from our carried-over losses, plus $3,000. Then we���ll know what further gains we can realize.
As many readers are no doubt aware, the IRS allows $3,000 in losses to be applied against ordinary income each year. I���ll take care not to realize so much in capital gains that I miss the opportunity to offset that $3,000 in ordinary income. After all, ordinary income tends to be taxed at a higher marginal rate than capital gains.
As I look ahead, I anticipate that at least some of the gains we realize will need to come from the sale of individual stocks. Why? When we sell mutual fund shares, we won���t know the selling price until after the fact. With individual stocks, on the other hand, we can set a limit price and expect to get it. That way, we can match our realized gains more precisely to the amount of our available carried-over losses.
All of this may seem overly complicated. Quite possibly. But in retirement, I know we���re going to be conducting an annual review of where next year���s money is coming from���and whether and how much capital gains and losses should be realized. As complex as all this may sound, I���d better get used to it because I���ll be doing it again.
Finally, as I write this, I can imagine someone recounting the adage about ���don���t let the tax tail wag the investment dog.��� I agree with that sentiment, but that isn���t my intention. We���d be happy to hold on to everything we currently own. If that weren���t the case, deciding what to sell would be a whole lot easier.
Michael Perry is a former career Army��officer and external��affairs executive��for a Fortune 100��company. In addition to personal finance and investing, his interests include reading, traveling,��being outdoors,��strength training and coaching, and cocktails. His previous��article was An Appreciated Gift.��
What about capital gains? In 2020, some of our mutual funds distributed capital gains, but we didn���t intentionally realize any other gains. Some of our realized losses offset the distributed fund gains. Another $3,000 was applied against ordinary income. But our remaining capital losses were carried over for future years. We intend to put some of these losses to use in 2021, allowing us to harvest more tax-free gains.
Our taxable accounts have a combination of index funds, actively managed funds and individual stocks. Where should we realize gains? One approach would be to simplify our portfolio by selling individual stocks, which include some rather small positions. As we get closer to retirement, having fewer holdings would make managing our investment income and taxes simpler. It would also make the portfolio easier for my wife to manage should I not be around to help.
But I���m not 100% convinced this is the right strategy. Besides being tax-efficient and very low cost, some of the individual stocks are nice dividend payers. As I near retirement, I wonder if this is the right time to remove a source of income. Finally, some of our holdings are undervalued, according to Morningstar. Why sell these now if they may have room to run?
Another approach would be to realize gains in one or more of our actively managed funds. That would slightly improve our overall portfolio���s tax efficiency and slightly reduce our overall fees. None of these funds is highly tax-inefficient, judging by the tax cost ratio provided by Morningstar. But there���s undoubtedly room for improvement. One drawback: If our goal is to use up our tax losses while not ending up with a net realized capital gain, we couldn���t eliminate any of these fund positions entirely if we took capital gains���which means we wouldn���t do anything to simplify our portfolio.
Whatever we decide, we won���t take much action until our funds announce their year-end distributions. At that point, we can subtract those distributions from our carried-over losses, plus $3,000. Then we���ll know what further gains we can realize.
As many readers are no doubt aware, the IRS allows $3,000 in losses to be applied against ordinary income each year. I���ll take care not to realize so much in capital gains that I miss the opportunity to offset that $3,000 in ordinary income. After all, ordinary income tends to be taxed at a higher marginal rate than capital gains.
As I look ahead, I anticipate that at least some of the gains we realize will need to come from the sale of individual stocks. Why? When we sell mutual fund shares, we won���t know the selling price until after the fact. With individual stocks, on the other hand, we can set a limit price and expect to get it. That way, we can match our realized gains more precisely to the amount of our available carried-over losses.
All of this may seem overly complicated. Quite possibly. But in retirement, I know we���re going to be conducting an annual review of where next year���s money is coming from���and whether and how much capital gains and losses should be realized. As complex as all this may sound, I���d better get used to it because I���ll be doing it again.
Finally, as I write this, I can imagine someone recounting the adage about ���don���t let the tax tail wag the investment dog.��� I agree with that sentiment, but that isn���t my intention. We���d be happy to hold on to everything we currently own. If that weren���t the case, deciding what to sell would be a whole lot easier.
Michael Perry is a former career Army��officer and external��affairs executive��for a Fortune 100��company. In addition to personal finance and investing, his interests include reading, traveling,��being outdoors,��strength training and coaching, and cocktails. His previous��article was An Appreciated Gift.��The post Working My Losses appeared first on HumbleDollar.
August 23, 2021
Inflation Insurance
ON AUG. 15, 1971, President Richard Nixon made the weighty decision to end the convertibility of the U.S. dollar into gold. By doing so, he drove a stake through the heart of the gold standard, a monetary system which fixed the worth of a unit of money to a specific amount of physical gold. Before that day, foreign central banks were able to exchange $35 for one ounce of gold from the vaults of the U.S. Federal Reserve.
By closing the so-called gold window half a century ago, Nixon ushered in the current era of fiat money. Fiat currencies���which include all currencies in existence today���aren���t backed by anything tangible. Rather, their value depends entirely upon the collective trust of people making transactions in those currencies. If that confidence evaporates, so does the value of that money.
What can lead to a loss of confidence in money? In a word, oversupply. Too much of anything can be a bad thing, and so it is with money. Print too much money and you devalue it. When a currency is devalued, inflation results.
Gold is called a precious metal precisely because it���s rare and difficult to mine. Though many have tried, gold cannot be fabricated. Because of this and other unique qualities, the yellow metal has been a store of value for over two millennia.
Gold���s value as an investment is far more controversial. Gold isn���t an investment in the traditional sense because it generates no cash flow. Result? There���s no way to assign an intrinsic value to an ounce of gold. In this regard, gold resembles other commodities. In all likelihood, however, gold will remain a store of value. Those who own gold, as I do, know that currencies have an uncomfortable history of being devalued. In my mind, gold is a form of insurance against this risk.
How has gold performed as an investment over the past five decades? Surprisingly well, it turns out. In U.S. dollar terms, gold has appreciated 8.2% annually, on average, since Aug. 15, 1971. But what has really happened is that the dollar���and other currencies���have depreciated against gold. If you hold the value of gold constant, the U.S. dollar has lost 7.65% in purchasing power per year, on average, since the nation left the gold standard 50 years ago.
Incidentally, advocates of cryptocurrencies claim they���re a store of value, too. Some go so far as to call them ���digital gold.��� I���m not smart enough to weigh in on cryptocurrencies. But it seems noteworthy to me that the number of cryptocurrencies has exploded from 66 to more than��5,000 since 2013. I prefer to own gold, which has a far longer history as a store of value.
By closing the so-called gold window half a century ago, Nixon ushered in the current era of fiat money. Fiat currencies���which include all currencies in existence today���aren���t backed by anything tangible. Rather, their value depends entirely upon the collective trust of people making transactions in those currencies. If that confidence evaporates, so does the value of that money.
What can lead to a loss of confidence in money? In a word, oversupply. Too much of anything can be a bad thing, and so it is with money. Print too much money and you devalue it. When a currency is devalued, inflation results.
Gold is called a precious metal precisely because it���s rare and difficult to mine. Though many have tried, gold cannot be fabricated. Because of this and other unique qualities, the yellow metal has been a store of value for over two millennia.
Gold���s value as an investment is far more controversial. Gold isn���t an investment in the traditional sense because it generates no cash flow. Result? There���s no way to assign an intrinsic value to an ounce of gold. In this regard, gold resembles other commodities. In all likelihood, however, gold will remain a store of value. Those who own gold, as I do, know that currencies have an uncomfortable history of being devalued. In my mind, gold is a form of insurance against this risk.
How has gold performed as an investment over the past five decades? Surprisingly well, it turns out. In U.S. dollar terms, gold has appreciated 8.2% annually, on average, since Aug. 15, 1971. But what has really happened is that the dollar���and other currencies���have depreciated against gold. If you hold the value of gold constant, the U.S. dollar has lost 7.65% in purchasing power per year, on average, since the nation left the gold standard 50 years ago.
Incidentally, advocates of cryptocurrencies claim they���re a store of value, too. Some go so far as to call them ���digital gold.��� I���m not smart enough to weigh in on cryptocurrencies. But it seems noteworthy to me that the number of cryptocurrencies has exploded from 66 to more than��5,000 since 2013. I prefer to own gold, which has a far longer history as a store of value.
The post Inflation Insurance appeared first on HumbleDollar.
Going Direct
HEARD OF DIRECT indexing? It���s supposed to be the next big thing in investing. Let me tell you why that isn���t likely.
Direct indexing arose from a shortcoming in the way exchange-traded funds (ETFs) work. Most ETFs mimic a market benchmark such as the S&P 500 or the Russell 2000, and are bought and sold on an exchange like stocks. Their main selling point is that there are no active portfolio managers selecting the securities, and that results in reduced fees. Despite their usefulness and broad acceptance, ETFs have at least one flaw: Investors can���t get the tax benefit from portfolio losses unless they sell the entire ETF.
Direct indexing is essentially a separately managed account that replicates a market benchmark. Instead of buying shares in an ETF that holds the entire index, investors buy the individual stocks in the index. Direct indexing proponents highlight two benefits. First is the ability to harvest individual stock losses to offset taxable gains, which supporters estimate could add 1% to annual returns. The second benefit takes direct indexing one step further. It allows investors to tweak the index to build a tailored portfolio suited to their values, interests or outlook.
But there are downsides. Here are four of them:
1. Limited loss-harvesting candidates. Tax management has been an attribute of separately managed accounts since their inception. Investors can realize losses on individual stocks to offset realized capital gains elsewhere, thereby reducing their current tax bill. Investors can also gift the lowest cost basis stocks���and hence the ones that would trigger the biggest tax bills���to a charitable organization and claim a tax deduction.
How does direct indexing differ? It doesn���t���except the portfolio reflects a market index rather than the stock choices of a money manager. The problem with tax-loss harvesting: Investors eventually��run out of tax losses to realize, limiting the additional return from tax management.
2. Blurring the lines with active investing. Custom indexing, as described above, is active management by a new name. Do you want to eliminate companies that burn coal? Do you want to eliminate companies that rank poorly on environmental, social or governance criteria? Do you want to add growing companies that are not yet part of the index? If you make those changes, your ���index��� is no longer an index. You have become an active investor, the very thing investing in an index was seeking to avoid.
3. Expenses. The fees on direct indexing products are 0.15% to 0.35% of assets each year, less than many actively managed mutual funds, but potentially more than triple the price of the most popular ETFs. Direct indexing has been made far more cost-efficient thanks to technology and zero-dollar brokerage commissions. Yet each bit of customization adds complexity to the management of your portfolio and increases costs. What if the product is offered free? The manager is making money somewhere else.
4. Complexity. If you direct index the S&P 500, imagine your statement showing 500 line items and the associated trading activity. And portfolios typically don���t stop at one ETF. Many will hold five to 10 ETFs. What will your statement look like with thousands of line items? How lengthy will the year-end tax statements be?
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.
Direct indexing arose from a shortcoming in the way exchange-traded funds (ETFs) work. Most ETFs mimic a market benchmark such as the S&P 500 or the Russell 2000, and are bought and sold on an exchange like stocks. Their main selling point is that there are no active portfolio managers selecting the securities, and that results in reduced fees. Despite their usefulness and broad acceptance, ETFs have at least one flaw: Investors can���t get the tax benefit from portfolio losses unless they sell the entire ETF.
Direct indexing is essentially a separately managed account that replicates a market benchmark. Instead of buying shares in an ETF that holds the entire index, investors buy the individual stocks in the index. Direct indexing proponents highlight two benefits. First is the ability to harvest individual stock losses to offset taxable gains, which supporters estimate could add 1% to annual returns. The second benefit takes direct indexing one step further. It allows investors to tweak the index to build a tailored portfolio suited to their values, interests or outlook.
But there are downsides. Here are four of them:
1. Limited loss-harvesting candidates. Tax management has been an attribute of separately managed accounts since their inception. Investors can realize losses on individual stocks to offset realized capital gains elsewhere, thereby reducing their current tax bill. Investors can also gift the lowest cost basis stocks���and hence the ones that would trigger the biggest tax bills���to a charitable organization and claim a tax deduction.
How does direct indexing differ? It doesn���t���except the portfolio reflects a market index rather than the stock choices of a money manager. The problem with tax-loss harvesting: Investors eventually��run out of tax losses to realize, limiting the additional return from tax management.
2. Blurring the lines with active investing. Custom indexing, as described above, is active management by a new name. Do you want to eliminate companies that burn coal? Do you want to eliminate companies that rank poorly on environmental, social or governance criteria? Do you want to add growing companies that are not yet part of the index? If you make those changes, your ���index��� is no longer an index. You have become an active investor, the very thing investing in an index was seeking to avoid.
3. Expenses. The fees on direct indexing products are 0.15% to 0.35% of assets each year, less than many actively managed mutual funds, but potentially more than triple the price of the most popular ETFs. Direct indexing has been made far more cost-efficient thanks to technology and zero-dollar brokerage commissions. Yet each bit of customization adds complexity to the management of your portfolio and increases costs. What if the product is offered free? The manager is making money somewhere else.
4. Complexity. If you direct index the S&P 500, imagine your statement showing 500 line items and the associated trading activity. And portfolios typically don���t stop at one ETF. Many will hold five to 10 ETFs. What will your statement look like with thousands of line items? How lengthy will the year-end tax statements be?
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 Going Direct appeared first on HumbleDollar.
August 22, 2021
Vive La Difference
THERE���S A LOT of handwringing right now about U.S. stock market valuations. Prof. Robert Shiller���s cyclically adjusted price-earnings ratio, or CAPE, has rarely been more famous���or perhaps infamous. It���s currently perched near 39, meaning buyers of the S&P 500 are paying almost 39 times average inflation-adjusted corporate earnings for the past 10 years. That number might mean little to many without proper context. It was around five at the worst of the Great Depression, and under 10 in the late 1970s and early 1980s.
Jump ahead to the dot-com bubble and you���ll see that it peaked at 44 in December 1999. After that came an historic drop in share prices. With the current record-low interest rates and huge fiscal spending, we���re nearing those lofty late 1990s highs once again.
It���s likely some investors have thought about moving some money from U.S. stocks to foreign markets. After all, CAPE ratios are far lower in many other��developed markets. There���s a twist, though: The U.S. market���s composition looks nothing like some of those foreign markets.
For example, the technology sector is 24% of the S&P 500 using Vanguard S&P 500 ETF (symbol: VOO) as a proxy. Leap across the pond to Europe, and you���ll discover that just 8% of Vanguard FTSE Europe ETF (VGK) is in the tech sector. Fast-growing tech stocks command higher valuation multiples than cyclical and defensive sectors such as materials, financials, staples, energy and industrials. All of these sectors feature more prominently in Europe���s market makeup.
The quants out there can perform a sector-neutral valuation analysis to get a truer sense of each country���s stock market valuation. Indeed, looking beyond a standard valuation metric such as the CAPE ratio would be wise, especially if you���re considering making major changes to your stock portfolio���s geographical allocation.
Jump ahead to the dot-com bubble and you���ll see that it peaked at 44 in December 1999. After that came an historic drop in share prices. With the current record-low interest rates and huge fiscal spending, we���re nearing those lofty late 1990s highs once again.
It���s likely some investors have thought about moving some money from U.S. stocks to foreign markets. After all, CAPE ratios are far lower in many other��developed markets. There���s a twist, though: The U.S. market���s composition looks nothing like some of those foreign markets.
For example, the technology sector is 24% of the S&P 500 using Vanguard S&P 500 ETF (symbol: VOO) as a proxy. Leap across the pond to Europe, and you���ll discover that just 8% of Vanguard FTSE Europe ETF (VGK) is in the tech sector. Fast-growing tech stocks command higher valuation multiples than cyclical and defensive sectors such as materials, financials, staples, energy and industrials. All of these sectors feature more prominently in Europe���s market makeup.
The quants out there can perform a sector-neutral valuation analysis to get a truer sense of each country���s stock market valuation. Indeed, looking beyond a standard valuation metric such as the CAPE ratio would be wise, especially if you���re considering making major changes to your stock portfolio���s geographical allocation.
The post Vive La Difference appeared first on HumbleDollar.
