Jonathan Clements's Blog, page 281
July 24, 2021
Unnecessary Breaks
IT���S SOCIETY���S responsibility to provide for those in need. ���Need��� is the key word here. It bothers me that so many resources are directed to those of us who made it to old age.
Although there are many low-income seniors, the generalization that we���re all income-challenged is a fallacy. According to the Congressional Research Service, ���The poverty rate for individuals aged 65 and older historically was higher than the rates for adults aged 18-64 and children under the age of 18, but today is the lowest among those three age groups.���
The fact is, seniors have a higher median net worth than most younger Americans. Their median income is equal to or greater than many middle-aged Americans raising families and saving for retirement. Nevertheless, senior discounts and tax advantages indirectly transfer monetary resources from younger to older Americans.
In New Jersey, for example, seniors with household income of up to $150,000 can get a rebate on property taxes and apply to have future increases frozen if their income doesn���t exceed $92,969. (For comparison, the median income for all households in New Jersey is just over $85,000.) Many states have similar programs with income limits that may or may not apply. There are also discounts of all kinds just because we���re old.
Contrary to what many believe, seniors are the only group of Americans virtually guaranteed not to be living on a fixed income, thanks to investment growth and Social Security's cost-of-living adjustments.
The post Unnecessary Breaks appeared first on HumbleDollar.
Picking the Fruit
LAST MONTH, the Federal Reserve released the results of its latest stress tests of major financial institutions. As an investor in Wells Fargo, I took special interest in the Fed���s findings. Why? If Wells Fargo passed the Fed���s stress test, it would be allowed to raise its dividend, which currently stands at a paltry 10 cents a share, amounting to a dividend yield of just 0.9%.
I���m fully aware that my obsession with stock dividends is less than rational. For one thing, I don���t spend them. My dividends are automatically reinvested in additional Wells Fargo shares. Nor do the dividends necessarily increase the value of Wells Fargo stock. Every dollar in dividends paid out to shareholders lowers the price of a company���s stock by the same amount���at least in theory. That���s why a stock often falls in price on its ex-dividend date, which is the first day a stock trades without the benefit of its next dividend.
And since I don���t actually spend my dividends, I really ought to prefer capital gains. After all, dividends are taxed the same year I receive them, but capital gains aren���t taxed until I sell the appreciated stock. In fact, the tax on capital gains may be avoided altogether by donating appreciated shares or bequeathing stock to your heirs, who inherit the stock with a step up in basis. Finally, I can always create ���homemade dividends��� by simply selling some shares as needed.
When economists examine the irrational behavior of dividend lovers like me, they scratch their heads. In 1976, economist Fischer Black pondered the conundrum in a paper titled The Dividend Puzzle . In his words, ���The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don���t fit together.���
But guess what? I still love my dividends���and I���m not alone. Meir Statman uses a wonderful metaphor in his book on behavioral finance, Finance for Normal People , which I think gets to the heart of people���s love affair with dividends. He describes dividends as the fruit harvested from an orchard, with the trees in the orchard representing the stocks. Investors love to pick the fruit but are loath to chop down the trees. When I sell shares of Wells Fargo to generate homemade dividends, it feels like I���m depleting my orchard.
Such mental accounting may explain why many people are too frugal in retirement, spending far less than their nest eggs would safely allow. They may be falling prey to the orchard mentality, living off their portfolio���s income but hesitant to draw down their portfolio because of an irrational fear they���ll deplete their orchard. I could certainly see myself behaving that way, which is one reason I���m strongly considering buying single premium income annuities for my retirement.
In case you���re wondering, Wells Fargo passed the Fed���s stress test and announced a doubling of its dividend to 20 cents a quarter. While that���s a far cry from its pre-pandemic 51-cent dividend, I���ll take every penny I can get, thank you. Wells Fargo also announced plans to repurchase $18 billion of shares, amounting to 10% of its current market capitalization. In effect, that increases my ownership stake in the company by 10%... meh.
I���m fully aware that my obsession with stock dividends is less than rational. For one thing, I don���t spend them. My dividends are automatically reinvested in additional Wells Fargo shares. Nor do the dividends necessarily increase the value of Wells Fargo stock. Every dollar in dividends paid out to shareholders lowers the price of a company���s stock by the same amount���at least in theory. That���s why a stock often falls in price on its ex-dividend date, which is the first day a stock trades without the benefit of its next dividend.
And since I don���t actually spend my dividends, I really ought to prefer capital gains. After all, dividends are taxed the same year I receive them, but capital gains aren���t taxed until I sell the appreciated stock. In fact, the tax on capital gains may be avoided altogether by donating appreciated shares or bequeathing stock to your heirs, who inherit the stock with a step up in basis. Finally, I can always create ���homemade dividends��� by simply selling some shares as needed.
When economists examine the irrational behavior of dividend lovers like me, they scratch their heads. In 1976, economist Fischer Black pondered the conundrum in a paper titled The Dividend Puzzle . In his words, ���The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don���t fit together.���
But guess what? I still love my dividends���and I���m not alone. Meir Statman uses a wonderful metaphor in his book on behavioral finance, Finance for Normal People , which I think gets to the heart of people���s love affair with dividends. He describes dividends as the fruit harvested from an orchard, with the trees in the orchard representing the stocks. Investors love to pick the fruit but are loath to chop down the trees. When I sell shares of Wells Fargo to generate homemade dividends, it feels like I���m depleting my orchard.
Such mental accounting may explain why many people are too frugal in retirement, spending far less than their nest eggs would safely allow. They may be falling prey to the orchard mentality, living off their portfolio���s income but hesitant to draw down their portfolio because of an irrational fear they���ll deplete their orchard. I could certainly see myself behaving that way, which is one reason I���m strongly considering buying single premium income annuities for my retirement.
In case you���re wondering, Wells Fargo passed the Fed���s stress test and announced a doubling of its dividend to 20 cents a quarter. While that���s a far cry from its pre-pandemic 51-cent dividend, I���ll take every penny I can get, thank you. Wells Fargo also announced plans to repurchase $18 billion of shares, amounting to 10% of its current market capitalization. In effect, that increases my ownership stake in the company by 10%... meh.
The post Picking the Fruit appeared first on HumbleDollar.
July 23, 2021
Getting Short
WE JUST LAUNCHED our newest feature: A blog that���ll be updated two or three times a day with new posts that typically run some 300 words. These posts will, I hope, complement the site���s longer articles, which we���ll continue to publish, though perhaps less frequently.
Why introduce a blog? It���ll allow HumbleDollar to be more timely. It���ll be a way to tackle topics that don���t require full-length articles. And it���ll be another opportunity to highlight the financial philosophy that drives much of what we write���and what makes HumbleDollar different from most other financial sites:
We think harping on the stock market���s daily action is foolish and that the forecasts of Wall Street���s chattering class aren���t just worthless, but potentially damaging to investors��� financial health. Expect the new blog to discourage such dangerous nonsense and prod readers to keep their gaze firmly fixed on the long term.
We believe folks should abandon efforts to beat the market, and instead buy index funds and collect the market���s return. What should we do with all the time we save? There���s much value that can be added by focusing on other areas of our financial life, including saving diligently, spending thoughtfully, buying the right insurance, managing debt, being smart about taxes, purchasing the right size home and planning our estate. These are all topics that���ll be tackled regularly in the blog.
We think that saving can bring at least as much happiness as spending, and sometimes more. Contentment lies not in a house chock-full of impulse purchases, but in knowing we���re prepared for life���s short-term bumps and on track for a financially comfortable future.
We think the tough part of managing money isn���t figuring out what to do but getting ourselves to do what we know is right. This ongoing struggle will be a frequent topic of the new blog.
We believe money isn���t an end in itself but rather a way to enhance our lives. But how can we best use our dollars? It isn���t always obvious, which is why it���s important to avoid snap financial decisions and instead think hard about what we want.
My hope: The new blog will be not just engaging, but also emphasize these key points���and thereby help all of us to avoid knee-jerk investment decisions and impulsive spending, and instead stay the course in our pursuit of a more thoughtful financial life.
HumbleDollar���s crew of frequent and occasional writers���some 30 in all���will almost all be contributing to the blog. Their willingness to share their stories, including both their triumphs and their struggles, is perhaps the site���s most enduring strength. I encourage you to stop by HumbleDollar every day and see what they have to say.
Why introduce a blog? It���ll allow HumbleDollar to be more timely. It���ll be a way to tackle topics that don���t require full-length articles. And it���ll be another opportunity to highlight the financial philosophy that drives much of what we write���and what makes HumbleDollar different from most other financial sites:
We think harping on the stock market���s daily action is foolish and that the forecasts of Wall Street���s chattering class aren���t just worthless, but potentially damaging to investors��� financial health. Expect the new blog to discourage such dangerous nonsense and prod readers to keep their gaze firmly fixed on the long term.
We believe folks should abandon efforts to beat the market, and instead buy index funds and collect the market���s return. What should we do with all the time we save? There���s much value that can be added by focusing on other areas of our financial life, including saving diligently, spending thoughtfully, buying the right insurance, managing debt, being smart about taxes, purchasing the right size home and planning our estate. These are all topics that���ll be tackled regularly in the blog.
We think that saving can bring at least as much happiness as spending, and sometimes more. Contentment lies not in a house chock-full of impulse purchases, but in knowing we���re prepared for life���s short-term bumps and on track for a financially comfortable future.
We think the tough part of managing money isn���t figuring out what to do but getting ourselves to do what we know is right. This ongoing struggle will be a frequent topic of the new blog.
We believe money isn���t an end in itself but rather a way to enhance our lives. But how can we best use our dollars? It isn���t always obvious, which is why it���s important to avoid snap financial decisions and instead think hard about what we want.
My hope: The new blog will be not just engaging, but also emphasize these key points���and thereby help all of us to avoid knee-jerk investment decisions and impulsive spending, and instead stay the course in our pursuit of a more thoughtful financial life.
HumbleDollar���s crew of frequent and occasional writers���some 30 in all���will almost all be contributing to the blog. Their willingness to share their stories, including both their triumphs and their struggles, is perhaps the site���s most enduring strength. I encourage you to stop by HumbleDollar every day and see what they have to say.
The post Getting Short appeared first on HumbleDollar.
Keeping My Cool
MY 2007 HONDA CR-V���s air conditioning system started having issues about three years ago. I took it to a shop where they added refrigerant and declared the problem fixed. A year later, the AC stopped working again so I took it to a different mechanic, who declared the problem solved after adding refrigerant and replacing a relay. Several months later, I was once again driving around in a car at ambient temperatures. Because I spent much of the summer of 2020 working from home, I decided not to bother with another repair.
Fast forward to a few weeks ago, when temperatures in the Northwest were forecast to reach record highs. I knew I needed to come up with a fix. My first thought? Trade in my low-mile, mint-condition Honda for a fancy new Kia. I justified my thinking by first telling myself I deserved a new car. Then I justified it using the fact that used cars are in demand right now. I went so far as to contact a new car dealer to request pricing information for both my trade-in and a new vehicle. The dopamine hit I got from thinking about having a new car completely overwhelmed the more practical parts of my brain.
In a moment of sanity, I told my husband I felt like I was trying to solve a $1,500 problem with a $25,000 solution. I found a local mechanic who specialized in AC issues and scheduled my car for a diagnostic panel. They quickly discovered the problem, gave me an estimate for the repair and, when I approved the fix, they ordered the parts and had everything repaired just 24 hours later. Ironically enough, the cost of the repair was almost exactly what I had predicted, coming in at $1,460. My lovingly cared for Honda now happily blows cold air again and I���m happily driving around without a $400-a-month car payment.
Fast forward to a few weeks ago, when temperatures in the Northwest were forecast to reach record highs. I knew I needed to come up with a fix. My first thought? Trade in my low-mile, mint-condition Honda for a fancy new Kia. I justified my thinking by first telling myself I deserved a new car. Then I justified it using the fact that used cars are in demand right now. I went so far as to contact a new car dealer to request pricing information for both my trade-in and a new vehicle. The dopamine hit I got from thinking about having a new car completely overwhelmed the more practical parts of my brain.
In a moment of sanity, I told my husband I felt like I was trying to solve a $1,500 problem with a $25,000 solution. I found a local mechanic who specialized in AC issues and scheduled my car for a diagnostic panel. They quickly discovered the problem, gave me an estimate for the repair and, when I approved the fix, they ordered the parts and had everything repaired just 24 hours later. Ironically enough, the cost of the repair was almost exactly what I had predicted, coming in at $1,460. My lovingly cared for Honda now happily blows cold air again and I���m happily driving around without a $400-a-month car payment.
The post Keeping My Cool appeared first on HumbleDollar.
Retire to Paradise?
I RECENTLY WROTE about how my wife and I downsized to our beach home. It had long been a dream of ours and we���re thrilled it came about. Right after the move, we climbed on a plane and experienced another common dream of retirees���living in an exotic tropical paradise.
We visited our son, daughter-in-law, grandson and their Boston terrier in Nosara, Costa Rica. Nosara is a beautiful village and resort area carved out of the jungle on Nicoya Peninsula, part of Costa Rica���s Pacific coast. It���s known as a yoga center, for its gorgeous beaches and as a mecca for surfers from around the world. It has a large expat population and a great vibe.
Andrew and Ashley had been living at our New Jersey shore home since May 2020, when COVID-19 drove them out of their Hoboken, N.J., apartment a few months after their first child, James, was born. This winter, they decided it was time for a bit of an adventure, so they rented a home in Nosara for 10 weeks.
It���s worked out great for them. They���ve been able to work, found top-quality childcare, made friends from around the world and even learned to surf. The house they rented is gorgeous, has a beautiful pool and plenty of room for visiting grandparents. It���s a 10-minute walk from one of the most beautiful beaches I���ve ever seen. In the morning, we���d drink coffee on the veranda while watching monkeys lounge in a nearby tree, and then stroll to the beach to watch the kids improve their surfing skills.
You often see articles about the best places to retire abroad. Central American countries are always mentioned, often for their inexpensive cost of living. International Living magazine recently rated Costa Rica as the No. 1 place to retire. The article stated that a retired couple could live a relaxed and comfortable lifestyle for $2,500 to $3,000 per month.
Having spent eight days there, I understand the attraction. It���s a beautiful place, the lifestyle is healthy, and the people are as friendly as anywhere I���ve been. If this is something you���re thinking about, here are a few points to consider:
The estimates of housing costs that you read about may not be representative of some of the country���s more desirable locations. In Nosara, you can easily pay well over $1 million for a nice two-bedroom house.
Costa Rica is known for its health care system, but accessibility can be an issue. The closest hospital to Nosara is in Nicoya, about an hour away. There is also a ���life flight��� service that can pick you up in Nosara by either plane or helicopter to get you quickly to San Jose, the capital.
Transportation can be a challenge. Nosara is a grueling two-and-a-half-hour drive from the closest airport, Liberia. The village is mostly bumpy dirt roads. People get around on dirt bikes, all-terrain vehicles, electric carts and pickup trucks. The plus side: You���ll be doing plenty of walking.
The infrastructure in Nosara is generally modern. The water is safe to drink, the electric grid is compatible with U.S. devices and fast internet is available. Reliability, however, is a bit of an issue. We had regular though brief electrical outages, as well as a planned four-hour outage one day.
As much as we enjoyed our short sojourn in the tropics, I don���t think we���re ready to move there permanently. It���s too far from friends and family, and it���s pretty hot and humid. But we enjoyed the excitement of learning about a new place, meeting new people and stepping out of our comfort zone. We want that feeling to continue.
Our plan is to visit different parts of the world that interest us and look at staying for longer periods, so we have the chance to embed ourselves in new and strange places. In the past, we���ve enjoyed renting homes and apartments throughout the U.S. and Italy. You feel a part of the community, and you can save money by shopping in local markets and cooking meals. Another way to save money, and broaden the experience, is sharing costs with friends and family. I���m thinking of a few weeks on Ireland���s Dingle Peninsula during the fall, somewhere warm and sunny in winter, the Pacific Northwest in spring and Canada���s Maritime provinces in summer. Sound good?
Richard Connor is��a semi-retired aerospace engineer with a keen interest in finance. He��enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter��@RConnor609��and check out his earlier articles.
We visited our son, daughter-in-law, grandson and their Boston terrier in Nosara, Costa Rica. Nosara is a beautiful village and resort area carved out of the jungle on Nicoya Peninsula, part of Costa Rica���s Pacific coast. It���s known as a yoga center, for its gorgeous beaches and as a mecca for surfers from around the world. It has a large expat population and a great vibe.
Andrew and Ashley had been living at our New Jersey shore home since May 2020, when COVID-19 drove them out of their Hoboken, N.J., apartment a few months after their first child, James, was born. This winter, they decided it was time for a bit of an adventure, so they rented a home in Nosara for 10 weeks.
It���s worked out great for them. They���ve been able to work, found top-quality childcare, made friends from around the world and even learned to surf. The house they rented is gorgeous, has a beautiful pool and plenty of room for visiting grandparents. It���s a 10-minute walk from one of the most beautiful beaches I���ve ever seen. In the morning, we���d drink coffee on the veranda while watching monkeys lounge in a nearby tree, and then stroll to the beach to watch the kids improve their surfing skills.
You often see articles about the best places to retire abroad. Central American countries are always mentioned, often for their inexpensive cost of living. International Living magazine recently rated Costa Rica as the No. 1 place to retire. The article stated that a retired couple could live a relaxed and comfortable lifestyle for $2,500 to $3,000 per month.
Having spent eight days there, I understand the attraction. It���s a beautiful place, the lifestyle is healthy, and the people are as friendly as anywhere I���ve been. If this is something you���re thinking about, here are a few points to consider:
The estimates of housing costs that you read about may not be representative of some of the country���s more desirable locations. In Nosara, you can easily pay well over $1 million for a nice two-bedroom house.
Costa Rica is known for its health care system, but accessibility can be an issue. The closest hospital to Nosara is in Nicoya, about an hour away. There is also a ���life flight��� service that can pick you up in Nosara by either plane or helicopter to get you quickly to San Jose, the capital.
Transportation can be a challenge. Nosara is a grueling two-and-a-half-hour drive from the closest airport, Liberia. The village is mostly bumpy dirt roads. People get around on dirt bikes, all-terrain vehicles, electric carts and pickup trucks. The plus side: You���ll be doing plenty of walking.
The infrastructure in Nosara is generally modern. The water is safe to drink, the electric grid is compatible with U.S. devices and fast internet is available. Reliability, however, is a bit of an issue. We had regular though brief electrical outages, as well as a planned four-hour outage one day.
As much as we enjoyed our short sojourn in the tropics, I don���t think we���re ready to move there permanently. It���s too far from friends and family, and it���s pretty hot and humid. But we enjoyed the excitement of learning about a new place, meeting new people and stepping out of our comfort zone. We want that feeling to continue.
Our plan is to visit different parts of the world that interest us and look at staying for longer periods, so we have the chance to embed ourselves in new and strange places. In the past, we���ve enjoyed renting homes and apartments throughout the U.S. and Italy. You feel a part of the community, and you can save money by shopping in local markets and cooking meals. Another way to save money, and broaden the experience, is sharing costs with friends and family. I���m thinking of a few weeks on Ireland���s Dingle Peninsula during the fall, somewhere warm and sunny in winter, the Pacific Northwest in spring and Canada���s Maritime provinces in summer. Sound good?
Richard Connor is��a semi-retired aerospace engineer with a keen interest in finance. He��enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter��@RConnor609��and check out his earlier articles.The post Retire to Paradise? appeared first on HumbleDollar.
July 22, 2021
Eating My Veggies
THIRTY YEARS AGO, I took a course on sales and entrepreneurship. We had to buy a few books, subscribe to The Economist and The New York Times, and buy an HP 12C calculator. This was not your usual sales class. I felt like I was piloting the space shuttle as I learned how to use that HP calculator.
I���ll never forget the first time the instructor had us calculate how much money we���d need when we retired. I don���t remember the exact number, but it was well into seven figures. I do remember laughing out loud, thinking that number can���t be real and, if it is, we���re doomed.
The purpose of the exercise was to encourage us to take our careers, investing and saving more seriously. For some, the number was too overwhelming because they were older than me and had fewer earning years ahead. They realized they���d have to work a lot longer than planned, radically change their savings and credit-card habits, or somehow double their income. Eating dog food in retirement was also a possibility.
When I work with people new to financial planning, I do a similar exercise. Almost nobody believes the number, even when I explain the effects of compounding, time and inflation. Some decide there���s no use trying to pay off their debts or start adding to their 401(k) because they���ll never have enough. Others start to change their behavior and realize the precise destination isn���t as important as committing to the journey.
Many of us need a jolt of pain and reality to change our ways. My gambling addiction taught me that, as did saving and investing. I like to think of that HP 12C experience as a metaphor for a heart attack. The shock prompted me to start eating more financial fruits and vegetables. Thirty years later and semi-retired far earlier than I originally planned, my financial heart is in much better shape.
I���ll never forget the first time the instructor had us calculate how much money we���d need when we retired. I don���t remember the exact number, but it was well into seven figures. I do remember laughing out loud, thinking that number can���t be real and, if it is, we���re doomed.
The purpose of the exercise was to encourage us to take our careers, investing and saving more seriously. For some, the number was too overwhelming because they were older than me and had fewer earning years ahead. They realized they���d have to work a lot longer than planned, radically change their savings and credit-card habits, or somehow double their income. Eating dog food in retirement was also a possibility.
When I work with people new to financial planning, I do a similar exercise. Almost nobody believes the number, even when I explain the effects of compounding, time and inflation. Some decide there���s no use trying to pay off their debts or start adding to their 401(k) because they���ll never have enough. Others start to change their behavior and realize the precise destination isn���t as important as committing to the journey.
Many of us need a jolt of pain and reality to change our ways. My gambling addiction taught me that, as did saving and investing. I like to think of that HP 12C experience as a metaphor for a heart attack. The shock prompted me to start eating more financial fruits and vegetables. Thirty years later and semi-retired far earlier than I originally planned, my financial heart is in much better shape.
The post Eating My Veggies appeared first on HumbleDollar.
Life and Death
I SAW MY MOTHER walking through the neighborhood the other day. She was wearing this big floppy hat hiding her face from the sun. But I knew it was her because I can tell by the way she walked. I see her from afar quite often. She drove by me just yesterday when I was coming out of the grocery store. I wonder why she didn't wave to me. I knew she saw me.
My mother passed away about two years ago. I often see people who remind me of my mother. I think about her a lot. I remember when she was in the emergency room after suffering a heart attack. The doctor asked her, ���If your heart flatlines, do you want me to try to revive you?��� My mother said, ���Yes, do whatever necessary. I want to live.���
My mother would often say to me, ���If I had something seriously wrong with me, they wouldn���t operate because I���m too old. They would just let me die.��� The upshot: My mother had an advance health care directive stating her wishes for medical treatment in case she was unable to communicate those wishes. She wanted doctors to take all reasonable steps to keep her alive. With power of attorney over my mother���s health care, I made sure the hospital and rehabilitation facility knew of her wishes.
When I think about my mother���s desires and her fears about life and death, I realize how important it to have in place not only estate planning decisions, but also end-of-life decisions.
My mother passed away about two years ago. I often see people who remind me of my mother. I think about her a lot. I remember when she was in the emergency room after suffering a heart attack. The doctor asked her, ���If your heart flatlines, do you want me to try to revive you?��� My mother said, ���Yes, do whatever necessary. I want to live.���
My mother would often say to me, ���If I had something seriously wrong with me, they wouldn���t operate because I���m too old. They would just let me die.��� The upshot: My mother had an advance health care directive stating her wishes for medical treatment in case she was unable to communicate those wishes. She wanted doctors to take all reasonable steps to keep her alive. With power of attorney over my mother���s health care, I made sure the hospital and rehabilitation facility knew of her wishes.
When I think about my mother���s desires and her fears about life and death, I realize how important it to have in place not only estate planning decisions, but also end-of-life decisions.
The post Life and Death appeared first on HumbleDollar.
Checking Up
MY WIFE AND I DO a mid-year and year-end financial review. This includes an updated family balance sheet, cashflow analysis, portfolio review and a review of retirement projections.
I���m semi-retired and do some consulting when work is available. This income isn���t guaranteed, so I keep a spreadsheet that estimates our income and tax burden for the year. I usually update this quarterly to see if we need to submit any estimated state or federal tax payments.
During our twice-yearly financial review, we discuss spending priorities for the next six months. Our 2021 mid-year review was less routine���because my wife retired at the end of June. We���ll most likely roll her company 401(k) into her IRA at Vanguard Group, at which point we���ll have to choose how to invest that money. The biggest issue, at least in my mind, is that for the first time we���ll have to start withdrawing funds from our retirement accounts. We need to decide which investments we���ll withdraw the money from and how much to withdraw.
I���m semi-retired and do some consulting when work is available. This income isn���t guaranteed, so I keep a spreadsheet that estimates our income and tax burden for the year. I usually update this quarterly to see if we need to submit any estimated state or federal tax payments.
During our twice-yearly financial review, we discuss spending priorities for the next six months. Our 2021 mid-year review was less routine���because my wife retired at the end of June. We���ll most likely roll her company 401(k) into her IRA at Vanguard Group, at which point we���ll have to choose how to invest that money. The biggest issue, at least in my mind, is that for the first time we���ll have to start withdrawing funds from our retirement accounts. We need to decide which investments we���ll withdraw the money from and how much to withdraw.
The post Checking Up appeared first on HumbleDollar.
Prices Just Doubled
IF YOU THINK BITCOIN or any other cryptocurrency will one day be used as readily as dollars and cents, give some thought to this year���s volatility. Suppose you were using your bitcoin stash to pay your $2,000 monthly mortgage payment. Between April and today, the effective cost of your mortgage would have doubled���because bitcoin's value has been pretty much��cut in half.
Now, if you were paid in bitcoin and your mortgage payment was fixed at some value specified in bitcoin, this wouldn���t matter. The fluctuations in bitcoin���s value against the dollar would be the equivalent of turmoil in the foreign-exchange markets���which isn���t a problem unless you plan to travel abroad or buy imported goods.
But given that we're paid in dollars and buy items denominated in dollars, the wild ride by cryptocurrencies is indeed a big problem for their future as a payment system. Something, however, tells me that most owners of cryptocurrencies give scant thought to spending the darn things, and instead their sole focus is turning a quick profit.
Now, if you were paid in bitcoin and your mortgage payment was fixed at some value specified in bitcoin, this wouldn���t matter. The fluctuations in bitcoin���s value against the dollar would be the equivalent of turmoil in the foreign-exchange markets���which isn���t a problem unless you plan to travel abroad or buy imported goods.
But given that we're paid in dollars and buy items denominated in dollars, the wild ride by cryptocurrencies is indeed a big problem for their future as a payment system. Something, however, tells me that most owners of cryptocurrencies give scant thought to spending the darn things, and instead their sole focus is turning a quick profit.
The post Prices Just Doubled appeared first on HumbleDollar.
Leaving the Country
ARE THERE TIMES when a near 100% international stock allocation makes sense? I believe there are���and that today is just such a moment.
Never in my life have I had such a low allocation to U.S. stocks. My overall portfolio is 60% stocks and 40% bonds. But the stock portion is comprised of just 15% U.S., with the remainder held in international stocks, split evenly between emerging and developed markets.
I realize that���s unorthodox. It would certainly be viewed as heretical by most financial advisors. But I believe there are four reasons to buck conventional wisdom:
1. The ���traditional��� international allocation is irrational.
It seems that most financial advisors and institutions recommend��that international stocks account for 20% to 30% of a portfolio���s stock allocation. Like one of the 10 commandments, this advice has been handed down from on high and accepted without questioning. But is this recommendation actually evidence-based? Research by the Vanguard Group suggests that the benefits of international diversification, in terms of reducing volatility, plateau at around 40% foreign stocks. Further international exposure, Vanguard contends, leads to increased volatility.
Others have suggested using global GDP as a guide. Today, the U.S. represents 25% of global GDP, so following this line of thought would mean allocating 75% of a portfolio���s stock allocation to international shares. On the other hand, efficient market proponents suggest weighting a portfolio according to global market capitalization, which would mean holding about 44% in international stocks, since U.S. companies account for 56% of global stock market value.
No matter how you slice it, allocating just a quarter or so of a portfolio to international stocks makes little sense���and even less sense when considering today���s valuations, which I���ll get to shortly. Of course, investors aren���t machines. They need to be comfortable with their portfolios. It���s my contention that the low allocation to international stocks in large part represents home bias, the behavioral tendency to favor investments familiar to us and shun ���foreign��� investments (pun intended). Not only is this behavior irrational, I fear it could cost investors dearly.
2. The ���global diversification through multinationals��� argument is flawed.
Vanguard founder Jack Bogle was famously unconvinced that international diversification was necessary. He argued that investing in the S&P 500 provides sufficient diversification since so many U.S. multinationals have sizable global revenues. Fair enough.
This argument, however, can also be flipped on its head. By investing in international stocks, an investor gets significant exposure to the U.S. economy because the U.S. is a net importer of goods. If the U.S. economy thrives, so will the exporters that supply it with products such as textiles, commodities, cars and semiconductors.
In other words, the same argument that people use to justify a low international allocation can also be used to justify a far higher international allocation. But it���s at this point in the debate that someone inevitably raises the dreaded F word: ���What about foreign exchange risk?���
3. Currency risk is overstated.
When U.S. investors hold foreign stocks, they have two exposures���one to the stocks themselves and the other to foreign currencies. If those currencies fall relative to the U.S. dollar���in other words, if the U.S. dollar strengthens in the foreign exchange market���that will lower the dollar value of foreign stocks for U.S. holders. This is what is meant by currency risk. This risk can be hedged and some funds that invest internationally do so, albeit at a cost.
Because investing overseas introduces currency risk, many investment professionals warn against having too much exposure to foreign stocks. But currency risk cuts both ways. Just as a strengthening dollar is a headwind to returns on international investments, a weakening dollar provides a tailwind���assuming currency exposure hasn���t been hedged.
Even if you shun international stocks altogether, you can���t completely escape currency risk in a globally interconnected economy. That���s because a depreciating dollar causes imports to become more expensive in dollar terms. This risk can be partly offset by owning international stocks, which benefit from a falling dollar.
More important, the currency risk associated with foreign investments may be overstated. According to Elroy Dimson, Paul Marsh and Mike Stanton, changes in foreign exchange rates largely reflect differential inflation rates among nations. If inflation in the U.S. is higher than in the Eurozone, the U.S. dollar would weaken relative to the euro by a similar magnitude. In fact, Dimson and his coauthors found that���in inflation-adjusted terms���the change in foreign exchange rates has averaged less than 1% per year since 1900. They concluded, ���This has important implications for long-run investors, as it means they are already protected to some extent from currency risk.���
4. U.S. stocks are in a bubble.
The most compelling argument for overweighting international stocks today is valuation. Historically, U.S. and international stock markets have had quite similar returns, close to 7% a year after inflation. But historical returns and expected returns are two distinct animals.
As I argued recently, expected returns from U.S. stocks are abysmal. Based on valuations and the tendency for asset classes to mean revert, the coming decade may be another ���lost decade��� for U.S. stocks. By any number of metrics, the U.S. stock market is in bubble territory. Ratio of total market capitalization to GDP? That would be 200%, the highest in recorded history. What about the cyclically adjusted price-earnings (CAPE) ratio? It���s at 38, a level only once surpassed, at the height of the tech bubble in 2000.
Some argue that rich valuations are justified by record low interest rates. Maybe. But why are European stocks far less expensive, despite even lower interest rates? And what happens to stock prices if interest rates finally begin to levitate from today���s moribund levels?
If you believe, as I do, that U.S. stocks are in bubble territory, does it still make sense to own them in the name of diversification? Does adding a ���bubble asset��� to your portfolio lower risk or increase it? Put yourself in the shoes of a Japanese investor in late 1989. Despite nosebleed valuations, you decide that Japanese stocks will form the core of your stock portfolio. How did that work out for you? You didn���t need a crystal ball to realize how poor the risk-return proposition for Japanese stocks was in the late 1980s. Instead, all you needed to do was look at valuations. I believe the same is true today for U.S. stocks.
If expected returns for the U.S., developed international and emerging stock markets were similar, I���d happily diversify across global markets, holding a good chunk of U.S. stocks in my portfolio. But that���s not the situation we find ourselves in today. Due to the immense outperformance of U.S. stocks since 2009, the outlook is far brighter for foreign markets. Price matters. And I���d argue that today price trumps diversification when it comes to portfolio construction.
Should stock markets mean revert and U.S. stocks underperform international shares over the coming decade���as I fully expect they will���I���ll happily return to owning U.S. stocks. As John Maynard Keynes purportedly said, ���When the facts change, I change my mind. What do you do, sir?���
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.
Never in my life have I had such a low allocation to U.S. stocks. My overall portfolio is 60% stocks and 40% bonds. But the stock portion is comprised of just 15% U.S., with the remainder held in international stocks, split evenly between emerging and developed markets.
I realize that���s unorthodox. It would certainly be viewed as heretical by most financial advisors. But I believe there are four reasons to buck conventional wisdom:
1. The ���traditional��� international allocation is irrational.
It seems that most financial advisors and institutions recommend��that international stocks account for 20% to 30% of a portfolio���s stock allocation. Like one of the 10 commandments, this advice has been handed down from on high and accepted without questioning. But is this recommendation actually evidence-based? Research by the Vanguard Group suggests that the benefits of international diversification, in terms of reducing volatility, plateau at around 40% foreign stocks. Further international exposure, Vanguard contends, leads to increased volatility.
Others have suggested using global GDP as a guide. Today, the U.S. represents 25% of global GDP, so following this line of thought would mean allocating 75% of a portfolio���s stock allocation to international shares. On the other hand, efficient market proponents suggest weighting a portfolio according to global market capitalization, which would mean holding about 44% in international stocks, since U.S. companies account for 56% of global stock market value.
No matter how you slice it, allocating just a quarter or so of a portfolio to international stocks makes little sense���and even less sense when considering today���s valuations, which I���ll get to shortly. Of course, investors aren���t machines. They need to be comfortable with their portfolios. It���s my contention that the low allocation to international stocks in large part represents home bias, the behavioral tendency to favor investments familiar to us and shun ���foreign��� investments (pun intended). Not only is this behavior irrational, I fear it could cost investors dearly.
2. The ���global diversification through multinationals��� argument is flawed.
Vanguard founder Jack Bogle was famously unconvinced that international diversification was necessary. He argued that investing in the S&P 500 provides sufficient diversification since so many U.S. multinationals have sizable global revenues. Fair enough.
This argument, however, can also be flipped on its head. By investing in international stocks, an investor gets significant exposure to the U.S. economy because the U.S. is a net importer of goods. If the U.S. economy thrives, so will the exporters that supply it with products such as textiles, commodities, cars and semiconductors.
In other words, the same argument that people use to justify a low international allocation can also be used to justify a far higher international allocation. But it���s at this point in the debate that someone inevitably raises the dreaded F word: ���What about foreign exchange risk?���
3. Currency risk is overstated.
When U.S. investors hold foreign stocks, they have two exposures���one to the stocks themselves and the other to foreign currencies. If those currencies fall relative to the U.S. dollar���in other words, if the U.S. dollar strengthens in the foreign exchange market���that will lower the dollar value of foreign stocks for U.S. holders. This is what is meant by currency risk. This risk can be hedged and some funds that invest internationally do so, albeit at a cost.
Because investing overseas introduces currency risk, many investment professionals warn against having too much exposure to foreign stocks. But currency risk cuts both ways. Just as a strengthening dollar is a headwind to returns on international investments, a weakening dollar provides a tailwind���assuming currency exposure hasn���t been hedged.
Even if you shun international stocks altogether, you can���t completely escape currency risk in a globally interconnected economy. That���s because a depreciating dollar causes imports to become more expensive in dollar terms. This risk can be partly offset by owning international stocks, which benefit from a falling dollar.
More important, the currency risk associated with foreign investments may be overstated. According to Elroy Dimson, Paul Marsh and Mike Stanton, changes in foreign exchange rates largely reflect differential inflation rates among nations. If inflation in the U.S. is higher than in the Eurozone, the U.S. dollar would weaken relative to the euro by a similar magnitude. In fact, Dimson and his coauthors found that���in inflation-adjusted terms���the change in foreign exchange rates has averaged less than 1% per year since 1900. They concluded, ���This has important implications for long-run investors, as it means they are already protected to some extent from currency risk.���
4. U.S. stocks are in a bubble.
The most compelling argument for overweighting international stocks today is valuation. Historically, U.S. and international stock markets have had quite similar returns, close to 7% a year after inflation. But historical returns and expected returns are two distinct animals.
As I argued recently, expected returns from U.S. stocks are abysmal. Based on valuations and the tendency for asset classes to mean revert, the coming decade may be another ���lost decade��� for U.S. stocks. By any number of metrics, the U.S. stock market is in bubble territory. Ratio of total market capitalization to GDP? That would be 200%, the highest in recorded history. What about the cyclically adjusted price-earnings (CAPE) ratio? It���s at 38, a level only once surpassed, at the height of the tech bubble in 2000.
Some argue that rich valuations are justified by record low interest rates. Maybe. But why are European stocks far less expensive, despite even lower interest rates? And what happens to stock prices if interest rates finally begin to levitate from today���s moribund levels?
If you believe, as I do, that U.S. stocks are in bubble territory, does it still make sense to own them in the name of diversification? Does adding a ���bubble asset��� to your portfolio lower risk or increase it? Put yourself in the shoes of a Japanese investor in late 1989. Despite nosebleed valuations, you decide that Japanese stocks will form the core of your stock portfolio. How did that work out for you? You didn���t need a crystal ball to realize how poor the risk-return proposition for Japanese stocks was in the late 1980s. Instead, all you needed to do was look at valuations. I believe the same is true today for U.S. stocks.
If expected returns for the U.S., developed international and emerging stock markets were similar, I���d happily diversify across global markets, holding a good chunk of U.S. stocks in my portfolio. But that���s not the situation we find ourselves in today. Due to the immense outperformance of U.S. stocks since 2009, the outlook is far brighter for foreign markets. Price matters. And I���d argue that today price trumps diversification when it comes to portfolio construction.
Should stock markets mean revert and U.S. stocks underperform international shares over the coming decade���as I fully expect they will���I���ll happily return to owning U.S. stocks. As John Maynard Keynes purportedly said, ���When the facts change, I change my mind. What do you do, sir?���
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 Leaving the Country appeared first on HumbleDollar.
