Jonathan Clements's Blog, page 287
May 30, 2021
Portfolio Insurance
A TEL AVIV WOMAN named Anat decided to surprise her elderly mother with a gift. Noticing that her mother had been sleeping on the same worn-out mattress for decades, Anat replaced it while her mother was away from the house. She then took the old mattress out to the curb.
It wasn't until the next morning that her mother noticed the change and asked what had happened to the old mattress. Anat explained that she had put it out with the trash, which had since been picked up. This sent her mother into a panic. It turned out she had hidden her life's savings in the old mattress���more than $1 million. According to news reports about the 2009 incident, they searched three different dumpsites across the city but never found it.
When I mentioned this story to a colleague, he described something similar. When his grandfather passed away, he helped clean out his house. In the freezer they found several packages labeled ���fish.��� These packages caught his eye because, he said, ���there were a lot of them, and they didn���t look like fish.��� As you can probably guess, when he opened them, he found piles of cash.
These stories are both funny and not funny at the same time. They���re also not unusual. According to a��Marist College��poll, people hide money in all kinds of places. More than 10% hide cash under the mattress. Even more hide money in the freezer. Other popular spots include the sock drawer and the cookie jar. There's also the��backyard.
I don���t recommend keeping cash in your home like this���unless it's in a safe���but I understand the emotional appeal. A pile of cash is tangible in a way that a bank balance isn���t. Especially in a volatile world, it's comforting to have a stable asset.
But amid today���s low interest rates, it seems many people are going to the other extreme���and shunning conservative investments. Prominent voices like hedge fund manager Ray Dalio are��saying, ���cash is and will continue to be trash��� and bonds are ���stupid.��� Why is he so negative? Because today's low interest rates mean that most bonds aren't keeping up with inflation. Even Warren Buffett, who is far less of a gunslinger than Dalio, has said, ���people who hold cash equivalents feel comfortable. They shouldn���t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.���
I understand this sentiment, but I don���t agree. I think it���s a matter of perspective. If you look at cash or bonds as a vehicle to make money, you���re almost guaranteed to be disappointed. In my opinion, however, that���s not why you want to own them. With cash and bonds, you aren���t trying to��make��money. Instead, they���re insurance���to help you avoid��losing��money.
In fact, I look at the bond side of a portfolio in the same way that I look at any insurance policy. Consider homeowner���s insurance. If, at the end of the year, your house is still standing and you haven���t made any claims, would you consider the premium you paid to have been a waste? Of course not. You���re glad nothing bad happened and likely don���t give a second thought to the small price you paid for insurance. This is even more true with health insurance and life insurance. We buy insurance to protect ourselves from all the things that could go wrong in life. In that way, dollars spent on insurance premiums aren���t wasted, but rather serve an important role.
Similarly, the role of bonds in a portfolio is to provide downside protection. In years when the stock market falls, that���s when bonds shine. When stocks were down more than 30% last year, retirees who needed cash to meet their living expenses hardly worried whether their bonds had lost a few percent to inflation.
In the finance literature, there is a framework called Roy���s Safety First Criterion. Published in 1952 by��A.D. Roy, it provides a quantitative lens through which to see the value of bonds. Without getting into the math, the basic idea is that an investment should always be evaluated in relation to both its prospective return��and��its risk. Specifically, Roy���s formula uses the standard deviation of an investment���that is, the variability of its returns from year to year���to measure risk. It���s through this lens that I think bonds begin to make a lot more sense. Consider the following data from Morningstar:
Over the past 95 years, domestic stocks have returned an average 10.3% a year, with volatility of nearly 20%.
Over that same time period, short-term U.S. government bonds have returned 3.3%, barely ahead of inflation. But the volatility has been just 3.1%.
In other words, with bonds, you wouldn���t have gotten rich���but the losses, whenever they occurred, wouldn���t have caused you to lose much sleep. Here���s another way to look at the numbers. Over that same period, the worst year for an all-stock portfolio was a loss of about 43%. Meanwhile, the worst year for an all-bond portfolio was a loss of just 5.1%. That���s the value of bonds.
Won't bonds lose value if interest rates rise? Yes, that's a valid concern, and we've seen some of that this year. That's why I'd stick with short- and intermediate-term bonds, which have the least sensitivity to interest rates. I would also invest only in government bonds. Of course, these bonds pay the least interest, but they also provide the greatest stability. The way I see it, if you're going to buy insurance, you shouldn't cut corners. Instead, you should secure the best coverage possible.
Are bonds the life of the party? Definitely not. But they still play a critical role: They're like the designated driver who enables people to enjoy the party. And, in that way, they���re invaluable.
Adam M. Grossman��is the founder of Mayport, a fixed-fee wealth management firm. In his series of free��e-books, he advocates an evidence-based��approach to personal finance. Follow Adam on Twitter @AdamMGrossman��and check out his earlier articles.
It wasn't until the next morning that her mother noticed the change and asked what had happened to the old mattress. Anat explained that she had put it out with the trash, which had since been picked up. This sent her mother into a panic. It turned out she had hidden her life's savings in the old mattress���more than $1 million. According to news reports about the 2009 incident, they searched three different dumpsites across the city but never found it.
When I mentioned this story to a colleague, he described something similar. When his grandfather passed away, he helped clean out his house. In the freezer they found several packages labeled ���fish.��� These packages caught his eye because, he said, ���there were a lot of them, and they didn���t look like fish.��� As you can probably guess, when he opened them, he found piles of cash.
These stories are both funny and not funny at the same time. They���re also not unusual. According to a��Marist College��poll, people hide money in all kinds of places. More than 10% hide cash under the mattress. Even more hide money in the freezer. Other popular spots include the sock drawer and the cookie jar. There's also the��backyard.
I don���t recommend keeping cash in your home like this���unless it's in a safe���but I understand the emotional appeal. A pile of cash is tangible in a way that a bank balance isn���t. Especially in a volatile world, it's comforting to have a stable asset.
But amid today���s low interest rates, it seems many people are going to the other extreme���and shunning conservative investments. Prominent voices like hedge fund manager Ray Dalio are��saying, ���cash is and will continue to be trash��� and bonds are ���stupid.��� Why is he so negative? Because today's low interest rates mean that most bonds aren't keeping up with inflation. Even Warren Buffett, who is far less of a gunslinger than Dalio, has said, ���people who hold cash equivalents feel comfortable. They shouldn���t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.���
I understand this sentiment, but I don���t agree. I think it���s a matter of perspective. If you look at cash or bonds as a vehicle to make money, you���re almost guaranteed to be disappointed. In my opinion, however, that���s not why you want to own them. With cash and bonds, you aren���t trying to��make��money. Instead, they���re insurance���to help you avoid��losing��money.
In fact, I look at the bond side of a portfolio in the same way that I look at any insurance policy. Consider homeowner���s insurance. If, at the end of the year, your house is still standing and you haven���t made any claims, would you consider the premium you paid to have been a waste? Of course not. You���re glad nothing bad happened and likely don���t give a second thought to the small price you paid for insurance. This is even more true with health insurance and life insurance. We buy insurance to protect ourselves from all the things that could go wrong in life. In that way, dollars spent on insurance premiums aren���t wasted, but rather serve an important role.
Similarly, the role of bonds in a portfolio is to provide downside protection. In years when the stock market falls, that���s when bonds shine. When stocks were down more than 30% last year, retirees who needed cash to meet their living expenses hardly worried whether their bonds had lost a few percent to inflation.
In the finance literature, there is a framework called Roy���s Safety First Criterion. Published in 1952 by��A.D. Roy, it provides a quantitative lens through which to see the value of bonds. Without getting into the math, the basic idea is that an investment should always be evaluated in relation to both its prospective return��and��its risk. Specifically, Roy���s formula uses the standard deviation of an investment���that is, the variability of its returns from year to year���to measure risk. It���s through this lens that I think bonds begin to make a lot more sense. Consider the following data from Morningstar:
Over the past 95 years, domestic stocks have returned an average 10.3% a year, with volatility of nearly 20%.
Over that same time period, short-term U.S. government bonds have returned 3.3%, barely ahead of inflation. But the volatility has been just 3.1%.
In other words, with bonds, you wouldn���t have gotten rich���but the losses, whenever they occurred, wouldn���t have caused you to lose much sleep. Here���s another way to look at the numbers. Over that same period, the worst year for an all-stock portfolio was a loss of about 43%. Meanwhile, the worst year for an all-bond portfolio was a loss of just 5.1%. That���s the value of bonds.
Won't bonds lose value if interest rates rise? Yes, that's a valid concern, and we've seen some of that this year. That's why I'd stick with short- and intermediate-term bonds, which have the least sensitivity to interest rates. I would also invest only in government bonds. Of course, these bonds pay the least interest, but they also provide the greatest stability. The way I see it, if you're going to buy insurance, you shouldn't cut corners. Instead, you should secure the best coverage possible.
Are bonds the life of the party? Definitely not. But they still play a critical role: They're like the designated driver who enables people to enjoy the party. And, in that way, they���re invaluable.
Adam M. Grossman��is the founder of Mayport, a fixed-fee wealth management firm. In his series of free��e-books, he advocates an evidence-based��approach to personal finance. Follow Adam on Twitter @AdamMGrossman��and check out his earlier articles.The post Portfolio Insurance appeared first on HumbleDollar.
May 29, 2021
Illusions of Safety
IF WE WANTED to design a portfolio that appeals to our worst investment instincts, we might couple a savings account with lottery tickets. Some governments have even issued bonds with just these characteristics.
What���s the attraction? The savings account ensures that part of our portfolio never loses value, while the lottery tickets let us dream of riches in return for a relatively small investment.
This year, we���ve seen the lottery-ticket mentality writ large, as investors take fliers on meme stocks, nonfungible tokens and cryptocurrencies in hopes of hitting the jackpot. For instance, earlier this year, dogecoin could be bought for under a penny���less than the price of a lottery ticket. With a little daydreaming available for so little money, maybe it���s no surprise that dogecoin is up more than 6,000% in 2021, even after this month���s shellacking.
But while this year���s frenzy over fringe investments has hogged the headlines, let���s not forget our other behavioral impulse: our strong aversion to losses. This instinct may not lead to short-term financial disaster. But it can wreak havoc over the long haul. What���s so wrong with trying to avoid losses? It can result in three crucial mistakes.
1. Confusing stability with safety. If we own stocks and stock funds, the market tells us every day what they���re worth. Let���s face it: Most of us would rather not know, which helps explain why we���re drawn to investments where the price seems stable, even if that stability is an illusion.
For instance, many investors prefer individual bonds to bond funds, because they know precisely what those bonds will be worth on the day they mature. What about the fact that this maturity value may be far lower because of inflation, or that we may get some quite different value if we sell at any time before maturity, or that we���re banking on a single issuer rather than getting the broad diversification offered by a fund? It seems many folks happily overlook these drawbacks in return for the illusion of safety.
Similarly, many investors are drawn to the certainty offered by equity-indexed annuities and tax-deferred fixed annuities, even though these insurance products require locking up money for many years and investors could face steep penalties if they exit early. A lack of daily price information is, I suspect, also part of the appeal���as it is for both real estate and venture capital investments. Until we go to sell, we don���t really know what a piece of real estate or a private business is worth���and that allows us to imagine the price is marching steadily higher, with no need for us to lose sleep.
2. Chasing yield. In the quest for psychological comfort, some investors focus not on price, but income. If a bond, stock or other investment kicks off a generous and predictable stream of interest or dividends, we can imagine it���s super-safe. Sometimes, that may be the case.
But often, that regular income disguises an otherwise dicey investment. Take General Electric, once considered to be the archetypal widows-and-orphans stock. In 2009, GE qualified as a ���dividend aristocrat��� because it had increased its dividend for 32 consecutive years. That, however, was also the year it slashed its dividend amid the financial crisis. Today, the stock pays just a penny a quarter, down from a high of 31 cents.
Over my career, I���ve seen yield-chasing investors torpedoed in countless investments, everything from option-income funds to short-term multi-market income funds to high-yield junk bonds to bank loan funds. The regular income gave the illusion of safety. But eventually, the price of these investments told another story, prompting many investors to panic and sell.
3. Forgetting taxes and inflation. While some purportedly conservative investments turn out to be riskier than investors expect, there are many truly safe investments, such as savings accounts, short-term Treasury bonds, bank certificates of deposit and savings bonds. Investors shouldn���t ever wake up one morning and discover these investments are worth far less than they imagined.
But they might feel that way 10 or 20 years down the road. With even high-yield online savings accounts paying just 0.5%, investors are looking at falling behind inflation by two percentage points a year over the next five years, based on current inflation expectations. Once taxes are figured in, things would look even more grim.
If you have money you���ll need to spend soon, I see no sensible alternative to holding cash investments and suffering this loss of purchasing power. What if you have a longer time horizon? To outpace the twin threats of inflation and taxes, you need to take greater risk���but you need to do so sensibly. Forget dogecoin and digital cat images. Instead, think total market index funds.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
The ancient philosophy of Daoism can help us manage money today, contend Jiab and Jim Wasserman. Those target-date funds built around low-cost indexing? Maybe they're a good idea.
"My parents lived on Social Security for the rest of their lives," recounts Dick Quinn. "I compare their life experience with my 'things are different' Twitter friends. Have things really got worse?"
If you pick individual stocks, there isn't just a risk that you'll underperform the market averages. Mike Flack lists nine other potential drawbacks���many of which he's personally acquainted with.
"Bonds shouldn���t be viewed as the same as cash," writes David Powell. "Both can be a good diversifier for stocks���and bonds are often better���but cash investments are the place for money you���ll need soon."
Planning to move money from one retirement account to another? Adam Grossman advises heeding the lesson of Alvan Bobrow���and arranging a direct rollover.
"Perhaps the biggest financial rule I broke was taking on more than $1 million of future expenses without a clear plan to cover the cost," writes Joe Kesler. "I���m talking about the decision to start a family."
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier��articles.
What���s the attraction? The savings account ensures that part of our portfolio never loses value, while the lottery tickets let us dream of riches in return for a relatively small investment.
This year, we���ve seen the lottery-ticket mentality writ large, as investors take fliers on meme stocks, nonfungible tokens and cryptocurrencies in hopes of hitting the jackpot. For instance, earlier this year, dogecoin could be bought for under a penny���less than the price of a lottery ticket. With a little daydreaming available for so little money, maybe it���s no surprise that dogecoin is up more than 6,000% in 2021, even after this month���s shellacking.
But while this year���s frenzy over fringe investments has hogged the headlines, let���s not forget our other behavioral impulse: our strong aversion to losses. This instinct may not lead to short-term financial disaster. But it can wreak havoc over the long haul. What���s so wrong with trying to avoid losses? It can result in three crucial mistakes.
1. Confusing stability with safety. If we own stocks and stock funds, the market tells us every day what they���re worth. Let���s face it: Most of us would rather not know, which helps explain why we���re drawn to investments where the price seems stable, even if that stability is an illusion.
For instance, many investors prefer individual bonds to bond funds, because they know precisely what those bonds will be worth on the day they mature. What about the fact that this maturity value may be far lower because of inflation, or that we may get some quite different value if we sell at any time before maturity, or that we���re banking on a single issuer rather than getting the broad diversification offered by a fund? It seems many folks happily overlook these drawbacks in return for the illusion of safety.
Similarly, many investors are drawn to the certainty offered by equity-indexed annuities and tax-deferred fixed annuities, even though these insurance products require locking up money for many years and investors could face steep penalties if they exit early. A lack of daily price information is, I suspect, also part of the appeal���as it is for both real estate and venture capital investments. Until we go to sell, we don���t really know what a piece of real estate or a private business is worth���and that allows us to imagine the price is marching steadily higher, with no need for us to lose sleep.
2. Chasing yield. In the quest for psychological comfort, some investors focus not on price, but income. If a bond, stock or other investment kicks off a generous and predictable stream of interest or dividends, we can imagine it���s super-safe. Sometimes, that may be the case.
But often, that regular income disguises an otherwise dicey investment. Take General Electric, once considered to be the archetypal widows-and-orphans stock. In 2009, GE qualified as a ���dividend aristocrat��� because it had increased its dividend for 32 consecutive years. That, however, was also the year it slashed its dividend amid the financial crisis. Today, the stock pays just a penny a quarter, down from a high of 31 cents.
Over my career, I���ve seen yield-chasing investors torpedoed in countless investments, everything from option-income funds to short-term multi-market income funds to high-yield junk bonds to bank loan funds. The regular income gave the illusion of safety. But eventually, the price of these investments told another story, prompting many investors to panic and sell.
3. Forgetting taxes and inflation. While some purportedly conservative investments turn out to be riskier than investors expect, there are many truly safe investments, such as savings accounts, short-term Treasury bonds, bank certificates of deposit and savings bonds. Investors shouldn���t ever wake up one morning and discover these investments are worth far less than they imagined.
But they might feel that way 10 or 20 years down the road. With even high-yield online savings accounts paying just 0.5%, investors are looking at falling behind inflation by two percentage points a year over the next five years, based on current inflation expectations. Once taxes are figured in, things would look even more grim.
If you have money you���ll need to spend soon, I see no sensible alternative to holding cash investments and suffering this loss of purchasing power. What if you have a longer time horizon? To outpace the twin threats of inflation and taxes, you need to take greater risk���but you need to do so sensibly. Forget dogecoin and digital cat images. Instead, think total market index funds.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
The ancient philosophy of Daoism can help us manage money today, contend Jiab and Jim Wasserman. Those target-date funds built around low-cost indexing? Maybe they're a good idea.
"My parents lived on Social Security for the rest of their lives," recounts Dick Quinn. "I compare their life experience with my 'things are different' Twitter friends. Have things really got worse?"
If you pick individual stocks, there isn't just a risk that you'll underperform the market averages. Mike Flack lists nine other potential drawbacks���many of which he's personally acquainted with.
"Bonds shouldn���t be viewed as the same as cash," writes David Powell. "Both can be a good diversifier for stocks���and bonds are often better���but cash investments are the place for money you���ll need soon."
Planning to move money from one retirement account to another? Adam Grossman advises heeding the lesson of Alvan Bobrow���and arranging a direct rollover.
"Perhaps the biggest financial rule I broke was taking on more than $1 million of future expenses without a clear plan to cover the cost," writes Joe Kesler. "I���m talking about the decision to start a family."
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier��articles.The post Illusions of Safety appeared first on HumbleDollar.
May 28, 2021
Getting Worse?
LEAVE IT TO ME to become entangled in Twitter ���discussions.���
I���m often driven to comment on those Tweets that contend that the opportunity to get ahead in America no longer exists, and that it���s impossible for many to save money or pay off their debts.
Recently, my confrontations resulted in a 30-something���who wanted more than $50,000 in student loans forgiven���informing me that, ���I am not interested in an old (@#X?) man���s point of view.��� What was so offensive about my point of view? I���d mentioned working two jobs, mortgaging the house and using most of my savings to pay for my four children���s college education. My young protagonist then dismissed me as ���privileged.���
This old man thinks taking responsibility has a great deal to do with economic success. I recall a news story about a married couple who decided they wouldn���t repay their student loans. They claimed they were misled about the value of their training to become phlebotomists and couldn���t find jobs. Seems they neglected to investigate that the starting��salary is about $23,000 and the average salary $31,000. My obsessive self went searching���and found several job openings for phlebotomists in their area.
Frequently, I���m told things are different. Things are different for sure. More and different opportunities abound. Consider the people who took advantage of the pandemic to make money. My teenage granddaughter earned $1,200 making and selling a necklace that helps folks avoid losing their face mask.
Incredible technology allows people to earn a good living from just about anywhere in the world. It isn���t just computer whizzes who have abundant opportunities. Skilled crafts people are also highly valued. I just remodeled the kitchen at our vacation home. The electrician charged $200 an hour and the plumber $285. I���m about to paint five rooms in my house. That���ll be $10,200, please.
My favorite Tweet so far: ���The days of starting in the mail room and working your way to executive are over.��� This one hit a nerve because that���s exactly what I did. Over? Why? Maybe it���s because they don���t want to cope with the setbacks, broken promises or disappointments that go with the journey. My journey took more than 45 years. Hey, if you can���t wait that long, invent a new app and become a millionaire by next Thursday.
I know corporate paternalism is long gone. My former employer has made many changes to employee benefits since I left. I don���t agree the changes were necessary, and they clearly shifted financial responsibility to employees and retirees. But I suspect the same thing could be said about the benefit changes I initiated 30 years ago, when I was working in human resources.
I wear a watch with the Mercedes logo on the face. The engraving on the back reads, ���Richard D Quinn, Faithful Service, 4-30-77.��� It was my father���s watch. He was a car salesman. That watch is what the company gave him at age 67 when he was told he must ���retire.��� No pension, no 401(k), no health benefits. My parents lived on Social Security for the rest of their lives. They lived through the Great Depression, they were leery of banks and had no interest in the stock market. I compare their life experience with my ���things are different��� Twitter friends. Have things really got worse?
Today, we complain about high health care costs. When I started working in 1961, there was no insurance coverage for services outside the hospital and no coverage for prescription drugs.
Talk about fair pay. Back in the good old days, my department manager was given a merit pay budget to allocate among his employees���and himself. Any guess who received the largest raise?
And opportunity? In the 1970s, I decided to look for a better job and interviewed at a different company. When I returned to the office the next day, my manager told me I wouldn���t be getting the new job. The person who had interviewed me called my manager, who told him not to hire me. Should I have been flattered? Twenty years later, I had the manager���s job.
We hear a lot about the inability to save for retirement. My contention: Virtually everyone can save and invest if they set the appropriate priorities. In January 2020, I wrote about the concept of ���financial fasting��� as a way to accumulate the money needed to invest. And the fact is, you don���t need much to get started as an investor. Some mutual funds and brokerage firms don���t even have required investment minimums.
No denying it, I���m old. But I firmly reject the notion that the world is so much harsher today than it was a few decades ago���and that opportunity in America retired when I did.
Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, he was a compensation and benefits executive.��Follow Dick on Twitter��@QuinnsComments��and check out his earlier��articles.
The post Getting Worse? appeared first on HumbleDollar.
May 27, 2021
Ignoring the Rules
ONE HALLOWEEN, some of my teenage buddies and I were having a great time throwing water balloons at trick-or-treaters. It was a lot of fun���until we got caught. After getting hauled down to the police station for a lecture, and then receiving another one when I got home, I���ve been pretty much on the straight and narrow ever since, including when it comes to money.
Over the years, I���ve discovered various tried-and-true rules of investing and those have been the keys to my success. In my personal Investor Hall of Fame, I���d include Warren Buffett for his lessons on patience and the value of letting compounding work to your benefit. I���d also include Burton Malkiel for the classic he authored, A Random Walk Down Wall Street . It taught me that the markets were so efficient that I���d be better off buying index funds than individual stocks. And, of course, there would be a place for Vanguard Group founder John Bogle, who made it possible to follow Malkiel���s advice by creating the low-cost index fund. These wise sages, along with others, provided me with the rules needed to succeed.
But despite my reverence for time-tested wisdom, I give myself a little wiggle room. Most of us can���t always invest like robots. Sometimes, we want to do something with our money that doesn���t follow the established rules for investment success. A popular compromise: Set up a ���fun money��� account. I allow myself to play with 5% or 10% of my portfolio. Here are four examples of how I���ve had fun by not following the rules.
1. I���m a little embarrassed to admit that I have a position in bitcoin. Crazy? Yes, I know. Buffett calls it ���rat poison squared.��� But even Buffett gets some things wrong. It isn���t unusual in the history of innovation to see resistance to new ideas.
For instance, if you���re drinking coffee as you read this, it���s a privilege that was once prohibited. In 1675, King Charles II banned the sale of��coffee in England because coffeehouses were deemed to have ���produced very evil and dangerous effects.��� In other words, people sat around drinking coffee and critiquing the king.
In fact, from refrigeration to margarine to recorded music, innovation��has a history of being resisted. Perhaps it���s predictable that a challenge to our understanding of money would also meet with cat calls.
We don���t yet know whether cryptocurrencies will have stamina and change how we think about money. But for this banker, it���s an invigorating debate���one that challenges me to set aside my preconceived notions about what constitutes money. I enjoy having some ���skin in the game,��� if only to focus my attention as the debate rages. And���who knows���maybe bitcoin will go to $1 million.
2. Some purists will think I���ve sinned because I own some individual stocks. Over the long term, the odds of an individual investor beating the market by picking stocks are very low. Even so, I think some good can come from investing in individual stocks.
It���s important to think of stocks not as blips on a computer screen, but as ownership of a company, and investing in individual stocks can help with that. I bought my kids Nike and Apple stock when they were little. I wanted to teach them that they owned a company that made things they used. Infecting my kids early on with pride in stock ownership made investors out of them as adults.
I also love owning Berkshire Hathaway. One of its holdings is BNSF, a railroad that runs through Montana. When I see a BNSF train pulling a long line of railcars, I smile, knowing it's making me money. And I always remember I own Dairy Queen when I have ice cream. It adds to the enjoyment.
3. Owning whole life insurance is harshly criticized by many, including some popular radio personalities. The argument against whole life is simple. It���s too expensive. We should buy cheap term insurance and invest the rest.
But hear me out. I���ll use one of my policies as an example. It���s a $25,000 face value policy I bought in 1985. I���ve paid $312.50 a year into it ever since. The cash value is now $30,500 and the death benefit is $54,887. I estimate the internal rate of return on the policy has been around 5.4%. Last year, the return was 5.03%. It���s from a AAA-rated mutual insurance company and the cash value only goes up. Where else could I get a risk-free, tax-free yield of 5.03% today?
I have a number of these policies yielding more than 5%. If I didn���t have them, I would be keeping emergency money in a savings account earning almost nothing. They allow me to earn a decent return and to invest more aggressively elsewhere. I���m not advocating anyone should buy whole life. But I���d argue these policies aren���t as bad a deal as some advisors suggest.
4. Perhaps the biggest financial rule I broke was taking on more than $1 million of future expenses without a clear plan to cover the cost. I���m talking about the decision my wife and I made to start a family.
According to the U.S. Department of Agriculture, the cost to raise a child through age 17 is $233,610. We had five, so that adds up to $1,168,050. I was 29 when we had the first one. Our net worth was $20,000. We didn���t look at the cost but proceeded on the assumption that if we lived frugally, worked hard and invested well, we would make it work.
Many���and probably most���families make the decision to have kids without a solid plan for how to cover the cost. That may seem financially irresponsible. But it���s a choice that most parents never regret.
Joe Kesler is the author of
Smart Money with Purpose
and the founder of a
website
with the same name, which is where a version of this article first appeared. He spent 40 years in community banking, assisting small businesses and consumers.��Joe served as chief executive of banks in Illinois and Montana. He currently lives with his wife in Missoula, Montana, spending his time writing on personal finance, serving on two bank boards and hiking in the Rocky Mountains. Check out Joe's previous articles.
Over the years, I���ve discovered various tried-and-true rules of investing and those have been the keys to my success. In my personal Investor Hall of Fame, I���d include Warren Buffett for his lessons on patience and the value of letting compounding work to your benefit. I���d also include Burton Malkiel for the classic he authored, A Random Walk Down Wall Street . It taught me that the markets were so efficient that I���d be better off buying index funds than individual stocks. And, of course, there would be a place for Vanguard Group founder John Bogle, who made it possible to follow Malkiel���s advice by creating the low-cost index fund. These wise sages, along with others, provided me with the rules needed to succeed.
But despite my reverence for time-tested wisdom, I give myself a little wiggle room. Most of us can���t always invest like robots. Sometimes, we want to do something with our money that doesn���t follow the established rules for investment success. A popular compromise: Set up a ���fun money��� account. I allow myself to play with 5% or 10% of my portfolio. Here are four examples of how I���ve had fun by not following the rules.
1. I���m a little embarrassed to admit that I have a position in bitcoin. Crazy? Yes, I know. Buffett calls it ���rat poison squared.��� But even Buffett gets some things wrong. It isn���t unusual in the history of innovation to see resistance to new ideas.
For instance, if you���re drinking coffee as you read this, it���s a privilege that was once prohibited. In 1675, King Charles II banned the sale of��coffee in England because coffeehouses were deemed to have ���produced very evil and dangerous effects.��� In other words, people sat around drinking coffee and critiquing the king.
In fact, from refrigeration to margarine to recorded music, innovation��has a history of being resisted. Perhaps it���s predictable that a challenge to our understanding of money would also meet with cat calls.
We don���t yet know whether cryptocurrencies will have stamina and change how we think about money. But for this banker, it���s an invigorating debate���one that challenges me to set aside my preconceived notions about what constitutes money. I enjoy having some ���skin in the game,��� if only to focus my attention as the debate rages. And���who knows���maybe bitcoin will go to $1 million.
2. Some purists will think I���ve sinned because I own some individual stocks. Over the long term, the odds of an individual investor beating the market by picking stocks are very low. Even so, I think some good can come from investing in individual stocks.
It���s important to think of stocks not as blips on a computer screen, but as ownership of a company, and investing in individual stocks can help with that. I bought my kids Nike and Apple stock when they were little. I wanted to teach them that they owned a company that made things they used. Infecting my kids early on with pride in stock ownership made investors out of them as adults.
I also love owning Berkshire Hathaway. One of its holdings is BNSF, a railroad that runs through Montana. When I see a BNSF train pulling a long line of railcars, I smile, knowing it's making me money. And I always remember I own Dairy Queen when I have ice cream. It adds to the enjoyment.
3. Owning whole life insurance is harshly criticized by many, including some popular radio personalities. The argument against whole life is simple. It���s too expensive. We should buy cheap term insurance and invest the rest.
But hear me out. I���ll use one of my policies as an example. It���s a $25,000 face value policy I bought in 1985. I���ve paid $312.50 a year into it ever since. The cash value is now $30,500 and the death benefit is $54,887. I estimate the internal rate of return on the policy has been around 5.4%. Last year, the return was 5.03%. It���s from a AAA-rated mutual insurance company and the cash value only goes up. Where else could I get a risk-free, tax-free yield of 5.03% today?
I have a number of these policies yielding more than 5%. If I didn���t have them, I would be keeping emergency money in a savings account earning almost nothing. They allow me to earn a decent return and to invest more aggressively elsewhere. I���m not advocating anyone should buy whole life. But I���d argue these policies aren���t as bad a deal as some advisors suggest.
4. Perhaps the biggest financial rule I broke was taking on more than $1 million of future expenses without a clear plan to cover the cost. I���m talking about the decision my wife and I made to start a family.
According to the U.S. Department of Agriculture, the cost to raise a child through age 17 is $233,610. We had five, so that adds up to $1,168,050. I was 29 when we had the first one. Our net worth was $20,000. We didn���t look at the cost but proceeded on the assumption that if we lived frugally, worked hard and invested well, we would make it work.
Many���and probably most���families make the decision to have kids without a solid plan for how to cover the cost. That may seem financially irresponsible. But it���s a choice that most parents never regret.
Joe Kesler is the author of
Smart Money with Purpose
and the founder of a
website
with the same name, which is where a version of this article first appeared. He spent 40 years in community banking, assisting small businesses and consumers.��Joe served as chief executive of banks in Illinois and Montana. He currently lives with his wife in Missoula, Montana, spending his time writing on personal finance, serving on two bank boards and hiking in the Rocky Mountains. Check out Joe's previous articles.The post Ignoring the Rules appeared first on HumbleDollar.
May 26, 2021
Picking Problems
I RECENTLY READ an interesting article about why you shouldn���t pick individual stocks. The author mentioned the classic reason: ���Since most people (even the professionals) can���t beat the index, you shouldn���t bother trying.���
He also mentioned another reason: ���The existential dilemma��of doing so��� how do you��know��if you are good at picking individual stocks?��� The author goes on to mention that, since luck plays such a significant factor in stock-picking, it could take a very long time to determine if you���re good or just lucky and, even then, you may never really know.
While these are both good reasons not to invest in individual stocks, it strikes me there are other reasons���nine of them, to be precise.
1. I���ve always been concerned that, when stock-pickers compare their results with an index, they may not know which index to use. I own a unique mix of master limited partnerships, individual stocks and mutual funds. I compare my results to the S&P 500. But since my portfolio is a little more value-oriented, maybe I should use the Russell 1000 Value Index. But I also own some foreign stocks, so maybe���. My concern about selecting the correct comparison index always seems to increase in years where I underperform the S&P 500.
2. Stock-pickers have to deal with buyouts and reorganizations, which then trigger capital gains. This plays havoc with tax planning and possibly with income planning. A few years back, a very significant position of mine, Kinder Morgan Partners, was reorganized from a master limited partnership to a corporation, sticking me with hefty unplanned capital gains. It didn���t help when the company subsequently cut its dividend, which led to a precipitous decrease in its stock price. Who likes to pay tax on capital gains, only to see the value of your current position is worth less than the capital gain you���re getting taxed on?
3. Brokerage firms can misclassify a stock���s dividends. The first page of a 1099 sums and classifies all the dividends, distributions, interest and so on. But what if it���s incorrect? I generally review my 1099���s details to see if there are any noticeable issues, but I certainly don���t go through it with a fine tooth comb. This year, I noticed my dividend amount was much higher than last year���s. It turns out that E*Trade incorrectly classified a tax-free spinoff of shares of Brookfield Renewable Partners as taxable. I���ve been ���discussing��� this with them for more than a month. Wish me luck.
4. Reporting each individual stock���s capital gains after a sale, buyout, special dividend and so on can be time consuming. Tax software may help with this issue, but you still need to verify the numbers (see No. 3). Also, prior spinoffs, returns of capital and multiple purchases can make determining the cost basis quite complicated. In 2011, brokerage firms started reporting cost basis, which is helpful. But if your stock has had multiple spinoffs or mergers, checking your brokerage firm���s math can be difficult.
5. A stock-picker who invests in foreign stocks will have to pay foreign taxes. He may then think, ���Well, I���ll just claim a foreign-tax credit and everything will be jake.��� Well, it may be���or may not.
6. If you own individual stocks, you can look forward to an avalanche of proxies. Each company states that ���your vote is important��� and offers the stock-picker the illusion of having a say in how ���your��� company is run. In reality, the amount of ���your��� say is vastly overstated, plus ���your��� company generally doesn���t have to abide by the results of ���your��� votes. Directors are reelected with less than a majority, and advisory votes on compensation are ignored. While your vote in public elections always counts, in corporate ���elections��� it���s much less so.
By sticking with mutual funds, you can avoid the hassle, the waste of time and the guilt. I take my shareholder responsibilities more lightly with every passing year and, now that I���m retired, I can't be bothered, though I always vote for independent chairpersons. Note: I voted against ExxonMobil management in this year's��proxy fight, which culminates with today's annual meeting. As my mother used to say, ���Hope springs eternal.���
7. If you own individual stocks and have beaten the index (see No. 1), you may now believe yourself to be an above-average investor. This may tempt you to use your individual stocks to write options. If you haven���t done so well, you may still be tempted. Mutual fund owners do not have this temptation.
For example, you underperform the index for a few years and think you can make up some of this shortfall by writing call options on your shares of, say, Walt Disney Co. But then Disney has an unexpectedly good quarter and your shares get called away, leading to unforeseen capital gains (see No. 2). You also then miss out on the subsequent share price increase. Then COVID-19 hits and Disney shares drop significantly, and you start feeling pretty good about your investing acumen���for a little while. Then Disney subsequently comes roaring back and then some, without you on board. Note: This is all hypothetical.
8. Some stock-pickers try to use their picks to generate a certain amount of income, an amount they feel they ���need��� from their portfolio. These folks tend to hew toward higher-yielding stocks. Common sense, corporate finance and tax regulations all argue that yield shouldn���t be a factor in selecting stocks. By focusing on yield, stock-pickers unnecessarily limit the stocks they might own, which can���t be a good thing. What if you need more income from your investments? Taking some capital gains, by selling a small portion of your portfolio, is the best way to accomplish this. It will also allow you to better time your capital gains to assist with tax planning (see No. 2).
9. Unless a stock-picker has the stomach of a jet pilot and the discipline of a Spartan warrior, buying individual stocks on a regular basis is almost impossible. When the stock market is setting record highs, you won���t invest, as you���ll think, ���How can the market get any higher?��� When the market is setting new lows, you won���t invest, as you���ll think, ���What if things get really ugly?��� Setting up automatic investment plans, where you invest regularly in low-cost mutual funds, will allow you to bypass such questions and the associated stress, while providing the added benefit of dollar-cost averaging.
By now, you may be thinking, ���Okay, we get it, enough already. It sounds like you���re trying to convince yourself.��� And you would be correct. The observant reader will have noticed I still own some individual stocks and ask, ���Why don���t I take my own advice?��� I���m trying. I���ve reduced my holdings in individual stocks. But in the words of the long-term smoker who���s trying to quit, ���It���s tougher than you think.���
Michael Flack blogs at��AfterActionReport.info. He���s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.
He also mentioned another reason: ���The existential dilemma��of doing so��� how do you��know��if you are good at picking individual stocks?��� The author goes on to mention that, since luck plays such a significant factor in stock-picking, it could take a very long time to determine if you���re good or just lucky and, even then, you may never really know.
While these are both good reasons not to invest in individual stocks, it strikes me there are other reasons���nine of them, to be precise.
1. I���ve always been concerned that, when stock-pickers compare their results with an index, they may not know which index to use. I own a unique mix of master limited partnerships, individual stocks and mutual funds. I compare my results to the S&P 500. But since my portfolio is a little more value-oriented, maybe I should use the Russell 1000 Value Index. But I also own some foreign stocks, so maybe���. My concern about selecting the correct comparison index always seems to increase in years where I underperform the S&P 500.
2. Stock-pickers have to deal with buyouts and reorganizations, which then trigger capital gains. This plays havoc with tax planning and possibly with income planning. A few years back, a very significant position of mine, Kinder Morgan Partners, was reorganized from a master limited partnership to a corporation, sticking me with hefty unplanned capital gains. It didn���t help when the company subsequently cut its dividend, which led to a precipitous decrease in its stock price. Who likes to pay tax on capital gains, only to see the value of your current position is worth less than the capital gain you���re getting taxed on?
3. Brokerage firms can misclassify a stock���s dividends. The first page of a 1099 sums and classifies all the dividends, distributions, interest and so on. But what if it���s incorrect? I generally review my 1099���s details to see if there are any noticeable issues, but I certainly don���t go through it with a fine tooth comb. This year, I noticed my dividend amount was much higher than last year���s. It turns out that E*Trade incorrectly classified a tax-free spinoff of shares of Brookfield Renewable Partners as taxable. I���ve been ���discussing��� this with them for more than a month. Wish me luck.
4. Reporting each individual stock���s capital gains after a sale, buyout, special dividend and so on can be time consuming. Tax software may help with this issue, but you still need to verify the numbers (see No. 3). Also, prior spinoffs, returns of capital and multiple purchases can make determining the cost basis quite complicated. In 2011, brokerage firms started reporting cost basis, which is helpful. But if your stock has had multiple spinoffs or mergers, checking your brokerage firm���s math can be difficult.
5. A stock-picker who invests in foreign stocks will have to pay foreign taxes. He may then think, ���Well, I���ll just claim a foreign-tax credit and everything will be jake.��� Well, it may be���or may not.
6. If you own individual stocks, you can look forward to an avalanche of proxies. Each company states that ���your vote is important��� and offers the stock-picker the illusion of having a say in how ���your��� company is run. In reality, the amount of ���your��� say is vastly overstated, plus ���your��� company generally doesn���t have to abide by the results of ���your��� votes. Directors are reelected with less than a majority, and advisory votes on compensation are ignored. While your vote in public elections always counts, in corporate ���elections��� it���s much less so.
By sticking with mutual funds, you can avoid the hassle, the waste of time and the guilt. I take my shareholder responsibilities more lightly with every passing year and, now that I���m retired, I can't be bothered, though I always vote for independent chairpersons. Note: I voted against ExxonMobil management in this year's��proxy fight, which culminates with today's annual meeting. As my mother used to say, ���Hope springs eternal.���
7. If you own individual stocks and have beaten the index (see No. 1), you may now believe yourself to be an above-average investor. This may tempt you to use your individual stocks to write options. If you haven���t done so well, you may still be tempted. Mutual fund owners do not have this temptation.
For example, you underperform the index for a few years and think you can make up some of this shortfall by writing call options on your shares of, say, Walt Disney Co. But then Disney has an unexpectedly good quarter and your shares get called away, leading to unforeseen capital gains (see No. 2). You also then miss out on the subsequent share price increase. Then COVID-19 hits and Disney shares drop significantly, and you start feeling pretty good about your investing acumen���for a little while. Then Disney subsequently comes roaring back and then some, without you on board. Note: This is all hypothetical.
8. Some stock-pickers try to use their picks to generate a certain amount of income, an amount they feel they ���need��� from their portfolio. These folks tend to hew toward higher-yielding stocks. Common sense, corporate finance and tax regulations all argue that yield shouldn���t be a factor in selecting stocks. By focusing on yield, stock-pickers unnecessarily limit the stocks they might own, which can���t be a good thing. What if you need more income from your investments? Taking some capital gains, by selling a small portion of your portfolio, is the best way to accomplish this. It will also allow you to better time your capital gains to assist with tax planning (see No. 2).
9. Unless a stock-picker has the stomach of a jet pilot and the discipline of a Spartan warrior, buying individual stocks on a regular basis is almost impossible. When the stock market is setting record highs, you won���t invest, as you���ll think, ���How can the market get any higher?��� When the market is setting new lows, you won���t invest, as you���ll think, ���What if things get really ugly?��� Setting up automatic investment plans, where you invest regularly in low-cost mutual funds, will allow you to bypass such questions and the associated stress, while providing the added benefit of dollar-cost averaging.
By now, you may be thinking, ���Okay, we get it, enough already. It sounds like you���re trying to convince yourself.��� And you would be correct. The observant reader will have noticed I still own some individual stocks and ask, ���Why don���t I take my own advice?��� I���m trying. I���ve reduced my holdings in individual stocks. But in the words of the long-term smoker who���s trying to quit, ���It���s tougher than you think.���
Michael Flack blogs at��AfterActionReport.info. He���s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.The post Picking Problems appeared first on HumbleDollar.
May 25, 2021
The Dao Is Up
WHEN PEOPLE MENTION Eastern philosophy, Westerners often have images of mystic monks in saffron robes, surrounded by clouds of incense and speaking in cryptic riddles like, ���What is the sound of one hand clapping?���
In fact, Asian philosophy can be very pragmatic in addressing everyday decisions, from family matters to investment choices���and many Westerners welcome the different approach to facing life���s challenges.
Daoism (also called Taoism) is one of the world���s oldest philosophies. It���s believed to have emerged more than 2,000 years ago during a period of dissolution, decline and prolonged warfare in China. Amid the chaos, many had a sense they lacked control over their life. Daoism helped address what to do when faced with such anxious times. Here are some of Daoism���s key points:
De (Te) . There is a natural flow (Dao or Tao) to all things, with everything acting in its own way within that flow���birds gotta fly, trees gotta grow toward light. It���s their innate power (De) of tapping into the greater flow (Dao) to thrive. When we feel out of sync or even going against the flow, it does no good to rail against the way things are or fight against them. It���s better is to see how we can operate within what���s happening.
Aware of our own De, we can each take advantage of our unique qualities, natural skills and power to make the best of things. Don���t waste our breath saying the market is irrational. Instead, we should figure out the best way to move within the flow.
��Wu wei. This is one of the most misunderstood ideas of Daoism because it is often translated as ���nonaction,��� seeming to imply that we should sit tight and hope all will be well. A better translation is ���effortless action.��� Imagine a rock in a stream. The rock seems to ���win��� by parting the stream. But come back after some years and you���ll find the stream has slowly eroded the rock away. That���s wu wei.
We tell our children to work through seeming setbacks, because the payoff is in the long game. We need to remember this for ourselves, perhaps socking away that little bit extra every year into a retirement account or paying a little more than the minimum due on debt. Such effortless actions can be the key to great long-run success.
Pu . As in Winnie, this concept originates from the idea of an uncut, rough piece of wood. Basically, don���t overcomplicate things and instead keep them as simple as possible. How many times do we start with a simple goal, but our diversions and clever workarounds take us in a far off and unwanted direction?
Make simple goals and maintain those goals. One goal might be time with loved ones. We shouldn���t derail it by spending 10 hours at work so we can somehow give more ���quality��� to the 30 minutes we end up devoting to the kids. Another goal might be retirement. We shouldn���t derail that goal by diverting boring steady growth investments into a get-rich-quick scheme. When we need something, we should try to get it and nothing more.
Fu . Many people are familiar with the yin-yang (Taijitu) symbol associated with Daoism. What most people don���t know is that the symbol is supposed to be rotating. This is to remind people that not only is life composed of opposites, but also that all things return (Fu) so that balance is restored. Sometimes darker, bad times (yin) prevail, and sometimes it���s lighter and better (yang) times.
We need to be mindful of this constant phasing in and out, and that it���s the totality that makes life what it is. A new job with a big raise doesn���t mean we need to stop saving for future bad times. A setback is not the end of our dreams, but perhaps a delay or an opening for a new direction. A balanced portfolio of stocks and bonds can hedge against the vicissitudes of the long-term market. Daoism also puts great emphasis on timing, that we need both the right outlook and right plan at the right time.
In many ways, a great overall ���Daoist��� investment is a low-cost target-date fund built around indexing. It doesn���t gamble by trying to ���time��� the market. It���s simple and goes with the flow of the market, good or bad, over time. It requires minimal maintenance and almost effortless action by investors, who merely need to contribute. The fund will adjust and rebalance at key moments, including shifting to less volatile investments as retirement gets closer.
There���s an old joke that the ancient Chinese invented the first complex bureaucracy, and then had to create the first philosophy to deal with the frustrations wrought by that bureaucracy. We have so many things that are different today. But the frustrations and anxiety that come with feeling things are in flux and beyond our control are timeless. Perhaps that means a philosophical outlook from long ago also still applies.
Jiab and Jim Wasserman just returned to Texas after spending the first three years of their retirement in Spain. Check out earlier articles from both��Jiab and Jim.
In fact, Asian philosophy can be very pragmatic in addressing everyday decisions, from family matters to investment choices���and many Westerners welcome the different approach to facing life���s challenges.
Daoism (also called Taoism) is one of the world���s oldest philosophies. It���s believed to have emerged more than 2,000 years ago during a period of dissolution, decline and prolonged warfare in China. Amid the chaos, many had a sense they lacked control over their life. Daoism helped address what to do when faced with such anxious times. Here are some of Daoism���s key points:
De (Te) . There is a natural flow (Dao or Tao) to all things, with everything acting in its own way within that flow���birds gotta fly, trees gotta grow toward light. It���s their innate power (De) of tapping into the greater flow (Dao) to thrive. When we feel out of sync or even going against the flow, it does no good to rail against the way things are or fight against them. It���s better is to see how we can operate within what���s happening.
Aware of our own De, we can each take advantage of our unique qualities, natural skills and power to make the best of things. Don���t waste our breath saying the market is irrational. Instead, we should figure out the best way to move within the flow.
��Wu wei. This is one of the most misunderstood ideas of Daoism because it is often translated as ���nonaction,��� seeming to imply that we should sit tight and hope all will be well. A better translation is ���effortless action.��� Imagine a rock in a stream. The rock seems to ���win��� by parting the stream. But come back after some years and you���ll find the stream has slowly eroded the rock away. That���s wu wei.
We tell our children to work through seeming setbacks, because the payoff is in the long game. We need to remember this for ourselves, perhaps socking away that little bit extra every year into a retirement account or paying a little more than the minimum due on debt. Such effortless actions can be the key to great long-run success.
Pu . As in Winnie, this concept originates from the idea of an uncut, rough piece of wood. Basically, don���t overcomplicate things and instead keep them as simple as possible. How many times do we start with a simple goal, but our diversions and clever workarounds take us in a far off and unwanted direction?
Make simple goals and maintain those goals. One goal might be time with loved ones. We shouldn���t derail it by spending 10 hours at work so we can somehow give more ���quality��� to the 30 minutes we end up devoting to the kids. Another goal might be retirement. We shouldn���t derail that goal by diverting boring steady growth investments into a get-rich-quick scheme. When we need something, we should try to get it and nothing more.
Fu . Many people are familiar with the yin-yang (Taijitu) symbol associated with Daoism. What most people don���t know is that the symbol is supposed to be rotating. This is to remind people that not only is life composed of opposites, but also that all things return (Fu) so that balance is restored. Sometimes darker, bad times (yin) prevail, and sometimes it���s lighter and better (yang) times.
We need to be mindful of this constant phasing in and out, and that it���s the totality that makes life what it is. A new job with a big raise doesn���t mean we need to stop saving for future bad times. A setback is not the end of our dreams, but perhaps a delay or an opening for a new direction. A balanced portfolio of stocks and bonds can hedge against the vicissitudes of the long-term market. Daoism also puts great emphasis on timing, that we need both the right outlook and right plan at the right time.
In many ways, a great overall ���Daoist��� investment is a low-cost target-date fund built around indexing. It doesn���t gamble by trying to ���time��� the market. It���s simple and goes with the flow of the market, good or bad, over time. It requires minimal maintenance and almost effortless action by investors, who merely need to contribute. The fund will adjust and rebalance at key moments, including shifting to less volatile investments as retirement gets closer.
There���s an old joke that the ancient Chinese invented the first complex bureaucracy, and then had to create the first philosophy to deal with the frustrations wrought by that bureaucracy. We have so many things that are different today. But the frustrations and anxiety that come with feeling things are in flux and beyond our control are timeless. Perhaps that means a philosophical outlook from long ago also still applies.
Jiab and Jim Wasserman just returned to Texas after spending the first three years of their retirement in Spain. Check out earlier articles from both��Jiab and Jim.The post The Dao Is Up appeared first on HumbleDollar.
May 24, 2021
Staying Wealthy
A CLOSE FRIEND’S long career in the motion picture business recently came to an end when the studio eliminated her job. Even before the pandemic, the industry was changing, so she wasn’t surprised or, for that matter, especially sad about getting laid off. She was lucky to receive a good severance package and is now ready to do something different. But finding the right job will likely take time, so carefully managing her cash through the transition period is crucial.
That’s why alarm bells sounded when she asked me for advice about a product she’d been pitched by a wealth management vice president at her bank. “You have all this cash sitting in savings earning little,” he said. “Why not invest it with us? I designed something for you that’s liquid, conservative and pays monthly tax-exempt income.”
Wow, specially designed just for my friend. How nice.
Did the VP ask about her cash needs in the months ahead? Did she share her risk tolerance before he pitched this? “Nope,” she told me. “I just said I’d like to earn more on my savings.”
“What if you put your cash in this investment—and it disappears when you need it most?” I asked.
I wouldn’t have been so worried if the product really was low risk and liquid, with a return better than a savings account or certificate of deposit. But I couldn’t think of any investment like that today, so I was curious to read the VP’s proposal.
What was this thing that he had “designed”? It turned out to be a portfolio of individual bonds and a bond fund actively managed by an outside investment advisor. The money would be held in a separately managed account, with a big chunk of the portfolio in municipal junk bonds. Thanks to its 1.5% per year account fee, it regularly returned less than its benchmark index. For comparison, Vanguard Total Bond Market ETF charges 0.035%. That’s the difference between $1,500 and $35 in costs each year on a $100,000 investment. And that isn’t the worst part.
Would this account be insured by the FDIC like my friend’s savings account? Of course, not. Has the pitched investment ever lost money before? Yes, in three of the last 10 years, including a 20% drop a year ago in March. As I see it, bonds shouldn’t be viewed as the same as cash investments. Both can be a good diversifier for stocks—and bonds are often the better choice—but cash investments are the place for money you’ll need to spend soon.
If my friend were back working and earning a steady income, taking on a bit more risk to keep up with inflation would make sense. But this product seemed like a great way to enhance the bank’s wealth, not hers, especially if her unemployment lasts longer than she hopes.
All this brought to mind Morgan Housel’s excellent book, The Psychology of Money . Housel writes, “There are a million ways to get wealthy, and plenty of books on how to do so. But there’s only one way to stay wealthy: some combination of frugality and paranoia.”
Housel summarizes money success in a single word: “survival.” To me, survival starts with having both the patience and sufficient cash to weather the worst situation you can imagine. I suggested to my friend that, in her case, patience meant not putting her money at risk of permanent loss by reaching for yield during this period when she doesn’t have a paycheck.
Housel is a fan of building a margin of safety into our financial plans. This boosts our chances of success. To achieve our goals, we don’t need everything to turn out exactly right. Instead, we’re prepared for a range of possible outcomes, all of which would leave us reasonably happy.
In Rational Expectations , the wise William Bernstein cuts through all of Wall Street’s nonsense around investment risk and what you need for financial survival with this simple clarity: “There are risky assets, there are riskless assets, and there is an exchange rate between them. When times are good, that exchange rate is low, and when blood flows in the streets, it is high.”
He adds, “Make absolutely sure you have enough riskless assets to tide you over during the bad times…. You must have patience, cash, and courage—and in that order.”
Today, it strikes me that patience is in short supply, leading some to jump into highflying investments and others to reach for yield. Fear of missing out on imagined gains—or the greed to get rich quick—drive many to “pay too much for the whistle,” as Ben Franklin would say.
What about my friend? In the end, she decided patience and FDIC-insured cash was the sensible way to stay wealthy until she resumes collecting a steady paycheck.
David Powell has spent his career writing software and leading engineering teams. During his 40 years working in tech, he has come to respect the limits of human imagination in any planning. Like the rest of us, David looks forward to a post-COVID world with lots of travel, shaking hands and dining in restaurants. Follow David on Twitter @AmpedToGo and check out his earlier articles.
That’s why alarm bells sounded when she asked me for advice about a product she’d been pitched by a wealth management vice president at her bank. “You have all this cash sitting in savings earning little,” he said. “Why not invest it with us? I designed something for you that’s liquid, conservative and pays monthly tax-exempt income.”
Wow, specially designed just for my friend. How nice.
Did the VP ask about her cash needs in the months ahead? Did she share her risk tolerance before he pitched this? “Nope,” she told me. “I just said I’d like to earn more on my savings.”
“What if you put your cash in this investment—and it disappears when you need it most?” I asked.
I wouldn’t have been so worried if the product really was low risk and liquid, with a return better than a savings account or certificate of deposit. But I couldn’t think of any investment like that today, so I was curious to read the VP’s proposal.
What was this thing that he had “designed”? It turned out to be a portfolio of individual bonds and a bond fund actively managed by an outside investment advisor. The money would be held in a separately managed account, with a big chunk of the portfolio in municipal junk bonds. Thanks to its 1.5% per year account fee, it regularly returned less than its benchmark index. For comparison, Vanguard Total Bond Market ETF charges 0.035%. That’s the difference between $1,500 and $35 in costs each year on a $100,000 investment. And that isn’t the worst part.
Would this account be insured by the FDIC like my friend’s savings account? Of course, not. Has the pitched investment ever lost money before? Yes, in three of the last 10 years, including a 20% drop a year ago in March. As I see it, bonds shouldn’t be viewed as the same as cash investments. Both can be a good diversifier for stocks—and bonds are often the better choice—but cash investments are the place for money you’ll need to spend soon.
If my friend were back working and earning a steady income, taking on a bit more risk to keep up with inflation would make sense. But this product seemed like a great way to enhance the bank’s wealth, not hers, especially if her unemployment lasts longer than she hopes.
All this brought to mind Morgan Housel’s excellent book, The Psychology of Money . Housel writes, “There are a million ways to get wealthy, and plenty of books on how to do so. But there’s only one way to stay wealthy: some combination of frugality and paranoia.”
Housel summarizes money success in a single word: “survival.” To me, survival starts with having both the patience and sufficient cash to weather the worst situation you can imagine. I suggested to my friend that, in her case, patience meant not putting her money at risk of permanent loss by reaching for yield during this period when she doesn’t have a paycheck.
Housel is a fan of building a margin of safety into our financial plans. This boosts our chances of success. To achieve our goals, we don’t need everything to turn out exactly right. Instead, we’re prepared for a range of possible outcomes, all of which would leave us reasonably happy.
In Rational Expectations , the wise William Bernstein cuts through all of Wall Street’s nonsense around investment risk and what you need for financial survival with this simple clarity: “There are risky assets, there are riskless assets, and there is an exchange rate between them. When times are good, that exchange rate is low, and when blood flows in the streets, it is high.”
He adds, “Make absolutely sure you have enough riskless assets to tide you over during the bad times…. You must have patience, cash, and courage—and in that order.”
Today, it strikes me that patience is in short supply, leading some to jump into highflying investments and others to reach for yield. Fear of missing out on imagined gains—or the greed to get rich quick—drive many to “pay too much for the whistle,” as Ben Franklin would say.
What about my friend? In the end, she decided patience and FDIC-insured cash was the sensible way to stay wealthy until she resumes collecting a steady paycheck.
David Powell has spent his career writing software and leading engineering teams. During his 40 years working in tech, he has come to respect the limits of human imagination in any planning. Like the rest of us, David looks forward to a post-COVID world with lots of travel, shaking hands and dining in restaurants. Follow David on Twitter @AmpedToGo and check out his earlier articles.The post Staying Wealthy appeared first on HumbleDollar.
May 23, 2021
IRA Earns IRS Ire
LET ME TELL YOU about Alvan Bobrow. His tale���and specifically his lawsuit���are important for every investor to understand. That���s because the legal loophole he sought to exploit is now a pothole for everyone else.
The first thing to know about Bobrow: He���s a tax attorney and, back in 2008, he had a clever idea. In need of cash, he took a $65,000 distribution���the technical term for a withdrawal���from his IRA. Ordinarily, a distribution from an IRA (unless it���s a Roth IRA or includes nondeductible contributions) is treated entirely as taxable income. For those younger than age 59��, an additional 10% penalty may also apply. But Bobrow knew a way to sidestep these taxes: He took advantage of the 60-day rollover rule.
To understand the rule, imagine you have an IRA at investment firm A and you wish to move it to firm B. To facilitate transfers like this, the 60-day rule permits you to take your money out of firm A and temporarily hold it in your bank account, before depositing it again at firm B. But to prevent taxpayers from abusing the rule, the IRS permits only one such move in any 12-month period. In other words, the IRS will allow you to take money out of an IRA without paying any tax, but��only��for 60 days at a time and��only��once per year.
But Bobrow saw a loophole: The way the rule was written, it appeared that the once-per-year limitation applied on an account-by-account basis. This would allow a taxpayer with multiple IRA accounts to daisy-chain together multiple 60-day periods, resulting in the tax-free use of IRA funds for much longer than 60 days.
Because Bobrow and his wife had several IRA accounts, that���s exactly what they did. In April 2008, Bobrow took a distribution from his first account and deposited the funds in his bank. Then, in June, he took a distribution from a second IRA and used it to pay back the first IRA. In July, he did the same thing again, taking funds from a third IRA and using it to pay back the second IRA before the 60-day clock ran out. Finally, on Sept. 30, he restored the funds to the third account. In the end, he was able to hold onto about $65,000 of IRA money on a tax-free basis for more than five months. This was far longer than the 60-day rule allowed, but Bobrow believed he was in the clear because each of his 60-day withdrawals came from a different account.
Problem is, he made a few missteps. Among them: His final deposit was a day late, coming in on day 61. That little error caused the IRS to take a closer look���and that���s when things went downhill for Bobrow. Because he missed the deadline, the IRS deemed the distribution taxable. It also assessed a penalty of more than $10,000.
Bobrow decided to challenge the penalty. He sued the IRS in Tax Court but was unsuccessful. The court agreed with the IRS that Bobrow violated the 60-day rule because of the extra day. But the��ruling��went further: The court also deemed Bobrow���s daisy-chaining maneuver to have been illegal. Prior to this ruling, everyone���including the IRS���had assumed that the once-per-year rule applied on an account-by-account basis. But the Tax Court ruled that it applied to all of a taxpayer���s IRAs��in aggregate. In other words, in the view of the court, taxpayers should be allowed only one rollover per year, regardless of how many accounts they might have. In issuing this ruling, the Tax Court effectively changed the law, and the IRS now enforces the modified rule.
The bottom line: Investors need to be very careful when moving retirement funds. Whether you���re moving money from a 401(k) or 403(b) to an IRA, or between IRAs, it���s critical to avoid running afoul of both the 60-day and once-per-year rules.
Fortunately, there���s an easy solution: Whenever you transfer funds among accounts, the custodian will give you a choice between a direct transfer and an indirect transfer. With an indirect transfer, the custodian writes you a check, which you can deposit in your bank account���for up to 60 days. That���s what the Bobrows did, and I don���t recommend it.
Instead, you want to choose a direct transfer. With this option, the funds are never in your possession. The old custodian either writes a check payable to the new custodian or sends an electronic transfer directly to the new custodian. Either way, since the funds never enter your bank account���which is the IRS���s primary concern���the 60-day rule doesn���t apply, and nor does the once-per-year rule. Because of that, I always recommend direct transfers.
Note: In some cases, even with a direct transfer, the old custodian will send a check to you and ask you to forward it to the new custodian. That���s no problem, as long as the check is payable to the new custodian. It still qualifies as a direct transfer.
Below are some common questions on this topic:
Do these rules apply to Roth IRAs? Yes. Even if a distribution from a Roth isn���t taxable, you still want to be careful in handling Roth funds. Violating the rules would mean the loss of future tax-free growth.
Does the once-per-year rule apply to Roth conversions? No. Because conversions are intended to be taxable, the IRS doesn't limit their frequency.
In Bobrow���s case, he was penalized for being just a day late. Is the IRS really that unforgiving? In the Bobrow case, the extra day was just the trigger that caused the audit. Examiners found other issues with his transactions. In reality, the IRS offers a lot of��leniency��with the 60-day rule. There is, however, no flexibility with the once-per-year rule.
What���s the difference between a rollover and a transfer? In practical terms, they���re synonymous. In technical terms, it���s called a transfer when you move funds between accounts that are of the same type���between two IRAs, for example, or between two 401(k)s. On the other hand, it���s called a rollover when you move money from one type of account to another���from, say, a 401(k) to an IRA. There are some differences between the rules governing rollovers and transfers. But either way, the key is to always choose the direct option.
I have a handful of retirement accounts scattered across different custodians. Can I use transfers or rollovers to combine them? In a lot of cases, you can combine accounts, but it depends on the type of account. The IRS provides a useful��visual guide. This is a good starting point but, as always, consider consulting an accountant.
Adam M. Grossman��is the founder of Mayport, a fixed-fee wealth management firm. In his series of free��e-books, he advocates an evidence-based��approach to personal finance. Follow Adam on Twitter @AdamMGrossman��and check out his earlier articles.
The first thing to know about Bobrow: He���s a tax attorney and, back in 2008, he had a clever idea. In need of cash, he took a $65,000 distribution���the technical term for a withdrawal���from his IRA. Ordinarily, a distribution from an IRA (unless it���s a Roth IRA or includes nondeductible contributions) is treated entirely as taxable income. For those younger than age 59��, an additional 10% penalty may also apply. But Bobrow knew a way to sidestep these taxes: He took advantage of the 60-day rollover rule.
To understand the rule, imagine you have an IRA at investment firm A and you wish to move it to firm B. To facilitate transfers like this, the 60-day rule permits you to take your money out of firm A and temporarily hold it in your bank account, before depositing it again at firm B. But to prevent taxpayers from abusing the rule, the IRS permits only one such move in any 12-month period. In other words, the IRS will allow you to take money out of an IRA without paying any tax, but��only��for 60 days at a time and��only��once per year.
But Bobrow saw a loophole: The way the rule was written, it appeared that the once-per-year limitation applied on an account-by-account basis. This would allow a taxpayer with multiple IRA accounts to daisy-chain together multiple 60-day periods, resulting in the tax-free use of IRA funds for much longer than 60 days.
Because Bobrow and his wife had several IRA accounts, that���s exactly what they did. In April 2008, Bobrow took a distribution from his first account and deposited the funds in his bank. Then, in June, he took a distribution from a second IRA and used it to pay back the first IRA. In July, he did the same thing again, taking funds from a third IRA and using it to pay back the second IRA before the 60-day clock ran out. Finally, on Sept. 30, he restored the funds to the third account. In the end, he was able to hold onto about $65,000 of IRA money on a tax-free basis for more than five months. This was far longer than the 60-day rule allowed, but Bobrow believed he was in the clear because each of his 60-day withdrawals came from a different account.
Problem is, he made a few missteps. Among them: His final deposit was a day late, coming in on day 61. That little error caused the IRS to take a closer look���and that���s when things went downhill for Bobrow. Because he missed the deadline, the IRS deemed the distribution taxable. It also assessed a penalty of more than $10,000.
Bobrow decided to challenge the penalty. He sued the IRS in Tax Court but was unsuccessful. The court agreed with the IRS that Bobrow violated the 60-day rule because of the extra day. But the��ruling��went further: The court also deemed Bobrow���s daisy-chaining maneuver to have been illegal. Prior to this ruling, everyone���including the IRS���had assumed that the once-per-year rule applied on an account-by-account basis. But the Tax Court ruled that it applied to all of a taxpayer���s IRAs��in aggregate. In other words, in the view of the court, taxpayers should be allowed only one rollover per year, regardless of how many accounts they might have. In issuing this ruling, the Tax Court effectively changed the law, and the IRS now enforces the modified rule.
The bottom line: Investors need to be very careful when moving retirement funds. Whether you���re moving money from a 401(k) or 403(b) to an IRA, or between IRAs, it���s critical to avoid running afoul of both the 60-day and once-per-year rules.
Fortunately, there���s an easy solution: Whenever you transfer funds among accounts, the custodian will give you a choice between a direct transfer and an indirect transfer. With an indirect transfer, the custodian writes you a check, which you can deposit in your bank account���for up to 60 days. That���s what the Bobrows did, and I don���t recommend it.
Instead, you want to choose a direct transfer. With this option, the funds are never in your possession. The old custodian either writes a check payable to the new custodian or sends an electronic transfer directly to the new custodian. Either way, since the funds never enter your bank account���which is the IRS���s primary concern���the 60-day rule doesn���t apply, and nor does the once-per-year rule. Because of that, I always recommend direct transfers.
Note: In some cases, even with a direct transfer, the old custodian will send a check to you and ask you to forward it to the new custodian. That���s no problem, as long as the check is payable to the new custodian. It still qualifies as a direct transfer.
Below are some common questions on this topic:
Do these rules apply to Roth IRAs? Yes. Even if a distribution from a Roth isn���t taxable, you still want to be careful in handling Roth funds. Violating the rules would mean the loss of future tax-free growth.
Does the once-per-year rule apply to Roth conversions? No. Because conversions are intended to be taxable, the IRS doesn't limit their frequency.
In Bobrow���s case, he was penalized for being just a day late. Is the IRS really that unforgiving? In the Bobrow case, the extra day was just the trigger that caused the audit. Examiners found other issues with his transactions. In reality, the IRS offers a lot of��leniency��with the 60-day rule. There is, however, no flexibility with the once-per-year rule.
What���s the difference between a rollover and a transfer? In practical terms, they���re synonymous. In technical terms, it���s called a transfer when you move funds between accounts that are of the same type���between two IRAs, for example, or between two 401(k)s. On the other hand, it���s called a rollover when you move money from one type of account to another���from, say, a 401(k) to an IRA. There are some differences between the rules governing rollovers and transfers. But either way, the key is to always choose the direct option.
I have a handful of retirement accounts scattered across different custodians. Can I use transfers or rollovers to combine them? In a lot of cases, you can combine accounts, but it depends on the type of account. The IRS provides a useful��visual guide. This is a good starting point but, as always, consider consulting an accountant.
Adam M. Grossman��is the founder of Mayport, a fixed-fee wealth management firm. In his series of free��e-books, he advocates an evidence-based��approach to personal finance. Follow Adam on Twitter @AdamMGrossman��and check out his earlier articles.The post IRA Earns IRS Ire appeared first on HumbleDollar.
May 22, 2021
Getting Framed
WE ALL HAVE LIMITED time and limited money. How can we make the most of these two scarce resources?
More than anything, the answer lies in getting the big picture right. That means thinking through the tradeoffs involved, so we don���t allocate too much time and money to some parts of our financial life, while neglecting others.
On that score, it���s hard to offer hard-and-fast rules because personal preferences play a key role. Still, here are two frameworks���one for money, the other for time���that I find useful.
Allocating money. In deciding how to divvy up our money between spending, investments, insurance and so on, the key factor is our human capital or the lack thereof. What���s human capital? That���s how economists refer to our income-earning ability.
Our human capital has four major implications for how we manage our money. First, while it���s reasonable to borrow early in our adult life to buy, say, a home or a college education, we should endeavor to pay off this debt by retirement, because���at that juncture���we���ll no longer have a paycheck to service these loans.
Second, we should take steps to ensure we���re healthy enough to collect a paycheck, and to protect ourselves and our family if we can���t. That means having health, disability and life insurance, as well as an emergency fund. Third, we should take part of each paycheck and set it aside for retirement, so we���ll be financially prepared for the day our paycheck disappears.
Finally, until we get within a decade or so of retirement, we should consider investing heavily in stocks, knowing we don���t need money from our portfolio because we have a paycheck to cover our living costs. We can view our human capital as similar to a bond���both generate regular income���which we then diversify by investing in stocks.
Here���s another way to think about the issue: Let���s say you���re age 45, you have $200,000 in stocks and nothing in conservative investments, and you save $10,000 every year. It might seem like you���re being super-aggressive, with your 100% stock portfolio. But between now and age 65, you���ll add $200,000 in new savings to your nest egg. You can view that $200,000 as cash in your portfolio. Result? Arguably, your overall investment mix is quite conservative, with 50% stocks and 50% cash, thanks to the savings you���ve yet to invest.
Your human capital dictates what you should be doing with your money. Doing all that you ought? You should feel free to use your remaining money as you wish, whether it���s vacations, dining out, helping your kids with college or whatever else you value. But what do you value? That brings us to a framework for thinking about time.
Allocating time. For some folks, managing money is an all-consuming hobby to which they happily devote endless hours. This investment of time probably won���t be well rewarded���especially if it���s spent guessing which stocks will outperform or which way markets are headed���but I assume these folks get great pleasure from trying.
What about the rest of us? If financial media coverage is any guide, 90% of our thoughts about money revolve around investing, especially the market���s daily action. This is almost certainly a gigantic waste of time. The evidence makes clear that the smart strategy is to settle on an appropriate mix of stocks, bonds and cash investments, and then implement that asset allocation using low-cost index funds. This should consume no more than an hour each year.
If we aren���t going to fret over the markets and our investments, how should we use our time? There are three aspects of our financial life where a little effort can yield far greater rewards.
First, we should look beyond our portfolio and spend time thinking about other financial issues. What size home should we buy? How can we minimize taxes? Do we have the right insurance? How can we hold down our borrowing costs? When should we claim Social Security? Do we have the right estate-planning documents? Perhaps most important, are we saving enough? These are all areas where some serious thought (or a top-notch fee-only financial advisor) can make a huge difference���and certainly do far more for our finances than worrying about the direction of stocks and interest rates.
Second, we should focus on improving our financial behavior. As with eating healthily and exercising regularly, the big struggle isn���t figuring out the right thing to do with our money. Instead, the problem is getting ourselves to do what we know is right. How can we get ourselves to stop procrastinating, so we get a will, buy term life insurance and sell those underperforming actively managed funds? How can we get ourselves to spend less, save more and stop fiddling with our portfolio? The key to a better financial future typically isn���t more knowledge, but rather a firmer grip on our meandering minds.
Third, we should spend time thinking about what we want from our life���and how money can help. Three things I focus on: Doing work I find meaningful, avoiding financial stress and spending time with those I love. This is where our thoughts about allocating money and allocating time come together.
There are certain things we ought to do with our money���and that���s driven by our human capital. There are certain things we ought to do with our time���both in terms of managing money and, of course, in terms of earning the stuff. Fulfilled those obligations? What���s left is discretionary. Fingers crossed, if we think hard about what we want from our discretionary time and money, we���ll be a little wiser in how we spend those two precious resources.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
"Many people are convinced their expenses will be vastly different in retirement," notes Dick Quinn. "Different perhaps. Lower? Not so much."
Catherine Horiuchi's two daughters just got accepted by colleges. She looks back at the application process���and the key lessons she learned.
"Death and taxes are indeed inevitable," writes Don Southworth, who is both a minister and a tax preparer. "But when prepared for with wisdom, they���re invitations to a better life."
Kristine Hayes's grandmother just turned 100, prompting Kristine to ask how she'll maintain her independence if she should live that long���and where she would turn for help.
"It strikes me that a very small portion of our assets should be in cryptocurrency," says Sonja Haggert. "Can you get more legitimate than the IRS asking if you own cryptocurrencies on the 1040?"
Yes, if you expect your tax bracket to be higher once you're retired, a Roth conversion can be a smart move. But as Adam Grossman explains, converting also offers four other key benefits.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier��articles.
More than anything, the answer lies in getting the big picture right. That means thinking through the tradeoffs involved, so we don���t allocate too much time and money to some parts of our financial life, while neglecting others.
On that score, it���s hard to offer hard-and-fast rules because personal preferences play a key role. Still, here are two frameworks���one for money, the other for time���that I find useful.
Allocating money. In deciding how to divvy up our money between spending, investments, insurance and so on, the key factor is our human capital or the lack thereof. What���s human capital? That���s how economists refer to our income-earning ability.
Our human capital has four major implications for how we manage our money. First, while it���s reasonable to borrow early in our adult life to buy, say, a home or a college education, we should endeavor to pay off this debt by retirement, because���at that juncture���we���ll no longer have a paycheck to service these loans.
Second, we should take steps to ensure we���re healthy enough to collect a paycheck, and to protect ourselves and our family if we can���t. That means having health, disability and life insurance, as well as an emergency fund. Third, we should take part of each paycheck and set it aside for retirement, so we���ll be financially prepared for the day our paycheck disappears.
Finally, until we get within a decade or so of retirement, we should consider investing heavily in stocks, knowing we don���t need money from our portfolio because we have a paycheck to cover our living costs. We can view our human capital as similar to a bond���both generate regular income���which we then diversify by investing in stocks.
Here���s another way to think about the issue: Let���s say you���re age 45, you have $200,000 in stocks and nothing in conservative investments, and you save $10,000 every year. It might seem like you���re being super-aggressive, with your 100% stock portfolio. But between now and age 65, you���ll add $200,000 in new savings to your nest egg. You can view that $200,000 as cash in your portfolio. Result? Arguably, your overall investment mix is quite conservative, with 50% stocks and 50% cash, thanks to the savings you���ve yet to invest.
Your human capital dictates what you should be doing with your money. Doing all that you ought? You should feel free to use your remaining money as you wish, whether it���s vacations, dining out, helping your kids with college or whatever else you value. But what do you value? That brings us to a framework for thinking about time.
Allocating time. For some folks, managing money is an all-consuming hobby to which they happily devote endless hours. This investment of time probably won���t be well rewarded���especially if it���s spent guessing which stocks will outperform or which way markets are headed���but I assume these folks get great pleasure from trying.
What about the rest of us? If financial media coverage is any guide, 90% of our thoughts about money revolve around investing, especially the market���s daily action. This is almost certainly a gigantic waste of time. The evidence makes clear that the smart strategy is to settle on an appropriate mix of stocks, bonds and cash investments, and then implement that asset allocation using low-cost index funds. This should consume no more than an hour each year.
If we aren���t going to fret over the markets and our investments, how should we use our time? There are three aspects of our financial life where a little effort can yield far greater rewards.
First, we should look beyond our portfolio and spend time thinking about other financial issues. What size home should we buy? How can we minimize taxes? Do we have the right insurance? How can we hold down our borrowing costs? When should we claim Social Security? Do we have the right estate-planning documents? Perhaps most important, are we saving enough? These are all areas where some serious thought (or a top-notch fee-only financial advisor) can make a huge difference���and certainly do far more for our finances than worrying about the direction of stocks and interest rates.
Second, we should focus on improving our financial behavior. As with eating healthily and exercising regularly, the big struggle isn���t figuring out the right thing to do with our money. Instead, the problem is getting ourselves to do what we know is right. How can we get ourselves to stop procrastinating, so we get a will, buy term life insurance and sell those underperforming actively managed funds? How can we get ourselves to spend less, save more and stop fiddling with our portfolio? The key to a better financial future typically isn���t more knowledge, but rather a firmer grip on our meandering minds.
Third, we should spend time thinking about what we want from our life���and how money can help. Three things I focus on: Doing work I find meaningful, avoiding financial stress and spending time with those I love. This is where our thoughts about allocating money and allocating time come together.
There are certain things we ought to do with our money���and that���s driven by our human capital. There are certain things we ought to do with our time���both in terms of managing money and, of course, in terms of earning the stuff. Fulfilled those obligations? What���s left is discretionary. Fingers crossed, if we think hard about what we want from our discretionary time and money, we���ll be a little wiser in how we spend those two precious resources.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
"Many people are convinced their expenses will be vastly different in retirement," notes Dick Quinn. "Different perhaps. Lower? Not so much."
Catherine Horiuchi's two daughters just got accepted by colleges. She looks back at the application process���and the key lessons she learned.
"Death and taxes are indeed inevitable," writes Don Southworth, who is both a minister and a tax preparer. "But when prepared for with wisdom, they���re invitations to a better life."
Kristine Hayes's grandmother just turned 100, prompting Kristine to ask how she'll maintain her independence if she should live that long���and where she would turn for help.
"It strikes me that a very small portion of our assets should be in cryptocurrency," says Sonja Haggert. "Can you get more legitimate than the IRS asking if you own cryptocurrencies on the 1040?"
Yes, if you expect your tax bracket to be higher once you're retired, a Roth conversion can be a smart move. But as Adam Grossman explains, converting also offers four other key benefits.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier��articles.The post Getting Framed appeared first on HumbleDollar.
May 21, 2021
Why We Own Bitcoin
GROWING UP, I remember my mother telling me to save because ���you never know what can happen.���
Like a pandemic?
I reference my mother because she was ahead of her time in preparedness and quite savvy about money. She bought gold when it wasn���t popular���and I think she would have bought bitcoin. Why? For the same reasons that my husband and I decided to take the plunge.
To be sure, bitcoin itself has plunged in recent weeks, and it's now down roughly 40% from its all-time high. But if anything, that should make potential buyers more enthusiastic, not less so. Yes, it's entirely possible the price will drop further. But there's one thing I'm confident about: While cryptocurrencies may continue to give owners a rollercoaster ride, they aren't going to disappear entirely.
Why not? Our society is becoming cashless. If there���s one thing that the pandemic has shown us, it���s that we don���t need cash. Between credit cards and Venmo, I���m hard pressed to remember the last time I used cash.
Like me, my mother would have been horrified at the amount of debt countries are accumulating and would have shared my deep-seated fear that this will result in inflation. Neither of us would have been able to explain the money supply in textbook economic terms. But inflation has impacted my life very noticeably. A cruise, which was scheduled for 2020 and didn���t happen, just went up 7% in price, even though the company has been holding our deposit for more than a year. And just look where the price of gas has gone.
If you���re a retiree, you���ve had to be more aggressive. Savings accounts and certificates of deposit provide the most meager of returns, so you���d better have funds in the stock market. While you���re at it, you might dip your toes into alternative assets, including cryptocurrencies.
Look at what has happened in just the past few years, and you can���t help but think this new commodity is for real. Fidelity Investments has a head of digital assets and a bitcoin division, and it���s looking to offer an exchange-traded bitcoin fund.�� There are now thousands of bitcoin ATMs��available. Major companies, such as Morgan Stanley and Goldman Sachs, are offering access to bitcoin and other cryptocurrencies. IBM, often seen as old and stodgy, has said it���s focused on blockchain and the industrial internet.
Wall Street has acknowledged the viability of cryptocurrencies with the listing of Coinbase on the exchange. Gary Gensler, the just confirmed chair of the Securities and Exchange Commission and a lecturer at MIT, taught a course on blockchain and money. You can watch his lecture on YouTube.
In looking at all of these developments in just a matter of a few years, it strikes me that a very small portion of our assets should be in cryptocurrency. We can buy in amounts as little as $100, because cryptocurrencies are available in fractional shares. Finally, can you get more legitimate than the IRS asking if you own cryptocurrencies on the front of the 1040 tax return?
Sonja Haggert is��the author of Invest, Reinvest, Rest. You can learn more at SonjaHaggert.com. Follow her on Twitter @SonjaHaggert��and��check out her earlier articles.
Like a pandemic?
I reference my mother because she was ahead of her time in preparedness and quite savvy about money. She bought gold when it wasn���t popular���and I think she would have bought bitcoin. Why? For the same reasons that my husband and I decided to take the plunge.
To be sure, bitcoin itself has plunged in recent weeks, and it's now down roughly 40% from its all-time high. But if anything, that should make potential buyers more enthusiastic, not less so. Yes, it's entirely possible the price will drop further. But there's one thing I'm confident about: While cryptocurrencies may continue to give owners a rollercoaster ride, they aren't going to disappear entirely.
Why not? Our society is becoming cashless. If there���s one thing that the pandemic has shown us, it���s that we don���t need cash. Between credit cards and Venmo, I���m hard pressed to remember the last time I used cash.
Like me, my mother would have been horrified at the amount of debt countries are accumulating and would have shared my deep-seated fear that this will result in inflation. Neither of us would have been able to explain the money supply in textbook economic terms. But inflation has impacted my life very noticeably. A cruise, which was scheduled for 2020 and didn���t happen, just went up 7% in price, even though the company has been holding our deposit for more than a year. And just look where the price of gas has gone.
If you���re a retiree, you���ve had to be more aggressive. Savings accounts and certificates of deposit provide the most meager of returns, so you���d better have funds in the stock market. While you���re at it, you might dip your toes into alternative assets, including cryptocurrencies.
Look at what has happened in just the past few years, and you can���t help but think this new commodity is for real. Fidelity Investments has a head of digital assets and a bitcoin division, and it���s looking to offer an exchange-traded bitcoin fund.�� There are now thousands of bitcoin ATMs��available. Major companies, such as Morgan Stanley and Goldman Sachs, are offering access to bitcoin and other cryptocurrencies. IBM, often seen as old and stodgy, has said it���s focused on blockchain and the industrial internet.
Wall Street has acknowledged the viability of cryptocurrencies with the listing of Coinbase on the exchange. Gary Gensler, the just confirmed chair of the Securities and Exchange Commission and a lecturer at MIT, taught a course on blockchain and money. You can watch his lecture on YouTube.
In looking at all of these developments in just a matter of a few years, it strikes me that a very small portion of our assets should be in cryptocurrency. We can buy in amounts as little as $100, because cryptocurrencies are available in fractional shares. Finally, can you get more legitimate than the IRS asking if you own cryptocurrencies on the front of the 1040 tax return?
Sonja Haggert is��the author of Invest, Reinvest, Rest. You can learn more at SonjaHaggert.com. Follow her on Twitter @SonjaHaggert��and��check out her earlier articles.The post Why We Own Bitcoin appeared first on HumbleDollar.
