Jonathan Clements's Blog, page 297
February 22, 2021
Acquired Taste
SPECIAL PURPOSE acquisition companies are hot. But will investors get burned?
Also known as “blank check” companies, special purpose acquisition companies (SPACs) are shell companies with no current business operations that raise investor funds through an initial public offering (IPO). The companies then seek a merger with a private company, allowing its new partner to go public without the delays and demands of a traditional IPO.
An additional advantage: The acquired companies are allowed to make projections about their business prospects, something not permitted with a traditional IPO. SPACs have existed for years. But they became wildly popular in 2020, raising $82 billion in the U.S., six times more than any previous year.
There are some characteristics common to most SPACs. They’re sold in $10 units, which consist of one common share plus an “out of the money” warrant or fractional warrant. The warrants typically have an exercise price of $11.50, meaning they give you the right to buy the underlying stock at that price and hence the warrants are only worth converting to the common stock if the share price rises above that level. Investors have five years to exercise their warrants after the merger. When SPAC units begin trading, they contain both the stock and the warrant, and have a “U” designation at the end of their ticker symbol to denote units.
SPACs can be traded through a brokerage firm, just like any other stock. While a SPAC will initially trade only as a single unit, investors later have the chance not only to buy and sell the units, but also to trade the underlying stock and warrants as separate securities. Result: There can be three securities associated with any one SPAC.
Because investors in the shell company’s units are effectively giving management a blank check, the warrants are one way to compensate them for the uncertainty involved. SPAC warrants often have a forced redemption price of $18 that can limit the upside. If you don’t exercise your warrants at the forced redemption price, they would expire worthless.
The proceeds raised in the IPO are held in trust. SPACs usually have a two-year window to either make an acquisition or liquidate the trust and return the proceeds to shareholders. The trust’s assets are held in Treasury securities, which many SPAC investors find appealing. Why? If no acquisition is made, the return of the units should be similar to a money market fund, but with the possibility of stock-like returns if the SPAC makes a favorable merger. One possible strategy: You could invest in a SPAC IPO and potentially redeem your shares for $10 plus interest before any merger happens, while hanging onto the warrants and the upside they may offer.
Indeed, when voting on any business combination, each stockholder has the right to redeem his or her stock for cash. Those stockholders who vote to redeem their shares receive cash equal to the IPO price plus accrued interest, but they still get to keep their warrants. Alternatively, shareholders may be offered the chance to vote to extend the search period for a suitable acquisition beyond two years.
After an acquisition, the management team of a SPAC—the founders—typically receive 20% of the new company. This generous slice dilutes the other shareholders and can lead to poor performance overall.
In addition to the investing public, the SPAC’s management team and the acquired private company, there can be other participants in each deal. Extra cash for the acquisition is often, though not always, raised from a group of large private investors, who are known as the PIPE investors. PIPE stands for private investment in public equity.
A SPAC’s share price often rises on announcement of a deal, especially if the target company is in a “hot” sector. Online gaming, electric vehicles and space exploration are popular with this crowd. Four high profile SPACs are DraftKings, Virgin Galactic, QuantumScape and Nikola. After the merger of a SPAC with a private company, the shares begin trading under the target company’s name and with a new stock symbol.
Are SPACs the sort of thing that the typical investor should buy? I spent my entire career managing money, so I’m comfortable dabbling in them. But my advice for most investors is to view SPACs as highly speculative investments. Skeptics suggest that, even though there’s a trust involved that holds Treasury securities, it’s possible that there’s less than $10 per share in the trust. On top of that, I’d be leery of assuming investors will continue to enjoy the sort of gains clocked by the early winners. Today, record amounts of SPAC money are chasing private companies, so there’s a real risk SPACs will end up overpaying for these private companies.
James McGlynn, CFA, RICP, is chief executive of
Next Quarter Century LLC
in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of
Retirement Planning Tips for Baby Boomers
. Check out his earlier articles.
Also known as “blank check” companies, special purpose acquisition companies (SPACs) are shell companies with no current business operations that raise investor funds through an initial public offering (IPO). The companies then seek a merger with a private company, allowing its new partner to go public without the delays and demands of a traditional IPO.
An additional advantage: The acquired companies are allowed to make projections about their business prospects, something not permitted with a traditional IPO. SPACs have existed for years. But they became wildly popular in 2020, raising $82 billion in the U.S., six times more than any previous year.
There are some characteristics common to most SPACs. They’re sold in $10 units, which consist of one common share plus an “out of the money” warrant or fractional warrant. The warrants typically have an exercise price of $11.50, meaning they give you the right to buy the underlying stock at that price and hence the warrants are only worth converting to the common stock if the share price rises above that level. Investors have five years to exercise their warrants after the merger. When SPAC units begin trading, they contain both the stock and the warrant, and have a “U” designation at the end of their ticker symbol to denote units.
SPACs can be traded through a brokerage firm, just like any other stock. While a SPAC will initially trade only as a single unit, investors later have the chance not only to buy and sell the units, but also to trade the underlying stock and warrants as separate securities. Result: There can be three securities associated with any one SPAC.
Because investors in the shell company’s units are effectively giving management a blank check, the warrants are one way to compensate them for the uncertainty involved. SPAC warrants often have a forced redemption price of $18 that can limit the upside. If you don’t exercise your warrants at the forced redemption price, they would expire worthless.
The proceeds raised in the IPO are held in trust. SPACs usually have a two-year window to either make an acquisition or liquidate the trust and return the proceeds to shareholders. The trust’s assets are held in Treasury securities, which many SPAC investors find appealing. Why? If no acquisition is made, the return of the units should be similar to a money market fund, but with the possibility of stock-like returns if the SPAC makes a favorable merger. One possible strategy: You could invest in a SPAC IPO and potentially redeem your shares for $10 plus interest before any merger happens, while hanging onto the warrants and the upside they may offer.
Indeed, when voting on any business combination, each stockholder has the right to redeem his or her stock for cash. Those stockholders who vote to redeem their shares receive cash equal to the IPO price plus accrued interest, but they still get to keep their warrants. Alternatively, shareholders may be offered the chance to vote to extend the search period for a suitable acquisition beyond two years.
After an acquisition, the management team of a SPAC—the founders—typically receive 20% of the new company. This generous slice dilutes the other shareholders and can lead to poor performance overall.
In addition to the investing public, the SPAC’s management team and the acquired private company, there can be other participants in each deal. Extra cash for the acquisition is often, though not always, raised from a group of large private investors, who are known as the PIPE investors. PIPE stands for private investment in public equity.
A SPAC’s share price often rises on announcement of a deal, especially if the target company is in a “hot” sector. Online gaming, electric vehicles and space exploration are popular with this crowd. Four high profile SPACs are DraftKings, Virgin Galactic, QuantumScape and Nikola. After the merger of a SPAC with a private company, the shares begin trading under the target company’s name and with a new stock symbol.
Are SPACs the sort of thing that the typical investor should buy? I spent my entire career managing money, so I’m comfortable dabbling in them. But my advice for most investors is to view SPACs as highly speculative investments. Skeptics suggest that, even though there’s a trust involved that holds Treasury securities, it’s possible that there’s less than $10 per share in the trust. On top of that, I’d be leery of assuming investors will continue to enjoy the sort of gains clocked by the early winners. Today, record amounts of SPAC money are chasing private companies, so there’s a real risk SPACs will end up overpaying for these private companies.
James McGlynn, CFA, RICP, is chief executive of
Next Quarter Century LLC
in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of
Retirement Planning Tips for Baby Boomers
. Check out his earlier articles.The post Acquired Taste appeared first on HumbleDollar.
February 21, 2021
Not That Simple
CHIMAMANDA ADICHIE coined the term “single story” in 2009. A novelist and a native of Nigeria, Adichie first came to the U.S. to attend college. Almost immediately, she was struck by the one-dimensional lens through which many saw her. It started with her roommate.
Knowing that Adichie had just arrived in this country, her roommate—an American—asked how she was able to speak English so well. Adichie had to explain that English is Nigeria’s official language. Her roommate was further surprised when Adichie chose to listen to the music of Mariah Carey. Her roommate had expected her to prefer, as she put it, “tribal music.” In short, Adichie says, her roommate was making the mistake of operating with a single story.
This sort of thing is common and can trip up investors, too. Faced with a complicated world, our minds naturally try to cut through the noise by looking for patterns. We develop shorthand stories to quickly characterize investments and put them in mental boxes. Growing companies, for example, are “going to the moon,” while struggling companies are “doomed to failure.” Some markets are “the future,” while others are “disasters.” Simple stories tend to be binary.
When we oversimplify like this, however, we run two risks—false positives and false negatives—both of which can be costly. With false positives, the single story focuses on everything that's attractive about an investment, while dismissing all of its risk factors. With false negatives, we do the opposite, writing off an investment as a dud without giving consideration to anything that's positive.
In today’s market, the risk of single stories seems particularly high. That's because markets are in the middle of what some have called an “everything rally.” Everything seems to be going up—growth stocks, value stocks, IPOs, SPACs, cryptocurrencies, even trading cards.
A few weeks ago, the focus was GameStop. But that was January’s story. Now other “shiny object” assets are going up. Consider the latest: dogecoin.
According to one of its creators, dogecoin wasn’t intended as an investment. Instead, it was initially created as a joke. But recently, it has gained traction, rising about 12-fold in this year’s first six weeks. Adding to dogecoin’s popularity: an endorsement from Elon Musk, who recently became the world’s wealthiest person after the value of his own company rose 700% last year. It’s beginning to feel a little bit like a hall of mirrors.
Of course, an everything rally can’t go on forever. It stands to reason that eventually some of these inflated assets will return to Earth, just as we saw with GameStop, while others will continue to prosper. How can you tell which will die and which will thrive? These kinds of highflying investments are like a Rorschach test—with their value in the eye of the beholder. That makes them unusually susceptible to single stories.
The solution? Work to gather the full story behind a prospective investment. Here's the five-part framework I recommend:
1. Consider the obvious merits. This is the easiest aspect of an investment to evaluate. If you're analyzing a stock, the company’s merits might include a unique product, increasing market share or a talented management team. You need to look at the company’s current earnings and ask how likely it is to continue delivering those results.
2. Consider the obvious risks. Each type of investment carries its own set of risks. For a technology stock, obvious risks might include signs of market saturation or a new competitor. For an energy company, an obvious risk would be low oil prices like we've seen in recent years. In the world of bonds, the big fear today is that interest rates might rise, perhaps significantly, if the government passes an outsized stimulus package. As in step No. 1, you can't perfectly predict or quantify any of this. Still, the goal is to force yourself to think about the risks involved.
3. Consider what opportunities might lie below the surface. In this step, you want to go beyond the information that’s plainly visible. For example, if you’re looking at a consumer products company, ask yourself if it might be working on a new product line. Consider Apple. Before it introduced the iPhone, no one knew it was coming and it wasn’t factored into the share price.
In the world of bonds, there are opportunities, too: Interest rates could drop unexpectedly, as they did last year. Or a slowdown in the stock market could cause a rally in bonds. The reality is, there’s an infinite set of things that could happen, but there’s no need to conceive of every possible outcome. The objective here is just to recognize that, with an investment, there might be—and often is—more than meets the eye.
4. Consider what risks might lurk below the surface. Suppose you’re looking at an investment, and it appears great. Again, Apple is a good example. What could go wrong? The late Harvard professor Clayton Christensen argued that the biggest risk for successful companies is what he called the “innovator’s dilemma.” Companies become so focused on doing what they do well that they get caught flatfooted when a new competitor delivers a better mousetrap. As you think about risks, keep this in mind. An investment that looks perfect only looks that way because you can’t see what’s below the surface.
5. Keep in mind that, in most cases, investments aren't necessarily “good” or “bad.” An investment that’s good for someone else might not be appropriate for you. Be wary of other people’s single stories.
A final note: As you evaluate an investment’s positives and negatives, be aware of the natural human tendency to put disproportionate weight on the negative. Four psychologists summed it up well in a 2001 study: “Bad impressions and bad stereotypes are quicker to form and more resistant to disconfirmation than good ones.” As you consider both sides of a potential investment, try to correct for the fact that you will inevitably find it easier to scare yourself out of an investment than to talk yourself into it.
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.
Knowing that Adichie had just arrived in this country, her roommate—an American—asked how she was able to speak English so well. Adichie had to explain that English is Nigeria’s official language. Her roommate was further surprised when Adichie chose to listen to the music of Mariah Carey. Her roommate had expected her to prefer, as she put it, “tribal music.” In short, Adichie says, her roommate was making the mistake of operating with a single story.
This sort of thing is common and can trip up investors, too. Faced with a complicated world, our minds naturally try to cut through the noise by looking for patterns. We develop shorthand stories to quickly characterize investments and put them in mental boxes. Growing companies, for example, are “going to the moon,” while struggling companies are “doomed to failure.” Some markets are “the future,” while others are “disasters.” Simple stories tend to be binary.
When we oversimplify like this, however, we run two risks—false positives and false negatives—both of which can be costly. With false positives, the single story focuses on everything that's attractive about an investment, while dismissing all of its risk factors. With false negatives, we do the opposite, writing off an investment as a dud without giving consideration to anything that's positive.
In today’s market, the risk of single stories seems particularly high. That's because markets are in the middle of what some have called an “everything rally.” Everything seems to be going up—growth stocks, value stocks, IPOs, SPACs, cryptocurrencies, even trading cards.
A few weeks ago, the focus was GameStop. But that was January’s story. Now other “shiny object” assets are going up. Consider the latest: dogecoin.
According to one of its creators, dogecoin wasn’t intended as an investment. Instead, it was initially created as a joke. But recently, it has gained traction, rising about 12-fold in this year’s first six weeks. Adding to dogecoin’s popularity: an endorsement from Elon Musk, who recently became the world’s wealthiest person after the value of his own company rose 700% last year. It’s beginning to feel a little bit like a hall of mirrors.
Of course, an everything rally can’t go on forever. It stands to reason that eventually some of these inflated assets will return to Earth, just as we saw with GameStop, while others will continue to prosper. How can you tell which will die and which will thrive? These kinds of highflying investments are like a Rorschach test—with their value in the eye of the beholder. That makes them unusually susceptible to single stories.
The solution? Work to gather the full story behind a prospective investment. Here's the five-part framework I recommend:
1. Consider the obvious merits. This is the easiest aspect of an investment to evaluate. If you're analyzing a stock, the company’s merits might include a unique product, increasing market share or a talented management team. You need to look at the company’s current earnings and ask how likely it is to continue delivering those results.
2. Consider the obvious risks. Each type of investment carries its own set of risks. For a technology stock, obvious risks might include signs of market saturation or a new competitor. For an energy company, an obvious risk would be low oil prices like we've seen in recent years. In the world of bonds, the big fear today is that interest rates might rise, perhaps significantly, if the government passes an outsized stimulus package. As in step No. 1, you can't perfectly predict or quantify any of this. Still, the goal is to force yourself to think about the risks involved.
3. Consider what opportunities might lie below the surface. In this step, you want to go beyond the information that’s plainly visible. For example, if you’re looking at a consumer products company, ask yourself if it might be working on a new product line. Consider Apple. Before it introduced the iPhone, no one knew it was coming and it wasn’t factored into the share price.
In the world of bonds, there are opportunities, too: Interest rates could drop unexpectedly, as they did last year. Or a slowdown in the stock market could cause a rally in bonds. The reality is, there’s an infinite set of things that could happen, but there’s no need to conceive of every possible outcome. The objective here is just to recognize that, with an investment, there might be—and often is—more than meets the eye.
4. Consider what risks might lurk below the surface. Suppose you’re looking at an investment, and it appears great. Again, Apple is a good example. What could go wrong? The late Harvard professor Clayton Christensen argued that the biggest risk for successful companies is what he called the “innovator’s dilemma.” Companies become so focused on doing what they do well that they get caught flatfooted when a new competitor delivers a better mousetrap. As you think about risks, keep this in mind. An investment that looks perfect only looks that way because you can’t see what’s below the surface.
5. Keep in mind that, in most cases, investments aren't necessarily “good” or “bad.” An investment that’s good for someone else might not be appropriate for you. Be wary of other people’s single stories.
A final note: As you evaluate an investment’s positives and negatives, be aware of the natural human tendency to put disproportionate weight on the negative. Four psychologists summed it up well in a 2001 study: “Bad impressions and bad stereotypes are quicker to form and more resistant to disconfirmation than good ones.” As you consider both sides of a potential investment, try to correct for the fact that you will inevitably find it easier to scare yourself out of an investment than to talk yourself into it.
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 Not That Simple appeared first on HumbleDollar.
February 20, 2021
Poor Old Me
HERE’S A COMMENT I’ve heard countless times in recent years: You should claim Social Security early because you’ll enjoy the money more in your 60s and because you’ll spend less later in retirement.
I think this is nonsense that rests on three wrongheaded assumptions:
That spending needs should drive when you claim Social Security.
That you will indeed spend less each year as you age.
That you’ll be better able to enjoy whatever money you have in your 60s than later in retirement.
Do you believe any or all of the above three statements? Let’s consider the facts and the logic behind each.
1. Claiming early. Yes, there are justifiable reasons for starting Social Security benefits early.
Perhaps you’re in poor health and, if married, so is your spouse. Perhaps, during your working years, you were the lower-earning spouse and thus your benefit will disappear when the first spouse dies. Perhaps you’re out of work, you have no retirement savings and you need to claim Social Security to buy groceries. Perhaps you lie awake at night fearful that the politicians will slash Social Security benefits—even for those already retired. In such cases, claiming Social Security at age 62 might make sense (though, to be honest, I think there’s scant chance that any politician hoping to get reelected would ever cut benefits for existing retirees).
But let’s consider a situation that probably describes most HumbleDollar readers: You’ve taken decent care of your health and it’s highly likely you’ll live to an average life expectancy, which would be the mid-80s for those currently in their 60s, and there’s a good chance you’ll live longer. You’ve also amassed a handsome nest egg, and you’ll cover your retirement costs with some combination of savings and Social Security benefits.
Sound like your situation? Even if you think you’ll spend less later in retirement—and we’ll get to that assumption in a moment—that still doesn’t mean you should claim Social Security early. Instead, drawing on both your retirement savings and Social Security, your goal should be to cover expenses over the course of your retirement in a way that maximizes the total dollars generated by those two sources. And, for most folks, the best way to do that is to cover expenses early in retirement with savings, while delaying Social Security and then relying more heavily on that income stream later on.
Don’t agree? Ask yourself this: Even if you’ll spend more in your 60s, why does it logically follow that you should claim Social Security early? Using this “logic,” it makes just as much sense to draw more heavily on savings in your 60s—and, in fact, almost every expert who has studied the issue has concluded that that’s the optimal strategy.
2. Spending less. According to the Bureau of Labor Statistics’ Consumer Expenditure Survey, households headed by someone age 65 to 74 spent $55,087 in 2019, versus $43,623 for those age 75 and up. In other words, it seems we do indeed spend less as we age.
But guess what? The survey also shows that income plunges as we age, with those 65 to 74 pulling in $65,943, while those 75 and up were at $41,937. That lower income can be explained by things like shrinking household size, as one spouse in a couple dies off, and by depleted retirement nest eggs and less earned income.
What I find most interesting, however, is spending versus income. Those early in retirement are spending 84% of their income, while those later in retirement are spending 104%. A reasonable interpretation: Older retirees aren’t spending less because they have less desire to spend. Instead, their financial situation is compelling them to cut back—and, if they had extra money, they’d likely spend more.
My contention: No matter what their age, most retirees spend what they feel they can reasonably afford to spend. I wouldn’t assume that you’ll spend less as you age. Instead, there’s every chance you’ll spend more—assuming you have the money. Moreover, even if you aren’t spending that money on travel, eating out and going to the theater, there’s every chance you’ll need the money for health care expenses and long-term-care costs, which often drive expenses far higher as we age.
3. Losing happiness. To state the obvious, the end of life likely won’t be a happy time. But what about prior to that? Does our happiness wane as we progress through retirement?
Two of the preeminent happiness researchers, David Blanchflower and Andrew Oswald, compiled data from seven key sources detailing happiness through life. Head to the end of their paper and you’ll find the data presented in seven charts. As you’ll discover, it’s hard to see much difference in the happiness of, say, those age 65 and those age 80. It seems we’re perfectly capable of enjoying life—and the money available to us—later in retirement.
In fact, you may discover that your continued happiness hinges on having more money to spend. At age 58, when I travel, I’m still willing to fly economy and take public transport to and from the airport. At age 81, when my mother travels, she flies business class and likes to hire a driver to meet her when she gets off the plane. She does that because she can afford it, but also because it now takes more money for her to travel comfortably.
If happiness research has anything to teach us, it’s that we aren’t very good at figuring out what will make us happy. We shouldn’t assume that, in our 80s, we’ll be content to sit in an armchair reading a book and watching reruns of old TV shows. Yes, some octogenarians happily do that—but many others do it unhappily, because their depleted nest egg leaves them with no other choice.
During our working years, to amass enough for a comfortable retirement, we need sympathy for our future self, and that means putting aside money for the retiree we’ll one day become. When we quit the workforce, we need to retain a little of that sympathy. We shouldn’t assume that our 80-year-old self won’t be capable of great happiness—and won’t find plenty of uses for the wealth we haven’t yet spent.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
There's a widespread assumption that all seniors struggle financially and cognitively. Dick Quinn—in his usual inimitable fashion—begs to disagree.
Haven't yet cut the cord? For years, David Powell stuck with traditional satellite and cable TV—but the quality and cost savings of streaming services finally won him over.
Congress keeps changing the rules that govern retirement accounts and Social Security. James McGlynn looks at what's happened over the past half-a-dozen years—and what it means for retirees.
"So now what?" asks Mike Zaccardi. "I’m financially independent, passionate about investments and financial planning, love to write and present, and can devour steak. How to blend those?"
Small positive steps repeated regularly can produce extraordinary results, notes Jiab Wasserman—and that's true not just of saving and investing, but also exercising and eating healthily.
Retirees worry about "leaving money on the table," so they claim Social Security early, opt for lump sum pension payouts and avoid income annuities. But these strategies often backfire, says Rick Connor.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.
I think this is nonsense that rests on three wrongheaded assumptions:
That spending needs should drive when you claim Social Security.
That you will indeed spend less each year as you age.
That you’ll be better able to enjoy whatever money you have in your 60s than later in retirement.
Do you believe any or all of the above three statements? Let’s consider the facts and the logic behind each.
1. Claiming early. Yes, there are justifiable reasons for starting Social Security benefits early.
Perhaps you’re in poor health and, if married, so is your spouse. Perhaps, during your working years, you were the lower-earning spouse and thus your benefit will disappear when the first spouse dies. Perhaps you’re out of work, you have no retirement savings and you need to claim Social Security to buy groceries. Perhaps you lie awake at night fearful that the politicians will slash Social Security benefits—even for those already retired. In such cases, claiming Social Security at age 62 might make sense (though, to be honest, I think there’s scant chance that any politician hoping to get reelected would ever cut benefits for existing retirees).
But let’s consider a situation that probably describes most HumbleDollar readers: You’ve taken decent care of your health and it’s highly likely you’ll live to an average life expectancy, which would be the mid-80s for those currently in their 60s, and there’s a good chance you’ll live longer. You’ve also amassed a handsome nest egg, and you’ll cover your retirement costs with some combination of savings and Social Security benefits.
Sound like your situation? Even if you think you’ll spend less later in retirement—and we’ll get to that assumption in a moment—that still doesn’t mean you should claim Social Security early. Instead, drawing on both your retirement savings and Social Security, your goal should be to cover expenses over the course of your retirement in a way that maximizes the total dollars generated by those two sources. And, for most folks, the best way to do that is to cover expenses early in retirement with savings, while delaying Social Security and then relying more heavily on that income stream later on.
Don’t agree? Ask yourself this: Even if you’ll spend more in your 60s, why does it logically follow that you should claim Social Security early? Using this “logic,” it makes just as much sense to draw more heavily on savings in your 60s—and, in fact, almost every expert who has studied the issue has concluded that that’s the optimal strategy.
2. Spending less. According to the Bureau of Labor Statistics’ Consumer Expenditure Survey, households headed by someone age 65 to 74 spent $55,087 in 2019, versus $43,623 for those age 75 and up. In other words, it seems we do indeed spend less as we age.
But guess what? The survey also shows that income plunges as we age, with those 65 to 74 pulling in $65,943, while those 75 and up were at $41,937. That lower income can be explained by things like shrinking household size, as one spouse in a couple dies off, and by depleted retirement nest eggs and less earned income.
What I find most interesting, however, is spending versus income. Those early in retirement are spending 84% of their income, while those later in retirement are spending 104%. A reasonable interpretation: Older retirees aren’t spending less because they have less desire to spend. Instead, their financial situation is compelling them to cut back—and, if they had extra money, they’d likely spend more.
My contention: No matter what their age, most retirees spend what they feel they can reasonably afford to spend. I wouldn’t assume that you’ll spend less as you age. Instead, there’s every chance you’ll spend more—assuming you have the money. Moreover, even if you aren’t spending that money on travel, eating out and going to the theater, there’s every chance you’ll need the money for health care expenses and long-term-care costs, which often drive expenses far higher as we age.
3. Losing happiness. To state the obvious, the end of life likely won’t be a happy time. But what about prior to that? Does our happiness wane as we progress through retirement?
Two of the preeminent happiness researchers, David Blanchflower and Andrew Oswald, compiled data from seven key sources detailing happiness through life. Head to the end of their paper and you’ll find the data presented in seven charts. As you’ll discover, it’s hard to see much difference in the happiness of, say, those age 65 and those age 80. It seems we’re perfectly capable of enjoying life—and the money available to us—later in retirement.
In fact, you may discover that your continued happiness hinges on having more money to spend. At age 58, when I travel, I’m still willing to fly economy and take public transport to and from the airport. At age 81, when my mother travels, she flies business class and likes to hire a driver to meet her when she gets off the plane. She does that because she can afford it, but also because it now takes more money for her to travel comfortably.
If happiness research has anything to teach us, it’s that we aren’t very good at figuring out what will make us happy. We shouldn’t assume that, in our 80s, we’ll be content to sit in an armchair reading a book and watching reruns of old TV shows. Yes, some octogenarians happily do that—but many others do it unhappily, because their depleted nest egg leaves them with no other choice.
During our working years, to amass enough for a comfortable retirement, we need sympathy for our future self, and that means putting aside money for the retiree we’ll one day become. When we quit the workforce, we need to retain a little of that sympathy. We shouldn’t assume that our 80-year-old self won’t be capable of great happiness—and won’t find plenty of uses for the wealth we haven’t yet spent.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
There's a widespread assumption that all seniors struggle financially and cognitively. Dick Quinn—in his usual inimitable fashion—begs to disagree.
Haven't yet cut the cord? For years, David Powell stuck with traditional satellite and cable TV—but the quality and cost savings of streaming services finally won him over.
Congress keeps changing the rules that govern retirement accounts and Social Security. James McGlynn looks at what's happened over the past half-a-dozen years—and what it means for retirees.
"So now what?" asks Mike Zaccardi. "I’m financially independent, passionate about investments and financial planning, love to write and present, and can devour steak. How to blend those?"
Small positive steps repeated regularly can produce extraordinary results, notes Jiab Wasserman—and that's true not just of saving and investing, but also exercising and eating healthily.
Retirees worry about "leaving money on the table," so they claim Social Security early, opt for lump sum pension payouts and avoid income annuities. But these strategies often backfire, says Rick Connor.
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 Poor Old Me appeared first on HumbleDollar.
February 19, 2021
Which Road?
I RECENTLY LEFT my fulltime position at an energy trading company. I had a good run and enjoyed the job. It was mainly the people, both my coworkers and our clients.
I also liked the business travel. It broke up the daily routine and put faces to names, plus there were the awesome ribeye steak dinners with clients. Speaking at conferences was fun, too.
But things evolve. To quote Rocky, “If I can change and you can change, everybody can change.” After studying to become a Chartered Financial Analyst, I began teaching and writing about finance. At work, I enjoyed helping colleagues with retirement planning and consulting on weather issues. I even have a “chief meteorologist” jacket from the company to prove it.
So now what? I’m financially independent, passionate about investments and financial planning, love to write and present, and can devour steak. How to blend those? Hmmm. It’s a tough one.
I’m considering various career paths. I could keep the foot on the gas, slow it down, really slow it down or pursue something new. The paradox of choice rears its ugly head. Here are a few possibilities I’m contemplating during my ample free time:
Keep grinding. I can likely land a solid finance job with a good salary that’ll challenge me. With this option, stress would be higher and it might limit my social life. One hurdle: I haven’t directly worked in investments and financial planning. The learning curve could be steep.
Slow down. I could also take a run-of-the-mill finance job with a lower salary and more anonymity. Maybe this option would allow me to continue pursuing my passion for writing and teaching. Boredom is a risk with this option. I might end up spending too much time on Twitter.
All-in on writing and teaching. Many might ask, “Why not just ditch the nine-to-five lifestyle and do what you’re passionate about?” Good point. I could make a fine living focusing on my side gigs. Maybe I will. But there are downsides: Money would be a lot less, I’d probably have too much free time and I’m not a big fan of working alone from home.
A life of service. I know the chief financial officer at my church. I’m sure it would be fulfilling to spend a hefty amount of time there, while still putting my finance skills to work. On top of that, there would be social benefits. But there wouldn’t be much money involved. Also, I’m 33 years old. I have a lot left in the tank. Serving fulltime might be a better choice in 10 years.
Something weird. I’ve joked on Twitter about pursuing another passion that’s important to me—the Brazilian steakhouse. I could become a “gaucho,” one of the individuals who cuts meat tableside for patrons. The big risk here: The position could be hazardous to my waistline and arteries.
Back to energy. Who knows? Maybe I’ll do another stint in energy if the right role arose. I truly enjoy opining on the important risks for public power market participants to consider. Behavioral economics, weather, trends in ESG (environmental, social, governance) investing: All of these things I know a ton about and are crucial to the business.
Many folks would love to be in my situation. So many interesting possibilities. It isn’t easy, though. I don’t know where I’ll be six months from now. I lean toward one of the above options one day, then another the next day. Studies show stress increases as options increase. Our brain has to work harder and use more energy to figure out the best decision. Other behavioral biases also come into play: regret aversion, loss aversion, thinking in certainties rather than probabilities.
Why should you care? We all face situations like this at one time or another. Weighing the pros and cons, while thinking more broadly about what’s important to you, are no small task. The financial planners out there might suggest my next step would be to read 7 Habits of Highly Effective People or perhaps answer George Kinder’s three questions. Another good tip I’ve received: Simply write down a few possible paths.
I’m open to suggestions from people with more life experience than me. Which road should I travel? Some good advice could change my life. No pressure.
Mike Zaccardi is an adjunct finance instructor at the University of North Florida, as well as an investment writer for financial advisors and investment firms. He's a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn, email him at MikeCZaccardi@gmail.com and check out his earlier articles.
I also liked the business travel. It broke up the daily routine and put faces to names, plus there were the awesome ribeye steak dinners with clients. Speaking at conferences was fun, too.
But things evolve. To quote Rocky, “If I can change and you can change, everybody can change.” After studying to become a Chartered Financial Analyst, I began teaching and writing about finance. At work, I enjoyed helping colleagues with retirement planning and consulting on weather issues. I even have a “chief meteorologist” jacket from the company to prove it.
So now what? I’m financially independent, passionate about investments and financial planning, love to write and present, and can devour steak. How to blend those? Hmmm. It’s a tough one.
I’m considering various career paths. I could keep the foot on the gas, slow it down, really slow it down or pursue something new. The paradox of choice rears its ugly head. Here are a few possibilities I’m contemplating during my ample free time:
Keep grinding. I can likely land a solid finance job with a good salary that’ll challenge me. With this option, stress would be higher and it might limit my social life. One hurdle: I haven’t directly worked in investments and financial planning. The learning curve could be steep.
Slow down. I could also take a run-of-the-mill finance job with a lower salary and more anonymity. Maybe this option would allow me to continue pursuing my passion for writing and teaching. Boredom is a risk with this option. I might end up spending too much time on Twitter.
All-in on writing and teaching. Many might ask, “Why not just ditch the nine-to-five lifestyle and do what you’re passionate about?” Good point. I could make a fine living focusing on my side gigs. Maybe I will. But there are downsides: Money would be a lot less, I’d probably have too much free time and I’m not a big fan of working alone from home.
A life of service. I know the chief financial officer at my church. I’m sure it would be fulfilling to spend a hefty amount of time there, while still putting my finance skills to work. On top of that, there would be social benefits. But there wouldn’t be much money involved. Also, I’m 33 years old. I have a lot left in the tank. Serving fulltime might be a better choice in 10 years.
Something weird. I’ve joked on Twitter about pursuing another passion that’s important to me—the Brazilian steakhouse. I could become a “gaucho,” one of the individuals who cuts meat tableside for patrons. The big risk here: The position could be hazardous to my waistline and arteries.
Back to energy. Who knows? Maybe I’ll do another stint in energy if the right role arose. I truly enjoy opining on the important risks for public power market participants to consider. Behavioral economics, weather, trends in ESG (environmental, social, governance) investing: All of these things I know a ton about and are crucial to the business.
Many folks would love to be in my situation. So many interesting possibilities. It isn’t easy, though. I don’t know where I’ll be six months from now. I lean toward one of the above options one day, then another the next day. Studies show stress increases as options increase. Our brain has to work harder and use more energy to figure out the best decision. Other behavioral biases also come into play: regret aversion, loss aversion, thinking in certainties rather than probabilities.
Why should you care? We all face situations like this at one time or another. Weighing the pros and cons, while thinking more broadly about what’s important to you, are no small task. The financial planners out there might suggest my next step would be to read 7 Habits of Highly Effective People or perhaps answer George Kinder’s three questions. Another good tip I’ve received: Simply write down a few possible paths.
I’m open to suggestions from people with more life experience than me. Which road should I travel? Some good advice could change my life. No pressure.
Mike Zaccardi is an adjunct finance instructor at the University of North Florida, as well as an investment writer for financial advisors and investment firms. He's a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn, email him at MikeCZaccardi@gmail.com and check out his earlier articles.
The post Which Road? appeared first on HumbleDollar.
February 18, 2021
One Day at a Time
JIM AND I RECENTLY moved from Granada, our first home in Spain, to Alicante, a city by the Mediterranean. The move gives us the opportunity to walk along the coast each day.
A few weeks ago, we hiked a rugged coastal trail that’s part of a nature preserve, with an ancient Roman dock still partially visible. Along the coastline, you can also see how layers of sand have built up over the centuries, compacting together to form the breathtaking sandstone hills we enjoy today.
It’s a reminder of how small acts can have a significant impact over time. I’ve always liked the expression, “In one day, you can’t do much, but over a long period of time you can accomplish a lot.” Small acts can yield a high—and even exponential—return, given enough time.
Such returns aren’t just financial. Here are three small acts that, if performed regularly, can help us reap large rewards in the long run.
1. Save and invest every month. Thanks to the gender wealth gap, this is especially important for women. I started saving as soon as I got my first regular job. In 1993, I worked in a public library, where I earned slightly more than minimum wage. The job allowed me to contribute pretax dollars to a 457 plan. When I left the library, my balance was a bit under $2,000. Since then, I transferred it to an IRA and, the last time I checked, the balance was almost $10,000.
In all my subsequent jobs in financial services, and as my income increased, I would max out my 401(k) and continue to save regardless of the economic situation, whether it be boom or bust. In fact, recessions and the accompanying stock market decline were the best time to invest, because the same dollar amount had more stock market buying power. Even though financial independence wasn’t my goal—it wasn’t a popular notion, like it is today—my diligent saving fast-tracked my finances, allowing me to retire in my early 50s.
Today, it takes little time or money to get started as an investor. You can set up a recurring transfer from your bank account to an investment account in perhaps 15 minutes. Don’t have much money for an initial investment? Financial firms like Charles Schwab and Fidelity Investments have mutual funds with no required investment minimum.
Once you have a regular savings program established, it isn’t going to eat up a lot of time—and, before too long, you should reach a tipping point, where your yearly investment return is more than your annual deposits, and your nest egg’s growth becomes exponential. Saving regularly will also give you a sense of control over your finances and your life, boosting happiness.
2. Exercise regularly. This has been proven to significantly reduce the risk of heart disease, strokes and various types of cancer. It can also improve your mood, give you more energy and improve the quality of your sleep. Some research indicates exercise even boosts concentration and learning. And, of course, it lowers medical costs.
If you’re starting an exercise habit from scratch, start simple. There’s no need to join the gym or spend a ton of money on a personal trainer. Something as simple as brisk walking for 30 minutes a day has been shown to deliver vast health improvements and trigger weight loss. As with saving and investing, the longer you can keep at it, the greater the return.
3. Eat well. This also has multiple benefits. A healthy diet can protect the human body against certain types of diseases, especially noncommunicable diseases such as obesity, diabetes, cardiovascular diseases, some types of cancer and skeletal conditions. It has also been shown to improve mental health. As with exercise, a healthy diet gives you more energy and helps you sleep better.
I avoid processed food as much as possible and limit my alcohol to an occasional glass of wine. I also adjust my diet based on my activity level. On days I play tennis or take long hikes, I may spurge, while on a day when I don’t do much physical activity, I’ll eat less and only healthy foods. Because I was raised in Thailand, where the cuisine is one of the healthiest, with lots of fresh fruits, vegetables, herbs and spices, my taste buds developed early on to enjoy and prefer healthy foods.
Eating healthily has been more difficult for my husband Jim, who was raised on a typical American diet. But through great effort—accompanied by much bemoaning the loss of fried food—even his taste buds have changed over time. Indeed, eating healthily, like saving and exercising regularly, can seem like a struggle at first. But if you do these things on a consistent basis for long enough, not only will you reap huge rewards, but also they’ll become habits—and probably enjoyable habits—and you’ll come to do them with hardly a second thought.
Jiab Wasserman and her husband Jim, who also writes for HumbleDollar, currently live in Alicante, Spain. They blog about downshifting, personal finance and other aspects of retirement—as well as about their experience relocating to another country—at YourThirdLife.com. Head to Linktree to learn more about Jiab, and also check out her earlier articles.
A few weeks ago, we hiked a rugged coastal trail that’s part of a nature preserve, with an ancient Roman dock still partially visible. Along the coastline, you can also see how layers of sand have built up over the centuries, compacting together to form the breathtaking sandstone hills we enjoy today.
It’s a reminder of how small acts can have a significant impact over time. I’ve always liked the expression, “In one day, you can’t do much, but over a long period of time you can accomplish a lot.” Small acts can yield a high—and even exponential—return, given enough time.
Such returns aren’t just financial. Here are three small acts that, if performed regularly, can help us reap large rewards in the long run.
1. Save and invest every month. Thanks to the gender wealth gap, this is especially important for women. I started saving as soon as I got my first regular job. In 1993, I worked in a public library, where I earned slightly more than minimum wage. The job allowed me to contribute pretax dollars to a 457 plan. When I left the library, my balance was a bit under $2,000. Since then, I transferred it to an IRA and, the last time I checked, the balance was almost $10,000.
In all my subsequent jobs in financial services, and as my income increased, I would max out my 401(k) and continue to save regardless of the economic situation, whether it be boom or bust. In fact, recessions and the accompanying stock market decline were the best time to invest, because the same dollar amount had more stock market buying power. Even though financial independence wasn’t my goal—it wasn’t a popular notion, like it is today—my diligent saving fast-tracked my finances, allowing me to retire in my early 50s.
Today, it takes little time or money to get started as an investor. You can set up a recurring transfer from your bank account to an investment account in perhaps 15 minutes. Don’t have much money for an initial investment? Financial firms like Charles Schwab and Fidelity Investments have mutual funds with no required investment minimum.
Once you have a regular savings program established, it isn’t going to eat up a lot of time—and, before too long, you should reach a tipping point, where your yearly investment return is more than your annual deposits, and your nest egg’s growth becomes exponential. Saving regularly will also give you a sense of control over your finances and your life, boosting happiness.
2. Exercise regularly. This has been proven to significantly reduce the risk of heart disease, strokes and various types of cancer. It can also improve your mood, give you more energy and improve the quality of your sleep. Some research indicates exercise even boosts concentration and learning. And, of course, it lowers medical costs.
If you’re starting an exercise habit from scratch, start simple. There’s no need to join the gym or spend a ton of money on a personal trainer. Something as simple as brisk walking for 30 minutes a day has been shown to deliver vast health improvements and trigger weight loss. As with saving and investing, the longer you can keep at it, the greater the return.
3. Eat well. This also has multiple benefits. A healthy diet can protect the human body against certain types of diseases, especially noncommunicable diseases such as obesity, diabetes, cardiovascular diseases, some types of cancer and skeletal conditions. It has also been shown to improve mental health. As with exercise, a healthy diet gives you more energy and helps you sleep better.
I avoid processed food as much as possible and limit my alcohol to an occasional glass of wine. I also adjust my diet based on my activity level. On days I play tennis or take long hikes, I may spurge, while on a day when I don’t do much physical activity, I’ll eat less and only healthy foods. Because I was raised in Thailand, where the cuisine is one of the healthiest, with lots of fresh fruits, vegetables, herbs and spices, my taste buds developed early on to enjoy and prefer healthy foods.
Eating healthily has been more difficult for my husband Jim, who was raised on a typical American diet. But through great effort—accompanied by much bemoaning the loss of fried food—even his taste buds have changed over time. Indeed, eating healthily, like saving and exercising regularly, can seem like a struggle at first. But if you do these things on a consistent basis for long enough, not only will you reap huge rewards, but also they’ll become habits—and probably enjoyable habits—and you’ll come to do them with hardly a second thought.
Jiab Wasserman and her husband Jim, who also writes for HumbleDollar, currently live in Alicante, Spain. They blog about downshifting, personal finance and other aspects of retirement—as well as about their experience relocating to another country—at YourThirdLife.com. Head to Linktree to learn more about Jiab, and also check out her earlier articles.The post One Day at a Time appeared first on HumbleDollar.
February 17, 2021
Dueling Desires
MANY YEARS AGO, when I first developed an interest in financial planning, I read as much as I could on the subject. I distinctly remember being in a bookstore—remember them?—and looking at the myriad of personal finance books. Two stuck out.
The first book purported to show how to maximize your spending throughout retirement and die with nothing. The second book purported to help with the opposite strategy—leaving millions to your children. The stark dichotomy struck me then and it’s stayed with me ever since.
Indeed, among my family, friends and old colleagues, I’ve noticed the same twin desires at work in their retirement planning. They want to maximize their retirement income, but they also want to leave a legacy to their children. This often manifests itself in their concern about “leaving money on the table” if they die early in retirement. It’s an emotional response, reflecting our well-documented tendency to be loss averse. We spend our adult life working hard to accumulate retirement savings. Once we get there, it’s hard to let those assets go.
This instinct can impact three crucial decisions: whether to take a lump sum rather than guaranteed monthly pension payments, when to claim Social Security and whether to use part of our nest egg to buy income annuities. My contention: The choices many folks make could end up backfiring—leaving them with both less retirement income and a smaller estate.
Pensions. Like me, a number of my friends and former colleagues are eligible for traditional defined benefit pensions. We know we’re part of the lucky few, as those without pensions frequently remind us.
My old employer’s pension plan has an attractive “early retirement subsidy” that allows retirees who meet certain criteria to retire with a full pension at age 60, instead of 65. Retirees are eligible to take their pension as either a monthly annuity or a lump sum. The lump sum calculation, however, doesn’t include the early retirement subsidy. Result: For a 60-year-old retiree, the present value of the subsidized monthly annuity is about 33% larger than the lump sum.
To me, the choice seemed obvious: Take the higher valued monthly annuity. It’ll provide steady income for my wife and me. But what seemed obvious to me wasn’t obvious to my old colleagues: They expressed the concern that, if they and their spouse die early in retirement, their children will get nothing if they opted for the monthly pension.
Social Security. Folks raise similar concerns about Social Security. Many financial planners believe retirees should delay claiming Social Security to get the largest benefit possible. This is especially true for married couples. By delaying the main breadwinner’s benefit until age 70, the couple will lock in the largest possible payment for both the retiree and the surviving spouse.
Boston College’s Center for Retirement Research has an excellent paper that explains how delaying Social Security is akin to purchasing an income annuity. More recently, the researchers there released another paper attempting to quantify the value of delaying. Both studies clearly show the financial value of claiming Social Security later—and yet many retirees take benefits early, fearful they’ll die young and “leave money on the table.”
Income annuities. Sold by insurance companies, these have the potential to play an important role in our retirement income plans. Last year, HumbleDollar’s James McGlynn published an excellent article describing how he’s integrated annuities into his retirement income plan.
Single premium immediate annuities—so called because you make a single investment in return for a predictable income stream—can be used to generate lifetime income or to cover a specified number of years. I’m considering buying them to provide income from age 65 until I claim Social Security at age 70. I’m also considering buying a qualified longevity annuity contract—a form of deferred income annuity—to provide income later in retirement. Both of these require giving a chunk of our portfolio to an insurance company in return for a guaranteed income stream.
Locking in a hefty amount of guaranteed income, whether from a pension, Social Security or income annuities, can greatly strengthen a retirement plan. On top of that, if you have guaranteed income to cover your regular expenses, you can take more risk with your portfolio by investing a higher percentage in stocks. Over a retirement that might last 20 or 30 years, that should mean better portfolio performance and potentially a far larger inheritance for your children.
In other words, avoiding income annuities, claiming Social Security early and opting for a lump sum payout from a pension plan might seem like the best strategy for leaving a legacy and generating a healthy amount of retirement income. But there’s a good chance that just the opposite will turn out to be true—and that, by locking in a healthy steam of guaranteed retirement income, you’ll end up leaving more money to your kids.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.
The first book purported to show how to maximize your spending throughout retirement and die with nothing. The second book purported to help with the opposite strategy—leaving millions to your children. The stark dichotomy struck me then and it’s stayed with me ever since.
Indeed, among my family, friends and old colleagues, I’ve noticed the same twin desires at work in their retirement planning. They want to maximize their retirement income, but they also want to leave a legacy to their children. This often manifests itself in their concern about “leaving money on the table” if they die early in retirement. It’s an emotional response, reflecting our well-documented tendency to be loss averse. We spend our adult life working hard to accumulate retirement savings. Once we get there, it’s hard to let those assets go.
This instinct can impact three crucial decisions: whether to take a lump sum rather than guaranteed monthly pension payments, when to claim Social Security and whether to use part of our nest egg to buy income annuities. My contention: The choices many folks make could end up backfiring—leaving them with both less retirement income and a smaller estate.
Pensions. Like me, a number of my friends and former colleagues are eligible for traditional defined benefit pensions. We know we’re part of the lucky few, as those without pensions frequently remind us.
My old employer’s pension plan has an attractive “early retirement subsidy” that allows retirees who meet certain criteria to retire with a full pension at age 60, instead of 65. Retirees are eligible to take their pension as either a monthly annuity or a lump sum. The lump sum calculation, however, doesn’t include the early retirement subsidy. Result: For a 60-year-old retiree, the present value of the subsidized monthly annuity is about 33% larger than the lump sum.
To me, the choice seemed obvious: Take the higher valued monthly annuity. It’ll provide steady income for my wife and me. But what seemed obvious to me wasn’t obvious to my old colleagues: They expressed the concern that, if they and their spouse die early in retirement, their children will get nothing if they opted for the monthly pension.
Social Security. Folks raise similar concerns about Social Security. Many financial planners believe retirees should delay claiming Social Security to get the largest benefit possible. This is especially true for married couples. By delaying the main breadwinner’s benefit until age 70, the couple will lock in the largest possible payment for both the retiree and the surviving spouse.
Boston College’s Center for Retirement Research has an excellent paper that explains how delaying Social Security is akin to purchasing an income annuity. More recently, the researchers there released another paper attempting to quantify the value of delaying. Both studies clearly show the financial value of claiming Social Security later—and yet many retirees take benefits early, fearful they’ll die young and “leave money on the table.”
Income annuities. Sold by insurance companies, these have the potential to play an important role in our retirement income plans. Last year, HumbleDollar’s James McGlynn published an excellent article describing how he’s integrated annuities into his retirement income plan.
Single premium immediate annuities—so called because you make a single investment in return for a predictable income stream—can be used to generate lifetime income or to cover a specified number of years. I’m considering buying them to provide income from age 65 until I claim Social Security at age 70. I’m also considering buying a qualified longevity annuity contract—a form of deferred income annuity—to provide income later in retirement. Both of these require giving a chunk of our portfolio to an insurance company in return for a guaranteed income stream.
Locking in a hefty amount of guaranteed income, whether from a pension, Social Security or income annuities, can greatly strengthen a retirement plan. On top of that, if you have guaranteed income to cover your regular expenses, you can take more risk with your portfolio by investing a higher percentage in stocks. Over a retirement that might last 20 or 30 years, that should mean better portfolio performance and potentially a far larger inheritance for your children.
In other words, avoiding income annuities, claiming Social Security early and opting for a lump sum payout from a pension plan might seem like the best strategy for leaving a legacy and generating a healthy amount of retirement income. But there’s a good chance that just the opposite will turn out to be true—and that, by locking in a healthy steam of guaranteed retirement income, you’ll end up leaving more money to your kids.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.The post Dueling Desires appeared first on HumbleDollar.
February 16, 2021
Change Gets Old
RETIREMENT RULES seem to get revised almost every year. Whether it’s IRAs, Roth IRAs or Social Security, Congress is constantly rewriting the regulations.
Just think about what’s happened over the past half-a-dozen years. The Bipartisan Budget Act of 2015 eliminated the “file and suspend” option for Social Security recipients. Savvy financial planners would advise clients who had reached their full Social Security retirement age to file for benefits, so their husband or wife could receive spousal benefits. The filers would then suspend their own benefit and continue to accrue delayed retirement credits until age 70.
But the politicians nixed this option, viewing it as unduly beneficial for wealthy and savvy filers. For now, you can still file a “restricted application”—where you apply for spousal benefits, but not benefits based on your own earnings record—but only if you were born before 1954. By 2024, even this loophole will no longer be useful, because those who could take advantage will have reached 70, the oldest age for claiming benefits.
In 2018, the Tax Cuts and Jobs Act eliminated the ability to recharacterize a traditional IRA that had been converted to a Roth. A recharacterization allowed you to reverse the transaction later in the year, which could be advantageous if you were facing a steep tax bill on a large Roth conversion—but the sum converted was now worth substantially less because of a stock market decline.
In 2020, the Secure Act gave us further changes, including ending the stretch IRA for most beneficiaries and raising the starting age for required minimum distributions (RMDs) from 70½ to 72. With the stretch IRA, beneficiaries could draw down an inherited IRA over their life expectancy, thus potentially squeezing decades of extra tax-deferred growth out of the account. Congress viewed this as mostly an estate planning tool for the rich and reduced the deferral period to a maximum 10 years.
What to do? Traditional IRA beneficiaries might withdraw a tenth of the inherited account each year over those 10 years, thereby avoiding the hefty tax bill triggered by withdrawing a large lump sum all at once, which would likely push them into a much higher tax bracket. Meanwhile, those who inherit Roth accounts should leave the account to grow tax-free, only withdrawing the balance at the end of the 10 years.
The 2020 Secure Act also raised the RMD start age from 70½ to 72, giving account holders an additional 18 months to defer distributions. (Even though the RMD beginning age was raised to 72, qualified charitable distributions can still be done starting at age 70½, a strange mismatch that Congress should probably fix.)
By raising the required minimum distribution start age to 72, retirees don’t just enjoy another 18 months of tax deferral. They’ll also have another 18 months to convert part of their IRA to a Roth without worrying about those RMDs. If you convert part of an IRA to a Roth in a year when you’re taking RMDs, the sum converted counts as additional taxable income on top of the required distribution—and will potentially get taxed at a steep rate, making the conversion less appealing.
Coincidentally, the IRS is also updating the life expectancy tables used for determining RMDs, so the calculation starting in 2022 will reflect today’s longer life expectancy. For example, under the current Uniform Lifetime Table, a 72-year-old IRA owner uses a life expectancy of 25.6 years. If you divide 100 by that 25.6, you find that a 72-year-old must typically take a minimum distribution equal to 3.91% of his or her retirement account balance as of the prior year-end. The new calculation in 2022 raises the assumed life expectancy to 27.4 years, thus trimming the required withdrawal to 3.65%.
These two changes—raising the RMD age to 72 and revising the RMD tables to reflect longer life expectancy—result in a reduction in the sum that must be pulled from retirement accounts each year. That means retirees can leave larger amounts in their account as a financial backstop in case they enjoy an especially long life.
What’s next? There’s already bipartisan talk of raising the RMD age again, this time to 75, and potentially exempting IRAs worth $100,000 or less from the RMD rules. Congress has been very good at minor tweaks. What about bigger issues? The politicians haven’t been quite so good at those. Almost nothing has been done to address Social Security’s long-term funding issues, which will loom large a decade or so from now.
James McGlynn, CFA, RICP, is chief executive of
Next Quarter Century LLC
in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of
Retirement Planning Tips for Baby Boomers
. Check out his earlier articles.
Just think about what’s happened over the past half-a-dozen years. The Bipartisan Budget Act of 2015 eliminated the “file and suspend” option for Social Security recipients. Savvy financial planners would advise clients who had reached their full Social Security retirement age to file for benefits, so their husband or wife could receive spousal benefits. The filers would then suspend their own benefit and continue to accrue delayed retirement credits until age 70.
But the politicians nixed this option, viewing it as unduly beneficial for wealthy and savvy filers. For now, you can still file a “restricted application”—where you apply for spousal benefits, but not benefits based on your own earnings record—but only if you were born before 1954. By 2024, even this loophole will no longer be useful, because those who could take advantage will have reached 70, the oldest age for claiming benefits.
In 2018, the Tax Cuts and Jobs Act eliminated the ability to recharacterize a traditional IRA that had been converted to a Roth. A recharacterization allowed you to reverse the transaction later in the year, which could be advantageous if you were facing a steep tax bill on a large Roth conversion—but the sum converted was now worth substantially less because of a stock market decline.
In 2020, the Secure Act gave us further changes, including ending the stretch IRA for most beneficiaries and raising the starting age for required minimum distributions (RMDs) from 70½ to 72. With the stretch IRA, beneficiaries could draw down an inherited IRA over their life expectancy, thus potentially squeezing decades of extra tax-deferred growth out of the account. Congress viewed this as mostly an estate planning tool for the rich and reduced the deferral period to a maximum 10 years.
What to do? Traditional IRA beneficiaries might withdraw a tenth of the inherited account each year over those 10 years, thereby avoiding the hefty tax bill triggered by withdrawing a large lump sum all at once, which would likely push them into a much higher tax bracket. Meanwhile, those who inherit Roth accounts should leave the account to grow tax-free, only withdrawing the balance at the end of the 10 years.
The 2020 Secure Act also raised the RMD start age from 70½ to 72, giving account holders an additional 18 months to defer distributions. (Even though the RMD beginning age was raised to 72, qualified charitable distributions can still be done starting at age 70½, a strange mismatch that Congress should probably fix.)
By raising the required minimum distribution start age to 72, retirees don’t just enjoy another 18 months of tax deferral. They’ll also have another 18 months to convert part of their IRA to a Roth without worrying about those RMDs. If you convert part of an IRA to a Roth in a year when you’re taking RMDs, the sum converted counts as additional taxable income on top of the required distribution—and will potentially get taxed at a steep rate, making the conversion less appealing.
Coincidentally, the IRS is also updating the life expectancy tables used for determining RMDs, so the calculation starting in 2022 will reflect today’s longer life expectancy. For example, under the current Uniform Lifetime Table, a 72-year-old IRA owner uses a life expectancy of 25.6 years. If you divide 100 by that 25.6, you find that a 72-year-old must typically take a minimum distribution equal to 3.91% of his or her retirement account balance as of the prior year-end. The new calculation in 2022 raises the assumed life expectancy to 27.4 years, thus trimming the required withdrawal to 3.65%.
These two changes—raising the RMD age to 72 and revising the RMD tables to reflect longer life expectancy—result in a reduction in the sum that must be pulled from retirement accounts each year. That means retirees can leave larger amounts in their account as a financial backstop in case they enjoy an especially long life.
What’s next? There’s already bipartisan talk of raising the RMD age again, this time to 75, and potentially exempting IRAs worth $100,000 or less from the RMD rules. Congress has been very good at minor tweaks. What about bigger issues? The politicians haven’t been quite so good at those. Almost nothing has been done to address Social Security’s long-term funding issues, which will loom large a decade or so from now.
James McGlynn, CFA, RICP, is chief executive of
Next Quarter Century LLC
in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of
Retirement Planning Tips for Baby Boomers
. Check out his earlier articles.The post Change Gets Old appeared first on HumbleDollar.
February 15, 2021
Crossing the Stream
IT BEGAN AS A trickle. Now, it’s a flood—and my family’s been swept up in it. For the past decade, we’ve streamed on-demand movies and Netflix shows, but we also continued to pay far too much for live TV using either cable or satellite services. No longer.
As Jannette Collins noted in a recent article, there are now numerous internet streaming services, including some free options. Our family has used some of these, but we still kept costly TV service for live broadcasts of news, sports and first-run shows.
To be sure, some live TV internet streaming services offer nearly all the same channels as cable and satellite providers. But “nearly” is a problem, especially for sports fans. Out-of-market football games were one reason I resisted switching to a live TV streaming service. If you want to watch all live NFL games for a team outside your local market, you’ll need DirecTV—and you’ll pay dearly for it.
There are reports that DirecTV’s NFL contract ends in 2022, at which point more streaming options are expected. NFL’s own Game Pass subscription service lets you stream any game after a daylong wait. With sports fans, patience is a rare commodity. My spouse and I have a bottomless well of patience and willpower for investing, but little interest in watching day-old sports.
Quality concerns are the other reason I’ve waited to “cut the cord.” We have a solid home network with an internet connection that consistently delivers at least 50 megabits per second, my minimum bar for good live TV streaming. But for a good streaming experience, service providers also have to invest in reliable infrastructure, and that takes time.
I first tried live streaming baseball games on MLB.TV in 2011. For the first few years, the quality of MLB’s service was a bit rough. But MLB.TV has matured nicely. Today, its live games seem on par with cable or satellite, plus the service offers time-saving features I love.
Finally, I took the plunge in December with a free two-week trial to YouTube TV, a Google subscription service focused on delivering live and recorded TV programs from local broadcast channels, as well as popular cable and satellite channels. At $65 a month, it’s one of the more expensive live TV streaming options, but it offers all the channels we regularly use. We loved our trial experience so much that we kept it and ditched our satellite service, saving $80 a month. The YouTube TV app is available for nearly every device.
Before crossing into the world of streaming, there are two other considerations, each with a potential budget impact.
Internet data caps. The amount of data you use for an hour of streamed content will depend on the high definition (HD) resolutions available from your streaming services, and whether they’re supported by your TV and home network. Many home broadband internet providers cap free data at a terabyte (1,000 gigabytes) per month, which is fine today. On Netflix, you can stream around 12 to 15 hours of 1080P HD resolution movies every day before you hit that limit.
But that terabyte monthly data cap will look less generous as 4K and high-dynamic range TVs and content become mainstream, because it takes more data to stream that same hour of higher resolution, better-looking movies. If you want to avoid data cap fees or paying for unlimited internet data, look for streaming services that let you choose a lower resolution. As you ponder the issue, be mindful of work and school data usage, especially with many of us working from home during COVID-19.
Aggregate subscription costs. Tempted to spend some of your cord-cutting savings on additional streaming services? Content kings like Disney are airing new content first on their streaming services, increasing the appeal of these services. With many cinemas shuttered during the pandemic, even films that would have launched in theaters are appearing first on streaming services. Problem is, these additional subscriptions can quickly add up, turning your initial savings into a hole in your pocket—one that’s easy to overlook.
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.
As Jannette Collins noted in a recent article, there are now numerous internet streaming services, including some free options. Our family has used some of these, but we still kept costly TV service for live broadcasts of news, sports and first-run shows.
To be sure, some live TV internet streaming services offer nearly all the same channels as cable and satellite providers. But “nearly” is a problem, especially for sports fans. Out-of-market football games were one reason I resisted switching to a live TV streaming service. If you want to watch all live NFL games for a team outside your local market, you’ll need DirecTV—and you’ll pay dearly for it.
There are reports that DirecTV’s NFL contract ends in 2022, at which point more streaming options are expected. NFL’s own Game Pass subscription service lets you stream any game after a daylong wait. With sports fans, patience is a rare commodity. My spouse and I have a bottomless well of patience and willpower for investing, but little interest in watching day-old sports.
Quality concerns are the other reason I’ve waited to “cut the cord.” We have a solid home network with an internet connection that consistently delivers at least 50 megabits per second, my minimum bar for good live TV streaming. But for a good streaming experience, service providers also have to invest in reliable infrastructure, and that takes time.
I first tried live streaming baseball games on MLB.TV in 2011. For the first few years, the quality of MLB’s service was a bit rough. But MLB.TV has matured nicely. Today, its live games seem on par with cable or satellite, plus the service offers time-saving features I love.
Finally, I took the plunge in December with a free two-week trial to YouTube TV, a Google subscription service focused on delivering live and recorded TV programs from local broadcast channels, as well as popular cable and satellite channels. At $65 a month, it’s one of the more expensive live TV streaming options, but it offers all the channels we regularly use. We loved our trial experience so much that we kept it and ditched our satellite service, saving $80 a month. The YouTube TV app is available for nearly every device.
Before crossing into the world of streaming, there are two other considerations, each with a potential budget impact.
Internet data caps. The amount of data you use for an hour of streamed content will depend on the high definition (HD) resolutions available from your streaming services, and whether they’re supported by your TV and home network. Many home broadband internet providers cap free data at a terabyte (1,000 gigabytes) per month, which is fine today. On Netflix, you can stream around 12 to 15 hours of 1080P HD resolution movies every day before you hit that limit.
But that terabyte monthly data cap will look less generous as 4K and high-dynamic range TVs and content become mainstream, because it takes more data to stream that same hour of higher resolution, better-looking movies. If you want to avoid data cap fees or paying for unlimited internet data, look for streaming services that let you choose a lower resolution. As you ponder the issue, be mindful of work and school data usage, especially with many of us working from home during COVID-19.
Aggregate subscription costs. Tempted to spend some of your cord-cutting savings on additional streaming services? Content kings like Disney are airing new content first on their streaming services, increasing the appeal of these services. With many cinemas shuttered during the pandemic, even films that would have launched in theaters are appearing first on streaming services. Problem is, these additional subscriptions can quickly add up, turning your initial savings into a hole in your pocket—one that’s easy to overlook.
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 Crossing the Stream appeared first on HumbleDollar.
February 14, 2021
Senior Assumptions
THERE ARE ADVANTAGES to being old. We seniors can leverage the widespread perception that we’re all poor, incapable of decision-making and inept at using technology.
I have fun with this.
We recently went car shopping. As we left the house, my wife turned and said, “You’re going dressed like that?”
“What’s wrong with the way I look?” I’m in my well-worn jeans, flannel shirt, suspenders and battered baseball cap.
“You look like a pauper.”
Ah, but that’s the idea. I could sense the initial lack of enthusiasm by the Jaguar salesman. Imagine what he thought when my 80-year-old wife scrutinized the sales agreement and told him we were overcharged by $314.85. They sent us a check.
In the good old days, when my wife and I would go out to eat, we’d occasionally receive the bill with a discount applied. I would delight in asking why the discount. “It’s a senior discount,” I’m told, whereupon I’d ask how the server knows I’m a senior.
Discounts abound for older Americans, all under the assumption we need them without regard to actual income or wealth. I play golf a couple of times a week and receive a reduced fee simply because I’m over age 65. Think about that: I can afford to play golf as often as I want—and yet somebody else is willing to subsidize me.
A senior discount on public transportation is one thing. But on a cruise? Yes, those also exist.
My wife recently had dental surgery. The bill was nearly $3,000, but that’s before a senior discount brought it down to $1,950. Our income is higher than that of the typical oral surgeon.
We seniors even get a break on our taxes. Are you age 65 or older? For the 2021 tax year, your standard deduction is typically bumped up by $1,350 per person if you’re married and $1,700 if you’re single.
My favorite senior insult occurs when calling a customer service line. After the representative determines your age, the tone of the conversation changes. Sometimes, I feel like I’m back in first grade, as the teacher slowly repeats each point. On occasion, I make it known they aren’t talking to a child.
If the topic is technology, it gets worse quickly. Give me a break: Yes, I’m watching The Adventures of Ozzie and Harriet—but I’m streaming it via YouTube on my TV or iPad. Okay, an eight-year-old grandson showed me how to do it. But he only had to show me once.
Assumptions about us seniors go beyond our basic cognitive abilities. Didn’t you know all seniors struggle financially? Have you ever heard a politician who didn’t use that broad generalization?
Of course, there are seniors who reach retirement after a life of low income and then find retirement to be even worse. Certainly, many seniors do struggle. But while Social Security is the bulk of retirement income for half of all seniors, that doesn’t mean broad generalizations are appropriate. Overall, Social Security benefits represent about 33% of the income of the elderly.
Such data points rely heavily on surveys. That raises the question of whether respondents are using a uniform definition of income, such as including interest, dividends and various government subsidies. And keep in mind that income is not the same as assets. Based on her income, my elderly aunt applied for and received a freeze on her property taxes. Meanwhile, she owned two houses, as well as a condo in Florida.
Moreover, at least 50% of seniors are no worse off than many younger Americans. In fact, Americans age 65 to 74 have the country’s highest median and average net worth, with even older Americans not far behind. Maybe it’s all those discounts we receive.
A recent USA Today article concluded that older Americans are struggling financially because of the pandemic, noting that 68 million “rely” on Social Security and they received a modest 1.3% cost-of-living adjustment (COLA) because of “paltry inflation.” Who’ll challenge such broad generalizations? Let me start.
Thanks to the pandemic, many retired seniors are saving money because of the inability to travel, dine out and engage in other activities. In addition, many retirees tell me they’ve done quite well with their investments over the past year. And, no, not all 68 million older Americans rely on Social Security. What about that COLA that’s just 1.3% because of paltry inflation? Talk about stating the obvious. Isn’t a COLA supposed to reflect inflation?
The reality is, our view of senior Americans relies on often-repeated assumptions and generalizations. But while those assumptions might apply to 50% of us, they have an outsized influence—because we’ve bamboozled 100% of struggling younger Americans into picking up the discount and subsidy tab for 100% of us old codgers.
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 Senior Assumptions appeared first on HumbleDollar.
February 13, 2021
My Confession
BACK IN 2017, I wrote about an oddity in my portfolio—an actively managed mutual fund that I bought without much thought to how it fit with my overall financial goals. Today, I have a confession. That fund isn’t the only oddity I own. In the interest of transparency—and because I hope readers will find it instructive—here are five more oddities, plus the thinking behind each:
While I firmly believe that low-cost index funds are the best way to build wealth and I believe that stock-picking is a fool’s errand, I own about a dozen individual stocks.
While I firmly believe that diversification is critical, one of these stocks accounts for more than 10% of my portfolio.
While I believe in the potential for value stocks to outperform—a view I reiterated just six days ago—I don’t have an overweight to value stocks myself.
While I despise hybrid stock-bond funds and regularly caution against them, I actually own one of these funds.
While I advise against private investment partnerships—because of the high fees and uneven quality—I’ve participated in a handful of such investments.
How do I explain these inconsistencies? Don’t I believe my own advice? Am I knowingly violating key investment principles because I think I know better—not unlike investment manager Cliff Asness, who once suggested it was okay for investors to “sin a little”? No, I wholeheartedly believe in the investment principles I advocate and I’m not trying to outsmart them. Here’s how I think about my apparent inconsistencies:
1. Yes, I have a collection of individual stocks, but that paints a misleading picture. The overwhelming majority of my portfolio is in a simple mix of index funds that’s designed to weather the stock market’s ups and downs. That, in my opinion, is the most important thing—to get the big picture right. No portfolio is entirely free of oddities.
2. All but one of the individual stocks in my portfolio represent tiny percentages. Many are just 0.1%. So why bother with them at all? The truth is that these are all vestiges from earlier in my career when I worked as an equity analyst—that is, as a stock-picker.
I keep these stocks because they’re reminders of the counterintuitive reality of stock-picking. On the one hand, there’s no doubt that the rewards when you pick a winner can dwarf the returns of a humble index fund. Indeed, in recent years, it has seemed easy to pick winners. Companies like Apple and Amazon aren’t exactly secrets, and their stocks have done phenomenally well.
But that’s just one side of the stock-picking coin. Here’s the other: What the data show, time after time, is that it’s incredibly difficult to build a portfolio of market-beating stocks. When I look at my own portfolio, I see this in living color. I can pat myself on the back for buying Netflix years ago. But I can’t escape seeing GE alongside it.
I also can’t escape the memory of A123 Systems, an electric car battery maker that went to zero. If I had allocated my A123 investment to Tesla instead, it probably would have put my kids through college. The bottom line: There’s no experience like your own experience. Maybe I pay a small price for hanging on to this motley collection of stocks, but they’ve more than paid for themselves with the large role they play in my investment mindset.
3. Owning a big winner is great, but it can leave you in a tricky spot. Suppose you own one or more of the so-called FAANG stocks—Facebook, Apple, Amazon, Netflix and Google (a.k.a. Alphabet). When stocks like these deliver outsized returns, it can leave an investor with two less-than-ideal options: You either live with the risk inherent in an outsized position—or you pay capital gains taxes to reduce it.
The challenge: Looking forward, you never know whether a big bet is going to help or hurt. If you did, there wouldn’t be any question of whether to hold it or sell it. That’s the situation I’m in, and it explains my one hefty individual stock position. Since I don’t have a crystal ball, I've adopted a split-the-difference approach, selling some shares, donating some and holding some. The lesson: In managing your portfolio, there will inevitably be challenges and imperfections. Don't worry too much about these things. As noted in No. 1 above, worry more about the big picture.
4. In my work as a financial planner, I try to be my own guinea pig. That explains the stock-bond fund that I despise so much. I thought it would be a great all-in-one solution, but I’ve since discovered its many drawbacks. Unfortunately, I bought it during the last recession at a low price, so there would be a tax bite if I sold now. There is a silver lining, though. Like the individual stocks, it’s a reminder of what not to do. That’s a small price to pay if I can use this experience to help others avoid the same pitfall.
5. Real estate is a challenging asset class. Almost without exception, my own portfolio—and that of my clients—is invested in stocks, bonds and cash investments. But that leaves a big hole: real estate. Many investment advisors use real estate investment trusts (REITs) to fill this hole, but I’ve never found this to be a satisfying solution. The returns of publicly traded REITs aren’t much to write home about, while nontraded REITs are something the SEC has written about.
This explains the investment partnerships I’ve tried out. They’re all in real estate. The results? They’ve been pretty good, even after the high fees, but it’s been very uneven. One project owns the land under a supermarket. That’s delivered steady but unexceptional returns. Another built apartments in an up-and-coming area, and that provided a quick, positive return.
But offsetting that gain is another project that’s been mired for years in a zoning battle and may be a total loss. I still don’t recommend private funds of any kind, including real estate, private equity and hedge funds. I just don’t think that, on average, they’re worth the fees, the opacity and the risk. But if you do go down this road, be sure to diversify. That’s always important, but it’s even more important in this realm.
6. English philosopher Carveth Read said, “It’s better to be vaguely right than precisely wrong.” If you ask why I recommend an overweight to value stocks but haven’t implemented it myself, this is the reason. When building a portfolio, there are some things that are important—and some things that are really important.
In my view, asset allocation and diversification are most important. I work hard to get those right, and that’s where I focus most of my time. Meanwhile, a tilt toward value is more like the icing on the cake, rather than the cake itself. Yes, I should add it, and I know I’m giving something up because I haven’t done it yet. But in the end, this helps illustrate a reality for all of us as we manage our financial life: No question, it’s good to have a true north in terms of investment principles. But if you veer a little to the left or the right, it doesn’t make you a sinner. It just makes you human.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
Want a happier retirement? Mike Drak looks back on the fallout from the pandemic—and spies eight lessons that can help us to be better prepared for retirement.
"I have yet to decide how I feel about these young adults incurring debt," writes Catherine Horiuchi. "It seems obvious that 18-year-olds, who haven’t worked much, can’t understand the effort required to pay off loans."
Value stocks have lagged badly over the past decade, but historically they've outpaced growth stocks by 4.5 percentage points a year. "My view is that value is just resting, not dead," contends Adam Grossman.
Tempted by Tesla, bitcoin and today's other hot investments? Joe Kesler has six suggestions.
"Two friends asked me how to start investing," recounts Marc Bisbal Arias. "I found myself recommending index funds. That made me realize my holdings didn’t reflect my views—and prompted my portfolio makeover."
Your legacy includes not just your wealth, but also your life’s story and your values. Kathleen Rehl’s advice: Make sure those get passed along—by writing a legacy letter.
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.
While I firmly believe that low-cost index funds are the best way to build wealth and I believe that stock-picking is a fool’s errand, I own about a dozen individual stocks.
While I firmly believe that diversification is critical, one of these stocks accounts for more than 10% of my portfolio.
While I believe in the potential for value stocks to outperform—a view I reiterated just six days ago—I don’t have an overweight to value stocks myself.
While I despise hybrid stock-bond funds and regularly caution against them, I actually own one of these funds.
While I advise against private investment partnerships—because of the high fees and uneven quality—I’ve participated in a handful of such investments.
How do I explain these inconsistencies? Don’t I believe my own advice? Am I knowingly violating key investment principles because I think I know better—not unlike investment manager Cliff Asness, who once suggested it was okay for investors to “sin a little”? No, I wholeheartedly believe in the investment principles I advocate and I’m not trying to outsmart them. Here’s how I think about my apparent inconsistencies:
1. Yes, I have a collection of individual stocks, but that paints a misleading picture. The overwhelming majority of my portfolio is in a simple mix of index funds that’s designed to weather the stock market’s ups and downs. That, in my opinion, is the most important thing—to get the big picture right. No portfolio is entirely free of oddities.
2. All but one of the individual stocks in my portfolio represent tiny percentages. Many are just 0.1%. So why bother with them at all? The truth is that these are all vestiges from earlier in my career when I worked as an equity analyst—that is, as a stock-picker.
I keep these stocks because they’re reminders of the counterintuitive reality of stock-picking. On the one hand, there’s no doubt that the rewards when you pick a winner can dwarf the returns of a humble index fund. Indeed, in recent years, it has seemed easy to pick winners. Companies like Apple and Amazon aren’t exactly secrets, and their stocks have done phenomenally well.
But that’s just one side of the stock-picking coin. Here’s the other: What the data show, time after time, is that it’s incredibly difficult to build a portfolio of market-beating stocks. When I look at my own portfolio, I see this in living color. I can pat myself on the back for buying Netflix years ago. But I can’t escape seeing GE alongside it.
I also can’t escape the memory of A123 Systems, an electric car battery maker that went to zero. If I had allocated my A123 investment to Tesla instead, it probably would have put my kids through college. The bottom line: There’s no experience like your own experience. Maybe I pay a small price for hanging on to this motley collection of stocks, but they’ve more than paid for themselves with the large role they play in my investment mindset.
3. Owning a big winner is great, but it can leave you in a tricky spot. Suppose you own one or more of the so-called FAANG stocks—Facebook, Apple, Amazon, Netflix and Google (a.k.a. Alphabet). When stocks like these deliver outsized returns, it can leave an investor with two less-than-ideal options: You either live with the risk inherent in an outsized position—or you pay capital gains taxes to reduce it.
The challenge: Looking forward, you never know whether a big bet is going to help or hurt. If you did, there wouldn’t be any question of whether to hold it or sell it. That’s the situation I’m in, and it explains my one hefty individual stock position. Since I don’t have a crystal ball, I've adopted a split-the-difference approach, selling some shares, donating some and holding some. The lesson: In managing your portfolio, there will inevitably be challenges and imperfections. Don't worry too much about these things. As noted in No. 1 above, worry more about the big picture.
4. In my work as a financial planner, I try to be my own guinea pig. That explains the stock-bond fund that I despise so much. I thought it would be a great all-in-one solution, but I’ve since discovered its many drawbacks. Unfortunately, I bought it during the last recession at a low price, so there would be a tax bite if I sold now. There is a silver lining, though. Like the individual stocks, it’s a reminder of what not to do. That’s a small price to pay if I can use this experience to help others avoid the same pitfall.
5. Real estate is a challenging asset class. Almost without exception, my own portfolio—and that of my clients—is invested in stocks, bonds and cash investments. But that leaves a big hole: real estate. Many investment advisors use real estate investment trusts (REITs) to fill this hole, but I’ve never found this to be a satisfying solution. The returns of publicly traded REITs aren’t much to write home about, while nontraded REITs are something the SEC has written about.
This explains the investment partnerships I’ve tried out. They’re all in real estate. The results? They’ve been pretty good, even after the high fees, but it’s been very uneven. One project owns the land under a supermarket. That’s delivered steady but unexceptional returns. Another built apartments in an up-and-coming area, and that provided a quick, positive return.
But offsetting that gain is another project that’s been mired for years in a zoning battle and may be a total loss. I still don’t recommend private funds of any kind, including real estate, private equity and hedge funds. I just don’t think that, on average, they’re worth the fees, the opacity and the risk. But if you do go down this road, be sure to diversify. That’s always important, but it’s even more important in this realm.
6. English philosopher Carveth Read said, “It’s better to be vaguely right than precisely wrong.” If you ask why I recommend an overweight to value stocks but haven’t implemented it myself, this is the reason. When building a portfolio, there are some things that are important—and some things that are really important.
In my view, asset allocation and diversification are most important. I work hard to get those right, and that’s where I focus most of my time. Meanwhile, a tilt toward value is more like the icing on the cake, rather than the cake itself. Yes, I should add it, and I know I’m giving something up because I haven’t done it yet. But in the end, this helps illustrate a reality for all of us as we manage our financial life: No question, it’s good to have a true north in terms of investment principles. But if you veer a little to the left or the right, it doesn’t make you a sinner. It just makes you human.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
Want a happier retirement? Mike Drak looks back on the fallout from the pandemic—and spies eight lessons that can help us to be better prepared for retirement.
"I have yet to decide how I feel about these young adults incurring debt," writes Catherine Horiuchi. "It seems obvious that 18-year-olds, who haven’t worked much, can’t understand the effort required to pay off loans."
Value stocks have lagged badly over the past decade, but historically they've outpaced growth stocks by 4.5 percentage points a year. "My view is that value is just resting, not dead," contends Adam Grossman.
Tempted by Tesla, bitcoin and today's other hot investments? Joe Kesler has six suggestions.
"Two friends asked me how to start investing," recounts Marc Bisbal Arias. "I found myself recommending index funds. That made me realize my holdings didn’t reflect my views—and prompted my portfolio makeover."
Your legacy includes not just your wealth, but also your life’s story and your values. Kathleen Rehl’s advice: Make sure those get passed along—by writing a legacy letter.
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 My Confession appeared first on HumbleDollar.
