Jonathan Clements's Blog, page 299
February 1, 2021
January’s Hits
MANAGING OUR finances should be a year-round endeavor—but there's something about a new year that gets folks thinking about money. In each of the past four years, HumbleDollar has seen a surge of traffic in January and that was true again this year, with readers perusing a record 403,000 of the site's pages last month. These were January's seven most popular articles:
"I’m going to focus my days more on living and less on investing," writes Dennis Friedman. "I’m going to enjoy my money instead of fretting about it. That’s my 2021 New Year’s resolution."
Retired and trying to figure out how much you can safely withdraw from your portfolio each year? Brian White discusses three popular approaches—and names his favorite.
HumbleDollar’s Bill Ehart spent time with financial expert Ben Carlson—and came away with five key insights.
How much income do you need in retirement and how much can you safely withdraw from your portfolio? Those are the two big retirement debates—and Dick Quinn finds them maddening.
If you died suddenly, would your family struggle to understand your finances? Adam Grossman's advice: Draw up a one-page summary explaining where everything can be found.
"If you really want to understand finance, formulas are helpful—and I don’t discount their value—but equally important is an understanding of psychology," writes Adam Grossman, who highlights four key ideas.
Starting at age 55, James McGlynn has converted part of his traditional IRA to a Roth each year. That's meant juggling a host of considerations—everything from QLACs to IRMAA to QCDs.
January also saw big traffic for some articles published in late December, including Hits 2017-20, Ten Tips for 2021 and Ten Years Retired. Meanwhile, last month's most popular newsletters were Don't Overdo It and Why We Go Wrong.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.
"I’m going to focus my days more on living and less on investing," writes Dennis Friedman. "I’m going to enjoy my money instead of fretting about it. That’s my 2021 New Year’s resolution."
Retired and trying to figure out how much you can safely withdraw from your portfolio each year? Brian White discusses three popular approaches—and names his favorite.
HumbleDollar’s Bill Ehart spent time with financial expert Ben Carlson—and came away with five key insights.
How much income do you need in retirement and how much can you safely withdraw from your portfolio? Those are the two big retirement debates—and Dick Quinn finds them maddening.
If you died suddenly, would your family struggle to understand your finances? Adam Grossman's advice: Draw up a one-page summary explaining where everything can be found.
"If you really want to understand finance, formulas are helpful—and I don’t discount their value—but equally important is an understanding of psychology," writes Adam Grossman, who highlights four key ideas.
Starting at age 55, James McGlynn has converted part of his traditional IRA to a Roth each year. That's meant juggling a host of considerations—everything from QLACs to IRMAA to QCDs.
January also saw big traffic for some articles published in late December, including Hits 2017-20, Ten Tips for 2021 and Ten Years Retired. Meanwhile, last month's most popular newsletters were Don't Overdo It and Why We Go Wrong.
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 January’s Hits appeared first on HumbleDollar.
January 31, 2021
Street Brawl
EVERY SO OFTEN, an arcane topic jumps from obscurity into the headlines. Such was the case last week when everyone was suddenly talking about the “short squeeze” on Wall Street. Below I’ll explain what happened and offer four thoughts on how to respond.
What does it mean to short a stock? In simple terms, it means you’re betting a stock will decline in price.
How does one accomplish this? First, you borrow the stock from another investor who owns it. Then you sell it. But, of course, you'll eventually need to return the stock to its original owner, so you'll have to buy it back later. Since you're betting that the price is going to drop, your hope is to pay less when you buy back the shares and then keep the difference. Suppose you sell a stock for $10. If you can buy it back later for $8, you've made a $2 profit.
How do you borrow a stock from another investor? The most common lenders are mutual funds, which lend out their holdings in exchange for “rental” fees. For some mutual funds, this rental income can be substantial. In fact, there have been cases in which an index fund has beaten its own index—a seemingly impossible feat. They can accomplish this, in part, by earning income from lending out their holdings. In 2019, Vanguard’s Total Stock Market Index Fund pulled in more than $150 million this way.
What is the risk in short-selling? In the example above, an investor borrows and sells a stock at $10, and later buys it back at $8, happily earning a profit of $2 when the price drops. But what if the price goes up instead? Then the short seller has a problem, because he or she still needs to buy the stock back to return it to its owner. The higher the stock goes, the bigger the problem is. Suppose the stock goes from $10 to $15. The short seller is looking at a loss of $5 per share. What if it goes to $25? The prospective loss grows to $15. And it could get far worse: Short sellers are exposed to potentially unlimited losses.
What is a short squeeze? When the price of a stock rises significantly, short sellers begin to panic. Recognizing they could be completely wiped out, short sellers scramble to buy back shares, so they can limit their losses. But this isn’t always easy. If a stock is widely shorted—known as a having a high “short interest”—there may not be enough shares available to buy back. This causes the panicked short seller to bid even more for the stock, hoping to capture shares at any price. This causes the price to go yet higher, inflicting further stress on other short sellers. The cycle intensifies as the price heads higher and higher.
What happened most recently? A group of investors on a message board called WallStreetBets started discussing stocks with high levels of short interest, including money-losing video game retailer GameStop. It’s difficult to say how many investors it took to initiate the squeeze on GameStop, but aggregate trading volume paints a picture.
Most days, fewer than 10 million shares change hands. But last week it grew to nearly 200 million shares. Along the way, GameStop’s share price rose geometrically. A few weeks ago, it was trading under $20 a share, but on Monday of last week it topped $75. On Tuesday, it nearly doubled to $148. On Wednesday, it was close to $350. On Thursday, it topped $450 in pre-market trading before dropping back. On Friday morning, it nearly doubled again in the first 15 minutes of trading and ended the regular trading day around $325.
How bad did the short squeeze become? It’s hard to quantify the losses. But what’s known is that two hedge funds threw in the towel on their short bets. At least one fund, Melvin Capital, was forced to accept a multi-billion-dollar lifeline and had to deny rumors it was headed for bankruptcy.
What happened from there? Almost immediately, opinions came in from all sides. One government regulator called for a 30-day trading moratorium on GameStop shares. But on Thursday, when the broker Robinhood implemented a ban on purchasing GameStop and other similarly targeted stocks—a ban that I thought made good sense—it was met with vitriol from those who viewed it as an attack on the rights of small investors. Late in the week, a class-action lawsuit was filed against this broker. Many politicians called on the SEC to investigate.
Why did this happen now? It’s usually hard to pinpoint the origin of a mania. In a lot of ways, the past week’s frenzy is just a continuation of what we saw last year, with a booming stock market fed by the advent of zero-commission trading, internet personalities who say "stocks always go up" and millions of people with more free time working from home.
But in this case, it’s possible to trace the origins. Since 2019, members of the WallStreetBets message board have been discussing GameStop. About three months ago, one member of the WallStreetBets message board put together a video in which he outlined the exact scenario that played out with GameStop.
How should you as an individual investor respond to all this? These are my recommendations:
Be careful of FOMO—the fear of missing out. I’m sure fortunes were made last week, and it may look like easy money. But this isn’t investing. I’m not sure it even deserves to be called speculation. One famous investor called it “unnatural, insane and dangerous.” That sums it up well. I’d stay far away from it.
If you’re fortunate enough to own a stock that’s run up hundreds of percent, I’d sell it immediately. Yes, it could go higher and you might get a better price later. But to state the obvious, it could easily go the other way—quickly.
Don’t get scared out of the stock market. One of the unfortunate side effects of manias: They scare sane people and can cause them to become overly cautious. If the current mania makes you uneasy about the stock market, that’s understandable, and I’m right there with you. But I would urge you to stick to your plan. As we saw last year, the market has a mind of its own and rarely responds in a predictable way. Don’t let the recent madness knock you off course. I would stick with your asset allocation and try to tune out the noise.
Be prepared for more volatility. When I watched the WallStreetBets video referenced above, it reminded me of the children's movie in which the villain has a plan to steal the Moon. It seemed delusional, and yet it actually happened. A loosely connected group of small investors used the power of online message boards and social media in a way that nearly brought down at least two multi-billion-dollar hedge funds. This isn’t something we’ve seen before, but I suspect we’ll see more of 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.
What does it mean to short a stock? In simple terms, it means you’re betting a stock will decline in price.
How does one accomplish this? First, you borrow the stock from another investor who owns it. Then you sell it. But, of course, you'll eventually need to return the stock to its original owner, so you'll have to buy it back later. Since you're betting that the price is going to drop, your hope is to pay less when you buy back the shares and then keep the difference. Suppose you sell a stock for $10. If you can buy it back later for $8, you've made a $2 profit.
How do you borrow a stock from another investor? The most common lenders are mutual funds, which lend out their holdings in exchange for “rental” fees. For some mutual funds, this rental income can be substantial. In fact, there have been cases in which an index fund has beaten its own index—a seemingly impossible feat. They can accomplish this, in part, by earning income from lending out their holdings. In 2019, Vanguard’s Total Stock Market Index Fund pulled in more than $150 million this way.
What is the risk in short-selling? In the example above, an investor borrows and sells a stock at $10, and later buys it back at $8, happily earning a profit of $2 when the price drops. But what if the price goes up instead? Then the short seller has a problem, because he or she still needs to buy the stock back to return it to its owner. The higher the stock goes, the bigger the problem is. Suppose the stock goes from $10 to $15. The short seller is looking at a loss of $5 per share. What if it goes to $25? The prospective loss grows to $15. And it could get far worse: Short sellers are exposed to potentially unlimited losses.
What is a short squeeze? When the price of a stock rises significantly, short sellers begin to panic. Recognizing they could be completely wiped out, short sellers scramble to buy back shares, so they can limit their losses. But this isn’t always easy. If a stock is widely shorted—known as a having a high “short interest”—there may not be enough shares available to buy back. This causes the panicked short seller to bid even more for the stock, hoping to capture shares at any price. This causes the price to go yet higher, inflicting further stress on other short sellers. The cycle intensifies as the price heads higher and higher.
What happened most recently? A group of investors on a message board called WallStreetBets started discussing stocks with high levels of short interest, including money-losing video game retailer GameStop. It’s difficult to say how many investors it took to initiate the squeeze on GameStop, but aggregate trading volume paints a picture.
Most days, fewer than 10 million shares change hands. But last week it grew to nearly 200 million shares. Along the way, GameStop’s share price rose geometrically. A few weeks ago, it was trading under $20 a share, but on Monday of last week it topped $75. On Tuesday, it nearly doubled to $148. On Wednesday, it was close to $350. On Thursday, it topped $450 in pre-market trading before dropping back. On Friday morning, it nearly doubled again in the first 15 minutes of trading and ended the regular trading day around $325.
How bad did the short squeeze become? It’s hard to quantify the losses. But what’s known is that two hedge funds threw in the towel on their short bets. At least one fund, Melvin Capital, was forced to accept a multi-billion-dollar lifeline and had to deny rumors it was headed for bankruptcy.
What happened from there? Almost immediately, opinions came in from all sides. One government regulator called for a 30-day trading moratorium on GameStop shares. But on Thursday, when the broker Robinhood implemented a ban on purchasing GameStop and other similarly targeted stocks—a ban that I thought made good sense—it was met with vitriol from those who viewed it as an attack on the rights of small investors. Late in the week, a class-action lawsuit was filed against this broker. Many politicians called on the SEC to investigate.
Why did this happen now? It’s usually hard to pinpoint the origin of a mania. In a lot of ways, the past week’s frenzy is just a continuation of what we saw last year, with a booming stock market fed by the advent of zero-commission trading, internet personalities who say "stocks always go up" and millions of people with more free time working from home.
But in this case, it’s possible to trace the origins. Since 2019, members of the WallStreetBets message board have been discussing GameStop. About three months ago, one member of the WallStreetBets message board put together a video in which he outlined the exact scenario that played out with GameStop.
How should you as an individual investor respond to all this? These are my recommendations:
Be careful of FOMO—the fear of missing out. I’m sure fortunes were made last week, and it may look like easy money. But this isn’t investing. I’m not sure it even deserves to be called speculation. One famous investor called it “unnatural, insane and dangerous.” That sums it up well. I’d stay far away from it.
If you’re fortunate enough to own a stock that’s run up hundreds of percent, I’d sell it immediately. Yes, it could go higher and you might get a better price later. But to state the obvious, it could easily go the other way—quickly.
Don’t get scared out of the stock market. One of the unfortunate side effects of manias: They scare sane people and can cause them to become overly cautious. If the current mania makes you uneasy about the stock market, that’s understandable, and I’m right there with you. But I would urge you to stick to your plan. As we saw last year, the market has a mind of its own and rarely responds in a predictable way. Don’t let the recent madness knock you off course. I would stick with your asset allocation and try to tune out the noise.
Be prepared for more volatility. When I watched the WallStreetBets video referenced above, it reminded me of the children's movie in which the villain has a plan to steal the Moon. It seemed delusional, and yet it actually happened. A loosely connected group of small investors used the power of online message boards and social media in a way that nearly brought down at least two multi-billion-dollar hedge funds. This isn’t something we’ve seen before, but I suspect we’ll see more of 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 Street Brawl appeared first on HumbleDollar.
January 30, 2021
Not What I Planned
I WROTE MY FIRST column for HumbleDollar four years ago. In that article, I described how a midlife divorce had forced me to learn as much as I could about investing and personal finance. As part of that education process, I spent hours creating spreadsheets designed to predict my financial health over the next decade.
Planning didn’t seem difficult back then because my life was quite simple. I shared a one-bedroom apartment with my elderly dog. I was saving nearly half my paycheck. I invested that money in a few low-cost mutual funds. I had a substantial amount of cash sitting in a credit union, which acted as my emergency fund.
I set up spreadsheets to forecast my retirement account balances and net worth. I had documents designed to predict the exact day I could leave fulltime work behind. I spent hours modeling a variety of scenarios for my future self, accounting for as many variables as possible.
I anticipated annual rent and salary increases. I guessed at future rates of inflation and taxation. I estimated how much I might spend on car maintenance, veterinary bills and utilities. Every time I thought of another variable, I added another line to my spreadsheets.
There was, however, one variable I didn’t accurately anticipate: life.
In the four years since I debuted on HumbleDollar, I’ve remarried. I’ve purchased two homes. I now live with four very active dogs. And while I still have the same job, a global pandemic—something I didn’t predict in any of my scenarios—has altered nearly every aspect of my workday. The only constant in my life? I still drive a 2007 Honda CRV.
Do I regret all the time I spent trying to predict a future that didn’t come close to matching my current reality? Not at all. As it turns out, I’m still meeting all the goals I identified four years ago, just in a much different way than I imagined.
Back then, I set a target of accumulating a $500,000 personal net worth before I turned age 55. Thanks to record high stock market levels, as well as increases in home equity values, I’ve easily exceeded that goal.
In 2017, my retirement account balance stood at $250,000. Even though I no longer contribute a high percentage of my paycheck to the account, the balance has continued to grow and currently sits at $410,000. Add in my share of the homes that my husband and I now own, as well as my savings account balance, and my net worth—at age 53—is just shy of $600,000.
I’m still on track to retire early. Four years ago, I had no idea where I’d live when I left my job. I didn’t know if I’d continue to rent or attempt to qualify for a mortgage. Now, housing isn’t much of a concern. My husband and I own a home in an Arizona retirement community, as well as a house in Portland, Oregon, where I currently work.
The biggest change I’ve experienced over the past four years? These days, I’m not so inclined to try to predict my future. Instead of obsessing about the unknown, I’m more focused on enjoying the pleasures that go along with living on a day-by-day basis.
Here are three key lessons I’ve learned over the past four years:
1. Focus on the big picture rather than the small details. When I tracked every facet of my financial life, I often found myself emotionally exhausted. Any unexpected expense I incurred made me worry I wouldn't be able to retire when I wanted. Stock market dips caused me to panic, believing my financial future was about to be derailed.
These days, I realize the only thing I need to focus on is my primary goal: Am I continuing to make progress toward a stable, comfortable retirement? The vision of what that retirement will look like, along with the path I take to get there, will no doubt continue to change. But for now, I've learned not to obsess about every fluctuation in my account balances, since I know I'm headed in the right direction.
2. Major life changes are easier when your financial foundation is solid. No debt, an excellent FICO credit score of 800 and a solid work history—including 23 years at my current job—all helped me to qualify easily for a mortgage. A sizable emergency fund meant not having to worry about the added expenses that go along with homeownership. Without that foundation in place, it's likely my life today would look very similar to the way it did four years ago.
3. Some things never change. Four years ago, I didn't have any credit card debt. Today, that's still true. I also continue to live within my means. Despite qualifying for a $403,000 mortgage two years ago, I chose to purchase a home for significantly less than that sum. I drive a 14-year-old car rather than spending several hundred dollars a month on a car payment.
The fundamentals of frugal living, which I've followed most of my life, have served me well. I have no intention of abandoning them, either now or in the future.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
Within five years of moving to the U.S., Pratima Gulati and her husband had amassed a $1 million net worth. Here's how they did it.
If you died suddenly, would your family struggle to understand your finances? Adam Grossman's advice: Draw up a one-page summary explaining where everything can be found.
To make sure she gets a full year of compounding, Jannette Collins made her 2021 contributions to her Roth IRA, solo 401(k) and health savings account in January. She explains what was involved.
"I’ve learned three lessons," writes Bill Ehart. "I’m not lucky. I can’t predict world events or the market’s reaction to them. Undiversified investment bets give me a few ways to win big and a lot of ways to lose."
Kenyon Sayler and his wife bought their first and only home in 1986—and had the mortgage paid off 11 years later. But were they smart to do so, or should they have stashed the money in stocks?
Sanjib Saha names his favorite financial book. It isn't about investing or personal finance.
Kristine Hayes is a departmental manager at a small, liberal arts college. She enjoys competitive pistol shooting and hanging out with her husband and their dogs. Check out Kristine's earlier articles.
Planning didn’t seem difficult back then because my life was quite simple. I shared a one-bedroom apartment with my elderly dog. I was saving nearly half my paycheck. I invested that money in a few low-cost mutual funds. I had a substantial amount of cash sitting in a credit union, which acted as my emergency fund.
I set up spreadsheets to forecast my retirement account balances and net worth. I had documents designed to predict the exact day I could leave fulltime work behind. I spent hours modeling a variety of scenarios for my future self, accounting for as many variables as possible.
I anticipated annual rent and salary increases. I guessed at future rates of inflation and taxation. I estimated how much I might spend on car maintenance, veterinary bills and utilities. Every time I thought of another variable, I added another line to my spreadsheets.
There was, however, one variable I didn’t accurately anticipate: life.
In the four years since I debuted on HumbleDollar, I’ve remarried. I’ve purchased two homes. I now live with four very active dogs. And while I still have the same job, a global pandemic—something I didn’t predict in any of my scenarios—has altered nearly every aspect of my workday. The only constant in my life? I still drive a 2007 Honda CRV.
Do I regret all the time I spent trying to predict a future that didn’t come close to matching my current reality? Not at all. As it turns out, I’m still meeting all the goals I identified four years ago, just in a much different way than I imagined.
Back then, I set a target of accumulating a $500,000 personal net worth before I turned age 55. Thanks to record high stock market levels, as well as increases in home equity values, I’ve easily exceeded that goal.
In 2017, my retirement account balance stood at $250,000. Even though I no longer contribute a high percentage of my paycheck to the account, the balance has continued to grow and currently sits at $410,000. Add in my share of the homes that my husband and I now own, as well as my savings account balance, and my net worth—at age 53—is just shy of $600,000.
I’m still on track to retire early. Four years ago, I had no idea where I’d live when I left my job. I didn’t know if I’d continue to rent or attempt to qualify for a mortgage. Now, housing isn’t much of a concern. My husband and I own a home in an Arizona retirement community, as well as a house in Portland, Oregon, where I currently work.
The biggest change I’ve experienced over the past four years? These days, I’m not so inclined to try to predict my future. Instead of obsessing about the unknown, I’m more focused on enjoying the pleasures that go along with living on a day-by-day basis.
Here are three key lessons I’ve learned over the past four years:
1. Focus on the big picture rather than the small details. When I tracked every facet of my financial life, I often found myself emotionally exhausted. Any unexpected expense I incurred made me worry I wouldn't be able to retire when I wanted. Stock market dips caused me to panic, believing my financial future was about to be derailed.
These days, I realize the only thing I need to focus on is my primary goal: Am I continuing to make progress toward a stable, comfortable retirement? The vision of what that retirement will look like, along with the path I take to get there, will no doubt continue to change. But for now, I've learned not to obsess about every fluctuation in my account balances, since I know I'm headed in the right direction.
2. Major life changes are easier when your financial foundation is solid. No debt, an excellent FICO credit score of 800 and a solid work history—including 23 years at my current job—all helped me to qualify easily for a mortgage. A sizable emergency fund meant not having to worry about the added expenses that go along with homeownership. Without that foundation in place, it's likely my life today would look very similar to the way it did four years ago.
3. Some things never change. Four years ago, I didn't have any credit card debt. Today, that's still true. I also continue to live within my means. Despite qualifying for a $403,000 mortgage two years ago, I chose to purchase a home for significantly less than that sum. I drive a 14-year-old car rather than spending several hundred dollars a month on a car payment.
The fundamentals of frugal living, which I've followed most of my life, have served me well. I have no intention of abandoning them, either now or in the future.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
Within five years of moving to the U.S., Pratima Gulati and her husband had amassed a $1 million net worth. Here's how they did it.
If you died suddenly, would your family struggle to understand your finances? Adam Grossman's advice: Draw up a one-page summary explaining where everything can be found.
To make sure she gets a full year of compounding, Jannette Collins made her 2021 contributions to her Roth IRA, solo 401(k) and health savings account in January. She explains what was involved.
"I’ve learned three lessons," writes Bill Ehart. "I’m not lucky. I can’t predict world events or the market’s reaction to them. Undiversified investment bets give me a few ways to win big and a lot of ways to lose."
Kenyon Sayler and his wife bought their first and only home in 1986—and had the mortgage paid off 11 years later. But were they smart to do so, or should they have stashed the money in stocks?
Sanjib Saha names his favorite financial book. It isn't about investing or personal finance.
Kristine Hayes is a departmental manager at a small, liberal arts college. She enjoys competitive pistol shooting and hanging out with her husband and their dogs. Check out Kristine's earlier articles.The post Not What I Planned appeared first on HumbleDollar.
January 29, 2021
Starting 2021 Right
AS SOON AS THE BALL dropped, ushering in the new year, I got my ball rolling, making contributions to three tax-favored accounts. Why did I do this in January? I like my investments to have all year to grow.
I go through the same routine every year, and it’s always a chore. I invariably forget what to do and, in any case, the steps involved often change.
The first account I contributed to was my Roth IRA. Since my income is too high to contribute directly to a Roth IRA, I do so via the “backdoor.” For that, you need two accounts: a traditional IRA and a Roth IRA conversion account. Here are the steps I took earlier this month:
I logged on to my traditional IRA and made an online ACH transfer from my bank account to my traditional IRA. (ACH stands for Automated Clearing House, which is a way to move money between banks without using paper checks, wire transfers, credit card networks or cash.) The 2021 IRA contribution limit is $6,000, plus $1,000 if you’re age 50 or older.
It’s easier if you set up the ACH link in advance. Otherwise, it might take several days to activate. Make sure you select the correct IRA contribution year and make sure your checking account balance is adequate before making the transfer.
When the transfer cleared, I converted the money from my traditional IRA to my Roth.
Next, I moved on to my solo 401(k), which is at TD Ameritrade. This is a 401(k) plan covering a business owner with no employees or the owner plus his or her spouse. It has the same rules and requirements as any other 401(k) plan. The business owner wears two hats with a solo 401(k)—employee and employer—and contributions can be made to the plan in both capacities.
The 2021 employee contribution limits are the same as with other 401(k) plans: $19,500, plus an additional $6,500 for those age 50 and over. You can also make an employer contribution, but it’ll be based on your income and you might not know what that number is until the end of the year. The employee account can be of the tax-deductible or Roth variety and is separate from the employer account, which is non-Roth only. Note: Your contribution can’t exceed your earned income. I made the full employee contribution in January as follows:
TD Ameritrade doesn’t allow ACH transfers into a solo 401(k), so I have to either wire money, which involves a fee, or submit a check. You can deliver a check to a local TD branch, which I used to do pre-pandemic, or mail a check.
When the check clears—I was amazed this took just five days from the time I mailed it—you can invest the money. I stashed the full employee amount in the Roth 401(k).
Finally, I contributed to my health savings account (HSA). If you have a qualifying high-deductible health insurance plan, you can make tax-deductible contributions to an HSA. The money can be invested in mutual funds and other securities, and then left to grow tax-free. Alternatively, you can withdraw the money tax-free to pay for qualified medical expenses.
If you opt to use non-HSA money to pay those medical expenses, the money in the HSA can grow for years. Keep your medical receipts and you can reimburse yourself with tax-free HSA withdrawals in the future. When used in this way, an HSA is referred to as a “stealth IRA.” Most health insurance providers will let you choose your HSA provider. Mine doesn’t. The process for Connect Your Care, where I have my HSA, is as follows:
Log on to the HSA site. Select “manage contributions” and then select “add contributions.” The 2021 limits are $3,600 for individuals and $7,200 for families, and you can contribute an extra $1,000 if you’re age 55 or older. The easiest way to make the contribution is online through an ACH transfer.
Once the transfer clears, invest the money. This year, the whole process took five days.
I can understand how all this can feel overwhelming, especially the first time around. You can, however, simplify the work in January by completing the following steps in advance:
Open the necessary accounts.
Have the logon and password information needed to access accounts online.
Set up ACH transfer capability from your checking or savings account to your retirement and health savings accounts.
Find out what the annual contribution limits are.
Make sure you have enough money in your bank accounts to cover the transfers.
Make a plan for how you’ll invest the contributions.
One last piece of advice: Keep step-by-step notes. Your future self will thank you.
Jannette Collins, MD, MEd, FACR is a radiologist and former chair of a university radiology department. Her previous article was Screening Choices. Janni's passions are finance and education. She is Director of Medical Content for
MRI Online
, an educational platform for radiologists, and blogs about radiology jobs, finance and education for
The Reading Room
. Follow Janni on Twitter
@JanniMD
.
I go through the same routine every year, and it’s always a chore. I invariably forget what to do and, in any case, the steps involved often change.
The first account I contributed to was my Roth IRA. Since my income is too high to contribute directly to a Roth IRA, I do so via the “backdoor.” For that, you need two accounts: a traditional IRA and a Roth IRA conversion account. Here are the steps I took earlier this month:
I logged on to my traditional IRA and made an online ACH transfer from my bank account to my traditional IRA. (ACH stands for Automated Clearing House, which is a way to move money between banks without using paper checks, wire transfers, credit card networks or cash.) The 2021 IRA contribution limit is $6,000, plus $1,000 if you’re age 50 or older.
It’s easier if you set up the ACH link in advance. Otherwise, it might take several days to activate. Make sure you select the correct IRA contribution year and make sure your checking account balance is adequate before making the transfer.
When the transfer cleared, I converted the money from my traditional IRA to my Roth.
Next, I moved on to my solo 401(k), which is at TD Ameritrade. This is a 401(k) plan covering a business owner with no employees or the owner plus his or her spouse. It has the same rules and requirements as any other 401(k) plan. The business owner wears two hats with a solo 401(k)—employee and employer—and contributions can be made to the plan in both capacities.
The 2021 employee contribution limits are the same as with other 401(k) plans: $19,500, plus an additional $6,500 for those age 50 and over. You can also make an employer contribution, but it’ll be based on your income and you might not know what that number is until the end of the year. The employee account can be of the tax-deductible or Roth variety and is separate from the employer account, which is non-Roth only. Note: Your contribution can’t exceed your earned income. I made the full employee contribution in January as follows:
TD Ameritrade doesn’t allow ACH transfers into a solo 401(k), so I have to either wire money, which involves a fee, or submit a check. You can deliver a check to a local TD branch, which I used to do pre-pandemic, or mail a check.
When the check clears—I was amazed this took just five days from the time I mailed it—you can invest the money. I stashed the full employee amount in the Roth 401(k).
Finally, I contributed to my health savings account (HSA). If you have a qualifying high-deductible health insurance plan, you can make tax-deductible contributions to an HSA. The money can be invested in mutual funds and other securities, and then left to grow tax-free. Alternatively, you can withdraw the money tax-free to pay for qualified medical expenses.
If you opt to use non-HSA money to pay those medical expenses, the money in the HSA can grow for years. Keep your medical receipts and you can reimburse yourself with tax-free HSA withdrawals in the future. When used in this way, an HSA is referred to as a “stealth IRA.” Most health insurance providers will let you choose your HSA provider. Mine doesn’t. The process for Connect Your Care, where I have my HSA, is as follows:
Log on to the HSA site. Select “manage contributions” and then select “add contributions.” The 2021 limits are $3,600 for individuals and $7,200 for families, and you can contribute an extra $1,000 if you’re age 55 or older. The easiest way to make the contribution is online through an ACH transfer.
Once the transfer clears, invest the money. This year, the whole process took five days.
I can understand how all this can feel overwhelming, especially the first time around. You can, however, simplify the work in January by completing the following steps in advance:
Open the necessary accounts.
Have the logon and password information needed to access accounts online.
Set up ACH transfer capability from your checking or savings account to your retirement and health savings accounts.
Find out what the annual contribution limits are.
Make sure you have enough money in your bank accounts to cover the transfers.
Make a plan for how you’ll invest the contributions.
One last piece of advice: Keep step-by-step notes. Your future self will thank you.
Jannette Collins, MD, MEd, FACR is a radiologist and former chair of a university radiology department. Her previous article was Screening Choices. Janni's passions are finance and education. She is Director of Medical Content for
MRI Online
, an educational platform for radiologists, and blogs about radiology jobs, finance and education for
The Reading Room
. Follow Janni on Twitter
@JanniMD
.The post Starting 2021 Right appeared first on HumbleDollar.
January 28, 2021
Home Free
MY SON AND HIS fiancée recently purchased their first home. They’ve asked me about things like how to fix a leaky faucet, but they haven’t asked me for financial advice—which is a good thing, because I’ve had very limited experience buying houses.
You see, my wife and I bought our first and only home in 1986. We paid $89,000, putting down $20,000 and taking out a $72,000 mortgage by the time we added in points, fees, taxes and the myriad other costs associated with a loan closing. Our interest rate was 8.5%.
We knew that we wanted to pay off the house early, so we started making extra principal payments. We also refinanced our mortgage twice as rates dropped. The upshot: We paid off the mortgage in 11 years.
But were we financially smart to do so? Remember, this was at the beginning of a long bull market. By paying the mortgage off early, we avoided some $88,000 in interest payments over what would have been the full life of the mortgage. That’s before factoring in the tax deduction for mortgage interest. If you figure that in, the savings might have been $65,000.
Had we had taken the $231.32 per month in extra principal we were paying on our mortgage—equal to more than $30,000 over 11 years—and instead directed it into the S&P 500, that $30,000 would have grown to $75,000 over the course of those 11 years. Throw in perhaps another $8,000 in dividends, and our $30,000 would have been worth $83,000 before taxes, and the sum would have continued to grow from there.
Or, to put it another way, the 8.5% interest rate we avoided, which was even less after our two refinancings, was well below the return we could have earned in the stock market. To be sure, investing in stocks is considerably riskier than avoiding interest by paying down a mortgage. Still, we clearly left money on the table.
So was it a good idea to pay off our mortgage early?
About two months before we made our last payment, the Fortune 500 company I was working for spun off 13% of its employees into a different corporate entity. Many of those employees subsequently lost their jobs.
A manager that I knew—who was making much more than I was as a junior engineer—confided to me that, if he lost his job, he only had about two months of living expenses saved. After that, he would be broke. He wouldn’t have just emptied his emergency fund, but literally he wouldn’t have any money to pay the bills.
Having a nearly fully paid off house gave us a tremendous psychological sense of well-being. My wife and I had also been frugal in other areas of our financial life, and we had both investment accounts and an emergency fund that would have allowed us to weather a long period of unemployment before we would come anywhere close to losing our home. I might lose my job. But I wasn’t going to be homeless, and we weren’t going to have to move and disrupt our children’s education.
So, if my son asked me if he should pay off his house early, what would I tell him? Make sure you have six months of living expenses in a very liquid form, such as a savings account or a money market fund. Make sure you’re contributing at least 10% of your salary to your employer’s 401(k), or more if that’s necessary to get the full employer match.
If you’re doing those two things, feel free to make extra principal payments with an eye to retiring your mortgage early. I have no idea what the stock market will do over the next 30 years. I do know that my son’s paying a historically low interest rate on his mortgage. Still, while I can’t place a dollar value on it, I know the peace of mind that comes from being mortgage-free—and he may be enormously grateful when the next economic downturn comes around.
Kenyon Sayler is a mechanical engineer at an international industrial firm. He and his wife Lisa are extraordinarily proud of their two adult sons. He enjoys walking his dog, traveling, reading and gardening.
You see, my wife and I bought our first and only home in 1986. We paid $89,000, putting down $20,000 and taking out a $72,000 mortgage by the time we added in points, fees, taxes and the myriad other costs associated with a loan closing. Our interest rate was 8.5%.
We knew that we wanted to pay off the house early, so we started making extra principal payments. We also refinanced our mortgage twice as rates dropped. The upshot: We paid off the mortgage in 11 years.
But were we financially smart to do so? Remember, this was at the beginning of a long bull market. By paying the mortgage off early, we avoided some $88,000 in interest payments over what would have been the full life of the mortgage. That’s before factoring in the tax deduction for mortgage interest. If you figure that in, the savings might have been $65,000.
Had we had taken the $231.32 per month in extra principal we were paying on our mortgage—equal to more than $30,000 over 11 years—and instead directed it into the S&P 500, that $30,000 would have grown to $75,000 over the course of those 11 years. Throw in perhaps another $8,000 in dividends, and our $30,000 would have been worth $83,000 before taxes, and the sum would have continued to grow from there.
Or, to put it another way, the 8.5% interest rate we avoided, which was even less after our two refinancings, was well below the return we could have earned in the stock market. To be sure, investing in stocks is considerably riskier than avoiding interest by paying down a mortgage. Still, we clearly left money on the table.
So was it a good idea to pay off our mortgage early?
About two months before we made our last payment, the Fortune 500 company I was working for spun off 13% of its employees into a different corporate entity. Many of those employees subsequently lost their jobs.
A manager that I knew—who was making much more than I was as a junior engineer—confided to me that, if he lost his job, he only had about two months of living expenses saved. After that, he would be broke. He wouldn’t have just emptied his emergency fund, but literally he wouldn’t have any money to pay the bills.
Having a nearly fully paid off house gave us a tremendous psychological sense of well-being. My wife and I had also been frugal in other areas of our financial life, and we had both investment accounts and an emergency fund that would have allowed us to weather a long period of unemployment before we would come anywhere close to losing our home. I might lose my job. But I wasn’t going to be homeless, and we weren’t going to have to move and disrupt our children’s education.
So, if my son asked me if he should pay off his house early, what would I tell him? Make sure you have six months of living expenses in a very liquid form, such as a savings account or a money market fund. Make sure you’re contributing at least 10% of your salary to your employer’s 401(k), or more if that’s necessary to get the full employer match.
If you’re doing those two things, feel free to make extra principal payments with an eye to retiring your mortgage early. I have no idea what the stock market will do over the next 30 years. I do know that my son’s paying a historically low interest rate on his mortgage. Still, while I can’t place a dollar value on it, I know the peace of mind that comes from being mortgage-free—and he may be enormously grateful when the next economic downturn comes around.
Kenyon Sayler is a mechanical engineer at an international industrial firm. He and his wife Lisa are extraordinarily proud of their two adult sons. He enjoys walking his dog, traveling, reading and gardening.The post Home Free appeared first on HumbleDollar.
January 27, 2021
Land of Opportunity
WE MOVED FROM INDIA to the U.S. in 2014 when my husband got a job with a Silicon Valley tech company—and we found ourselves living in one of the world’s most expensive places.
On top of that, when our daughter was born, I left the workforce for a few years to look after her, which meant we had a period when we lived on just one paycheck. Still, within five years of arriving in the U.S., our net worth had climbed from zero to more than $1 million. Here’s how we did it:
1. Pick the right employer. This makes sense anywhere, but it’s especially critical in the San Francisco Bay Area, where you need an income that matches the high cost of living. My husband and I decided he should ignore the charms of hot startups and instead stick with a big tech company with a staggering growth rate. As a former Google chief executive said, “If you’re offered a seat on a rocket ship, don’t ask what seat. Just get on.”
The top tech companies offer generous stock grants when you first sign on and they often award similar amounts of shares each year thereafter. Half of our net worth came from those stock grants. When the stock would vest, we’d sell it, putting the proceeds toward a house down payment and investing the rest in Vanguard Total Stock Market ETF.
2. Fund the 401(k). From the very first year, my husband maxed out his 401(k), earning a 6% match. This meant we were adding some $30,000 total each year to our net worth. Funding a 401(k) might sound like commonsense. But from what I’ve heard, a lot of new immigrants don’t contribute to their 401(k) for the first few years, because they don’t understand the benefits.
3. Live small. In Silicon Valley, we’re surrounded by people who are doing well financially. There’s constant pressure to “keep up with the Joneses.” But for our first three years in the Bay Area, we lived in a small one-bedroom apartment that we sublet from a friend.
When it came time to buy, we skipped the big expensive house and opted for an older 988-square-foot condo. That meant the mortgage payments were affordable, allowing us to invest every month in the stock market. It also gave us the financial breathing room so I could take time away from work when the baby was born. The condo is now worth 15% more than what we paid.
4. Drive cheap. When we arrived in the U.S., we bought a 2014 Nissan Altima. It was a certified preowned car purchased directly from Nissan, it came with a one-year warranty—and it’s still a part of our family.
We’ve been tempted many times to buy a Tesla. We avoided test-driving one until a few years ago, fearing we wouldn’t be able to resist—but, so far, we have. Our Nissan is holding its value and has enough space for the three of us. When grandparents visit, it isn’t difficult to rent an SUV.
5. Love the index. We’ve contributed 20% of our base pay to the Vanguard index fund over the past five years. That’s on top of the money we’ve invested when we sold my husband’s vested stock. Admittedly, we check our portfolio often—sometimes daily—but we’ve managed to control ourselves and not panic sell in response to market moves.
6. Put savings first. My husband and I find budgeting boring. But thanks to our relatively modest lifestyle, we don’t have to. We follow the "pay yourself first" method, investing automatically in all kinds of financial accounts, including a health savings account, an employee stock purchase plan, a 529 savings plan and a “future vacation” savings account. Every paycheck, we also pay off all outstanding credit card bills. We’re then free to use whatever’s left for discretionary “fun” spending.
Pratima Gulati is a human resource professional in Silicon Valley. She has an MBA and a keen interest in personal finance.
On top of that, when our daughter was born, I left the workforce for a few years to look after her, which meant we had a period when we lived on just one paycheck. Still, within five years of arriving in the U.S., our net worth had climbed from zero to more than $1 million. Here’s how we did it:
1. Pick the right employer. This makes sense anywhere, but it’s especially critical in the San Francisco Bay Area, where you need an income that matches the high cost of living. My husband and I decided he should ignore the charms of hot startups and instead stick with a big tech company with a staggering growth rate. As a former Google chief executive said, “If you’re offered a seat on a rocket ship, don’t ask what seat. Just get on.”
The top tech companies offer generous stock grants when you first sign on and they often award similar amounts of shares each year thereafter. Half of our net worth came from those stock grants. When the stock would vest, we’d sell it, putting the proceeds toward a house down payment and investing the rest in Vanguard Total Stock Market ETF.
2. Fund the 401(k). From the very first year, my husband maxed out his 401(k), earning a 6% match. This meant we were adding some $30,000 total each year to our net worth. Funding a 401(k) might sound like commonsense. But from what I’ve heard, a lot of new immigrants don’t contribute to their 401(k) for the first few years, because they don’t understand the benefits.
3. Live small. In Silicon Valley, we’re surrounded by people who are doing well financially. There’s constant pressure to “keep up with the Joneses.” But for our first three years in the Bay Area, we lived in a small one-bedroom apartment that we sublet from a friend.
When it came time to buy, we skipped the big expensive house and opted for an older 988-square-foot condo. That meant the mortgage payments were affordable, allowing us to invest every month in the stock market. It also gave us the financial breathing room so I could take time away from work when the baby was born. The condo is now worth 15% more than what we paid.
4. Drive cheap. When we arrived in the U.S., we bought a 2014 Nissan Altima. It was a certified preowned car purchased directly from Nissan, it came with a one-year warranty—and it’s still a part of our family.
We’ve been tempted many times to buy a Tesla. We avoided test-driving one until a few years ago, fearing we wouldn’t be able to resist—but, so far, we have. Our Nissan is holding its value and has enough space for the three of us. When grandparents visit, it isn’t difficult to rent an SUV.
5. Love the index. We’ve contributed 20% of our base pay to the Vanguard index fund over the past five years. That’s on top of the money we’ve invested when we sold my husband’s vested stock. Admittedly, we check our portfolio often—sometimes daily—but we’ve managed to control ourselves and not panic sell in response to market moves.
6. Put savings first. My husband and I find budgeting boring. But thanks to our relatively modest lifestyle, we don’t have to. We follow the "pay yourself first" method, investing automatically in all kinds of financial accounts, including a health savings account, an employee stock purchase plan, a 529 savings plan and a “future vacation” savings account. Every paycheck, we also pay off all outstanding credit card bills. We’re then free to use whatever’s left for discretionary “fun” spending.
Pratima Gulati is a human resource professional in Silicon Valley. She has an MBA and a keen interest in personal finance.The post Land of Opportunity appeared first on HumbleDollar.
January 26, 2021
How to Lose
MY OLD INVESTING self was like the guy in the meme who twists around to ogle a woman in a red dress, while his girlfriend looks ready to break his neck.
Just as jumping from one relationship to another introduces new risks, the same holds true for jumping in and out of different investments. For me—and for most people, I’d wager—investing in individual stocks and narrowly focused funds involves a certain amount of trading, and we know such trading is an exercise in futility. Even the vast majority of professional fund managers can’t consistently beat the market averages. If your reaction to that is, “Yeah, but maybe I can, I’ve got a good handle on the way the world works,” you may need professional help with your portfolio.
Despite ample evidence that most investors trail the market averages, we all tend to “feel lucky,” like the ill-fated villain staring down Clint Eastwood in Dirty Harry. Why? A key reason: Stock market averages get a big boost each year from a minority of stocks that post big gains, and those huge winners make beating the market look easy. So how about buying those big winners? Unfortunately, yesterday’s winners aren’t necessarily tomorrow’s top dogs.
In fact, past performance has no predictive power. It may seem obvious today that we should have bought Facebook, Apple, Netflix, Microsoft, Amazon, Tesla and Google’s parent company Alphabet. But these “obvious” winners only seem that way in hindsight.
On top of our unjustified confidence in our own stock-picking abilities, we have a host of other behavioral faults, including impatience, a desire for quick gratification and the feeling that the grass is always greener somewhere else. Result? In our efforts to beat the market, we flit back and forth among different investments, as our latest stock picks lose their luster.
After taking fliers over the years on gold and energy funds, biotech and telecom stocks, and emerging markets specialty funds that focus on consumer companies, I’ve learned three key lessons:
I’m not lucky.
I can’t predict world events or the market’s reaction to them.
Undiversified investment bets give me a few ways to win big and a lot of ways to lose.
I came by these lessons the hard way. I would make a new investment and be excited, thinking I’d made a good bet. I’d anticipate my potential gains and the validation that I’d outsmarted the market. I would tell myself I understood the potential downside, but really, I was practically counting my winnings.
But the thrill would soon fade, along with my original investment rationale. Perhaps the idea had come from some legendary portfolio manager or from something I read. But when my new holdings struggled, I lacked a frame of reference by which to decide whether to sell or hold.
A star manager might have said a drug company’s clinical trials were going well or that certain companies were going to gain market share. But then these things didn’t happen, and the stocks underperformed. Was this bad news now fully priced in? It’s nobody’s job on Wall Street to answer that, least of all the managers who touted the investments in the first place, and they probably wouldn’t know anyway.
Another example: About six years ago, I read a series of articles that convinced me that the next big trend was emerging markets consumer spending growth. That prompted me to buy some high-cost niche exchange-traded funds. But the two funds I bought consistently underperformed. One has continued to do so since I sold, while the other folded last May. Again, no one can tell you when or if such performance will turn around. Wall Street gets paid to sell you high-expense funds and keep you in them. Those high fees pay for a lot of research, writing and marketing, which in turn filters its way into the financial press, which then encourages you to buy.
There are two sources of investment risk: systematic risk, which is the danger that the broad market will fall, and unsystematic risk, which is the danger that your particular investments will lag behind the market.
Investors in individual stocks and sector funds face both risks. By contrast, owners of broad stock market index funds face only systematic risk. Indexing lacks the allure of sexy strangers and the prospect of quick investment scores, but the strategy’s risks are also far lower.
Success in broad market-cap-weighted index funds hinges on fewer variables. You just need aggregate share prices—driven ultimately by corporate profit and dividend growth—to rise at well above the rate of inflation, as they have for more than a century in the global stock market, despite two world wars, hyperinflation, stagflation, market crashes, panics and depressions. In other words, with broad stock market index funds, you’re making just one bet—and it’s a pretty good one for globally diversified investors with long time horizons.
William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart and check out his earlier articles.
The post How to Lose appeared first on HumbleDollar.
January 25, 2021
Seven Habits
BEING A BOOKWORM, I’ve read countless tomes on investing and personal finance. Many were helpful, but my favorite isn’t even about finance. Instead, my vote goes to Stephen Covey’s masterpiece, The Seven Habits of Highly Effective People.
Surprised? What does a self-improvement book about character development have to do with finance? The connection between the two didn’t occur to me until I recently listened to a podcast on personal finance books. Several picks were about the psychology of money and sound financial habits. That’s when it dawned on me how much Covey’s book has helped me with my finances.
It’s been years since I first read the book, but I still skim through it every now and then. As I practiced the lessons over the years, I got better at my work and personal commitments. Unknowingly, these seven habits also crept into my financial decisions.
Habit No. 1: Be proactive. Financial success won’t happen automatically. We each need to take the initiative and take responsibility. Proactive people realize that procrastination and success seldom go together. They do whatever it takes to get on a wealth-building path.
That begins with figuring out the steps toward financial independence. Proactive folks use all available resources to learn. They ask for help from mentors, family members, coworkers, friends and professionals, until they get a handle on financial matters.
Instead of leaving things to chance, proactive people focus on things they can control. They don’t complain about unfair pay, because they’re busy finding ways to increase their income and reduce their spending. Result? Missing the employer’s match on a 401(k) or paying sales loads for underperforming mutual funds don’t exist in their playbook.
Habit No. 2: Begin with the end in mind. How many of us have gone through a phase of mindless spending or aimless saving? How many still are? I know I have, and I suspect I’m not alone.
Before hitting the road, we better know where it leads and if it’s heading to the place we want to go. The same is true for our life and money goals. Without a firm handle on our financial objectives, it’s nearly impossible to know how much to save, how to allocate investment assets and how to be tax smart. Without a written investment policy statement, it’s hard to start building assets and to stay on track.
What could go wrong if we lack direction? We may spend too much for too long on the wrong things, only to realize later that important money goals were left behind. Or we may end up working too hard until later in life and save tons of money, only to discover that there isn’t enough time left to enjoy the wealth we’ve amassed.
Habit No. 3: Put first things first. Our time and energy aren’t limitless, but our desires tend to be. We can only amass a finite amount of savings, while our demands can seem infinite. How do we strike the right balance?
The trick is simple. Prioritize the important stuff—which will likely include long-term goals that don’t currently seem too urgent—and forget the rest. Is it important to get the car fixed if it breaks down? Of course, it is, so why not save some money for emergencies? Will we need money after we stop working? You bet, so why not take a chunk of each paycheck and stash it in a retirement fund? Is it important to have a shinier car than the neighbors? Maybe not, so how about using the money instead for a more meaningful purpose?
Habit No. 4: Think win-win. As a novice investor, I picked individual stocks and had some beginner’s luck. I was convinced I could outperform other investors, because I didn’t truly understand the difference between skill and luck. I hoped to win by outsmarting the person on the other side of my trades.
Before my delusion caused serious damage, I came to learn about the win-win game of passive investing. Stock investing doesn’t have to be a zero-sum game. The pie gets bigger over time, thanks to long-term economic growth and its positive impact on stock prices. Passive investors win by owning diversified portfolios that are guaranteed to collect the market’s return, while low-cost fund companies win by earning reasonable fees from a large asset base. That’s a win-win.
Habit No. 5: Seek first to understand, then to be understood. We often promote our own point of view, while failing to listen to others. In life, this makes it hard to build relationships and collaborate with those around us. When investing, it leads to myriad behavioral biases. For instance, when we’re too rigid about our investment thesis, we lose objectivity. We selectively seek out information that confirms our beliefs. But if, instead, we listen to other points of view rather than pushing our own, we can avoid such overconfidence and the financial damage that often results.
Habit No. 6: Synergize. The ingredients of financial success are well known: Start early, embrace frugality, get your asset allocation right, dollar-cost average and so on. But the real magic happens when all these ingredients work together and reinforce each other. That synergy ignites the power of compounding and has the potential to make our financial future so much brighter.
Habit No. 7: Sharpen the saw. Learning about personal finance and money management isn’t hard. To get started as investors, all we need to do is grasp a few basic financial concepts.
But as we progress through life, new financial challenges inevitably crop up. Thinking about buying a home? Wondering if your taxes are too high? Hoping to send kids to college? Worrying about retirement? To navigate these issues, we need to make financial education a lifelong endeavor.
Sanjib Saha is a software engineer by profession, but he's now transitioning to early retirement. Self-taught in investments, he passed the Series 65 licensing exam as a non-industry candidate. Sanjib is passionate about raising financial literacy and enjoys helping others with their finances. Check out his earlier articles.
Surprised? What does a self-improvement book about character development have to do with finance? The connection between the two didn’t occur to me until I recently listened to a podcast on personal finance books. Several picks were about the psychology of money and sound financial habits. That’s when it dawned on me how much Covey’s book has helped me with my finances.
It’s been years since I first read the book, but I still skim through it every now and then. As I practiced the lessons over the years, I got better at my work and personal commitments. Unknowingly, these seven habits also crept into my financial decisions.
Habit No. 1: Be proactive. Financial success won’t happen automatically. We each need to take the initiative and take responsibility. Proactive people realize that procrastination and success seldom go together. They do whatever it takes to get on a wealth-building path.
That begins with figuring out the steps toward financial independence. Proactive folks use all available resources to learn. They ask for help from mentors, family members, coworkers, friends and professionals, until they get a handle on financial matters.
Instead of leaving things to chance, proactive people focus on things they can control. They don’t complain about unfair pay, because they’re busy finding ways to increase their income and reduce their spending. Result? Missing the employer’s match on a 401(k) or paying sales loads for underperforming mutual funds don’t exist in their playbook.
Habit No. 2: Begin with the end in mind. How many of us have gone through a phase of mindless spending or aimless saving? How many still are? I know I have, and I suspect I’m not alone.
Before hitting the road, we better know where it leads and if it’s heading to the place we want to go. The same is true for our life and money goals. Without a firm handle on our financial objectives, it’s nearly impossible to know how much to save, how to allocate investment assets and how to be tax smart. Without a written investment policy statement, it’s hard to start building assets and to stay on track.
What could go wrong if we lack direction? We may spend too much for too long on the wrong things, only to realize later that important money goals were left behind. Or we may end up working too hard until later in life and save tons of money, only to discover that there isn’t enough time left to enjoy the wealth we’ve amassed.
Habit No. 3: Put first things first. Our time and energy aren’t limitless, but our desires tend to be. We can only amass a finite amount of savings, while our demands can seem infinite. How do we strike the right balance?
The trick is simple. Prioritize the important stuff—which will likely include long-term goals that don’t currently seem too urgent—and forget the rest. Is it important to get the car fixed if it breaks down? Of course, it is, so why not save some money for emergencies? Will we need money after we stop working? You bet, so why not take a chunk of each paycheck and stash it in a retirement fund? Is it important to have a shinier car than the neighbors? Maybe not, so how about using the money instead for a more meaningful purpose?
Habit No. 4: Think win-win. As a novice investor, I picked individual stocks and had some beginner’s luck. I was convinced I could outperform other investors, because I didn’t truly understand the difference between skill and luck. I hoped to win by outsmarting the person on the other side of my trades.
Before my delusion caused serious damage, I came to learn about the win-win game of passive investing. Stock investing doesn’t have to be a zero-sum game. The pie gets bigger over time, thanks to long-term economic growth and its positive impact on stock prices. Passive investors win by owning diversified portfolios that are guaranteed to collect the market’s return, while low-cost fund companies win by earning reasonable fees from a large asset base. That’s a win-win.
Habit No. 5: Seek first to understand, then to be understood. We often promote our own point of view, while failing to listen to others. In life, this makes it hard to build relationships and collaborate with those around us. When investing, it leads to myriad behavioral biases. For instance, when we’re too rigid about our investment thesis, we lose objectivity. We selectively seek out information that confirms our beliefs. But if, instead, we listen to other points of view rather than pushing our own, we can avoid such overconfidence and the financial damage that often results.
Habit No. 6: Synergize. The ingredients of financial success are well known: Start early, embrace frugality, get your asset allocation right, dollar-cost average and so on. But the real magic happens when all these ingredients work together and reinforce each other. That synergy ignites the power of compounding and has the potential to make our financial future so much brighter.
Habit No. 7: Sharpen the saw. Learning about personal finance and money management isn’t hard. To get started as investors, all we need to do is grasp a few basic financial concepts.
But as we progress through life, new financial challenges inevitably crop up. Thinking about buying a home? Wondering if your taxes are too high? Hoping to send kids to college? Worrying about retirement? To navigate these issues, we need to make financial education a lifelong endeavor.
Sanjib Saha is a software engineer by profession, but he's now transitioning to early retirement. Self-taught in investments, he passed the Series 65 licensing exam as a non-industry candidate. Sanjib is passionate about raising financial literacy and enjoys helping others with their finances. Check out his earlier articles.The post Seven Habits appeared first on HumbleDollar.
January 24, 2021
For Their Sake
A FEW YEARS BACK, I found myself in the emergency room, thinking I had a serious condition. As I sat there, I worried about my family, including my wife and young children. If I didn’t come home, would my wife have a clear picture of our finances?
Fortunately, the health scare turned out to be a false alarm, but it was a wakeup call. Sure, I had an estate plan, but I realized that a binder full of legalese wasn’t enough. There's a lot more we can do to organize our financial life so it’s easier on our heirs. Below are the organizational principles I recommend:
Financial map. If you’ve prepared an estate plan, that’s great. But don’t stop there. Put yourself in your family’s shoes. Would they know where to find the original, signed documents? Would they know how to contact your attorney and what steps to take first? I recommend drawing up a simple, one-page summary—what I call a financial map—that will tell your heirs where to find important documents, vendors and the other information that I describe below. You could distribute the map on paper or share it with a tool like Google Docs.
Contact list. These days, most people’s contacts are stored on their phones. But even if you could get into someone’s phone, it might not be much help. Instead, when someone dies, the most useful thing is a short list of key contacts. This should include your attorney, accountant, financial advisor and insurance agent. Immediately after someone has died, these are the most critical contacts. While less urgent, I would include other vendors, such as your cable TV provider, cellphone carrier and landlord or condo association. Here’s how to think about it: Suppose someone had to pay the most basic bills to keep your home running. Who are those vendors? All those names should go on your financial map.
Balance sheet. Your estate plan spells out who will inherit your assets, but it doesn’t say what those assets are or where they can be found. These days, many people hold assets at a mix of banks, brokers and workplace retirement plans. You may also have life insurance policies. On the liability side, you might have a mortgage and other loans. That’s why I would periodically print out a balance sheet and stow it alongside your estate planning documents. In your financial map, note where these documents can be found. If you write out even the simplest balance sheet, your heirs won’t have to spend time tracking everything down and they won't have to worry that they've missed something.
Further commentary. In most cases, a simple balance sheet is sufficient. But if you have any unusual holdings—an annuity, a pension, employee stock options or stock in a private company or partnership—you should write up brief descriptions for each. This is a good opportunity to research details that would be particularly relevant to your heirs. Does your pension have a survivor benefit? Do your stock options vest upon death? It’s much easier for you to research these key provisions now than it would be for your heirs.
Assets under the radar. Do you have assets that would be hard to find—a safe deposit box, for example? I’ve seen more than one person hide cash around the house, stashing it in books and filing cabinets. Be sure to document any assets like this which may be under the radar. Better yet, purchase a small home safe and let your attorney know the combination.
Easily accessible funds. When someone dies, banks and brokers move quickly to freeze the deceased person’s assets. That’s why you want to be sure to hold at least some assets in a joint account with a spouse or other family member. Alternatively, or in addition, you could hold assets in a revocable trust that includes a co-trustee.
Letters. To complement their formal estate plan, many people write letters to provide further guidance to guardians, trustees or executors. These letters can articulate some of your more personal wishes—how you want your children raised or how you want your personal effects distributed. Suppose you own a summer home, an antique car or something else of unique value. In one of your letters, you could indicate how you’d like these special assets handled.
Passwords. In the old days, if you gathered folks’ mail for a month or two, you could get up to speed on their financial life and stay current with their bills. But today, so many bills arrive electronically that you really need to provide heirs with electronic access to your financial life. Otherwise, they’ll struggle to do even the simplest things like pay your electric bill. That’s why I recommend using a password manager. Then provide your master password to your spouse, if you’re married. Alternatively, you could store the master password in your safe, making a note of that on your financial map.
Subscriptions. In the past, I've recommended using one dedicated credit card for all subscription services—Netflix, newspaper, cellphone and so on. This has several benefits, including making it easy for someone else to see a consolidated list of the services you use. Paired with access to your password manager, this would make it far simpler for your heirs to log into your accounts and decide what to do with each.
Arrangements. If you’ve prepaid for a funeral or bought a plot, note this on your financial map.
Estate planning is, understandably, not the most enjoyable task, so don’t feel you need to tackle the above items all at once. I’d start by filling out your financial map and then go from there.
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.
Fortunately, the health scare turned out to be a false alarm, but it was a wakeup call. Sure, I had an estate plan, but I realized that a binder full of legalese wasn’t enough. There's a lot more we can do to organize our financial life so it’s easier on our heirs. Below are the organizational principles I recommend:
Financial map. If you’ve prepared an estate plan, that’s great. But don’t stop there. Put yourself in your family’s shoes. Would they know where to find the original, signed documents? Would they know how to contact your attorney and what steps to take first? I recommend drawing up a simple, one-page summary—what I call a financial map—that will tell your heirs where to find important documents, vendors and the other information that I describe below. You could distribute the map on paper or share it with a tool like Google Docs.
Contact list. These days, most people’s contacts are stored on their phones. But even if you could get into someone’s phone, it might not be much help. Instead, when someone dies, the most useful thing is a short list of key contacts. This should include your attorney, accountant, financial advisor and insurance agent. Immediately after someone has died, these are the most critical contacts. While less urgent, I would include other vendors, such as your cable TV provider, cellphone carrier and landlord or condo association. Here’s how to think about it: Suppose someone had to pay the most basic bills to keep your home running. Who are those vendors? All those names should go on your financial map.
Balance sheet. Your estate plan spells out who will inherit your assets, but it doesn’t say what those assets are or where they can be found. These days, many people hold assets at a mix of banks, brokers and workplace retirement plans. You may also have life insurance policies. On the liability side, you might have a mortgage and other loans. That’s why I would periodically print out a balance sheet and stow it alongside your estate planning documents. In your financial map, note where these documents can be found. If you write out even the simplest balance sheet, your heirs won’t have to spend time tracking everything down and they won't have to worry that they've missed something.
Further commentary. In most cases, a simple balance sheet is sufficient. But if you have any unusual holdings—an annuity, a pension, employee stock options or stock in a private company or partnership—you should write up brief descriptions for each. This is a good opportunity to research details that would be particularly relevant to your heirs. Does your pension have a survivor benefit? Do your stock options vest upon death? It’s much easier for you to research these key provisions now than it would be for your heirs.
Assets under the radar. Do you have assets that would be hard to find—a safe deposit box, for example? I’ve seen more than one person hide cash around the house, stashing it in books and filing cabinets. Be sure to document any assets like this which may be under the radar. Better yet, purchase a small home safe and let your attorney know the combination.
Easily accessible funds. When someone dies, banks and brokers move quickly to freeze the deceased person’s assets. That’s why you want to be sure to hold at least some assets in a joint account with a spouse or other family member. Alternatively, or in addition, you could hold assets in a revocable trust that includes a co-trustee.
Letters. To complement their formal estate plan, many people write letters to provide further guidance to guardians, trustees or executors. These letters can articulate some of your more personal wishes—how you want your children raised or how you want your personal effects distributed. Suppose you own a summer home, an antique car or something else of unique value. In one of your letters, you could indicate how you’d like these special assets handled.
Passwords. In the old days, if you gathered folks’ mail for a month or two, you could get up to speed on their financial life and stay current with their bills. But today, so many bills arrive electronically that you really need to provide heirs with electronic access to your financial life. Otherwise, they’ll struggle to do even the simplest things like pay your electric bill. That’s why I recommend using a password manager. Then provide your master password to your spouse, if you’re married. Alternatively, you could store the master password in your safe, making a note of that on your financial map.
Subscriptions. In the past, I've recommended using one dedicated credit card for all subscription services—Netflix, newspaper, cellphone and so on. This has several benefits, including making it easy for someone else to see a consolidated list of the services you use. Paired with access to your password manager, this would make it far simpler for your heirs to log into your accounts and decide what to do with each.
Arrangements. If you’ve prepaid for a funeral or bought a plot, note this on your financial map.
Estate planning is, understandably, not the most enjoyable task, so don’t feel you need to tackle the above items all at once. I’d start by filling out your financial map and then go from there.
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 For Their Sake appeared first on HumbleDollar.
January 23, 2021
Don’t Overdo It
THRIFTY. FRUGAL. CHEAP. Pick the adjective you favor, and you could apply it to me.
I’ve spent almost my entire adult life being financially careful. I haven’t carried a credit card balance or overdrawn my checking account since my early 20s. I was an early convert to low-cost index funds. When I worked at The Wall Street Journal and at Citigroup, I brought my breakfast and a thermos of coffee to the office every day, and occasionally lunch as well. I run a lean refrigerator, rarely throwing away food because I only stock what I’m confident I’ll eat.
But even I have my limits. I’m all for saving money, but some of the articles and comments I read leave me shaking my head. Want to lead the frugal life? Here are five thoughts:
1. Cars trump coffee. The criticism directed at millennials, with their supposed obsession with Frappuccinos and avocado toast, strikes me as silly. Partly, it smacks of misguided generational jousting. We shouldn’t be surprised that the current generation spends more than the generations that came before. That’s what happens in a society with a rising standard of living.
More important, a few cups of coffee pale in significance next to the cost of housing and cars, which together account for half of U.S. household spending. If folks are struggling to save, it almost certainly isn’t because of their coffee habit. Instead, they’re likely boxed in by high housing costs and steep monthly debt payments, including for cars and college loans.
2. Everybody has passions. To be sure, if somebody downs a $6 specialty coffee every day, the long-term cost could be significant. (Because no article on the perils of high-cost coffee would be complete without such a calculation, the answer is $212,000. The question: How much would you have after four decades if you invested $6 a day and earned 4% a year?)
But what if you really love overpriced coffee? Why shouldn’t you buy it? If mocha lattes are what make your heart sing, I see no reason not to buy them, as long as you’re saving enough for your various goals. This goes to my disdain for budgeting: If we’re diligently funding retirement and other investment accounts every month, it doesn’t much matter what we do with the rest of our money—and there’s no need to track where every penny goes.
3. Three basis points won’t kill us. In recent months, I’ve received multiple emails from readers, asking whether they should swap from index mutual funds into lower-cost exchange-traded index funds (ETFs). This is a particular issue at Vanguard Group, where there’s a corresponding ETF for almost every index mutual fund and making the switch to the ETF might save you perhaps 0.01 to 0.05 percentage points a year. In Wall Street lingo, those fractions of a percent are called basis points.
As I’ve argued elsewhere, shifting from index mutual funds to ETFs isn’t the slam dunk that many folks imagine. While ETFs typically have lower annual expenses, you’ll get nicked for the bid-ask spread when you buy and sell. Still, if you plan to stick with an ETF for more than a few years, it’s probably worth making the swap.
But don’t get too excited about the savings. Suppose that, by swapping to the ETF, you can lower your annual expenses by 0.03 percentage point. We're talking $30 a year on a $100,000 investment. I wouldn’t turn up my nose at an extra $30. But I’m also not going to argue this is a must-do investment move.
4. We save now so we can spend later. Five years ago, at a financial conference, a fellow attendee sidled up to me and whispered, “You see that guy over there filling up a shopping bag with bottles of orange juice from the drinks buffet? He’s worth $50 million.”
I’m not greatly bothered by such cheapskate behavior. But it does raise the question: Will the guy ever get much pleasure from his $50 million, beyond admiring his net worth’s impressive size? We shouldn’t get so good at saving money that we can’t eventually bring ourselves to spend the fruits of our frugality.
What if we’re reluctant to spend on ourselves? I think there’s great virtue in spending on others, for two reasons. First, giving to others—whether it’s to family, friends or a favorite charity—often sparks greater happiness than spending on ourselves, so it can help us to get joy from money we’d otherwise be loath to spend. Second, by giving away some of our money, we may see that parting with a sliver of our wealth doesn’t necessarily trigger financial Armageddon, and that may make us a tad more relaxed about future spending.
5. Excessive frugality costs time. As I’ve noted before, time is the ultimate limited resource. If we spend hours hunting for the lowest price, we waste precious time. If we track every penny we spend, that’s time that could be devoted to something more enjoyable. If we’re so miserly that we spend our days worrying about how much we spend, we’re taking our good habits—which have the potential to free us from financial concerns—and turning them into the same mental burden that afflicts those who have no savings. The bottom line: There’s a point of diminishing returns in our efforts to save money and accumulate more and, if we overdo it, there’s a grave risk we’ll miss the big picture.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
Last year was financially wrenching for many folks, but there are still reasons for optimism. Anika Hedstrom's advice: Focus on the facts—and don't let your emotions get the better of you.
Stock market investors seem oblivious to the upheaval in Washington. What's going on? Adam Grossman offers his take.
"Like a good poker player, don’t sweat losses if you have a process that puts the probabilities in your favor," writes Joe Kesler. "Focus on tax efficiency, holding down costs and investing in line with your risk tolerance."
Tempted by preferred shares with their handsome yields, currently around 5%? Rick Moberg says there are five reasons to be cautious.
HumbleDollar’s Bill Ehart spent time with financial expert Ben Carlson—and came away with five key insights.
How much income do you need in retirement and how much can you safely withdraw from your portfolio? Those are the two big retirement debates—and Dick Quinn finds them maddening.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.
I’ve spent almost my entire adult life being financially careful. I haven’t carried a credit card balance or overdrawn my checking account since my early 20s. I was an early convert to low-cost index funds. When I worked at The Wall Street Journal and at Citigroup, I brought my breakfast and a thermos of coffee to the office every day, and occasionally lunch as well. I run a lean refrigerator, rarely throwing away food because I only stock what I’m confident I’ll eat.
But even I have my limits. I’m all for saving money, but some of the articles and comments I read leave me shaking my head. Want to lead the frugal life? Here are five thoughts:
1. Cars trump coffee. The criticism directed at millennials, with their supposed obsession with Frappuccinos and avocado toast, strikes me as silly. Partly, it smacks of misguided generational jousting. We shouldn’t be surprised that the current generation spends more than the generations that came before. That’s what happens in a society with a rising standard of living.
More important, a few cups of coffee pale in significance next to the cost of housing and cars, which together account for half of U.S. household spending. If folks are struggling to save, it almost certainly isn’t because of their coffee habit. Instead, they’re likely boxed in by high housing costs and steep monthly debt payments, including for cars and college loans.
2. Everybody has passions. To be sure, if somebody downs a $6 specialty coffee every day, the long-term cost could be significant. (Because no article on the perils of high-cost coffee would be complete without such a calculation, the answer is $212,000. The question: How much would you have after four decades if you invested $6 a day and earned 4% a year?)
But what if you really love overpriced coffee? Why shouldn’t you buy it? If mocha lattes are what make your heart sing, I see no reason not to buy them, as long as you’re saving enough for your various goals. This goes to my disdain for budgeting: If we’re diligently funding retirement and other investment accounts every month, it doesn’t much matter what we do with the rest of our money—and there’s no need to track where every penny goes.
3. Three basis points won’t kill us. In recent months, I’ve received multiple emails from readers, asking whether they should swap from index mutual funds into lower-cost exchange-traded index funds (ETFs). This is a particular issue at Vanguard Group, where there’s a corresponding ETF for almost every index mutual fund and making the switch to the ETF might save you perhaps 0.01 to 0.05 percentage points a year. In Wall Street lingo, those fractions of a percent are called basis points.
As I’ve argued elsewhere, shifting from index mutual funds to ETFs isn’t the slam dunk that many folks imagine. While ETFs typically have lower annual expenses, you’ll get nicked for the bid-ask spread when you buy and sell. Still, if you plan to stick with an ETF for more than a few years, it’s probably worth making the swap.
But don’t get too excited about the savings. Suppose that, by swapping to the ETF, you can lower your annual expenses by 0.03 percentage point. We're talking $30 a year on a $100,000 investment. I wouldn’t turn up my nose at an extra $30. But I’m also not going to argue this is a must-do investment move.
4. We save now so we can spend later. Five years ago, at a financial conference, a fellow attendee sidled up to me and whispered, “You see that guy over there filling up a shopping bag with bottles of orange juice from the drinks buffet? He’s worth $50 million.”
I’m not greatly bothered by such cheapskate behavior. But it does raise the question: Will the guy ever get much pleasure from his $50 million, beyond admiring his net worth’s impressive size? We shouldn’t get so good at saving money that we can’t eventually bring ourselves to spend the fruits of our frugality.
What if we’re reluctant to spend on ourselves? I think there’s great virtue in spending on others, for two reasons. First, giving to others—whether it’s to family, friends or a favorite charity—often sparks greater happiness than spending on ourselves, so it can help us to get joy from money we’d otherwise be loath to spend. Second, by giving away some of our money, we may see that parting with a sliver of our wealth doesn’t necessarily trigger financial Armageddon, and that may make us a tad more relaxed about future spending.
5. Excessive frugality costs time. As I’ve noted before, time is the ultimate limited resource. If we spend hours hunting for the lowest price, we waste precious time. If we track every penny we spend, that’s time that could be devoted to something more enjoyable. If we’re so miserly that we spend our days worrying about how much we spend, we’re taking our good habits—which have the potential to free us from financial concerns—and turning them into the same mental burden that afflicts those who have no savings. The bottom line: There’s a point of diminishing returns in our efforts to save money and accumulate more and, if we overdo it, there’s a grave risk we’ll miss the big picture.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
Last year was financially wrenching for many folks, but there are still reasons for optimism. Anika Hedstrom's advice: Focus on the facts—and don't let your emotions get the better of you.
Stock market investors seem oblivious to the upheaval in Washington. What's going on? Adam Grossman offers his take.
"Like a good poker player, don’t sweat losses if you have a process that puts the probabilities in your favor," writes Joe Kesler. "Focus on tax efficiency, holding down costs and investing in line with your risk tolerance."
Tempted by preferred shares with their handsome yields, currently around 5%? Rick Moberg says there are five reasons to be cautious.
HumbleDollar’s Bill Ehart spent time with financial expert Ben Carlson—and came away with five key insights.
How much income do you need in retirement and how much can you safely withdraw from your portfolio? Those are the two big retirement debates—and Dick Quinn finds them maddening.
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 Don’t Overdo It appeared first on HumbleDollar.
