Jonathan Clements's Blog, page 30

The unexpected detour to deccumulation, finding peace in fixed income

For years, my financial trajectory was meticulously planned. I'd diligently accumulated a substantial pension pot, culminating in the recent sale of my business. The path was clear: a smooth transition into early retirement at 58, aiming for a conservative sub-3% drawdown rate. Full steam ahead, I thought, to the promised land of financial independence.

But then, something unexpected happened. In the months leading up to my planned exit, a strange attraction to Fixed-Term Immediate Annuities (FTIAs) began to grow. The allure of a guaranteed income stream, something I hadn't seriously considered before, became increasingly powerful.

My thinking, I admit, might seem unconventional, perhaps even unorthodox, to traditional financial planners. However, if I squint through a certain lens – one that prioritizes peace of mind alongside potential growth – this strategy makes profound sense for me.

Here's how I now see it: I've opted to treat a portion of my portfolio as a ten-year "collapsing bond ladder" in the form of FTIAs. This guaranteed income stream effectively acts as a solid, predictable foundation for my essential living expenses during the initial decade of my retirement.

The kicker, for me, lies in the ripple effect this creates across my remaining portfolio. By having that critical, immediate income secured, I've been able to confidently increase my equity allocation in the rest of my investments. This tactical shift significantly mitigates one of the most insidious risks of early retirement: Sequence of Returns Risk during those first, vulnerable ten years. With my core income assured, I can weather market downturns without the panic of needing to sell depressed assets. This, in turn, provides my higher-equity portfolio a far greater opportunity to generate superior long-term returns.

I understand that, on paper, this strategy might appear "suboptimal" to those focused purely on maximizing theoretical returns. But here's the profound truth I've discovered: personal finance is, as the name unequivocally states, personal. For me, the quiet assurance of a guaranteed income stream possesses a quality all its own. It's the silent guardian that lets me sleep soundly through market volatility, knowing my essential needs are met. It's the trade-off I willingly make for a profound sense of security and peace of mind – and that, to me, is a return far more valuable than any percentage point on a spreadsheet.

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Getting a later start-college versus retirement, a growing conundrum by R Quinn

Our oldest child is age 55, - three children ages 14 and 12 (twins),

our second is age 54 - three children ages 14, 13 and 10,

our third age 51 - three children 18,17 and 13,

and our fourth age 50 - two children ages 20 and 17

All ages are rounded.

Look at these ages and what comes to mind, college, retirement? Pretty sure not retirement any time soon. This is what I ponder when I read about FIRE or even early retirement before age 60. Our children will be near or over age 60 when our grandchildren finish college. I look at these ages and wonder how they will ever retire. 

Needless to say none of our children has a pension and two don’t have a 401k, two are working two jobs. 

All this is why we fund 529 plans and help our children occasionally and why I am keen to leave the largest legacy we can. Once again I find my thinking out of the norm. An article on MarketWatch says boomers intend to spend their money and leaving an inheritance is not a priority. 

This example is similar to the reality for many families. The trend of people having children at older ages is well-documented in the United States. However, according to the Census Bureau the average family size in 2022 was 3.13, but even one or two children with these age scenarios may have a significant impact on finances, especially retirement. 

I was 45 when our oldest child entered college and they were all finished ten years later.  I suspect there are people who don’t see their children’s college as an obligatory expense. That is a choice. 

In any case, saving for retirement should be the priority, but it’s still a tough road for people who start families later in life. 

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A Nuanced View of FIRE

Well, mostly FI, but some RE. (FIRE standing for Financial Independence, Retire Early). Christine Benz from Morningstar recently attended a CampFI event in Spain, and wrote about her experience here.

She comments that "A lot of people have a caricatured perception of the FI community. They assume that everyone is trying to live on $10 a day in order to hang it up at age 35." While she met some young people, she met older people as well. She concludes that she learned some valuable lessons from her fellow attendees. A recommended read.

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Feeling grateful and paying forward

Just weeks into my retirement, while sitting on a beach beside the Giant's Causeway on Ireland's north coast, a profound sense of gratitude washed over me. It was for a person whose name I couldn't recall and a face I'd forgotten.

Forty years prior, in my very first job, I served a customer who turned out to be a pension salesman. To make a long story short, he persuaded an 18-year-old me to open a personal pension, one that wisely increased its contributions annually with inflation.

This initial leap, albeit with an arguably overpriced and high-fee pension, ignited the wonder of compounding over a 40-year period. That momentum ultimately led to me enjoying that serene, empty beach on a workday, watching the Atlantic rollers break against the ancient rocks.

Today, I'm affectionately known by the children of my family and friends as the one who constantly urges them to open a pension and 'pay their future selves.' Thankfully, I've witnessed quite a few youngsters take that advice, and their success brings me immense satisfaction."

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Selling our business – the journey so far

I’m sure that there are several on Humble Dollar who have navigated this path – selling a family business and moving on to whatever is next. We are part way along that journey, and it feels like a good time begin sharing our story.

For some background, we own and operate an automotive workshop in a small country town called Heyfield in Victoria, Australia. My Dad is now a 60 year veteran of the automotive industry, having commenced his apprenticeship at 16, and looking to finally exit at the age of 76. Dad tried to exit working life at 68 but found out he was not very good at retirement. He still really needed to be in business, so decided it would be a great idea to buy a workshop in Heyfield that had been on the market for some time.

I was 20 years in engineering and project management. I was reasonably successful, so each project got larger than the last. Once the budget got over a certain mark, everything went from interesting and satisfying to very stressful. So owning and operating an automotive workshop sounded pretty good.

Over the last 9 years we have exceeded our expectations. We started with no operating software, no customer list, no staff. Just a workshop and a steady trickle of local customers. We have been able to increase to 8 staff, build a really strong customer base and create a steady, profitable business.

But with my Dad now well into his seventies, and starting to see 80 on the horizon, we decided that it would be a good time to sell the business. This would give my Dad a chance to try out retirement again – I hope this attempt is better than his last! And at 51 it gives me the chance to tackle something new and different for my next chapter.

At this point we have a buyer that has had finance approved and is waiting for the final documents from the bank, so they can “sign on the dotted line”.  Every indication is that the sale will proceed successfully, but I’ll really believe it when the money is in the bank!

So while we wait for the bank, moving at it’s own glacial pace, some thoughts on the process.

Joys and sorrows of small business

Over 9 years we have had great joy and satisfaction from building a strong local business.

We have had very loyal and stable staff, many of whom started with us as apprentices or with no previous experience. We have seen all our team grow and develop. There were difficulties, challenges and mistakes along the way, but our crew has been a real strength of the business throughout.

We have also developed some wonderful relationships with our loyal customer base. In a small town, a business like ours feels very, very interconnected with the local community and economy.

But small business is hard. We work long, intense hours. Dealing with the general public is challenging. Modern motor vehicles are complex, and getting more so all the time.

Our time in this business has been a tremendous success, but that success comes only with lots of effort and grit.

Passing the baton

During the sale process, both my Dad and I have been well aligned that we don’t want to just extract every possible dollar from the sale. We want to be paid a fair price, but we want to drive past the workshop and see it thriving. To bump into our staff around town and hear that they still have interesting, well paid jobs.

I have often thought of an article by Nick Maggiulli, “Don’t take the last dollar” on his Dollars and Data blog. Nick argues (quite rightly I think) that striving to get every dollar in this particular negotiation won’t necessarily get you the long term result you would desire. That mindset has helped us keep a focus on what’s important. We regularly tell the buyers that we want them to succeed. That during the handover phase we will do all we can to set them up with the information and knowledge they need. That after handover we will remain available for any questions they might have.

It feels good to be passing on a business with these discussions being at the forefront, rather than arguing over line items in a contract.

What’s next?

For me, I refuse to think about that yet! As I said, I’ll believe a sale is complete when the money is in the bank. Then I’ll explore my next phase in life, maybe after a little holiday.

For my Dad, I really hope that he can navigate the transition to retirement better this time. Apart from his 4 year apprenticeship, all his automotive career has been either in partnership or as owner of a small automotive business. He has committed so much time and energy to that pursuit that moving into retirement will not be easy. But I’m hopeful and optimistic that at 76, nearly 77, he is better prepared than at 68!

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Building Memories by Edmund Marsh

When my wife asked for a hint for the Father’s Day present I was hankering to get, I was stumped for a day or so. I don’t need a new tie or wallet, or the new garden tool that I sometimes suggest. My eventual answer didn’t surprise her, but she was amused. I’ve asked my daughter to answer two questions: What’s the origin of Father’s Day in our country, and does she think it’s worth observing?

I already know the answer to the first question. The idea was born in the mind of a young woman who admired her father, but didn’t gain traction until championed by men’s wear retailers hoping to profit from the gift-giving. I figure the story will entertain my daughter, since she’s savvy to the commercial aspect of holidays, and loves to pick out the logical fallacies in an advertiser’s argument.

But I’m curious to know how these feelings influence her answer to my second question. For me, the answer is yes, and I’m certain I’ll always honor the memory of my own father on Father’s Day.

My father liked to work. As a young man, he poured many hours into his automotive service business, and later his jobs as a school administrator and county school superintendent. Never content with the limits of a regular business day, he also enlisted early morning, evening and Saturday hours to work out a new bus route, write a grant proposal or even build a new set of shelves for an office or classroom. I was usually recruited to help with the handy-man projects, even at a young age. The skills I learned during our labor have served me for a lifetime, though I was hardly a cheerful apprentice at the time.

For him, on the other hand, work was a pleasure. But he worked at having fun, as well. He liked to hunt, and he was good at it, because he studied the game and practiced until he mastered it. As a boy, I benefited from his love of his hobby. We spent hours together during the season, and forged memories shared only by us.

Decades later, I was shocked the day he told me a brain tumor was the cause of his recent headaches. He was about the age I am now. In typical fashion, the morning after a surgery to remove the tumor, he was out of bed and ready to go home and back to work. He returned to his job to complete his last four-year term as county school superintendent at age 66.

In the early years of his retirement, he embarked on a flurry of building projects. First up was remodeling his own house, then my brother’s. And there were community jobs as well, such as constructing an outdoor pavilion attached to the old railroad depot for the local historical society and charitable handy-man work through his church.

At age 71, he agreed to devote his time to a multi-year project to help me rebuild the house I now live in. His age gave him an edge, for he was schooled in the construction of old houses. In the beginning, it was a chore to keep pace with him. I worked full-time as a physical therapist, with off hours spent on the house, but he worked even when I was away. He was driven by the ticking clock and wanted to help me while he still could. His mind was tireless and he pushed his body beyond the point of exhaustion.

A vivid memory illustrates his restless devotion: One weekend, as we sat in his truck gazing at the sagging joists and half-rotted decking of the dilapidated dock on my pond, he slyly asked what business I once plied. I sheepishly admitted I used to be a dock builder, and agreed my present dock was shameful. The following weekend, I was surprised to discover the dock had been repaired. My father had used his sleepless time in the wee hours to do the work by the headlights of his truck.

My father’s brain cancer returned a dozen years after he was first diagnosed. That time, he received computer-guided radiation that killed the tumor, but also some of the surrounding brain tissue. Initially, his cognition was noticeably affected, but he improved, to slowly decline in the ensuing years.

My father lived more than a decade after his second treatment, but he was not the same man. My overriding memories, however, are of the man who gave the last part of his best self doing all he could to help his family, until he could do no more. I hope my daughter will cherish a similar memory of me.

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No Time Left for Calculating My Net Worth

Oh my, I’m beginning to think that some of the articles I find on the internet aren't really news at all. Below is one I clicked on today. It reminds me of those free dinners that Mike Flack recently posted about. I also think it ties in well with Dave Lancaster's post about calculating net worth. 

The article didn’t define how it calculated net worth. I assume it includes checking and savings, IRAs and similar accounts, it did mention that home equity is included. It probably did not include the monetized value of pensions and Social Security, though these factors can greatly impact financial security. For example, I know couples with meager savings, but close to $200k per year in pension and SS; I wouldn’t classify them as belonging in levels 1, 2, 3, or possibly 4.

The article ended by telling me that the level 6 people use advisors, and asking me if I used one, providing me with a link that could hook me up. I still have about $20 million to go before I hit level 6, so no need to click on that link yet. 

Here you go, enjoy.

Here are the 6 levels of wealth for retirement-age Americans — are you near the top or bottom of the pyramid?

Financial vulnerable (Household net worth $69,500 and under)
Lower middle class (Household net worth between $69,500 and $394,300)
Solidly middle class (Household net worth between $394,300 and $1.16 million)
Upper middle class (Household net worth between $1.2 million and $2.9 million)
Affluent (Household net worth $2.9 million or more)
Top 1% (Household net worth $21.7 million or more)

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Medicare Advantage with No Premiums vs Traditional Medicare with a Plan G Supplement

This is a decision I had to make several years ago when I turned 65. I started out with a no premium five star local Advantage plan to take “advantage” of the free perks for the first year, then switched to traditional Medicare with a plan G supplement, the most expensive plan. To most this would seem quite contradictory, but let me explain my reasoning. Medicare allows first time enrollees to trial an Advantage plan for up to a year, and the switch to a traditional plan with supplement with guaranteed issue and premiums as if you had signed up for the supplement initially.

I chose the Advantage plan first so I could utilize the free eye exam, and the full value of the  dental benefits, as well as an amount for exercise equipment. I am healthy so I rolled the dice regarding deductibles, copays, etc. Unfortunately an ER visit made my bet a loser (but my wife who initiated the same plan won the bet).

Towards the end of the year on the Advantage plan I signed up for traditional Medicare and a plan G supplement. This was not a result of losing the bet, but was the plan all along. Even though a plan G was the most expensive plan it comes with no deductible other than the Federal part B deductible, and no prior authorizations required. My wife worked in the medical field in nursing homes and saw the constant battle to have Advantage plans keep their insureds in rehabilitation until they were ready for discharge. Also I am very frugal so I have a tendency to look at the cost of everything to determine if it is a good value. If I were not having full coverage without a deductible I would most likely, to my detriment, delay seeking treatment for a perceived medical issue.

So both my wife and I have the more expensive plan. This year’s cost for medical issue just under 6K for all premiums and the Federal part B deductible. We have zero premium Rx plan with no copays, deductibles, for our few medications. We like the cost certainty in the future and have planned for the annual increases in our financial plan.

So my question is, how did you decide whether to sign up for an Advantage plan versus traditional Medicare with a supplement?

 

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Australian superannuation – a local perspective

Around the world there are a vast number of ways that countries seek to provide financial support to its retirees. I certainly won’t profess to being an expert in any, including my home of Australia, but I thought it might be interesting to give some insight into how our superannuation scheme works, along with some of my thoughts.

Back in 1974, around 32% of Australians had access to retirement funds via a range of pension schemes. This obviously left a lot of Australians without any formal structure to save and invest for their retirement. This meant they had to rely on a mix of their own savings and the government aged pension.

In 1983, the first steps towards our current superannuation scheme began. In an era when trade unions were a much more powerful influence on government policy than today, the unions agreed to forego a 3% wage increase, which would instead be made as a contribution to a new superannuation system that would apply to all Australian workers.

In 1992, the employee contributions were matched with 3% paid by the employer. This signaled the start of the superannuation scheme as we know it today. Over time, with some hiccups along the way, there has been bipartisan support to steadily raise the level of contributions being paid. This currently stands at 11.5% of normal time wages (excluding overtime, bonuses etc.) but will increase shortly to 12%.

Like most large, government regulated schemes, there is lots of complexity in our superannuation system. But I like to keep things simple, so here are the bare bones:

 

The employer pays 12% of the employee’s ordinary time earnings (excluding overtime, bonuses etc.) into an approved fund. This applies to all employees regardless of how much they are earning or their age.For people earning less than $250,000 each year, this is taxed at 15%. For those over $250,000 per annum, this raises to 30%.Employees can contribute extra to their superannuation fund. These are also taxed at 15% / 30%, which offers a considerable tax saving compared to normal income tax.For those born after 30 June 1964, retirement funds become available from age 60. For those born before on or before that date the age to access superannuation is lower.Once in retirement phase, there are range of options as to how the funds can be withdrawn, including as a lump sum or as an income stream.

The basis of the Australian “super” scheme is simple, but it has some interesting effects and outcomes.

Tax effectiveness

The advice from any accountant or financial planner when it comes to reducing tax is “put more into super”. The gap between the superannuation tax rate and our income tax rates makes it highly attractive to contribute more into your fund, especially for higher earners with some disposable income to spare.

As a business owner, this can be a frustrating piece of advice. I would love to put more into super, if only it wasn’t tied up in stock, debtors etc.!

A large bucket of money

As of mid 2024, Australian superannuation funds constituted around $4 trillion. For a small nation like Australia, this represents a large pool of capital that needs to be allocated.  And for the 12 months prior, net inflows were around $65 billion.

To put this in perspective, the total market capital of our ASX200 (our version of the S&P 500) was around $2.45 trillion. So super funds represented 160% of our total stock market, and the net inflows for the year represented around $2.6% of our total stock market.

This has obviously meant that funds have had to be allocated in a range of investment vehicles, including global share market funds and unlisted funds such as infrastructure. I think that this is a positive for Australians as we are forced to avoid too much “home bias” with our super funds.

A cultural fit

I am blessed to have an intelligent sister who happens to lecture in political science at Australian National University. A large part of her role has been surveying Australians regarding a range of views about democracy and democratic systems. Similar surveys are conducted globally, giving a chance to compare various views across countries. My sister’s summary often boils down to Australians being a pretty compliant culture.

Despite whatever our tourism marketing and Crocodile Dundee might suggest, our nature seems to be to accept rules and regulations put to us, as long as there seems to be some good reason behind it. As an example, Australia have readily accepted gun laws that would be seen as quite extreme to other parts of the world.

So the idea of a compulsory savings scheme sits OK with Australians, but I imagine that in many parts of the world this would be seen as draconian and unacceptable.

Future benefits

When working as an employee or running a business, superannuation has a cost. The 12% put to super funds could be either additional wages for the employee or a reduced cost for the business (likely some combination of both).

But undoubtedly the pain felt today will provide significant benefits for Australians and the Australian economy in the long run.

I think that people probably feel more comfortable about their retirement knowing that their super fund is steadily increasing right throughout their working life.

For our government, the reliance on our aged pension scheme will reduce in the future, which takes some strain off our national budget.

As an employer, it feels good to see funds going into our employee’s super funds each month, thinking that this builds some future stability and comfort for them.

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Good in Theory

STATISTICIAN GEORGE E.P. Box once made this observation: “All models are wrong,” he said, “but some are useful.” This certainly applies to finance, where many of the concepts are imperfect but can nonetheless still be useful. Below are four such examples.

Market valuation. Are stocks overpriced? It’s a question without an easy answer. Even academics who have studied the topic can never be entirely sure. Consider the cyclically adjusted price-earnings (CAPE) ratio. Developed in the 1980s by Yale professor Robert Shiller and a colleague, the CAPE ratio gained fame for correctly forecasting the bursting of the “dot-com” technology bubble in 2000. Shiller’s book Irrational Exuberance was published just days before the market peaked. That forecast cemented the CAPE’s reputation.

But in 2013, a group of researchers at London Business School took a closer look and found that—aside from the CAPE’s success in 2000—its forecasts wouldn’t have been very helpful. Elroy Dimson, who led this research, concluded: “We learn far less from valuation ratios about how to make profits in the future than about how we might have profited in the past.”

Even Shiller acknowledges that the CAPE’s predictive abilities can fall short. In 2021, Shiller made this seemingly contradictory statement in an opinion piece: “The stock market is already quite expensive. But it is also true that stock prices are fairly reasonable right now.”

Here’s how he explained this: While the stock market at the time was expensive by historical standards, Shiller noted that investors should never look at any one metric in a vacuum. Investments need to be considered in comparison to other available investment options. On that basis, he said, stocks were not expensive, because bonds at the time were also expensive.

The bottom line: We shouldn’t ignore valuation ratios. They can provide a useful point of reference. But we should never react too strongly to any particular reading.

Market efficiency. In 2013, an unusual event occurred in Stockholm. When that year’s Nobel Prizes in economics were awarded, two of the winners presented a seeming contradiction. One was Eugene Fama, who developed key ideas in finance that are known as Modern Portfolio Theory (MPT). According to this theory, stock prices are always rational because they reflect all available information. Thus, according to MPT, there can be no such thing as a bubble, because—by definition—prices are always accurate. When share prices are high, in other words, it’s for a good reason and not because investors are irrational.

Another of the Nobel winners that year, however, was Robert Shiller, whose work argued precisely the opposite. In Irrational Exuberance, he demonstrated that markets aren’t always rational and that asset bubbles can and do occur—with the run-up in the late 1990s being a prime example.

Despite these opposing views, the Nobel committee granted both Fama and Shiller the prize in economics at the same time. How did the committee explain its decision? On the one hand, it agreed with Fama: “Stock prices are extremely difficult to predict in the short run.”

But over the long term, the committee said, prices are more predictable, and valuation metrics like the CAPE—while not perfect—can be helpful.

In other words, Shiller and Fama can both be right, even if their ideas seem at odds. Both have acknowledged this, if grudgingly. In an interview, Fama explained it this way: Modern Portfolio Theory “is a model, so it’s not completely true. No models are completely true.” But, he added, “It’s a good working model for most practical uses.” And that’s the key point: Markets may be rational over the long term but are often irrational in the short term. This idea can help investors maintain equanimity through the market’s regular ups and downs.

Inflation. Another model which is sometimes accurate is the Phillips curve, which suggests an inverse relationship between inflation and unemployment. It says that when unemployment is low, inflation will tend to be higher, and vice versa. This theory was developed in the 1950s and seemed to hold true for a time. But more recently, that relationship appears to have broken down. Between 2000 and 2020, inflation was extremely low despite unemployment also being low.

In 2019, Mary Daly, president of the San Francisco Federal Reserve Bank, commented: “As for the Phillips curve… most arguments today center around whether it’s dead or just gravely ill. Either way, the relationship between unemployment and inflation has become very difficult to spot.” 

Why the change? A key factor is globalization. Low-cost imports, especially from China, grew substantially, helping to hold down consumer prices. It was an ideal economic situation. This is a reason higher tariffs are a concern. If imports from Asia are limited, the Phillips curve tradeoff between inflation and employment may once again become a problem.

Taxes. Another economic model that seems to be partly true is the Laffer curve. Developed in the 1970s by economist Arthur Laffer, this theory argues that government revenue should increase when tax rates are lower. It’s counterintuitive, but the idea is that tax cuts should spur economic growth.

The Laffer curve is presented as a bell curve. At one end, with a 0% tax rate, the government would collect no revenue. And at the other, with a 100% tax rate, the government would also collect no revenue, because no one would work. Therefore, Laffer argued, there must be an optimal rate in between that maximizes government revenue. 

The question: What is that rate? This is precisely the debate that’s occurring today in Washington.

The bottom line for investors: Economics is not a perfect science. It describes relationships which are sometimes true, but can also change, sometimes permanently. For that reason, these models are useful to understand—but should never be taken as gospel.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.

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