Jonathan Clements's Blog, page 301
January 12, 2021
Goodbye Assets
MY TWINS ARE SENIORS in high school. That means, pandemic or no pandemic, we spent the fall applying to colleges.
Here in California, the pandemic closed public schools in March and most did not reopen for in-person teaching with the start of the current academic year. That forced parents to stand in for college counselors. The preparations high school juniors usually engage in, such as visiting colleges and taking standardized tests, didn’t occur this past spring or summer. Student athletes spent the summer practicing in parks and driveways. Grades suffered under remote learning. For all these reasons, applying to college has been more difficult.
And then there’s the price tag.
Post-secondary education can be relatively inexpensive—or it can break the Bank of Mom and Dad. The federal government supplies some grants and many loans to limit the immediate financial damage, and colleges also dole out money from their own funds. Still, the student loan crisis is front page news. That’s one reason so many parents try to ensure their young adults don’t leave college with crushing debt.
The federal government’s role begins with the Free Application for Federal Student Aid, or FAFSA, with “free” meaning it doesn’t cost you to ask. FAFSA calculates a family’s expected family contribution (EFC) based on the parents’ and student’s income and assets. On top of that, colleges use their own guidelines to distribute the grant money they control.
For families earning below about $50,000, the EFC will likely be $0. After that, the amount rises sharply—and sometimes unfairly. For instance, middle-class single parents, along with older parents with a healthy amount of savings, may be shocked by how much they’re expected to pay toward college costs. There’s no way to sugarcoat it: Parents with decent incomes, or who’ve successfully set aside a chunk of money, end up paying plenty when their kids go to more expensive colleges.
Consider the parents’ assets. In broad terms, the EFC assumes parents will put as much as 5.64% of their wealth every year toward college costs. We’re talking about things like money in bank accounts, regular taxable brokerage accounts, parent-owned 529 plans and second homes. The good news: A few key items are excluded, such as money in retirement accounts and the value of the family’s primary residence.
Imagine you’ve carefully saved $100,000 outside a retirement account to serve as an emergency fund to cover six months of troubles. If your assets are assessed at the full 5.64%, you will lose $5,640 of the $100,000 in year one. The next year, you’ll be expected to put 5.64% of the remaining $94,360 toward college costs, or $5,322. In year three, you pay 5.64% of $89,038, equal to $5,022. At the start of Junior’s senior year, $84,016 remains in your emergency fund. The last bite will cost you $4,739, leaving you with $79,278 and a slow road to building your emergency savings back to its pre-college value.
Oops. The problem: Few students graduate in four years. Some can’t get required classes or change majors. Many interrupt their college years with work or other activities, or they drop out entirely.
The National Center for Education Statistics reports that it takes six years for 62% of incoming public university freshmen to graduate. The number rises slightly to 67% for private nonprofit schools, but drops precipitously to 25% for private for-profit schools. The six-year rate varies based on school selectivity, with a six-year graduation rate of 90% for schools with selective acceptance—meaning just one out of four are admitted—but only 34% for schools with open admissions.
Add those extra two years for your no-longer cherubic child, and your emergency fund drops to $70,587 (with contributions of $4,471 in year five and $4,219 in year six). By then, Junior’s sister could be well along in her six-year undergraduate degree, each year with its own continuing bite out of your non-retirement investments.
Numerous projections have suggested that slightly more than a third of all jobs in the near future will require a bachelor’s degree. Many respected and well-compensated professions require no more than a two-year degree in a specialized program, which your child can earn at a nearby community college.
The upshot: It’s a wonder more parents don’t question the traditional undergraduate college experience. I fault the “college prep” track, which is the principal goal of most public high schools. My advice: Talking through the myriad college options, and how to pay for them, is a homework assignment that needs to be completed by all high schoolers—along with their parents.
Catherine Horiuchi recently retired from the University of San Francisco's School of Management, where she was an associate professor teaching graduate courses in public policy, public finance and government technology. Catherine's earlier articles include Leaving Early, Good Company and From Two to One.
Here in California, the pandemic closed public schools in March and most did not reopen for in-person teaching with the start of the current academic year. That forced parents to stand in for college counselors. The preparations high school juniors usually engage in, such as visiting colleges and taking standardized tests, didn’t occur this past spring or summer. Student athletes spent the summer practicing in parks and driveways. Grades suffered under remote learning. For all these reasons, applying to college has been more difficult.
And then there’s the price tag.
Post-secondary education can be relatively inexpensive—or it can break the Bank of Mom and Dad. The federal government supplies some grants and many loans to limit the immediate financial damage, and colleges also dole out money from their own funds. Still, the student loan crisis is front page news. That’s one reason so many parents try to ensure their young adults don’t leave college with crushing debt.
The federal government’s role begins with the Free Application for Federal Student Aid, or FAFSA, with “free” meaning it doesn’t cost you to ask. FAFSA calculates a family’s expected family contribution (EFC) based on the parents’ and student’s income and assets. On top of that, colleges use their own guidelines to distribute the grant money they control.
For families earning below about $50,000, the EFC will likely be $0. After that, the amount rises sharply—and sometimes unfairly. For instance, middle-class single parents, along with older parents with a healthy amount of savings, may be shocked by how much they’re expected to pay toward college costs. There’s no way to sugarcoat it: Parents with decent incomes, or who’ve successfully set aside a chunk of money, end up paying plenty when their kids go to more expensive colleges.
Consider the parents’ assets. In broad terms, the EFC assumes parents will put as much as 5.64% of their wealth every year toward college costs. We’re talking about things like money in bank accounts, regular taxable brokerage accounts, parent-owned 529 plans and second homes. The good news: A few key items are excluded, such as money in retirement accounts and the value of the family’s primary residence.
Imagine you’ve carefully saved $100,000 outside a retirement account to serve as an emergency fund to cover six months of troubles. If your assets are assessed at the full 5.64%, you will lose $5,640 of the $100,000 in year one. The next year, you’ll be expected to put 5.64% of the remaining $94,360 toward college costs, or $5,322. In year three, you pay 5.64% of $89,038, equal to $5,022. At the start of Junior’s senior year, $84,016 remains in your emergency fund. The last bite will cost you $4,739, leaving you with $79,278 and a slow road to building your emergency savings back to its pre-college value.
Oops. The problem: Few students graduate in four years. Some can’t get required classes or change majors. Many interrupt their college years with work or other activities, or they drop out entirely.
The National Center for Education Statistics reports that it takes six years for 62% of incoming public university freshmen to graduate. The number rises slightly to 67% for private nonprofit schools, but drops precipitously to 25% for private for-profit schools. The six-year rate varies based on school selectivity, with a six-year graduation rate of 90% for schools with selective acceptance—meaning just one out of four are admitted—but only 34% for schools with open admissions.
Add those extra two years for your no-longer cherubic child, and your emergency fund drops to $70,587 (with contributions of $4,471 in year five and $4,219 in year six). By then, Junior’s sister could be well along in her six-year undergraduate degree, each year with its own continuing bite out of your non-retirement investments.
Numerous projections have suggested that slightly more than a third of all jobs in the near future will require a bachelor’s degree. Many respected and well-compensated professions require no more than a two-year degree in a specialized program, which your child can earn at a nearby community college.
The upshot: It’s a wonder more parents don’t question the traditional undergraduate college experience. I fault the “college prep” track, which is the principal goal of most public high schools. My advice: Talking through the myriad college options, and how to pay for them, is a homework assignment that needs to be completed by all high schoolers—along with their parents.
Catherine Horiuchi recently retired from the University of San Francisco's School of Management, where she was an associate professor teaching graduate courses in public policy, public finance and government technology. Catherine's earlier articles include Leaving Early, Good Company and From Two to One.The post Goodbye Assets appeared first on HumbleDollar.
January 11, 2021
Drawing It Down
BUILDING A NEST EGG is relatively easy: Save as much as you can starting as early as you can. Invest in a diversified mix of low-cost mutual funds. Rebalance periodically. And tune out the noise.
By contrast, determining how much you can safely spend in retirement is far trickier. Consider three strategies.
First, there’s the much-discussed 4% withdrawal rate. In the first year of retirement, you spend 4% of your portfolio’s beginning-of-year value. In subsequent years, you increase that amount by the inflation rate. With that simple strategy, and a mix of 50% stocks and 50% bonds, your retirement savings should last 30 years. The problem is, you could run out of money sooner if the market performs poorly—and, of course, there’s a danger you may live longer than 30 years.
A second, even simpler approach: Spend a fixed percentage of your portfolio’s value every year. Let’s say your portfolio finishes the year at $900,000. You might spend 5% of that sum, or $45,000, the following year. With the percentage-of-portfolio strategy, you can never run out of money, because each year you’re limited to a percentage of whatever remains. But your spending could vary widely from year to year. For example, if the market falls and you finish the year with a portfolio that’s 20% smaller, you’re forced to spend 20% less the following year.
That brings me to a third way of determining how much to spend: the ceiling-and-floor method suggested by Vanguard Group. With this strategy, you again aim to spend a fixed percentage of your nest egg’s year-end value. But unlike with the second strategy, if last year was bad, there’s a limit—or floor—on how much you reduce your spending. Similarly, if the market’s performance last year was stellar, there’s a limit—or ceiling—on how much you increase your spending.
Say you start with $1 million and you’ve chosen a target of 4% spending per year, but the amount your portfolio withdrawals can change each year is limited by a 5% ceiling and a –2.5% floor. In the first year of retirement, you spend your target percentage, which is 4% or $40,000.
During that first year, your portfolio soars 20%, reaching $1.2 million at year-end. But instead of spending 4% of that sum in year two, or $48,000, you increase your spending by just 5% from the first year’s level, to $42,000. Conversely, if the market performed really badly in year one, the most you’d reduce your spending in year two is 2.5%, equal to $39,000.
Got that? To use the ceiling-and-floor approach, you’d compute three numbers at the start of each year:
Your portfolio balance as of Dec. 31 multiplied by your target percentage, which might be 4% or 5%.
The preceding year’s spending level increased by the 5% ceiling.
The preceding year’s spending level reduced by the 2.5% floor.
You then allow yourself to spend whichever of these three numbers falls in the middle. Result: You can spend more when you’re coming off a good year and you spend less if it was a bad year, but your spending doesn’t vary too much because of the limits imposed by the ceiling and floor.
A 2010 Vanguard study showed that, with a 5% ceiling and –2.5% floor, you’re less likely to run out of money than if you adhere strictly to the standard 4% withdrawal rate. In addition, you’re less likely to end up denying yourself and leaving behind an unnecessarily large estate, which is a danger with the percentage-of-portfolio approach. A 2020 Vanguard paper looked at the strategy again, this time using a 5% ceiling and –1.5% floor, while also factoring in annual inflation adjustments.
I like the ceiling-and-floor strategy, in part because my wife and I have no children and thus we don’t feel the need to leave behind a large estate. But in practice, I don’t use any of these approaches. Why not? They’re fairly simplistic and don’t take into account major life changes, such as selling your house or moving into a continuing care retirement community. They also don’t consider tax nuances, such as whether you’re selling investments that will trigger a big tax bill or not.
Instead, before my wife and I retired, I looked at how much we were spending each year and then figured out how that would change once we retired. I use that amount as our spending target. Yes, each year, I also use the Vanguard ceiling-and-floor method to make sure we aren’t too far off base. As long as we’re close to that spending level, I can be reasonably confident that my wife and I won’t run out of money.
Brian White is retired from the University of North Carolina, where he worked as a systems programmer and then director of information technology in the computer science department. His previous articles include Late to the Rescue, A Simpler Life and Time to Retire. Brian likes hiking with his wife in a nearby forest, dancing to rocking blues music, camping with friends and stamp collecting. He also enjoys doing Volunteer Income Tax Assistance (VITA) work at the Chapel Hill senior center.
By contrast, determining how much you can safely spend in retirement is far trickier. Consider three strategies.
First, there’s the much-discussed 4% withdrawal rate. In the first year of retirement, you spend 4% of your portfolio’s beginning-of-year value. In subsequent years, you increase that amount by the inflation rate. With that simple strategy, and a mix of 50% stocks and 50% bonds, your retirement savings should last 30 years. The problem is, you could run out of money sooner if the market performs poorly—and, of course, there’s a danger you may live longer than 30 years.
A second, even simpler approach: Spend a fixed percentage of your portfolio’s value every year. Let’s say your portfolio finishes the year at $900,000. You might spend 5% of that sum, or $45,000, the following year. With the percentage-of-portfolio strategy, you can never run out of money, because each year you’re limited to a percentage of whatever remains. But your spending could vary widely from year to year. For example, if the market falls and you finish the year with a portfolio that’s 20% smaller, you’re forced to spend 20% less the following year.
That brings me to a third way of determining how much to spend: the ceiling-and-floor method suggested by Vanguard Group. With this strategy, you again aim to spend a fixed percentage of your nest egg’s year-end value. But unlike with the second strategy, if last year was bad, there’s a limit—or floor—on how much you reduce your spending. Similarly, if the market’s performance last year was stellar, there’s a limit—or ceiling—on how much you increase your spending.
Say you start with $1 million and you’ve chosen a target of 4% spending per year, but the amount your portfolio withdrawals can change each year is limited by a 5% ceiling and a –2.5% floor. In the first year of retirement, you spend your target percentage, which is 4% or $40,000.
During that first year, your portfolio soars 20%, reaching $1.2 million at year-end. But instead of spending 4% of that sum in year two, or $48,000, you increase your spending by just 5% from the first year’s level, to $42,000. Conversely, if the market performed really badly in year one, the most you’d reduce your spending in year two is 2.5%, equal to $39,000.
Got that? To use the ceiling-and-floor approach, you’d compute three numbers at the start of each year:
Your portfolio balance as of Dec. 31 multiplied by your target percentage, which might be 4% or 5%.
The preceding year’s spending level increased by the 5% ceiling.
The preceding year’s spending level reduced by the 2.5% floor.
You then allow yourself to spend whichever of these three numbers falls in the middle. Result: You can spend more when you’re coming off a good year and you spend less if it was a bad year, but your spending doesn’t vary too much because of the limits imposed by the ceiling and floor.
A 2010 Vanguard study showed that, with a 5% ceiling and –2.5% floor, you’re less likely to run out of money than if you adhere strictly to the standard 4% withdrawal rate. In addition, you’re less likely to end up denying yourself and leaving behind an unnecessarily large estate, which is a danger with the percentage-of-portfolio approach. A 2020 Vanguard paper looked at the strategy again, this time using a 5% ceiling and –1.5% floor, while also factoring in annual inflation adjustments.
I like the ceiling-and-floor strategy, in part because my wife and I have no children and thus we don’t feel the need to leave behind a large estate. But in practice, I don’t use any of these approaches. Why not? They’re fairly simplistic and don’t take into account major life changes, such as selling your house or moving into a continuing care retirement community. They also don’t consider tax nuances, such as whether you’re selling investments that will trigger a big tax bill or not.
Instead, before my wife and I retired, I looked at how much we were spending each year and then figured out how that would change once we retired. I use that amount as our spending target. Yes, each year, I also use the Vanguard ceiling-and-floor method to make sure we aren’t too far off base. As long as we’re close to that spending level, I can be reasonably confident that my wife and I won’t run out of money.
Brian White is retired from the University of North Carolina, where he worked as a systems programmer and then director of information technology in the computer science department. His previous articles include Late to the Rescue, A Simpler Life and Time to Retire. Brian likes hiking with his wife in a nearby forest, dancing to rocking blues music, camping with friends and stamp collecting. He also enjoys doing Volunteer Income Tax Assistance (VITA) work at the Chapel Hill senior center.The post Drawing It Down appeared first on HumbleDollar.
January 10, 2021
Moving the Target
IT’S GETTING TO THAT time when New Year’s resolutions start falling by the wayside. Most people don’t worry too much about this. But it would be nice if there were a way to give resolutions more of a shelf life.
Todd Herman, a performance coach who has trained dozens of Olympic athletes, offers one possible solution. He calls it the “90-day year.” The premise is that a year is just too long a timeframe. As Herman puts it, if you have a yearlong goal, it’s like trying to shoot an arrow at a target so far away that it’s beyond the horizon.
Hal Hershfield, a psychology professor at the University of California, Los Angeles, provides another perspective on the problem. Hershfield has done research on the choices that consumers make, especially those involving finances. One of his findings: We don’t always make decisions that are in our best interest because we see our future self as a different person. Sure, we recognize that the person we will be tomorrow is the same person we are today. But the further out we look, the more likely we are to see our future self as a separate person and, because of that, we’re less interested in helping that other person.
The key, then, is to bring our future self closer. Or, in Herman’s terms, to bring the target closer so it’s no longer beyond the horizon. That’s why he recommends 90-day “years.” In other words, split the traditional year into four 90-day mini-years, each with smaller goals. That’ll make each of those smaller goals much more achievable.
How can you apply this concept to your finances? I recommend drawing up a personal finance calendar each year. What should that calendar look like? For the reasons cited by both Herman and Hershfield, you want to do the opposite of traditional New Year's resolutions. Instead of a grandiose, long-term goal, think small and plan short term. Choose goals small enough that you’ll be able to complete them in 90 days.
What specifically should go on this calendar? It depends on your age and life stage, but here are some ideas.
1. Investments (Part I). In my view, the most important element of any investment portfolio is its asset allocation. That’s because—to a great extent—asset allocation will dictate both your risk level and your potential returns. This is the place to start in evaluating your investments, and I would revisit it regularly.
2. Investments (Part II). After checking your overall asset allocation, you’ll want to check the breakdown within each category. Within stocks, is your portfolio tilted toward domestic stocks or international? Large cap or small? Growth or value? And don’t be complacent about bonds. They carry risk, too. Do you own Treasury bonds, corporate bonds, high yield bonds or something else?
3. Investments (Part III). The final step in reviewing your investments is to check your individual holdings. If you’ve accumulated a collection of individual stocks and other holdings over the years, you’ll want to review them regularly. This is especially true if you have an outsized position in any one stock, and even more so if it’s your employer’s stock.
4. Account choices. The tax code, as I’m sure you know, treats traditional IRAs, health savings accounts, 529 plans and other account types very differently. You want to make sure you’re taking advantage of every opportunity available. As your circumstances change, and as the tax code changes, it’s important to review how much you have in each account and how much you’re adding to each.
5. Household budget. There are two schools of thought on budgeting. The first, popularized by the notion of the “latte factor,” argues that you should control little expenses because they can add up over time. The opposing school of thought argues that you really only need to worry about big line items. For example, shave $300 a month off your mortgage by refinancing and that’ll accomplish far more than cutting back on coffee and other small expenses.
My view is that both are important, but they’re separate tasks. I’d set up one quarterly task to look at the big picture and another to scrub through smaller line items.
6. Insurance (Part I). As your personal life and your financial life evolve, make sure your insurance coverage remains aligned with your needs—especially your disability and life insurance.
7. Insurance (Part II). Insurance coverage levels are most important. But a separate task is to shop around for the best deal on that coverage. Once insurance agents have sold you a policy, they don’t have a big incentive to review it regularly. But if you ask them, they will.
8. Estate planning. If you expect your assets to exceed the federal estate tax exclusion, especially once the current high exclusion sunsets in 2026, you’ll want to make this task a big part of your annual schedule. While estate planning tasks can feel like drudgery, I believe it’s worth the effort. Remember, the federal estate tax alone will take 40 cents out of every dollar you bequeath that’s above the exclusion, and state taxes may also be an issue.
9. Charitable giving. You probably receive a flood of charitable solicitations every December. I understand why charities do this, but the result can be haphazard giving. If you have a substantial charitable budget, I’d make it an annual task to review the overall amount, the allocation among recipients, the timing and your process for giving.
10. Taxes. If you’re like most people, you’re so glad when your tax return is done each year that you’re happy to file it away and move on. But it can be invaluable to spend some quality time with your accountant after your return is completed. Ask for his or her observations and recommendations, especially if your tax situation is complex or you have a high income.
11. Risk management. Financial risk extends beyond your portfolio, so take time each year to think more broadly about risk. Do you have a safe for valuables in your home? Do you use a password manager to generate online passwords? Do you use two-factor authentication, especially on your email? Do you have verbal passwords set up with your financial institutions? Do you have a mechanism for monitoring your credit? Such questions may not seem urgent today—but, if something goes awry, you’ll be glad you asked them.
Adam M. Grossman’s previous articles include Those Messy Humans, What We've Learned and Unhelpful Advice. Adam is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, Adam advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman.
Todd Herman, a performance coach who has trained dozens of Olympic athletes, offers one possible solution. He calls it the “90-day year.” The premise is that a year is just too long a timeframe. As Herman puts it, if you have a yearlong goal, it’s like trying to shoot an arrow at a target so far away that it’s beyond the horizon.
Hal Hershfield, a psychology professor at the University of California, Los Angeles, provides another perspective on the problem. Hershfield has done research on the choices that consumers make, especially those involving finances. One of his findings: We don’t always make decisions that are in our best interest because we see our future self as a different person. Sure, we recognize that the person we will be tomorrow is the same person we are today. But the further out we look, the more likely we are to see our future self as a separate person and, because of that, we’re less interested in helping that other person.
The key, then, is to bring our future self closer. Or, in Herman’s terms, to bring the target closer so it’s no longer beyond the horizon. That’s why he recommends 90-day “years.” In other words, split the traditional year into four 90-day mini-years, each with smaller goals. That’ll make each of those smaller goals much more achievable.
How can you apply this concept to your finances? I recommend drawing up a personal finance calendar each year. What should that calendar look like? For the reasons cited by both Herman and Hershfield, you want to do the opposite of traditional New Year's resolutions. Instead of a grandiose, long-term goal, think small and plan short term. Choose goals small enough that you’ll be able to complete them in 90 days.
What specifically should go on this calendar? It depends on your age and life stage, but here are some ideas.
1. Investments (Part I). In my view, the most important element of any investment portfolio is its asset allocation. That’s because—to a great extent—asset allocation will dictate both your risk level and your potential returns. This is the place to start in evaluating your investments, and I would revisit it regularly.
2. Investments (Part II). After checking your overall asset allocation, you’ll want to check the breakdown within each category. Within stocks, is your portfolio tilted toward domestic stocks or international? Large cap or small? Growth or value? And don’t be complacent about bonds. They carry risk, too. Do you own Treasury bonds, corporate bonds, high yield bonds or something else?
3. Investments (Part III). The final step in reviewing your investments is to check your individual holdings. If you’ve accumulated a collection of individual stocks and other holdings over the years, you’ll want to review them regularly. This is especially true if you have an outsized position in any one stock, and even more so if it’s your employer’s stock.
4. Account choices. The tax code, as I’m sure you know, treats traditional IRAs, health savings accounts, 529 plans and other account types very differently. You want to make sure you’re taking advantage of every opportunity available. As your circumstances change, and as the tax code changes, it’s important to review how much you have in each account and how much you’re adding to each.
5. Household budget. There are two schools of thought on budgeting. The first, popularized by the notion of the “latte factor,” argues that you should control little expenses because they can add up over time. The opposing school of thought argues that you really only need to worry about big line items. For example, shave $300 a month off your mortgage by refinancing and that’ll accomplish far more than cutting back on coffee and other small expenses.
My view is that both are important, but they’re separate tasks. I’d set up one quarterly task to look at the big picture and another to scrub through smaller line items.
6. Insurance (Part I). As your personal life and your financial life evolve, make sure your insurance coverage remains aligned with your needs—especially your disability and life insurance.
7. Insurance (Part II). Insurance coverage levels are most important. But a separate task is to shop around for the best deal on that coverage. Once insurance agents have sold you a policy, they don’t have a big incentive to review it regularly. But if you ask them, they will.
8. Estate planning. If you expect your assets to exceed the federal estate tax exclusion, especially once the current high exclusion sunsets in 2026, you’ll want to make this task a big part of your annual schedule. While estate planning tasks can feel like drudgery, I believe it’s worth the effort. Remember, the federal estate tax alone will take 40 cents out of every dollar you bequeath that’s above the exclusion, and state taxes may also be an issue.
9. Charitable giving. You probably receive a flood of charitable solicitations every December. I understand why charities do this, but the result can be haphazard giving. If you have a substantial charitable budget, I’d make it an annual task to review the overall amount, the allocation among recipients, the timing and your process for giving.
10. Taxes. If you’re like most people, you’re so glad when your tax return is done each year that you’re happy to file it away and move on. But it can be invaluable to spend some quality time with your accountant after your return is completed. Ask for his or her observations and recommendations, especially if your tax situation is complex or you have a high income.
11. Risk management. Financial risk extends beyond your portfolio, so take time each year to think more broadly about risk. Do you have a safe for valuables in your home? Do you use a password manager to generate online passwords? Do you use two-factor authentication, especially on your email? Do you have verbal passwords set up with your financial institutions? Do you have a mechanism for monitoring your credit? Such questions may not seem urgent today—but, if something goes awry, you’ll be glad you asked them.
Adam M. Grossman’s previous articles include Those Messy Humans, What We've Learned and Unhelpful Advice. Adam is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, Adam advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman.The post Moving the Target appeared first on HumbleDollar.
January 9, 2021
Easy Wins
IF YOU SAW $20 on the sidewalk, you’d pick it up, right? Unfortunately, when we buy stocks and stock funds, there are no guarantees we’ll emerge a winner. But elsewhere in our financial life, $20 bills abound—and it often takes little effort and scant risk to grab this free money.
Looking for some easy financial wins? Here are 15 of them:
If you’re eligible for a Roth IRA and you have the spare cash to fund the account, there’s almost no downside. The money will grow tax-free once it’s in the Roth, plus you can withdraw your contributions at any time for any reason, with no taxes or penalties owed. The one modest disadvantage: It’ll be at least five years, and likely far longer, before you can get access to the account’s investment earnings without triggering taxes or penalties.
If your employer offers a 401(k) with an employer match, contributing enough to earn the full match is perhaps the greatest free lunch available. Yes, your money will be effectively locked up until age 59½ because of the 10% tax penalty on early withdrawals. But that’s a small price to pay to get free money from your employer—plus, even if you ended up tapping the account early and paying the 10% penalty, there’s a good chance you’d still come out ahead.
Got bonds or cash investments sitting in a regular taxable account? You can almost certainly improve your overall financial return by selling these investments and using the proceeds to pay down debt. Why? The interest you’re earning on these investments is likely less than the interest rate you’re paying on the money you borrowed. But there are two caveats. First, if you sell bonds, you may trigger capital gains taxes. Second, by selling investments to reduce debt, you’ll have less ready access to cash.
If you have money languishing in your checking account or a savings account at your local brick-and-mortar bank, you might be able to earn an extra 0.5% over the next 12 months by moving that money into a high-yield online savings account.
Want to give to charity, but doubt you’ll have enough deductions to itemize and thereby get a tax break for your generosity? Consider bunching two or three years of donations into a single year. If you aren’t sure which charities to support, you can always park the money in a donor-advised fund for now. A digression: In last month’s coronavirus relief legislation, Congress extended the “above the line” tax break to 2021 for those who give to charity and don’t itemize. In 2021, the deduction is capped at $300 for individuals and $600 for couples.
Want to give to charity and you’re in your 70s or older? Consider making a qualified charitable distribution from your IRA directly to your favorite charity. While you won’t get a tax deduction for your donation, the distribution counts toward the required minimum distribution from your retirement accounts. Result: You’ll have less taxable income to report—which is as good as, and often better than, getting a tax deduction—plus you could enjoy a few other key financial benefits, including lower Medicare premiums.
Thanks to the standard deduction, single individuals can have taxable income of $12,550 in 2021 and pay zero federal income taxes, while married couples can pull in $25,100 without worrying about taxes. If you're on track to have a year with no taxable income, you should find some way to generate at least enough income to take advantage of this freebie. What if you overshoot by a little? That wouldn’t be so terrible: The additional income would be taxed at just 10%.
Got investments in your regular taxable account that have climbed in value? In 2021, if your total taxable income is below $52,950 and you’re single, your realized long-term capital gains would be taxed at 0%. If you’re married, the threshold is $105,900. These sums assume you claim the standard deduction. If you have enough deductions to itemize, the figures would be somewhat higher.
Got losing investments in your taxable account? You could sell those, and then use the realized losses to offset realized capital gains and up to $3,000 in ordinary income. Be warned: If you plan to buy back the losing position you sold, you’ll need to wait more than 30 days or you risk running afoul of the wash-sale rule, thereby invalidating the loss.
If you have children still living at home or in college, and who would normally be subject to the so-called kiddie tax, they can have up to $1,100 in investment gains and pay no tax. But there’s a potential downside: The money you invest for your children will be considered their asset and will count heavily against them in the college financial-aid formulas, so you shouldn’t stash dollars in their name if you think they’ll be eligible for aid.
If you’re self-employed or run a small business, think carefully about when you incur costs and when you ask customers to pay. If 2021 will be a good year but you expect 2022 to be leaner, you might buy that new computer equipment this year, so you can offset the cost against this year’s higher income. Meanwhile, toward year-end, you might hold off billing clients until 2022, so the income gets pushed into next year—when you’re potentially in a lower tax bracket. The risk with this strategy: You misjudge 2022 and have a better year than you expect.
In 2021, you can give up to $15,000 to as many folks as you wish, without triggering the gift tax. Making regular gifts is a great way to shrink the size of your taxable estate. That might not seem like much of a worry with the federal estate tax exemption now at $11.7 million. But remember, 17 states, plus Washington, DC, have their own estate or inheritance tax. Those state taxes often kick in at much lower asset levels, which means making regular gifts can be a smart idea even for those with moderate amounts of wealth. Such gifts may also help should you need assistance from Medicaid in paying nursing home costs.
If you regularly get a big tax refund, reduce your tax withholding—and stash the extra money in an online savings account, where you’ll earn a little interest. Yes, I know folks like receiving a large tax refund, because it feels like a financial windfall. Yes, you’ll have to restrain yourself from spending the money that accumulates in your savings account. But if you have the necessary self-discipline, reducing your withholding is the rational thing to do—and a way to make a little extra money.
Whenever you buy something, use a rewards credit card. Thanks to the card, you could get 1% to 5% of your money back. The danger: That small bonus might encourage you to overspend.
Go through your checking account and credit card statements, looking at all regular deductions, including those for gym memberships, streaming services, magazine subscriptions and so on. Not using some of these services? Cancelling them is an easy financial win.
Here’s one that doesn’t quite fit the list—but I figured I ought to mention: You might have heard financial experts refer to diversification as the financial market’s “only free lunch.” What do they mean by that? By diversifying more broadly, you can potentially earn the same long-run return, but with less volatility in your portfolio’s performance. The danger: This broader diversification could hurt your investment results in the short term.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
Not many folks still do their taxes by hand. Andrew Forsythe is one of them. He argues it's worth the hassle.
If you're covered by Medicare and you have a good year financially, your premiums could soar two years later—a nasty surprise that just hit Sonja Haggert and her husband.
"Not all cash hoarders are losing sleep over their loss of purchasing power," writes Sanjib Saha. "Perhaps they value liquidity and peace of mind. Cash is the right choice for them, even if it isn’t for others."
Struggling to see the silver lining in the difficulties—financial and otherwise—of the past year? Joe Kesler has five suggestions.
"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.
What intrigued readers last month? Check out the seven most popular articles published by HumbleDollar in December.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook. Jonathan's most recent articles include Our Report Card, What Money Can Buy and Time Limited.
Looking for some easy financial wins? Here are 15 of them:
If you’re eligible for a Roth IRA and you have the spare cash to fund the account, there’s almost no downside. The money will grow tax-free once it’s in the Roth, plus you can withdraw your contributions at any time for any reason, with no taxes or penalties owed. The one modest disadvantage: It’ll be at least five years, and likely far longer, before you can get access to the account’s investment earnings without triggering taxes or penalties.
If your employer offers a 401(k) with an employer match, contributing enough to earn the full match is perhaps the greatest free lunch available. Yes, your money will be effectively locked up until age 59½ because of the 10% tax penalty on early withdrawals. But that’s a small price to pay to get free money from your employer—plus, even if you ended up tapping the account early and paying the 10% penalty, there’s a good chance you’d still come out ahead.
Got bonds or cash investments sitting in a regular taxable account? You can almost certainly improve your overall financial return by selling these investments and using the proceeds to pay down debt. Why? The interest you’re earning on these investments is likely less than the interest rate you’re paying on the money you borrowed. But there are two caveats. First, if you sell bonds, you may trigger capital gains taxes. Second, by selling investments to reduce debt, you’ll have less ready access to cash.
If you have money languishing in your checking account or a savings account at your local brick-and-mortar bank, you might be able to earn an extra 0.5% over the next 12 months by moving that money into a high-yield online savings account.
Want to give to charity, but doubt you’ll have enough deductions to itemize and thereby get a tax break for your generosity? Consider bunching two or three years of donations into a single year. If you aren’t sure which charities to support, you can always park the money in a donor-advised fund for now. A digression: In last month’s coronavirus relief legislation, Congress extended the “above the line” tax break to 2021 for those who give to charity and don’t itemize. In 2021, the deduction is capped at $300 for individuals and $600 for couples.
Want to give to charity and you’re in your 70s or older? Consider making a qualified charitable distribution from your IRA directly to your favorite charity. While you won’t get a tax deduction for your donation, the distribution counts toward the required minimum distribution from your retirement accounts. Result: You’ll have less taxable income to report—which is as good as, and often better than, getting a tax deduction—plus you could enjoy a few other key financial benefits, including lower Medicare premiums.
Thanks to the standard deduction, single individuals can have taxable income of $12,550 in 2021 and pay zero federal income taxes, while married couples can pull in $25,100 without worrying about taxes. If you're on track to have a year with no taxable income, you should find some way to generate at least enough income to take advantage of this freebie. What if you overshoot by a little? That wouldn’t be so terrible: The additional income would be taxed at just 10%.
Got investments in your regular taxable account that have climbed in value? In 2021, if your total taxable income is below $52,950 and you’re single, your realized long-term capital gains would be taxed at 0%. If you’re married, the threshold is $105,900. These sums assume you claim the standard deduction. If you have enough deductions to itemize, the figures would be somewhat higher.
Got losing investments in your taxable account? You could sell those, and then use the realized losses to offset realized capital gains and up to $3,000 in ordinary income. Be warned: If you plan to buy back the losing position you sold, you’ll need to wait more than 30 days or you risk running afoul of the wash-sale rule, thereby invalidating the loss.
If you have children still living at home or in college, and who would normally be subject to the so-called kiddie tax, they can have up to $1,100 in investment gains and pay no tax. But there’s a potential downside: The money you invest for your children will be considered their asset and will count heavily against them in the college financial-aid formulas, so you shouldn’t stash dollars in their name if you think they’ll be eligible for aid.
If you’re self-employed or run a small business, think carefully about when you incur costs and when you ask customers to pay. If 2021 will be a good year but you expect 2022 to be leaner, you might buy that new computer equipment this year, so you can offset the cost against this year’s higher income. Meanwhile, toward year-end, you might hold off billing clients until 2022, so the income gets pushed into next year—when you’re potentially in a lower tax bracket. The risk with this strategy: You misjudge 2022 and have a better year than you expect.
In 2021, you can give up to $15,000 to as many folks as you wish, without triggering the gift tax. Making regular gifts is a great way to shrink the size of your taxable estate. That might not seem like much of a worry with the federal estate tax exemption now at $11.7 million. But remember, 17 states, plus Washington, DC, have their own estate or inheritance tax. Those state taxes often kick in at much lower asset levels, which means making regular gifts can be a smart idea even for those with moderate amounts of wealth. Such gifts may also help should you need assistance from Medicaid in paying nursing home costs.
If you regularly get a big tax refund, reduce your tax withholding—and stash the extra money in an online savings account, where you’ll earn a little interest. Yes, I know folks like receiving a large tax refund, because it feels like a financial windfall. Yes, you’ll have to restrain yourself from spending the money that accumulates in your savings account. But if you have the necessary self-discipline, reducing your withholding is the rational thing to do—and a way to make a little extra money.
Whenever you buy something, use a rewards credit card. Thanks to the card, you could get 1% to 5% of your money back. The danger: That small bonus might encourage you to overspend.
Go through your checking account and credit card statements, looking at all regular deductions, including those for gym memberships, streaming services, magazine subscriptions and so on. Not using some of these services? Cancelling them is an easy financial win.
Here’s one that doesn’t quite fit the list—but I figured I ought to mention: You might have heard financial experts refer to diversification as the financial market’s “only free lunch.” What do they mean by that? By diversifying more broadly, you can potentially earn the same long-run return, but with less volatility in your portfolio’s performance. The danger: This broader diversification could hurt your investment results in the short term.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
Not many folks still do their taxes by hand. Andrew Forsythe is one of them. He argues it's worth the hassle.
If you're covered by Medicare and you have a good year financially, your premiums could soar two years later—a nasty surprise that just hit Sonja Haggert and her husband.
"Not all cash hoarders are losing sleep over their loss of purchasing power," writes Sanjib Saha. "Perhaps they value liquidity and peace of mind. Cash is the right choice for them, even if it isn’t for others."
Struggling to see the silver lining in the difficulties—financial and otherwise—of the past year? Joe Kesler has five suggestions.
"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.
What intrigued readers last month? Check out the seven most popular articles published by HumbleDollar in December.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook. Jonathan's most recent articles include Our Report Card, What Money Can Buy and Time Limited.The post Easy Wins appeared first on HumbleDollar.
January 8, 2021
Silver Lining
“IT WAS THE MOST stressful time of my career, but also the most rewarding.” I heard that comment, as well as variations on it, from many bankers over the past few months as they talked about PPP, or Payment Protection Program, the federal loan program launched to help ease the financial distress caused by the pandemic.
PPP has been criticized because not all the money has ended up with companies it was intended to help. Still, it saved millions of small businesses from going under.
One young lender told me that, while dealing with PPP loan applications, she worked past midnight for weeks, had to juggle childcare and struggled to understand the program because of a lack of clear guidance, all while trying to reassure desperate small business owners that she’d secure the funding they needed to save their livelihood. And yet, despite the pressure, she wouldn’t have missed the experience for anything, because she knew she made a huge difference to her community.
Bankers are like many professionals. They can grow disillusioned. We enter a profession with noble goals to provide affordable housing or bring new jobs to our community, but our idealistic thinking gets muddied by the paperwork, the sales goals and the office politics, and eventually we burn out. The FIRE—financial independence, retire early—movement, which encourages saving voraciously so we can retire as early as possible, at least partly reflects this disillusionment.
But from what I’ve observed, the COVID-19 pandemic and PPP rollout has cut through the banking world’s frequent frustrations to remind even veterans like me of how important we are to our community. To be sure, not everybody has found the past year professionally rewarding. I know a doctor who actively discourages aspiring medical students from joining the profession, because he hates the red tape and the constant haggling with insurance companies.
Struggling to see the silver lining in the difficulties of the past year? Here are five suggestions to leverage 2020 into something good:
My daughter put my wife and me through an exercise recently. “What do you want?” she asked us. After I answered, she said, “What do you want, Dad?” After I answered again, she asked me the same question eight more times. Eventually, I began to catch on, realizing that this was an exercise designed to get me to think deeply about what was buried in my psyche. As I ponder goals for 2021, I’m going to be asking myself and my wife that simple question.
Talk to your financial advisor about what you want and evaluate whether your current finances will get you there. While travel may not be the most noble pursuit or life purpose, it’s high on my list of goals for 2021. Now is a great time to examine your investment buckets to make sure you have sufficient funds and you’re planning appropriately, so you can achieve what you want.
Get your affairs in order. There’s nothing like a pandemic to remind us of our mortality. My to-do list for 2021 includes contacting my lawyer to make a few changes to our estate plan. I also want to make a list of where we keep important documents and give it to one of our children. We can’t control our money from the grave—at least not for long—but we can make intelligent choices while we’re alive, so where our money goes is aligned with our goals and values.
Reevaluate charitable giving. COVID-19 has clearly had an uneven impact around the world. Other than staying at home, many of us haven’t suffered. But lower-income service workers in the U.S. have suffered greatly, as have workers in developing countries around the world. I’m reevaluating our giving to see if our charitable dollars could have greater impact in 2021.
Find ways to thank the essential workers in your life for what they’ve done. Gratitude is a great exercise. I sat down at Thanksgiving and wrote numerous notes of appreciation to folks who have shown great leadership or served others. It’s a good exercise for all of us—and it could prompt you not just to change your charitable donations, but also to rethink how you use your money more generally.
Joe Kesler is the author of
Smart Money with Purpose
and the founder of a
website
with the same name, which is where a version of this article first appeared. He spent 40 years in community banking, assisting small businesses and consumers. Joe served as chief executive of banks in Illinois and Montana. He currently lives with his wife in Missoula, Montana, spending his time writing on personal finance, serving on two bank boards and hiking in the Rocky Mountains. Joe's previous articles include About Tomorrow, Prepare for Pain and Doing Good.
PPP has been criticized because not all the money has ended up with companies it was intended to help. Still, it saved millions of small businesses from going under.
One young lender told me that, while dealing with PPP loan applications, she worked past midnight for weeks, had to juggle childcare and struggled to understand the program because of a lack of clear guidance, all while trying to reassure desperate small business owners that she’d secure the funding they needed to save their livelihood. And yet, despite the pressure, she wouldn’t have missed the experience for anything, because she knew she made a huge difference to her community.
Bankers are like many professionals. They can grow disillusioned. We enter a profession with noble goals to provide affordable housing or bring new jobs to our community, but our idealistic thinking gets muddied by the paperwork, the sales goals and the office politics, and eventually we burn out. The FIRE—financial independence, retire early—movement, which encourages saving voraciously so we can retire as early as possible, at least partly reflects this disillusionment.
But from what I’ve observed, the COVID-19 pandemic and PPP rollout has cut through the banking world’s frequent frustrations to remind even veterans like me of how important we are to our community. To be sure, not everybody has found the past year professionally rewarding. I know a doctor who actively discourages aspiring medical students from joining the profession, because he hates the red tape and the constant haggling with insurance companies.
Struggling to see the silver lining in the difficulties of the past year? Here are five suggestions to leverage 2020 into something good:
My daughter put my wife and me through an exercise recently. “What do you want?” she asked us. After I answered, she said, “What do you want, Dad?” After I answered again, she asked me the same question eight more times. Eventually, I began to catch on, realizing that this was an exercise designed to get me to think deeply about what was buried in my psyche. As I ponder goals for 2021, I’m going to be asking myself and my wife that simple question.
Talk to your financial advisor about what you want and evaluate whether your current finances will get you there. While travel may not be the most noble pursuit or life purpose, it’s high on my list of goals for 2021. Now is a great time to examine your investment buckets to make sure you have sufficient funds and you’re planning appropriately, so you can achieve what you want.
Get your affairs in order. There’s nothing like a pandemic to remind us of our mortality. My to-do list for 2021 includes contacting my lawyer to make a few changes to our estate plan. I also want to make a list of where we keep important documents and give it to one of our children. We can’t control our money from the grave—at least not for long—but we can make intelligent choices while we’re alive, so where our money goes is aligned with our goals and values.
Reevaluate charitable giving. COVID-19 has clearly had an uneven impact around the world. Other than staying at home, many of us haven’t suffered. But lower-income service workers in the U.S. have suffered greatly, as have workers in developing countries around the world. I’m reevaluating our giving to see if our charitable dollars could have greater impact in 2021.
Find ways to thank the essential workers in your life for what they’ve done. Gratitude is a great exercise. I sat down at Thanksgiving and wrote numerous notes of appreciation to folks who have shown great leadership or served others. It’s a good exercise for all of us—and it could prompt you not just to change your charitable donations, but also to rethink how you use your money more generally.
Joe Kesler is the author of
Smart Money with Purpose
and the founder of a
website
with the same name, which is where a version of this article first appeared. He spent 40 years in community banking, assisting small businesses and consumers. Joe served as chief executive of banks in Illinois and Montana. He currently lives with his wife in Missoula, Montana, spending his time writing on personal finance, serving on two bank boards and hiking in the Rocky Mountains. Joe's previous articles include About Tomorrow, Prepare for Pain and Doing Good.The post Silver Lining appeared first on HumbleDollar.
January 7, 2021
Price of Success
MY HUSBAND AND I are planners. We can tell you where we’ll be living 15 years from now, the trip we plan to take in 2022 and how much we’ll likely pay in taxes this year.
What we didn’t plan for: Paying more for Medicare—a lot more.
If you’re covered by Medicare, you’ll likely know that this year you pay $148.50 in monthly premiums for Medicare Part B, plus a premium for the Part D prescription drug benefit, which is $51.20 a month each for my husband and me. What you may not realize is that if you have a good year financially—in our case, we sold a piece of real estate—you may pay quite a bit more.
The Social Security Administration calls this IRMAA, short for income-related monthly adjustment amount, and it hinges on your tax return from two years earlier. IRMAA is determined by taking your adjusted gross income and adding your tax-exempt interest. In the notice you get from the Social Security Administration, this amount is referred to as your modified adjusted gross income (MAGI).
If your MAGI in 2019 was $88,000 or more and you’re single, or $176,000 and above and you’re married, you’ll pay more in Medicare premiums in 2021. The Part B and Part D combined monthly surcharge can be anywhere from $71.70 to $433.50—and that’s only for one of you. A married couple could be paying an additional $867 every month, equal to more than $10,000 for a year. Your surcharge is recalculated each year.
I know what you’re probably thinking. Should someone who benefited from a good financial year be whining? Perhaps not. But for us, it was more the element of surprise. The planners in us asked, “How could we have done this differently?”
Could we have sold the property before we were eligible for Medicare? Doubtful. Could we have worked with the buyer to be paid over a period of years? Maybe. Although we knew there would be Medicare premium adjustments at a certain income level, we had no idea it would be so much.
In a phone conversation my husband had with Medicare, the representative told him to fill out Form SSA-44, which you can use to request a reduction in your IRMAA surcharge if you were subject to certain life-changing events. These events include the following:
You marry.
You divorce or your marriage is annulled.
You become a widow or widower.
You or your spouse stop working or reduce your work hours.
You or your spouse lost income from income-producing property due to a disaster or event beyond your control.
You or your spouse experience a scheduled cessation, termination or reorganization of an employer’s pension plan.
You or your spouse receive a settlement from an employer’s closure, bankruptcy or reorganization.
No, our long-term capital gain didn’t qualify.
While we were delving into the ins and outs of IRMAA, we realized another surprise will eventually come our way. What will happen to our tax bill when one of us is no longer here? If our income remains the same but one of us is now filing as a single individual rather than as a couple, the surviving spouse will likely be in a higher tax bracket and face a much steeper tax bill.
Just something to think about and plan for. What’s the old saying? Forewarned is forearmed.
Sonja Haggert's previous articles include Friend Requests, Right Turn and Getting Used. She's the author of Invest, Reinvest, Rest. You can learn more at SonjaHaggert.com. Follow her on Twitter @SonjaHaggert.
What we didn’t plan for: Paying more for Medicare—a lot more.
If you’re covered by Medicare, you’ll likely know that this year you pay $148.50 in monthly premiums for Medicare Part B, plus a premium for the Part D prescription drug benefit, which is $51.20 a month each for my husband and me. What you may not realize is that if you have a good year financially—in our case, we sold a piece of real estate—you may pay quite a bit more.
The Social Security Administration calls this IRMAA, short for income-related monthly adjustment amount, and it hinges on your tax return from two years earlier. IRMAA is determined by taking your adjusted gross income and adding your tax-exempt interest. In the notice you get from the Social Security Administration, this amount is referred to as your modified adjusted gross income (MAGI).
If your MAGI in 2019 was $88,000 or more and you’re single, or $176,000 and above and you’re married, you’ll pay more in Medicare premiums in 2021. The Part B and Part D combined monthly surcharge can be anywhere from $71.70 to $433.50—and that’s only for one of you. A married couple could be paying an additional $867 every month, equal to more than $10,000 for a year. Your surcharge is recalculated each year.
I know what you’re probably thinking. Should someone who benefited from a good financial year be whining? Perhaps not. But for us, it was more the element of surprise. The planners in us asked, “How could we have done this differently?”
Could we have sold the property before we were eligible for Medicare? Doubtful. Could we have worked with the buyer to be paid over a period of years? Maybe. Although we knew there would be Medicare premium adjustments at a certain income level, we had no idea it would be so much.
In a phone conversation my husband had with Medicare, the representative told him to fill out Form SSA-44, which you can use to request a reduction in your IRMAA surcharge if you were subject to certain life-changing events. These events include the following:
You marry.
You divorce or your marriage is annulled.
You become a widow or widower.
You or your spouse stop working or reduce your work hours.
You or your spouse lost income from income-producing property due to a disaster or event beyond your control.
You or your spouse experience a scheduled cessation, termination or reorganization of an employer’s pension plan.
You or your spouse receive a settlement from an employer’s closure, bankruptcy or reorganization.
No, our long-term capital gain didn’t qualify.
While we were delving into the ins and outs of IRMAA, we realized another surprise will eventually come our way. What will happen to our tax bill when one of us is no longer here? If our income remains the same but one of us is now filing as a single individual rather than as a couple, the surviving spouse will likely be in a higher tax bracket and face a much steeper tax bill.
Just something to think about and plan for. What’s the old saying? Forewarned is forearmed.
Sonja Haggert's previous articles include Friend Requests, Right Turn and Getting Used. She's the author of Invest, Reinvest, Rest. You can learn more at SonjaHaggert.com. Follow her on Twitter @SonjaHaggert.The post Price of Success appeared first on HumbleDollar.
January 6, 2021
Eye of the Beholder
ARE JUNK BONDS risky? That was the question from a friend in his late 20s, whom I’ll call Josh. I answered that they were probably risky for him, but quite safe for me. Josh looked puzzled—until I explained that risk is in the eye of the beholder.
Josh has a stable career that pays well, but he doesn’t plan to stick with it forever. Instead, he wants a job that relates to his passion for outdoor activities. His strategy? Sock away as much money as possible. Once he’s done saving for retirement, he’ll switch to a more interesting job that pays just enough to sustain his lifestyle.
Josh has many years before he taps his retirement fund. He needs growth to maximize the power of investment compounding over his long time horizon. Income investments, whether FDIC-insured bank deposits or high-yield bonds, would endanger his nest egg’s growth prospects. He’s safer buying stocks and taking more risk.
My situation is different. I’ll soon start to live off my investments. I’m always looking to diversify my portfolio’s income sources. I can live with small doses of high-yield bonds, preferred stock and senior bank loans to boost my cashflow. No, these investments don’t promise price stability. But I can count on these riskier sources of income for my non-essential expenses.
All investments are risky in one way or another. But their risk should not be viewed in isolation. An investor’s own situation and objectives matter the most. An investment is risky when it doesn’t align with your overall financial goals. It’s safe when it fits well with the rest of your investments and it has a clear purpose in your portfolio.
Consider two casino games. In the first game, there’s a 25% chance of doubling your money. Otherwise, you get back just half of what you bet. The second game is riskier. On average, you’d lose all your money 99 times out of 100. But when you win, your payoff is 100 times your bet. If you walked into the casino with cash in your pocket, which would you choose?
Recently, I ran a webinar about investment risk and I presented this choice to participants. Of the 70 respondents, 40% chose to play the first game and less than 10% went with the second one. Of the remaining participants, some rejected both choices, while the rest said that their decision would depend on other factors.
Was there a single correct answer to my question? Not really. Each answer can be the perfect choice for one person and completely absurd for another. The decision depends on what each player wants, rather than on the games themselves.
Take the first game. If you don’t mind spending a few bucks to have some fun, it could be ideal. Sure, you’d lose money over time, because the expected return on each bet is negative. But the entertainment could be worth every penny.
In real life, many investments are unappealing at first glance. Some may even lose money over time. Cash is a good example. In today’s low-interest environment, its inflation-adjusted return is negative. Still, not all cash hoarders are losing sleep over their loss of purchasing power. Perhaps they value stability, liquidity and peace of mind. Cash is the right choice for them, even if it isn’t for others.
People who crave the thrill of a big win would choose the second game. To them, the potential pleasure of hitting the one-in-a-100 jackpot trumps the strong likelihood of repeatedly losing. But my webinar poll suggests that such people are in the minority. That’s because most of us dread losses. For those who don’t, the second game may be the correct choice.
An acquaintance of mine would probably like the second game. He trades TQQQ, the triple-leveraged exchanged-traded fund that’s tied to the Nasdaq 100 index. He says the perils of leveraged ETFs don’t bother him. From his perspective, it’d be riskier to give up his chance of a big win, however slim the odds are.
To understand why some poll respondents shunned both games, let’s put on our homo economicus hat. In the long run, neither game should be profitable. The first game favors the casino. Over time, a player would likely lose an average 12½ cents on every $1 bet. With the second game, a player can expect to break even over time, but nothing more. Someone who’s looking to make money would pass on both games and instead search for a better alternative.
I recently found myself in a similar spot. I needed to invest my annual work bonus. I had no appetite to invest more in the stock market, which I consider overvalued, though I was tempted by the shares of my favorite cruise line. I explored long-maturity individual bonds. But the paltry yields and the inflation risk discouraged me. Finally, I decided that this time my best course of action would be to wait on the sidelines, while I looked for alternatives.
What about the remaining poll participants who couldn’t decide which game to play? Are they overthinkers? I doubt it. Our money decisions are rarely black and white. They often depend on many factors, including nonfinancial factors. If we can’t decide, it doesn’t necessarily mean we’re indecisive. Sometimes, we simply need more data before we choose.
A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Behind Closed Doors, Neglected Child and Fatal Attraction. Self-taught in investments, Sanjib passed the Series 65 licensing exam as a non-industry candidate. He's passionate about raising financial literacy and enjoys helping others with their finances.
Josh has a stable career that pays well, but he doesn’t plan to stick with it forever. Instead, he wants a job that relates to his passion for outdoor activities. His strategy? Sock away as much money as possible. Once he’s done saving for retirement, he’ll switch to a more interesting job that pays just enough to sustain his lifestyle.
Josh has many years before he taps his retirement fund. He needs growth to maximize the power of investment compounding over his long time horizon. Income investments, whether FDIC-insured bank deposits or high-yield bonds, would endanger his nest egg’s growth prospects. He’s safer buying stocks and taking more risk.
My situation is different. I’ll soon start to live off my investments. I’m always looking to diversify my portfolio’s income sources. I can live with small doses of high-yield bonds, preferred stock and senior bank loans to boost my cashflow. No, these investments don’t promise price stability. But I can count on these riskier sources of income for my non-essential expenses.
All investments are risky in one way or another. But their risk should not be viewed in isolation. An investor’s own situation and objectives matter the most. An investment is risky when it doesn’t align with your overall financial goals. It’s safe when it fits well with the rest of your investments and it has a clear purpose in your portfolio.
Consider two casino games. In the first game, there’s a 25% chance of doubling your money. Otherwise, you get back just half of what you bet. The second game is riskier. On average, you’d lose all your money 99 times out of 100. But when you win, your payoff is 100 times your bet. If you walked into the casino with cash in your pocket, which would you choose?
Recently, I ran a webinar about investment risk and I presented this choice to participants. Of the 70 respondents, 40% chose to play the first game and less than 10% went with the second one. Of the remaining participants, some rejected both choices, while the rest said that their decision would depend on other factors.
Was there a single correct answer to my question? Not really. Each answer can be the perfect choice for one person and completely absurd for another. The decision depends on what each player wants, rather than on the games themselves.
Take the first game. If you don’t mind spending a few bucks to have some fun, it could be ideal. Sure, you’d lose money over time, because the expected return on each bet is negative. But the entertainment could be worth every penny.
In real life, many investments are unappealing at first glance. Some may even lose money over time. Cash is a good example. In today’s low-interest environment, its inflation-adjusted return is negative. Still, not all cash hoarders are losing sleep over their loss of purchasing power. Perhaps they value stability, liquidity and peace of mind. Cash is the right choice for them, even if it isn’t for others.
People who crave the thrill of a big win would choose the second game. To them, the potential pleasure of hitting the one-in-a-100 jackpot trumps the strong likelihood of repeatedly losing. But my webinar poll suggests that such people are in the minority. That’s because most of us dread losses. For those who don’t, the second game may be the correct choice.
An acquaintance of mine would probably like the second game. He trades TQQQ, the triple-leveraged exchanged-traded fund that’s tied to the Nasdaq 100 index. He says the perils of leveraged ETFs don’t bother him. From his perspective, it’d be riskier to give up his chance of a big win, however slim the odds are.
To understand why some poll respondents shunned both games, let’s put on our homo economicus hat. In the long run, neither game should be profitable. The first game favors the casino. Over time, a player would likely lose an average 12½ cents on every $1 bet. With the second game, a player can expect to break even over time, but nothing more. Someone who’s looking to make money would pass on both games and instead search for a better alternative.
I recently found myself in a similar spot. I needed to invest my annual work bonus. I had no appetite to invest more in the stock market, which I consider overvalued, though I was tempted by the shares of my favorite cruise line. I explored long-maturity individual bonds. But the paltry yields and the inflation risk discouraged me. Finally, I decided that this time my best course of action would be to wait on the sidelines, while I looked for alternatives.
What about the remaining poll participants who couldn’t decide which game to play? Are they overthinkers? I doubt it. Our money decisions are rarely black and white. They often depend on many factors, including nonfinancial factors. If we can’t decide, it doesn’t necessarily mean we’re indecisive. Sometimes, we simply need more data before we choose.
A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Behind Closed Doors, Neglected Child and Fatal Attraction. Self-taught in investments, Sanjib passed the Series 65 licensing exam as a non-industry candidate. He's passionate about raising financial literacy and enjoys helping others with their finances.The post Eye of the Beholder appeared first on HumbleDollar.
January 5, 2021
Taxing Endeavor
I’M A DINOSAUR. Not only do I prepare my own tax return with no help from an accountant or tax preparer, but also I do it by hand. Yep, that’s right—no TurboTax or other computer program.
I really can’t use the computer programs because I often attach an oddball form or two that they don’t offer. On top of that, I always add “annotations” to parts of my return. These additional explanatory notes may be helpful to the IRS. But just as important, they’re reminders to me of why I did things a certain way, just in case I’m later called on to explain.
Why not just hire a pro to do my tax return? It probably wouldn’t cost all that much and it would save me many hours of hard labor. Back in my working days, our small law firm had an accountant who did our partnership return, and he often kidded me about my unusual habit. I once remarked that I’m probably the last person in America to do their taxes by hand, to which he replied, “No, I think there are two others.”
This eccentricity had a pretty natural origin. When I finished school and started working, I did my own taxes. In those days—the late 1970s—there were no computer programs to assist and I didn’t want to spend money on hiring a pro. In any event, my return was extremely simple, so I just did it. Well, it became a habit, an annual ritual. And habits can be, well, habit forming.
Moreover, as painful as the process can be—nobody thinks wading through countless IRS forms and often-confusing instructions is enjoyable—I found it valuable. For starters, it helped me understand, at least at an elementary level, how our tax system works. Of more importance, it gave me a once-a-year overview of my and, after I married, my family’s financial situation. It forced me to consider where our income came from, how it was being taxed and what measures I could take in the coming year to reduce our tax burden.
Happily, something has come along to make the whole complicated process much easier: the internet. In the early days, one of the most frustrating parts of the undertaking was getting the right forms. It never failed that, invariably while at home and during the weekend, I’d find myself deep in the weeds of our tax return, only to discover that I needed such-and-such form to proceed.
Well, of course, I hadn’t anticipated that one. I was stopped in my tracks and instead, at the next opportunity during regular business hours, I had to drive out to the IRS office, which was always inconveniently located, and stand in line waiting for my turn at the counter, so I could ask for the magical form. In those days, the IRS would include in the package it mailed out at least some of the forms you used the prior year, but never the more obscure ones. Those forms weren’t available at the post office, either. The upshot: When the internet came along, it was the happiest event in my long history as a tax filer. To be able to find any form, no matter how esoteric, on the IRS website, and then print it out at home, was a godsend.
But even beyond the forms and instructions, the internet has been a huge help. Now, when I encounter one of the confusing issues that inevitably comes up, I’m not just stuck with whatever the IRS has to say about it. Instead, I can usually find some learned explanation from the tax pros on the web. Heck, if you’re really brave, you can access the entire Internal Revenue Code online.
Another advantage of this self-imposed chore: If you do it yourself and keep decent notes, you can likely also handle any inquiries from the IRS on your own. When my kids were in college and I was using their 529 accounts to pay for expenses, I received a “letter audit” from the IRS, requiring me to justify all the outlays. I won’t say it wasn’t a pain. But equipped with my notes and records, I put together a detailed response. Ultimately, I got a letter saying that not only were they satisfied with my explanation, but also they had determined they owed me money—and a check was included.
As our kids came of age, finished college and entered the world of work, I encouraged each of them to tackle their own return. It truly is an important learning experience. If I hear a complaint that it’s so boring, I have a ready answer. When I was young, I likewise couldn’t imagine anything more tedious than spending a few hours with a tax return. But once gainfully employed and paying taxes, I eventually had a revelation: This is my money we’re talking about here. Suddenly, the whole business was a lot more interesting.
Andrew Forsythe retired in 2017 after almost four decades practicing criminal law in Austin, Texas, first as a prosecutor and then as a defense attorney. His wife Rosalinda and he, along with their dogs, live outside Austin, at the edge of the Texas Hill Country. Their four kids are now grown, independent and successful. They're also blessed with four beautiful grandkids. Andrew loves dogs, and enjoys collecting pocketknives and flashlights. His previous articles include Weekend Warriors, Cheap and Proud and Slim Pickings.
I really can’t use the computer programs because I often attach an oddball form or two that they don’t offer. On top of that, I always add “annotations” to parts of my return. These additional explanatory notes may be helpful to the IRS. But just as important, they’re reminders to me of why I did things a certain way, just in case I’m later called on to explain.
Why not just hire a pro to do my tax return? It probably wouldn’t cost all that much and it would save me many hours of hard labor. Back in my working days, our small law firm had an accountant who did our partnership return, and he often kidded me about my unusual habit. I once remarked that I’m probably the last person in America to do their taxes by hand, to which he replied, “No, I think there are two others.”
This eccentricity had a pretty natural origin. When I finished school and started working, I did my own taxes. In those days—the late 1970s—there were no computer programs to assist and I didn’t want to spend money on hiring a pro. In any event, my return was extremely simple, so I just did it. Well, it became a habit, an annual ritual. And habits can be, well, habit forming.
Moreover, as painful as the process can be—nobody thinks wading through countless IRS forms and often-confusing instructions is enjoyable—I found it valuable. For starters, it helped me understand, at least at an elementary level, how our tax system works. Of more importance, it gave me a once-a-year overview of my and, after I married, my family’s financial situation. It forced me to consider where our income came from, how it was being taxed and what measures I could take in the coming year to reduce our tax burden.
Happily, something has come along to make the whole complicated process much easier: the internet. In the early days, one of the most frustrating parts of the undertaking was getting the right forms. It never failed that, invariably while at home and during the weekend, I’d find myself deep in the weeds of our tax return, only to discover that I needed such-and-such form to proceed.
Well, of course, I hadn’t anticipated that one. I was stopped in my tracks and instead, at the next opportunity during regular business hours, I had to drive out to the IRS office, which was always inconveniently located, and stand in line waiting for my turn at the counter, so I could ask for the magical form. In those days, the IRS would include in the package it mailed out at least some of the forms you used the prior year, but never the more obscure ones. Those forms weren’t available at the post office, either. The upshot: When the internet came along, it was the happiest event in my long history as a tax filer. To be able to find any form, no matter how esoteric, on the IRS website, and then print it out at home, was a godsend.
But even beyond the forms and instructions, the internet has been a huge help. Now, when I encounter one of the confusing issues that inevitably comes up, I’m not just stuck with whatever the IRS has to say about it. Instead, I can usually find some learned explanation from the tax pros on the web. Heck, if you’re really brave, you can access the entire Internal Revenue Code online.
Another advantage of this self-imposed chore: If you do it yourself and keep decent notes, you can likely also handle any inquiries from the IRS on your own. When my kids were in college and I was using their 529 accounts to pay for expenses, I received a “letter audit” from the IRS, requiring me to justify all the outlays. I won’t say it wasn’t a pain. But equipped with my notes and records, I put together a detailed response. Ultimately, I got a letter saying that not only were they satisfied with my explanation, but also they had determined they owed me money—and a check was included.
As our kids came of age, finished college and entered the world of work, I encouraged each of them to tackle their own return. It truly is an important learning experience. If I hear a complaint that it’s so boring, I have a ready answer. When I was young, I likewise couldn’t imagine anything more tedious than spending a few hours with a tax return. But once gainfully employed and paying taxes, I eventually had a revelation: This is my money we’re talking about here. Suddenly, the whole business was a lot more interesting.
Andrew Forsythe retired in 2017 after almost four decades practicing criminal law in Austin, Texas, first as a prosecutor and then as a defense attorney. His wife Rosalinda and he, along with their dogs, live outside Austin, at the edge of the Texas Hill Country. Their four kids are now grown, independent and successful. They're also blessed with four beautiful grandkids. Andrew loves dogs, and enjoys collecting pocketknives and flashlights. His previous articles include Weekend Warriors, Cheap and Proud and Slim Pickings.The post Taxing Endeavor appeared first on HumbleDollar.
January 4, 2021
December’s Hits
WHAT INTRIGUED readers last month? Folks once again flocked to articles focused on retirement issues, along the way helping propel HumbleDollar to its best month ever in terms of pageviews. Here are December's seven most popular articles:
Naming beneficiaries for your retirement accounts? When it comes to your spouse, there's a crucial difference between IRAs and 401(k)s. James McGlynn digs into the details.
Did you claim Social Security, only to discover you don’t need the extra income right now? As Rick Connor explains, you have two options.
Not working can be hard work. Inflation is a worry. Financial emergencies still happen. Dick Quinn offers eight insights from his first decade of retirement.
Sure, money can buy you more stuff. But there are 12 other things it can also buy—all of them arguably far more valuable.
Want to make the most of your retirement? Anika Hedstrom offers a four-step program—one that, ideally, you start years before you actually quit the workforce.
Personal finance is mostly about the future. But what can you do to help yourself today? Adam Grossman offers eight suggestions.
If you have money you don’t currently want to invest or don’t yet need to spend, you might consider a short-term barbell, says Tom Welsh—one that combines an online savings account with ultra-short bonds.
Meanwhile, December's most popular newsletters were Next Year Foretold and Time Limited.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook. Jonathan's most recent articles include Our Report Card, Long Time Coming and Dialed In.
Naming beneficiaries for your retirement accounts? When it comes to your spouse, there's a crucial difference between IRAs and 401(k)s. James McGlynn digs into the details.
Did you claim Social Security, only to discover you don’t need the extra income right now? As Rick Connor explains, you have two options.
Not working can be hard work. Inflation is a worry. Financial emergencies still happen. Dick Quinn offers eight insights from his first decade of retirement.
Sure, money can buy you more stuff. But there are 12 other things it can also buy—all of them arguably far more valuable.
Want to make the most of your retirement? Anika Hedstrom offers a four-step program—one that, ideally, you start years before you actually quit the workforce.
Personal finance is mostly about the future. But what can you do to help yourself today? Adam Grossman offers eight suggestions.
If you have money you don’t currently want to invest or don’t yet need to spend, you might consider a short-term barbell, says Tom Welsh—one that combines an online savings account with ultra-short bonds.
Meanwhile, December's most popular newsletters were Next Year Foretold and Time Limited.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook. Jonathan's most recent articles include Our Report Card, Long Time Coming and Dialed In.The post December’s Hits appeared first on HumbleDollar.
January 3, 2021
Those Messy Humans
WHEN I THINK BACK to Finance 101, what I recall—more than anything—is a whole lot of formulas. First came the calculation for present value, then formulas for valuing bonds, stocks, options, futures, forwards and all sorts of other financial instruments.
This was interesting. But with each passing year, I’ve come to realize that this introduction to finance was also incomplete. It was incomplete because—to state the obvious—the real world doesn’t always adhere to formulas. Yes, the prices of financial assets are connected in one way or another to these formulas, but the connection is often loose, at best. And sometimes the connection becomes so frayed that it’s nearly impossible to see.
Why don’t the prices of investment assets more closely follow their respective formulas? The reason, in a word: people. Or to be more specific: people and their emotions. 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. For that, there may be no better guide than Morgan Housel’s recently published book, The Psychology of Money. The book offers many useful ideas, but I’d like to highlight four that may be particularly helpful as we enter the new year:
1. Risk
On the topic of risk, Housel provides both a timely warning and a counterintuitive insight. I’ll start with the warning. “You can plan for every risk,” he says, “except the things that are too crazy to cross your mind.” For that reason, “the most important part of every plan is planning on your plan not going according to plan.” In other words, plan as if another 2020 might happen this year—or in any given year.
How is this accomplished? If you turn to the textbook, there’s definitely a formula for structuring an “optimal” portfolio. That will yield the right answer mathematically, but it may not be the answer that makes the most sense. That's why Housel suggests putting the math aside.
Instead, he recommends two steps. First, save more than you think you might ever need. Second, keep more of your savings in cash than you think you might need. In short, build room for error into your financial plan. These steps might seem unnecessarily conservative. Still, I agree that this is a good way to protect yourself from a universe of unknown unknowns.
Housel also provides an insight that might make you feel better about being conservative. “Room for error,” he says, “is underappreciated and misunderstood. It’s often viewed as a conservative hedge, used by those who don’t want to take much risk.... But when used appropriately, it’s quite the opposite.”
Why? Housel explains the twin benefits of maintaining a conservative balance sheet. Most obviously, it helps you to avoid ruin when the unexpected occurs. In addition, it allows you to “remain standing” when there’s a market downturn. By this, he means that you’ll be in a strong position—both financially and emotionally—to be a buyer the next time the market drops like it did in 2020.
2. History
We’re all influenced by our own personal experiences with money. That’s no surprise. There’s also a generational element to this. It’s well known that people who grew up during the Depression are naturally more conservative. But this phenomenon isn’t limited to children of the Depression. Housel points out that the economic environment during our own formative years affects us all.
Consider inflation. “If you were born in 1960s America, inflation during your teens and 20s... sent prices up more than threefold. But if you were born in 1990, inflation has been so low for your whole adult life that it’s probably never crossed your mind.” The same applies to each generation’s experience with stock market returns, with interest rates and with unemployment.
As a result, we all have biases—sometimes conscious but usually not—in how we think about money. Of course, there’s nothing you can do to change your own history. What you can do, though, is to try to be aware of these unconscious biases. That, in turn, may help you to be as objective as possible in making financial decisions.
3. Role models
Housel points out an interesting paradox: We like learning from the experiences of other people—but sometimes there isn’t a whole lot to learn. That’s because it’s so difficult to measure the role of luck in any one person’s success or failure. If you ask folks to explain their own success, they probably won't attribute much of it to luck.
Housel’s view, however, is that there’s always an element of luck in anyone’s success. The lesson: Don’t try too hard to copy from someone else’s financial playbook. For a lot of reasons—including luck—it probably won’t work. Instead, develop an investment strategy that’s the best fit for you.
4. Time
The benefits of compound interest are well understood. But usually this concept is illustrated with uninspiring charts and graphs. Housel takes a different approach, providing living examples, including Warren Buffett, who has been investing longer than most of us have been alive. Buffett bought his first stock when he was just 11. Today, he’s 90. The result: “Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday.” Without taking anything away from Buffett’s intelligence or skill, there’s no question that compounding has worked in his favor.
The lesson: If there’s a young person in your life—a child, a grandchild, a niece or nephew—the greatest (financial) gift you can give that person is to help him or her get started investing. Get your favorite teenagers set up with a Roth IRA, and I can almost guarantee they’ll be forever grateful.
Adam M. Grossman’s previous articles include What We've Learned, Unhelpful Advice and Help Today's Self. Adam is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, Adam advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman.
This was interesting. But with each passing year, I’ve come to realize that this introduction to finance was also incomplete. It was incomplete because—to state the obvious—the real world doesn’t always adhere to formulas. Yes, the prices of financial assets are connected in one way or another to these formulas, but the connection is often loose, at best. And sometimes the connection becomes so frayed that it’s nearly impossible to see.
Why don’t the prices of investment assets more closely follow their respective formulas? The reason, in a word: people. Or to be more specific: people and their emotions. 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. For that, there may be no better guide than Morgan Housel’s recently published book, The Psychology of Money. The book offers many useful ideas, but I’d like to highlight four that may be particularly helpful as we enter the new year:
1. Risk
On the topic of risk, Housel provides both a timely warning and a counterintuitive insight. I’ll start with the warning. “You can plan for every risk,” he says, “except the things that are too crazy to cross your mind.” For that reason, “the most important part of every plan is planning on your plan not going according to plan.” In other words, plan as if another 2020 might happen this year—or in any given year.
How is this accomplished? If you turn to the textbook, there’s definitely a formula for structuring an “optimal” portfolio. That will yield the right answer mathematically, but it may not be the answer that makes the most sense. That's why Housel suggests putting the math aside.
Instead, he recommends two steps. First, save more than you think you might ever need. Second, keep more of your savings in cash than you think you might need. In short, build room for error into your financial plan. These steps might seem unnecessarily conservative. Still, I agree that this is a good way to protect yourself from a universe of unknown unknowns.
Housel also provides an insight that might make you feel better about being conservative. “Room for error,” he says, “is underappreciated and misunderstood. It’s often viewed as a conservative hedge, used by those who don’t want to take much risk.... But when used appropriately, it’s quite the opposite.”
Why? Housel explains the twin benefits of maintaining a conservative balance sheet. Most obviously, it helps you to avoid ruin when the unexpected occurs. In addition, it allows you to “remain standing” when there’s a market downturn. By this, he means that you’ll be in a strong position—both financially and emotionally—to be a buyer the next time the market drops like it did in 2020.
2. History
We’re all influenced by our own personal experiences with money. That’s no surprise. There’s also a generational element to this. It’s well known that people who grew up during the Depression are naturally more conservative. But this phenomenon isn’t limited to children of the Depression. Housel points out that the economic environment during our own formative years affects us all.
Consider inflation. “If you were born in 1960s America, inflation during your teens and 20s... sent prices up more than threefold. But if you were born in 1990, inflation has been so low for your whole adult life that it’s probably never crossed your mind.” The same applies to each generation’s experience with stock market returns, with interest rates and with unemployment.
As a result, we all have biases—sometimes conscious but usually not—in how we think about money. Of course, there’s nothing you can do to change your own history. What you can do, though, is to try to be aware of these unconscious biases. That, in turn, may help you to be as objective as possible in making financial decisions.
3. Role models
Housel points out an interesting paradox: We like learning from the experiences of other people—but sometimes there isn’t a whole lot to learn. That’s because it’s so difficult to measure the role of luck in any one person’s success or failure. If you ask folks to explain their own success, they probably won't attribute much of it to luck.
Housel’s view, however, is that there’s always an element of luck in anyone’s success. The lesson: Don’t try too hard to copy from someone else’s financial playbook. For a lot of reasons—including luck—it probably won’t work. Instead, develop an investment strategy that’s the best fit for you.
4. Time
The benefits of compound interest are well understood. But usually this concept is illustrated with uninspiring charts and graphs. Housel takes a different approach, providing living examples, including Warren Buffett, who has been investing longer than most of us have been alive. Buffett bought his first stock when he was just 11. Today, he’s 90. The result: “Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday.” Without taking anything away from Buffett’s intelligence or skill, there’s no question that compounding has worked in his favor.
The lesson: If there’s a young person in your life—a child, a grandchild, a niece or nephew—the greatest (financial) gift you can give that person is to help him or her get started investing. Get your favorite teenagers set up with a Roth IRA, and I can almost guarantee they’ll be forever grateful.
Adam M. Grossman’s previous articles include What We've Learned, Unhelpful Advice and Help Today's Self. Adam is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, Adam advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman.The post Those Messy Humans appeared first on HumbleDollar.
