Jonathan Clements's Blog, page 305
December 3, 2020
Behind Closed Doors
IF YOU OWN an actively managed mutual fund, you expect the fund’s managers to buy and sell stocks and bonds as they see fit—and yet all that trading isn’t necessarily driven by their investment decisions.
Why not? Imagine the fund has had a few years of underperformance. That might prompt impatient investors to take their money elsewhere. This exodus can create headaches for the shareholders who still have faith in the fund. How so? When shares are redeemed, the fund has to pay departing investors their share of the fund’s assets. The fund would have some money set aside for this purpose. That cash, alas, can drag down a fund’s performance in rising markets.
What if there isn’t enough standby cash to cover large outflows? Unless a fund can transfer assets in-kind to departing shareholders—a rare occurrence—it’s required to sell part of its holdings to raise cash. That’s where the trouble starts.
First, a fund’s own selling can further drive down the price of a stock or bond it’s looking to unload, hurting the fund’s return. This selling also generates trading costs, taking a bite out of the fund’s performance. To make matters worse, selling appreciated assets can cause the fund to realize capital gains, leading to big tax bills. Who foots that tax bill? Not those who jumped ship. Instead, it’s the investors who hung tough.
Sound bad? Given a choice, I wouldn’t want the destiny of my funds to be controlled by the actions of my fellow investors. That’s why I became intrigued by a possible alternative, closed-end funds, or CEFs.
A CEF is an actively managed fund that can be bought and sold in the secondary market, just like the shares of any publicly traded company. At its initial public offering (IPO), a closed-end fund raises money by selling a fixed number of shares. The money raised is then invested—but only after subtracting a steep sales commission that’s paid to the selling brokers. Thanks to that steep commission, you don’t want to buy a CEF at its IPO, because you’re effectively purchasing the fund at a premium to its net asset value (NAV), which is the value of the fund’s assets figured on a per-share basis.
After the IPO, CEF shares are neither continuously created for new investors nor redeemed by the fund company when shareholders sell—a crucial difference from a traditional mutual fund. Instead, arriving and departing investors have to buy and sell the publicly traded shares. Since the fund’s managers don’t have to worry about investors pulling money out of the fund itself, they can manage the fund’s portfolio better and even venture into illiquid investments that reward patience.
CEFs date back to 1893, nearly 30 years before the first U.S. mutual fund was launched. Yet there are only 500 or so of them, managing less than $300 billion in assets, compared to almost 8,000 mutual funds that manage over $20 trillion. Why haven’t CEFs taken off?
For starters, CEFs are rarely bought by institutional investors. They also fly under the radar due to limited research coverage by professional analysts. That means the onus is on individual investors to learn about them. Some people also fear that demand for a fund will dry up in the secondary market, leaving them owning a fund with a depressed share price.
Despite those drawbacks, CEFs may appeal to investors looking for higher yields. While many early CEFs focused on stocks, the funds have now become a favored vehicle for everyday investors seeking more income, in part because of three unique advantages offered by the CEF structure.
First, you may be able to buy a CEF at a discount to its NAV, so you purchase $1 of fund assets for just 90 or 95 cents. Buying at a discount also means your yield will be higher than the fund’s portfolio yield. This past spring, during the coronavirus selloff, I got the chance to buy a real estate CEF at a steep discount. You can screen funds by various criteria here, including whether they trade at a discount and what market segment they focus on.
Second, the closed nature of these funds allows their managers to choose from a broader set of income-producing assets. Some of these investments may be illiquid but promise more yield.
Third, most CEFs borrow money with an eye to boosting both yield and total return. The hope: The long-term return on the additional investments bought with the borrowed money will be greater than the cost of borrowing. Keep in mind that this leverage magnifies not just gains, but also losses, so the ride for fund shareholders can be a whole lot rougher.
Among CEFs that borrow, average leverage is 33%, meaning funds borrow an additional 33 cents for every $1 they have in net assets. One danger: If the market turns south, a highly leveraged CEF could breach its borrowing limit—and be forced to sell portfolio holdings at rock-bottom prices to pay down leverage.
CEF leverage can take the form of loans or it might come from issuing preferred shares. The leverage makes a fund more expensive, thanks to the interest on the loans or the dividends paid on the preferred shares. Leveraged funds also have more assets to manage, and fund managers charge advisory fees on that larger pool of assets. That means leveraged funds are more lucrative for fund managers—but they may not be more lucrative for investors.
Want to learn more? I occasionally check out this visual depiction of the CEF universe and then explore those market segments that interest me.
A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Neglected Child, Fatal Attraction and Identity Crisis. 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.
Why not? Imagine the fund has had a few years of underperformance. That might prompt impatient investors to take their money elsewhere. This exodus can create headaches for the shareholders who still have faith in the fund. How so? When shares are redeemed, the fund has to pay departing investors their share of the fund’s assets. The fund would have some money set aside for this purpose. That cash, alas, can drag down a fund’s performance in rising markets.
What if there isn’t enough standby cash to cover large outflows? Unless a fund can transfer assets in-kind to departing shareholders—a rare occurrence—it’s required to sell part of its holdings to raise cash. That’s where the trouble starts.
First, a fund’s own selling can further drive down the price of a stock or bond it’s looking to unload, hurting the fund’s return. This selling also generates trading costs, taking a bite out of the fund’s performance. To make matters worse, selling appreciated assets can cause the fund to realize capital gains, leading to big tax bills. Who foots that tax bill? Not those who jumped ship. Instead, it’s the investors who hung tough.
Sound bad? Given a choice, I wouldn’t want the destiny of my funds to be controlled by the actions of my fellow investors. That’s why I became intrigued by a possible alternative, closed-end funds, or CEFs.
A CEF is an actively managed fund that can be bought and sold in the secondary market, just like the shares of any publicly traded company. At its initial public offering (IPO), a closed-end fund raises money by selling a fixed number of shares. The money raised is then invested—but only after subtracting a steep sales commission that’s paid to the selling brokers. Thanks to that steep commission, you don’t want to buy a CEF at its IPO, because you’re effectively purchasing the fund at a premium to its net asset value (NAV), which is the value of the fund’s assets figured on a per-share basis.
After the IPO, CEF shares are neither continuously created for new investors nor redeemed by the fund company when shareholders sell—a crucial difference from a traditional mutual fund. Instead, arriving and departing investors have to buy and sell the publicly traded shares. Since the fund’s managers don’t have to worry about investors pulling money out of the fund itself, they can manage the fund’s portfolio better and even venture into illiquid investments that reward patience.
CEFs date back to 1893, nearly 30 years before the first U.S. mutual fund was launched. Yet there are only 500 or so of them, managing less than $300 billion in assets, compared to almost 8,000 mutual funds that manage over $20 trillion. Why haven’t CEFs taken off?
For starters, CEFs are rarely bought by institutional investors. They also fly under the radar due to limited research coverage by professional analysts. That means the onus is on individual investors to learn about them. Some people also fear that demand for a fund will dry up in the secondary market, leaving them owning a fund with a depressed share price.
Despite those drawbacks, CEFs may appeal to investors looking for higher yields. While many early CEFs focused on stocks, the funds have now become a favored vehicle for everyday investors seeking more income, in part because of three unique advantages offered by the CEF structure.
First, you may be able to buy a CEF at a discount to its NAV, so you purchase $1 of fund assets for just 90 or 95 cents. Buying at a discount also means your yield will be higher than the fund’s portfolio yield. This past spring, during the coronavirus selloff, I got the chance to buy a real estate CEF at a steep discount. You can screen funds by various criteria here, including whether they trade at a discount and what market segment they focus on.
Second, the closed nature of these funds allows their managers to choose from a broader set of income-producing assets. Some of these investments may be illiquid but promise more yield.
Third, most CEFs borrow money with an eye to boosting both yield and total return. The hope: The long-term return on the additional investments bought with the borrowed money will be greater than the cost of borrowing. Keep in mind that this leverage magnifies not just gains, but also losses, so the ride for fund shareholders can be a whole lot rougher.
Among CEFs that borrow, average leverage is 33%, meaning funds borrow an additional 33 cents for every $1 they have in net assets. One danger: If the market turns south, a highly leveraged CEF could breach its borrowing limit—and be forced to sell portfolio holdings at rock-bottom prices to pay down leverage.
CEF leverage can take the form of loans or it might come from issuing preferred shares. The leverage makes a fund more expensive, thanks to the interest on the loans or the dividends paid on the preferred shares. Leveraged funds also have more assets to manage, and fund managers charge advisory fees on that larger pool of assets. That means leveraged funds are more lucrative for fund managers—but they may not be more lucrative for investors.
Want to learn more? I occasionally check out this visual depiction of the CEF universe and then explore those market segments that interest me.
A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Neglected Child, Fatal Attraction and Identity Crisis. 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 Behind Closed Doors appeared first on HumbleDollar.
December 2, 2020
About Tomorrow
I’M NOT MUCH of a bartender. But when my wife and I hosted an art show in Missoula for a friend, I got the chance to serve wine while meeting a whole new group of people. Bankers—my usual social circle—tend to be strait-laced analytical types, so it was entertaining to spend an evening meeting creative folks from our thriving arts community.
One young couple, who sported an array of tattoos and piercings, had a story that caught my attention. I’ll call them Louise and Leonardo. They had recently moved to Missoula from Asheville, North Carolina, another cool mountain town with a lot of similarities to Missoula.
Not too far into the conversation, it became apparent that they’d moved to Montana on a whim, didn’t have jobs, had little money and held to a philosophy that emphasized living in the moment. The concept of deferred gratification wasn’t part of their thinking. They believed that they had many years ahead of them when they could work, but right now they wanted to pursue their passion for travel and new experiences.
Do you have a Leonardo or Louise in your life? I don’t want to minimize the challenges of discussing bourgeois values with 20-somethings infatuated with the pursuit of their passion at all costs. Are there ways to pass along financial advice without crushing their dreams of a life full of meaning and purpose? Here are my four suggestions:
Introduce them to their future self. Snapchat, for instance, has a photo filter called Time Machine that lets you watch yourself age, becoming a much older and grayer you. Some money psychologists see great value in this. The theory: If we can visualize our older selves, it will help motivate us to defer spending and instead save for the person we’ll become.
Face-aging apps can help open up a discussion with the Leonardos and Louises of the world—and do so in a fun way. When we’re young, it’s easy to find just about everything interesting and think that’s your life’s passion. But in truth, it can take years to discover what you’re truly passionate about. At that juncture, you’ll want to be in a financial position to do what you love. Perhaps using an aging app can help spark a discussion about purpose later in life and the wisdom of doing a little financial preparation today.
Show the power of compounding. For instance, you might demonstrate how saving regularly for a dozen or 15 years can help folks reach an inflection point, where their annual investment gains equal what they’re saving each year. The dream of never worrying again about money can be motivating to those who would prefer to focus their life on other matters.
Introduce the concept of ownership. Buy your Leonardo and Louise a few shares of a company whose products they use and understand. I did this with my granddaughter. She’s a big fan of Disney, so I bought her a share of Walt Disney Co. You might even get the stock certificate framed—and be sure to reinvest the dividends, so they see how that helps drive investment growth.
Lead by example. The goal isn’t to be rich for the sake of having lots of money. Instead, show how saving money allows you to live generously and to lead the life you want. There’s no more powerful example to the younger generation than an authentic life that has meaning and purpose.
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 Prepare for Pain, Doing Good and True Wealth.
One young couple, who sported an array of tattoos and piercings, had a story that caught my attention. I’ll call them Louise and Leonardo. They had recently moved to Missoula from Asheville, North Carolina, another cool mountain town with a lot of similarities to Missoula.
Not too far into the conversation, it became apparent that they’d moved to Montana on a whim, didn’t have jobs, had little money and held to a philosophy that emphasized living in the moment. The concept of deferred gratification wasn’t part of their thinking. They believed that they had many years ahead of them when they could work, but right now they wanted to pursue their passion for travel and new experiences.
Do you have a Leonardo or Louise in your life? I don’t want to minimize the challenges of discussing bourgeois values with 20-somethings infatuated with the pursuit of their passion at all costs. Are there ways to pass along financial advice without crushing their dreams of a life full of meaning and purpose? Here are my four suggestions:
Introduce them to their future self. Snapchat, for instance, has a photo filter called Time Machine that lets you watch yourself age, becoming a much older and grayer you. Some money psychologists see great value in this. The theory: If we can visualize our older selves, it will help motivate us to defer spending and instead save for the person we’ll become.
Face-aging apps can help open up a discussion with the Leonardos and Louises of the world—and do so in a fun way. When we’re young, it’s easy to find just about everything interesting and think that’s your life’s passion. But in truth, it can take years to discover what you’re truly passionate about. At that juncture, you’ll want to be in a financial position to do what you love. Perhaps using an aging app can help spark a discussion about purpose later in life and the wisdom of doing a little financial preparation today.
Show the power of compounding. For instance, you might demonstrate how saving regularly for a dozen or 15 years can help folks reach an inflection point, where their annual investment gains equal what they’re saving each year. The dream of never worrying again about money can be motivating to those who would prefer to focus their life on other matters.
Introduce the concept of ownership. Buy your Leonardo and Louise a few shares of a company whose products they use and understand. I did this with my granddaughter. She’s a big fan of Disney, so I bought her a share of Walt Disney Co. You might even get the stock certificate framed—and be sure to reinvest the dividends, so they see how that helps drive investment growth.
Lead by example. The goal isn’t to be rich for the sake of having lots of money. Instead, show how saving money allows you to live generously and to lead the life you want. There’s no more powerful example to the younger generation than an authentic life that has meaning and purpose.
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 Prepare for Pain, Doing Good and True Wealth.The post About Tomorrow appeared first on HumbleDollar.
December 1, 2020
November’s Hits
WHAT WAS WORRYING folks last month—other than the election, the coronavirus and their post-Thanksgiving weight? For HumbleDollar readers, it seems retirement was the big concern. Of November's seven most popular articles, five were focused on retirement issues:
Don't put off your retirement wish list until you fully retire, advises Dennis Friedman—or you may never get the chance to do the things you dreamed of.
"We may not be done with our simplifying," says Brian White. "When I get tired of managing our investments, I’ll just move all our money into a Vanguard target-date fund or one of the firm’s target-risk funds."
Worried that your ability to handle your finances will slip as you grow older? Dennis Friedman offers eight pointers.
Confused about the Social Security earnings test and about how benefits are taxed? Richard Connor offers a refresher course on both topics.
"Valuations matter," writes John Lim. "Regression to the mean is real. Both principles argue for moving from growth to value and from U.S. stocks to international markets."
Want to make sure you’re prepared for retirement—and make the most of it once you quit the workforce? Dick Quinn offers 10 pointers inspired by 10 U.S. and U.K. television shows.
Veteran money manager Jeremy Grantham says you should dump U.S. stocks and load up on emerging markets. A smart strategy? Adam Grossman has his doubts.
What about our weekly newsletters? During November, the two most popular were Never Assume and Future Shock.
Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Dialed In, Ain't Everything and Bad Influence.
Don't put off your retirement wish list until you fully retire, advises Dennis Friedman—or you may never get the chance to do the things you dreamed of.
"We may not be done with our simplifying," says Brian White. "When I get tired of managing our investments, I’ll just move all our money into a Vanguard target-date fund or one of the firm’s target-risk funds."
Worried that your ability to handle your finances will slip as you grow older? Dennis Friedman offers eight pointers.
Confused about the Social Security earnings test and about how benefits are taxed? Richard Connor offers a refresher course on both topics.
"Valuations matter," writes John Lim. "Regression to the mean is real. Both principles argue for moving from growth to value and from U.S. stocks to international markets."
Want to make sure you’re prepared for retirement—and make the most of it once you quit the workforce? Dick Quinn offers 10 pointers inspired by 10 U.S. and U.K. television shows.
Veteran money manager Jeremy Grantham says you should dump U.S. stocks and load up on emerging markets. A smart strategy? Adam Grossman has his doubts.
What about our weekly newsletters? During November, the two most popular were Never Assume and Future Shock.
Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Dialed In, Ain't Everything and Bad Influence.The post November’s Hits appeared first on HumbleDollar.
November 30, 2020
Rate Debate
THE 4% RULE has almost mythic status in the financial planning world. Originally suggested by Bill Bengen in a 1994 article, the rule provides a simple way for retirees to figure out how much they can withdraw from their portfolio without running out of money. In a recent article, Bengen updated his rule.
The rule defines the maximum amount retirees should withdraw from their portfolio in the first year of retirement. Got a $500,000 nest egg? The 4% rule suggests you can pull out $20,000 in the first 12 months after you quit the workforce. Included in this sum are any dividends and interest you receive.
In subsequent years, you would withdraw the same amount, but adjusted upward for inflation. In all of the historical scenarios that Bengen analyzed, this strategy successfully ensured that a retiree’s savings lasted at least 30 years. Bengen assumed a portfolio of 50% S&P 500 and 50% Treasury bonds. To come up with his rule, he looked at 76 years of historical stock and bond returns
In a 2006 book, Bengen updated his rule to 4.5%. He accomplished this by adding U.S. small-company stocks to the portfolio. His research showed that 4.5% rate worked for all rolling three-decade periods since 1926. He used similar assumptions—"a tax-advantaged account, annual [inflation] adjustments and a minimum of 30 years of portfolio longevity.” The 4.5% turned out to be the maximum that worked for an individual who retired and faced a “worst case” scenario of terrible market returns and high inflation. Bengen’s research also showed that individuals who retired during more favorable periods were able to successfully withdraw up to 13%.
Michael Kitces expanded on Bengen’s original analysis in a 2008 article. Kitces considered an additional parameter, the market’s current valuation as measured by the cyclically adjusted price-earnings (CAPE) ratio, otherwise known as the Shiller P/E or P/E 10. CAPE takes the S&P 500’s current value and divides it by average inflation-adjusted earnings for the past 10 years. Kitces’s analysis showed an inverse relationship between CAPE and the maximum safe withdrawal rate. In other words, the higher CAPE is when you retire, the lower the safe withdrawal rate.
This approach makes intuitive sense. If you retire at a time of historically high valuations, you have a smaller chance of receiving average market returns in future. Kitces’s research also provided insights into the importance of the first 15 years of portfolio returns, as well as whether a retiree should revise his or her investment mix based on the market’s CAPE multiple at retirement.
In Bengen’s recent article, he updated and expanded his original research by using quarterly historical returns. That increases the number of data points significantly. As before, he determines historically safe withdrawals rates for a 30-year retirement period, assuming a tax-advantaged portfolio. The portfolio analyzed included a mix of 30% U.S. large-company stocks, 20% U.S. small-cap stocks and 50% intermediate-term U.S. government bonds.
In this new analysis, Bengen improves on Kitces’s work by adding another variable to the mix—the starting inflation rate. He organized the results in groupings according to both the 12-month inflation rate and the stock market’s CAPE ratio at the time of retirement. Lower inflation environments and low CAPE values lead to higher safe withdrawal rates. As of this writing, trailing 12-month inflation is 1.2% and the current CAPE ratio is over 30. According to Bengen’s article, that suggests the maximum safe withdrawal rate is 5% for today’s newly minted retirees.
A caveat: There’s currently debate about whether the stock market is as overpriced as it appears, because recent corporate earnings have been crushed by the COVID-19 economic slowdown. On top of that, some argue that the dominance of technology companies in the S&P 500 has skewed market valuations higher. Tech companies’ reported earnings are depressed by their hefty spending on research and development, and the way that spending is treated under current accounting standards.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles include For Goodness Sake, That Monthly Check and Margin of Safety. Follow Rick on Twitter @RConnor609.
The rule defines the maximum amount retirees should withdraw from their portfolio in the first year of retirement. Got a $500,000 nest egg? The 4% rule suggests you can pull out $20,000 in the first 12 months after you quit the workforce. Included in this sum are any dividends and interest you receive.
In subsequent years, you would withdraw the same amount, but adjusted upward for inflation. In all of the historical scenarios that Bengen analyzed, this strategy successfully ensured that a retiree’s savings lasted at least 30 years. Bengen assumed a portfolio of 50% S&P 500 and 50% Treasury bonds. To come up with his rule, he looked at 76 years of historical stock and bond returns
In a 2006 book, Bengen updated his rule to 4.5%. He accomplished this by adding U.S. small-company stocks to the portfolio. His research showed that 4.5% rate worked for all rolling three-decade periods since 1926. He used similar assumptions—"a tax-advantaged account, annual [inflation] adjustments and a minimum of 30 years of portfolio longevity.” The 4.5% turned out to be the maximum that worked for an individual who retired and faced a “worst case” scenario of terrible market returns and high inflation. Bengen’s research also showed that individuals who retired during more favorable periods were able to successfully withdraw up to 13%.
Michael Kitces expanded on Bengen’s original analysis in a 2008 article. Kitces considered an additional parameter, the market’s current valuation as measured by the cyclically adjusted price-earnings (CAPE) ratio, otherwise known as the Shiller P/E or P/E 10. CAPE takes the S&P 500’s current value and divides it by average inflation-adjusted earnings for the past 10 years. Kitces’s analysis showed an inverse relationship between CAPE and the maximum safe withdrawal rate. In other words, the higher CAPE is when you retire, the lower the safe withdrawal rate.
This approach makes intuitive sense. If you retire at a time of historically high valuations, you have a smaller chance of receiving average market returns in future. Kitces’s research also provided insights into the importance of the first 15 years of portfolio returns, as well as whether a retiree should revise his or her investment mix based on the market’s CAPE multiple at retirement.
In Bengen’s recent article, he updated and expanded his original research by using quarterly historical returns. That increases the number of data points significantly. As before, he determines historically safe withdrawals rates for a 30-year retirement period, assuming a tax-advantaged portfolio. The portfolio analyzed included a mix of 30% U.S. large-company stocks, 20% U.S. small-cap stocks and 50% intermediate-term U.S. government bonds.
In this new analysis, Bengen improves on Kitces’s work by adding another variable to the mix—the starting inflation rate. He organized the results in groupings according to both the 12-month inflation rate and the stock market’s CAPE ratio at the time of retirement. Lower inflation environments and low CAPE values lead to higher safe withdrawal rates. As of this writing, trailing 12-month inflation is 1.2% and the current CAPE ratio is over 30. According to Bengen’s article, that suggests the maximum safe withdrawal rate is 5% for today’s newly minted retirees.
A caveat: There’s currently debate about whether the stock market is as overpriced as it appears, because recent corporate earnings have been crushed by the COVID-19 economic slowdown. On top of that, some argue that the dominance of technology companies in the S&P 500 has skewed market valuations higher. Tech companies’ reported earnings are depressed by their hefty spending on research and development, and the way that spending is treated under current accounting standards.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles include For Goodness Sake, That Monthly Check and Margin of Safety. Follow Rick on Twitter @RConnor609.The post Rate Debate appeared first on HumbleDollar.
November 29, 2020
Game Theory
WHEN I WAS A KID, I never liked the game Monopoly. I found it slow and uninteresting. But now, as a parent, I see its value. I’ve tried a lot of things to teach my children about money, but nothing comes close to Monopoly in its ability to convey important personal finance lessons.
Sure, it helps kids practice basics like addition and subtraction—but there's a lot more to it. If you'll be spending time with children over the holidays, I recommend giving Monopoly a try. Here are five fundamental lessons I think the game can teach them:
1. Yield. Every property on the Monopoly board is different. Some cost more than others and each pays a different rental rate. As a result, some are much better deals than others. Kentucky Avenue, for example, costs $220 and its rent is $18, resulting in a yield of about 8%. Meanwhile, Boardwalk is much more expensive, at $400, but its rent is also higher, at $50, putting its yield at 12.5%. This makes Boardwalk a much better buy, even though it's so much more expensive. Little kids tend to focus only on the prices of properties, but this is an opportunity to teach them about rates of return.
2. Total return. Income yield is only one way in which a property can be valuable. A second key lesson: An asset may be worth more to someone else than it is to you. In fact, the often-overlooked reason the game is called Monopoly is because players can double the rents they earn when they own all the properties in a set. Result? If another player has all but one of the properties in a set, and you hold the remaining one, he or she might pay an above-market rate to buy it from you. That's the second lesson. Most assets carry two types of return potential: income and appreciation. Whenever you're evaluating a purchase, you want to consider both.
3. Luck. Chance cards illustrate the role of luck—both good and bad—in everyone's financial life. Sometimes, good fortune drops out of the sky (“Advance to Go, Collect $200”). Sometimes, bad luck comes along (“Speeding Fine, Pay $15”). The lesson: Life isn't always predictable and it isn't always fair—an especially good lesson for little kids. But there are ways to protect yourself from bad luck, including holding more cash than you think you'll ever need.
4. Liquidity. If a player ends up in financial distress, properties can be mortgaged to raise cash or they can be sold to another player. But you might end up selling at a fire-sale price. There are lessons in this about leverage, liquidity and financial stability.
5. Risk preference. Monopoly participants seem to fall into three groups, each with varying degrees of risk aversion. Some rarely buy properties, so as to conserve cash. Others are willing to open their wallets, but only for properties they think make sense. Meanwhile, those in the third group are willing to spend top dollar buying up the most valuable properties—and they'll spend even more to populate them with houses and hotels. I'm sure a psychologist would have a lot to say about why this is the case. But for kids, the basic lesson is to see that people are different in this way and to see how other approaches work out. It's important also for kids to see the role of luck, which can cause a good strategy to fail or an unwise strategy to succeed.
A further lesson on risk: In Monopoly, as in real life, the amount of risk you decide to take is a choice—but only to an extent. Those who take too little risk can see their savings dwindle. Those who take too much risk can, of course, fall into bankruptcy. Monopoly does a good job illustrating how risk is a choice, but only within certain boundaries.
While Monopoly mirrors real life in multiple ways, there are two respects in which it's unrealistic. First, when you set up a Monopoly game, each player receives the same amount of cash. That makes sense for a kids’ game. But, of course, that isn’t how the real world works. Monopoly would be a different game if each player started with a different amount of cash. That's a different kind of lesson, but probably worth pointing out to children.
Second, Monopoly is all about buying and selling investments. There's no concept of work. For most people, though, you can't start investing until you've spent some time working and saving. That probably would have been difficult to build into the game, but it is a key shortcoming. By ignoring the value of work, it leaves players with the idea that the only way to build wealth is by investing.
A final thought: When I was growing up in Massachusetts, we once took a field trip to Plymouth Plantation. The lesson I learned: Landing in New England in November wasn't the wisest move. About half the Pilgrims didn't make it through that first winter. If it weren't for the help of Native Americans, who taught them key survival skills, it would have been much worse.
Therein lies the final lesson I try to convey to my children when playing Monopoly. In our financial life, most people will experience a mix of successes and challenges—for a variety of reasons, including plain old bad luck. For that reason, we shouldn't judge ourselves—or others—too harshly.
Adam M. Grossman’s previous articles include Trends That End, Getting Personal and Sweat the Big Stuff. 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.
Sure, it helps kids practice basics like addition and subtraction—but there's a lot more to it. If you'll be spending time with children over the holidays, I recommend giving Monopoly a try. Here are five fundamental lessons I think the game can teach them:
1. Yield. Every property on the Monopoly board is different. Some cost more than others and each pays a different rental rate. As a result, some are much better deals than others. Kentucky Avenue, for example, costs $220 and its rent is $18, resulting in a yield of about 8%. Meanwhile, Boardwalk is much more expensive, at $400, but its rent is also higher, at $50, putting its yield at 12.5%. This makes Boardwalk a much better buy, even though it's so much more expensive. Little kids tend to focus only on the prices of properties, but this is an opportunity to teach them about rates of return.
2. Total return. Income yield is only one way in which a property can be valuable. A second key lesson: An asset may be worth more to someone else than it is to you. In fact, the often-overlooked reason the game is called Monopoly is because players can double the rents they earn when they own all the properties in a set. Result? If another player has all but one of the properties in a set, and you hold the remaining one, he or she might pay an above-market rate to buy it from you. That's the second lesson. Most assets carry two types of return potential: income and appreciation. Whenever you're evaluating a purchase, you want to consider both.
3. Luck. Chance cards illustrate the role of luck—both good and bad—in everyone's financial life. Sometimes, good fortune drops out of the sky (“Advance to Go, Collect $200”). Sometimes, bad luck comes along (“Speeding Fine, Pay $15”). The lesson: Life isn't always predictable and it isn't always fair—an especially good lesson for little kids. But there are ways to protect yourself from bad luck, including holding more cash than you think you'll ever need.
4. Liquidity. If a player ends up in financial distress, properties can be mortgaged to raise cash or they can be sold to another player. But you might end up selling at a fire-sale price. There are lessons in this about leverage, liquidity and financial stability.
5. Risk preference. Monopoly participants seem to fall into three groups, each with varying degrees of risk aversion. Some rarely buy properties, so as to conserve cash. Others are willing to open their wallets, but only for properties they think make sense. Meanwhile, those in the third group are willing to spend top dollar buying up the most valuable properties—and they'll spend even more to populate them with houses and hotels. I'm sure a psychologist would have a lot to say about why this is the case. But for kids, the basic lesson is to see that people are different in this way and to see how other approaches work out. It's important also for kids to see the role of luck, which can cause a good strategy to fail or an unwise strategy to succeed.
A further lesson on risk: In Monopoly, as in real life, the amount of risk you decide to take is a choice—but only to an extent. Those who take too little risk can see their savings dwindle. Those who take too much risk can, of course, fall into bankruptcy. Monopoly does a good job illustrating how risk is a choice, but only within certain boundaries.
While Monopoly mirrors real life in multiple ways, there are two respects in which it's unrealistic. First, when you set up a Monopoly game, each player receives the same amount of cash. That makes sense for a kids’ game. But, of course, that isn’t how the real world works. Monopoly would be a different game if each player started with a different amount of cash. That's a different kind of lesson, but probably worth pointing out to children.
Second, Monopoly is all about buying and selling investments. There's no concept of work. For most people, though, you can't start investing until you've spent some time working and saving. That probably would have been difficult to build into the game, but it is a key shortcoming. By ignoring the value of work, it leaves players with the idea that the only way to build wealth is by investing.
A final thought: When I was growing up in Massachusetts, we once took a field trip to Plymouth Plantation. The lesson I learned: Landing in New England in November wasn't the wisest move. About half the Pilgrims didn't make it through that first winter. If it weren't for the help of Native Americans, who taught them key survival skills, it would have been much worse.
Therein lies the final lesson I try to convey to my children when playing Monopoly. In our financial life, most people will experience a mix of successes and challenges—for a variety of reasons, including plain old bad luck. For that reason, we shouldn't judge ourselves—or others—too harshly.
Adam M. Grossman’s previous articles include Trends That End, Getting Personal and Sweat the Big Stuff. 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 Game Theory appeared first on HumbleDollar.
November 28, 2020
Dialed In
HOW DO WE GET from here to retirement? Amid the financial markets’ daily turmoil, it might seem like one big crapshoot.
But in truth, navigating this journey is pretty straightforward, because there are just five key variables—our time horizon, current nest egg, savings rate, target nest egg and investment return. With a few tweaks to these “dials,” we may discover it’s far easier to reach our retirement goal. Which dials are most effective? Much depends on how close we are to retirement age.
To get a handle on the issue, imagine the goal is to retire at age 65 with today’s equivalent of $1 million, which should be enough to kick off $40,000 in retirement income, assuming a 4% withdrawal rate. After adjusting for inflation, let’s also assume stocks earn 4% a year and bonds 0%.
That brings us to our base case: We begin investing for retirement at age 25 with a mix of 60% stocks and 40% bonds. We sock away a little over $15,000 a year, with that sum rising each year with inflation. If all goes well, our nest egg should—in today’s dollars—be worth some $169,000 at age 35, $384,000 at age 45, $655,000 at 55 and our coveted $1 million at 65.
Boosting returns. Does saving $15,000 a year seem too onerous? Remember, while I’m assuming that we step up the sum we save each year with inflation, our ability to save should rise faster than that over our career, as we get pay raises that outpace the inflation rate. The upshot: Even if we can’t hit $15,000 in annual savings during our initial working years, that target may be much more manageable later on.
Still, if we want to dial down the required annual savings rate, the No. 1 thing we can do is raise our portfolio’s expected investment return, especially if we’re early in our career. We can do that by cutting investment costs and making the most of retirement accounts. But the key step is to allocate more to stocks. For instance, if we opted for 80% stocks rather than 60% from the get-go, the required savings rate starting at age 25 drops from above $15,000 a year to around $12,700.
Meanwhile, if we’re closer to retirement, continuing to invest aggressively can also pay handsome dividends—assuming the stock market performs as hoped. But for market returns to be a big help at that late stage, we need to have been good savers up until that point, so we have a plump portfolio to benefit from those expected higher stock returns.
If we haven’t been such good savers, investment returns become less crucial. Let’s say we’re age 50, have $100,000 saved and hope to hit $500,000 by age 65. Even if we hold 80% stocks rather than 60%, that only trims the required annual savings rate from $20,000 to $18,000. On top of that, there’s a greater danger of disappointing investment returns, given the relatively short time horizon.
Delaying retirement. So what’s the best strategy if we’ve been tardy with our retirement savings? We might postpone retirement from, say, age 65 to 67. If we’re age 50, with $100,000 saved and $500,000 desired at retirement, delaying retirement by two years trims the required annual savings from $20,000 to $17,000. What if we both delay retirement by two years and hold 80% stocks, rather than 60%? That cuts the necessary savings from $20,000 a year to below $15,000.
While a two-year retirement delay can be a smart move if we’re late to the savings game, it shouldn’t be necessary if we’ve been good savers for much of our career—and it probably won’t make that much difference to our required savings rate. With 60% in stocks and a $1 million goal, our hypothetical 25-year-olds still need to save $14,000 a year if they delay retirement from age 65 to 67—or, alternatively, if they start saving at age 23 rather than at 25. In other words, toughing it out in the workforce for two more years only cuts the required savings rate by roughly $1,000 a year.
I’m not arguing that $1,000 less per year isn’t meaningful. But if we’re already saving for 40 years, tacking on an extra two years is far less crucial than it is for those who start late. Don’t want to delay retirement past age 65? Do the obvious: Save diligently in your 20s and early 30s. Indeed, if we don’t start saving until age 35 or so, postponing retirement by two or three years may be our only choice if we want a financially comfortable retirement.
Trimming the target. If we start saving late in life, we’ll likely need every dollar we can amass—and we’ll probably end up with far less than $1 million. By contrast, if we start saving diligently at age 25, we might discover we have more than enough for a comfortable retirement, especially once we factor in Social Security.
For instance, imagine we began saving $15,000 a year at age 25 and got to 55 with the $655,000 nest egg mentioned above. And then—bam!—we’re laid off, or we decide to go part-time, or perhaps we want to pursue a different career. Whatever the case, we end up with a lower income and hence less ability to save.
What to do? To hit our $1 million, we could invest more aggressively or delay retirement by a few years. But perhaps the wiser course is to lower our target nest egg from $1 million to $900,000. If we do that, the required annual savings rate over our final 10 years in the workforce drops from $15,000 to just $6,000.
One final scenario: What if we want to retire early? If our goal is $1 million and we hold a 60-40 stock-bond mix, we could retire at age 58 if we save $20,000 a year starting at age 25, with that sum rising each year with inflation. What if we save that $20,000 a year, while also holding an 80-20 portfolio? If the markets perform as expected, we could potentially retire 10 years early—at age 55.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
"I found an 'other debits' item of $5,450," recounts Brian White. "It turned out William was paying 21% of his bond income toward an unnecessary management fee, since his bonds needed no management."
When the stairs got too much for Dick Quinn and his wife, they moved into a 55-plus community. Condo living isn't for everyone, he allows, but they have no regrets.
"After this year's startling rally, I felt flushed with cash," says Dennis Friedman. "So instead of rebalancing into bonds or cash, I rebalanced into a new sofa, remodeled kitchen and a new car."
We usually spend without guilt or subsequent regret—plus 10 other signs that money has the right importance in our life.
"Valuations matter," writes John Lim. "Regression to the mean is real. Both principles argue for moving from growth to value and from U.S. stocks to international markets."
Is the financial trend your friend—or is it about to end? Adam Grossman's advice: Be wary of predictions, especially those that are extreme or alarmist.
Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Ain't Everything, Bad Influence and Never Assume.
But in truth, navigating this journey is pretty straightforward, because there are just five key variables—our time horizon, current nest egg, savings rate, target nest egg and investment return. With a few tweaks to these “dials,” we may discover it’s far easier to reach our retirement goal. Which dials are most effective? Much depends on how close we are to retirement age.
To get a handle on the issue, imagine the goal is to retire at age 65 with today’s equivalent of $1 million, which should be enough to kick off $40,000 in retirement income, assuming a 4% withdrawal rate. After adjusting for inflation, let’s also assume stocks earn 4% a year and bonds 0%.
That brings us to our base case: We begin investing for retirement at age 25 with a mix of 60% stocks and 40% bonds. We sock away a little over $15,000 a year, with that sum rising each year with inflation. If all goes well, our nest egg should—in today’s dollars—be worth some $169,000 at age 35, $384,000 at age 45, $655,000 at 55 and our coveted $1 million at 65.
Boosting returns. Does saving $15,000 a year seem too onerous? Remember, while I’m assuming that we step up the sum we save each year with inflation, our ability to save should rise faster than that over our career, as we get pay raises that outpace the inflation rate. The upshot: Even if we can’t hit $15,000 in annual savings during our initial working years, that target may be much more manageable later on.
Still, if we want to dial down the required annual savings rate, the No. 1 thing we can do is raise our portfolio’s expected investment return, especially if we’re early in our career. We can do that by cutting investment costs and making the most of retirement accounts. But the key step is to allocate more to stocks. For instance, if we opted for 80% stocks rather than 60% from the get-go, the required savings rate starting at age 25 drops from above $15,000 a year to around $12,700.
Meanwhile, if we’re closer to retirement, continuing to invest aggressively can also pay handsome dividends—assuming the stock market performs as hoped. But for market returns to be a big help at that late stage, we need to have been good savers up until that point, so we have a plump portfolio to benefit from those expected higher stock returns.
If we haven’t been such good savers, investment returns become less crucial. Let’s say we’re age 50, have $100,000 saved and hope to hit $500,000 by age 65. Even if we hold 80% stocks rather than 60%, that only trims the required annual savings rate from $20,000 to $18,000. On top of that, there’s a greater danger of disappointing investment returns, given the relatively short time horizon.
Delaying retirement. So what’s the best strategy if we’ve been tardy with our retirement savings? We might postpone retirement from, say, age 65 to 67. If we’re age 50, with $100,000 saved and $500,000 desired at retirement, delaying retirement by two years trims the required annual savings from $20,000 to $17,000. What if we both delay retirement by two years and hold 80% stocks, rather than 60%? That cuts the necessary savings from $20,000 a year to below $15,000.
While a two-year retirement delay can be a smart move if we’re late to the savings game, it shouldn’t be necessary if we’ve been good savers for much of our career—and it probably won’t make that much difference to our required savings rate. With 60% in stocks and a $1 million goal, our hypothetical 25-year-olds still need to save $14,000 a year if they delay retirement from age 65 to 67—or, alternatively, if they start saving at age 23 rather than at 25. In other words, toughing it out in the workforce for two more years only cuts the required savings rate by roughly $1,000 a year.
I’m not arguing that $1,000 less per year isn’t meaningful. But if we’re already saving for 40 years, tacking on an extra two years is far less crucial than it is for those who start late. Don’t want to delay retirement past age 65? Do the obvious: Save diligently in your 20s and early 30s. Indeed, if we don’t start saving until age 35 or so, postponing retirement by two or three years may be our only choice if we want a financially comfortable retirement.
Trimming the target. If we start saving late in life, we’ll likely need every dollar we can amass—and we’ll probably end up with far less than $1 million. By contrast, if we start saving diligently at age 25, we might discover we have more than enough for a comfortable retirement, especially once we factor in Social Security.
For instance, imagine we began saving $15,000 a year at age 25 and got to 55 with the $655,000 nest egg mentioned above. And then—bam!—we’re laid off, or we decide to go part-time, or perhaps we want to pursue a different career. Whatever the case, we end up with a lower income and hence less ability to save.
What to do? To hit our $1 million, we could invest more aggressively or delay retirement by a few years. But perhaps the wiser course is to lower our target nest egg from $1 million to $900,000. If we do that, the required annual savings rate over our final 10 years in the workforce drops from $15,000 to just $6,000.
One final scenario: What if we want to retire early? If our goal is $1 million and we hold a 60-40 stock-bond mix, we could retire at age 58 if we save $20,000 a year starting at age 25, with that sum rising each year with inflation. What if we save that $20,000 a year, while also holding an 80-20 portfolio? If the markets perform as expected, we could potentially retire 10 years early—at age 55.
Latest Articles
HERE ARE THE SIX other articles published by HumbleDollar this week:
"I found an 'other debits' item of $5,450," recounts Brian White. "It turned out William was paying 21% of his bond income toward an unnecessary management fee, since his bonds needed no management."
When the stairs got too much for Dick Quinn and his wife, they moved into a 55-plus community. Condo living isn't for everyone, he allows, but they have no regrets.
"After this year's startling rally, I felt flushed with cash," says Dennis Friedman. "So instead of rebalancing into bonds or cash, I rebalanced into a new sofa, remodeled kitchen and a new car."
We usually spend without guilt or subsequent regret—plus 10 other signs that money has the right importance in our life.
"Valuations matter," writes John Lim. "Regression to the mean is real. Both principles argue for moving from growth to value and from U.S. stocks to international markets."
Is the financial trend your friend—or is it about to end? Adam Grossman's advice: Be wary of predictions, especially those that are extreme or alarmist.
Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Ain't Everything, Bad Influence and Never Assume.The post Dialed In appeared first on HumbleDollar.
November 27, 2020
Live It Up
THE HOLIDAY SEASON is here—and retailers will be looking to make up for the sales they lost during the pandemic. Let me offer some advice you won’t hear elsewhere: Go ahead and splurge.
What do I want for Christmas? To be honest, not much. But then again, my wife and I have been spending money this year as if Christmas were a year-long event. We remodeled the house, filled it with new furniture and bought a new car.
What I probably need is not more material things, but something that could make me a better person. A behavior transplant would do the trick. Something like persistence. Indeed, a little more persistence would be a good attribute to have going into the new year. It might help me to eat better, exercise more and generally live a more fulfilling lifestyle.
As I grow older, I tend to make excuses for indulging and for not having the willpower to do the right thing on a consistent basis. I’ll say to myself, “I’m not getting any younger. Why toe the line? Live it up and enjoy yourself.”
I had a lot of perseverance when I was younger and saving for retirement. I would contribute diligently to my 401(k), IRAs and savings accounts. I benefited financially from this unrelenting behavior. It’s probably the main reason I have a comfortable retirement today.
Saving for long-term goals, such as a starter home, the children’s college education or your own retirement, requires an unwavering commitment. This is one of the most difficult parts about accumulating wealth. You could argue it’s more important than asset allocation and investment selection.
Why is it so difficult? You have to delay gratification, forgoing smaller rewards today for larger rewards later. That irresistible luxury car, bought on a whim, can derail the best-laid financial plan to purchase a home. But this year was not the time for me to save money diligently—and perhaps you, too, should be a little less frugal.
As a retiree, you adjust your spending based on how well your investment portfolio is performing. My portfolio is doing well this year, so I’ve been spending money. I’m retired and not concerned about losing my job. I have money invested in the stock market, and I stuck with my funds through the collapse and rebound of the market.
After this year's startling rally, I felt flushed with cash. It was a good time for me to open my wallet and take advantage of my stock market gains. It might be a while before I get this chance again. So instead of rebalancing my portfolio into bonds or cash, I rebalanced it into a new sofa, remodeled kitchen and a new car.
I actually felt good about spending money this year. When I saw four people working on our house, it made me feel like I was helping to keep people employed during the pandemic. I was doing my small part to keep our economy going. Consumer spending accounts for almost 70% of economic growth. During these difficult times, our economy is more dependent than ever on our ability to spend.
If you can afford to spend money and there’s something you want or need, this holiday season might be a good time to make that purchase. It doesn’t have to be a large expenditure. Even an extra takeout meal from your favorite local restaurant would suffice. At this time of need, such purchases are a small but important way to spur economic growth and help others.
Dennis Friedman retired from Boeing Satellite Systems after a 30-year career in manufacturing. Born in Ohio, Dennis is a California transplant with a bachelor's degree in history and an MBA. A self-described "humble investor," he likes reading historical novels and about personal finance. His previous articles include Don't Delay, Try Not to Slip and Go Long. Follow Dennis on Twitter @DMFrie.
What do I want for Christmas? To be honest, not much. But then again, my wife and I have been spending money this year as if Christmas were a year-long event. We remodeled the house, filled it with new furniture and bought a new car.
What I probably need is not more material things, but something that could make me a better person. A behavior transplant would do the trick. Something like persistence. Indeed, a little more persistence would be a good attribute to have going into the new year. It might help me to eat better, exercise more and generally live a more fulfilling lifestyle.
As I grow older, I tend to make excuses for indulging and for not having the willpower to do the right thing on a consistent basis. I’ll say to myself, “I’m not getting any younger. Why toe the line? Live it up and enjoy yourself.”
I had a lot of perseverance when I was younger and saving for retirement. I would contribute diligently to my 401(k), IRAs and savings accounts. I benefited financially from this unrelenting behavior. It’s probably the main reason I have a comfortable retirement today.
Saving for long-term goals, such as a starter home, the children’s college education or your own retirement, requires an unwavering commitment. This is one of the most difficult parts about accumulating wealth. You could argue it’s more important than asset allocation and investment selection.
Why is it so difficult? You have to delay gratification, forgoing smaller rewards today for larger rewards later. That irresistible luxury car, bought on a whim, can derail the best-laid financial plan to purchase a home. But this year was not the time for me to save money diligently—and perhaps you, too, should be a little less frugal.
As a retiree, you adjust your spending based on how well your investment portfolio is performing. My portfolio is doing well this year, so I’ve been spending money. I’m retired and not concerned about losing my job. I have money invested in the stock market, and I stuck with my funds through the collapse and rebound of the market.
After this year's startling rally, I felt flushed with cash. It was a good time for me to open my wallet and take advantage of my stock market gains. It might be a while before I get this chance again. So instead of rebalancing my portfolio into bonds or cash, I rebalanced it into a new sofa, remodeled kitchen and a new car.
I actually felt good about spending money this year. When I saw four people working on our house, it made me feel like I was helping to keep people employed during the pandemic. I was doing my small part to keep our economy going. Consumer spending accounts for almost 70% of economic growth. During these difficult times, our economy is more dependent than ever on our ability to spend.
If you can afford to spend money and there’s something you want or need, this holiday season might be a good time to make that purchase. It doesn’t have to be a large expenditure. Even an extra takeout meal from your favorite local restaurant would suffice. At this time of need, such purchases are a small but important way to spur economic growth and help others.
Dennis Friedman retired from Boeing Satellite Systems after a 30-year career in manufacturing. Born in Ohio, Dennis is a California transplant with a bachelor's degree in history and an MBA. A self-described "humble investor," he likes reading historical novels and about personal finance. His previous articles include Don't Delay, Try Not to Slip and Go Long. Follow Dennis on Twitter @DMFrie.The post Live It Up appeared first on HumbleDollar.
November 26, 2020
Ain’t Everything
MONEY IS IMPORTANT. But how do we ensure it has the right importance in our life—and no more? Here are 11 signs we’ve got it about right:
We aren’t jealous of others or lust after the things they have.
We borrow when we must—but we never borrow so much that we stress ourselves out today or put our future self at risk.
We consciously spend a little less today so we enjoy the long-run happiness that comes with money in the bank and the knowledge that we can cope with financial adversity.
When there’s a big down day in the financial markets, we might feel anxious—but it doesn’t wreck our day or ruin our sleep.
We view money as a way to improve our life, rather than as an obstacle that constantly holds us back.
We spend after pondering the alternatives—but, truth be told, thoughts of spending don’t consume much of our time.
We don’t fret about how we’ll pay the monthly bills or how we’ll cope with surprise expenses.
When we look at our portfolio, we feel more contentment about what we have than fear about what the future might bring.
We usually spend without guilt or subsequent regret.
We know what our financial goals are and we’re confident we’ll get there.
We feel we’re in charge of our finances—not the other way around.
Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Bad Influence, Never Assume and Future Shock
We aren’t jealous of others or lust after the things they have.
We borrow when we must—but we never borrow so much that we stress ourselves out today or put our future self at risk.
We consciously spend a little less today so we enjoy the long-run happiness that comes with money in the bank and the knowledge that we can cope with financial adversity.
When there’s a big down day in the financial markets, we might feel anxious—but it doesn’t wreck our day or ruin our sleep.
We view money as a way to improve our life, rather than as an obstacle that constantly holds us back.
We spend after pondering the alternatives—but, truth be told, thoughts of spending don’t consume much of our time.
We don’t fret about how we’ll pay the monthly bills or how we’ll cope with surprise expenses.
When we look at our portfolio, we feel more contentment about what we have than fear about what the future might bring.
We usually spend without guilt or subsequent regret.
We know what our financial goals are and we’re confident we’ll get there.
We feel we’re in charge of our finances—not the other way around.
Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Bad Influence, Never Assume and Future ShockThe post Ain’t Everything appeared first on HumbleDollar.
November 25, 2020
Late to the Rescue
MY FATHER-IN-LAW William retired from Duke University after teaching there for more than 30 years. He had a good pension, which—along with Social Security—covered all his expenses at the continuing care retirement community (CCRC) where he spent most of his retirement. Almost to the end, he was mentally sharp. I saw no need to inquire about his finances. I was mistaken.
In summer 2014, my wife noticed that William, then age 96, had left a large check for a matured life insurance policy on his desk for a couple of months. On investigating further, she saw that there were some bills—things not covered by the CCRC—that he had left unpaid. She spoke with her father, who agreed to grant her power of attorney. Since I’m more interested in financial matters than my wife, she enlisted my help.
First, I organized his records. This took some time, because William saved everything he received from his bank, broker, pension fund and more. Next, I moved most of the money he had at the Duke credit union to the State Employees’ Credit Union, which was then paying about eight times more interest on money market accounts. That made him a couple thousand bucks in a year for very little effort.
Then I started looking through his statements from a large national brokerage firm. There were 32-page monthly reports and eight-page quarterly reports, neither of which provided much useful information. Instead, they appeared to be written to impress the reader with the fine management the company provided, making it seem like the folks there were doing a lot of work for their fees. I found that 92% of William’s portfolio was invested in 14 North Carolina municipal bonds with an average 5% coupon rate.
The bonds had a market value of $621,027 and, in 2014, paid $25,501 in interest. On William’s account statement, I found an unexplained “other debits” item of $5,450. From his 2014 brokerage tax statement, I learned that the $5,450 was for a “private investors fee.” It turned out William was paying 21% of his bond income toward an unnecessary management fee, since his bonds needed no management.
The other 8% of his portfolio, equal to $57,428, was split between 15 actively managed mutual funds. These had an “MFA fee” of $948 on top of the fund expenses, which averaged 0.92%. In total, William was paying 2.7% annually in fees for his mutual funds.
I immediately wrote a letter for my wife to sign, telling the brokerage firm that we no longer wanted the municipal bonds managed. We also directed the firm to sell all the mutual funds and send a check. There were some capital gains, but those were more than offset by capital losses carried over from the sale of two timeshares that William also owned.
A representative from the brokerage firm called and tried to convince me that we should continue to let the firm manage the municipal bonds. I told him we were happy to leave the bonds where they were and just collect the interest. He said, “Yes, but these are managed,” as if that somehow made them more valuable. I replied that we didn’t need any further management.
Unfortunately, William’s health deteriorated and he died in September 2015 at age 97. My wife was executor of his estate. The changes we’d made to William’s brokerage account and bank account meant the estate—which was split between my wife and her three siblings—was several thousand dollars larger.
My regret: I wish we had looked into his finances earlier, because he was getting bad advice and paying way too much for it. He didn’t need 92% of his holdings in municipal bonds, especially when his fixed expenses were covered by a pension and Social Security. William would have done far better with his money in a small set of low-cost index funds. For financial advice, he could have hired a fee-only financial planner for less than the brokerage firm was charging—and I would have happily advised him for nothing.
Brian White 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 A Simpler Life, Time to Retire and Limited Selection. 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.
In summer 2014, my wife noticed that William, then age 96, had left a large check for a matured life insurance policy on his desk for a couple of months. On investigating further, she saw that there were some bills—things not covered by the CCRC—that he had left unpaid. She spoke with her father, who agreed to grant her power of attorney. Since I’m more interested in financial matters than my wife, she enlisted my help.
First, I organized his records. This took some time, because William saved everything he received from his bank, broker, pension fund and more. Next, I moved most of the money he had at the Duke credit union to the State Employees’ Credit Union, which was then paying about eight times more interest on money market accounts. That made him a couple thousand bucks in a year for very little effort.
Then I started looking through his statements from a large national brokerage firm. There were 32-page monthly reports and eight-page quarterly reports, neither of which provided much useful information. Instead, they appeared to be written to impress the reader with the fine management the company provided, making it seem like the folks there were doing a lot of work for their fees. I found that 92% of William’s portfolio was invested in 14 North Carolina municipal bonds with an average 5% coupon rate.
The bonds had a market value of $621,027 and, in 2014, paid $25,501 in interest. On William’s account statement, I found an unexplained “other debits” item of $5,450. From his 2014 brokerage tax statement, I learned that the $5,450 was for a “private investors fee.” It turned out William was paying 21% of his bond income toward an unnecessary management fee, since his bonds needed no management.
The other 8% of his portfolio, equal to $57,428, was split between 15 actively managed mutual funds. These had an “MFA fee” of $948 on top of the fund expenses, which averaged 0.92%. In total, William was paying 2.7% annually in fees for his mutual funds.
I immediately wrote a letter for my wife to sign, telling the brokerage firm that we no longer wanted the municipal bonds managed. We also directed the firm to sell all the mutual funds and send a check. There were some capital gains, but those were more than offset by capital losses carried over from the sale of two timeshares that William also owned.
A representative from the brokerage firm called and tried to convince me that we should continue to let the firm manage the municipal bonds. I told him we were happy to leave the bonds where they were and just collect the interest. He said, “Yes, but these are managed,” as if that somehow made them more valuable. I replied that we didn’t need any further management.
Unfortunately, William’s health deteriorated and he died in September 2015 at age 97. My wife was executor of his estate. The changes we’d made to William’s brokerage account and bank account meant the estate—which was split between my wife and her three siblings—was several thousand dollars larger.
My regret: I wish we had looked into his finances earlier, because he was getting bad advice and paying way too much for it. He didn’t need 92% of his holdings in municipal bonds, especially when his fixed expenses were covered by a pension and Social Security. William would have done far better with his money in a small set of low-cost index funds. For financial advice, he could have hired a fee-only financial planner for less than the brokerage firm was charging—and I would have happily advised him for nothing.
Brian White 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 A Simpler Life, Time to Retire and Limited Selection. 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 Late to the Rescue appeared first on HumbleDollar.
November 24, 2020
Last Stop
I GREW UP in a small apartment. Truth be told, I was never enthusiastic about maintaining a house, but I did so for 45 years. Eight years after I retired in 2010, the house and its stairs became too much for my wife and me.
We considered moving to a smaller one-story house and briefly flirted with a continuing care community. We even looked at one community and found it too expensive, especially having to hand over a partially refundable $900,000 upfront fee, with no interest earned on the money.
When a condo in a nearby 55-plus community came on the market, our realtor convinced us to take a look. Here we are two years later and we’re pleased with our decision. We have two bedrooms with walk-in closets, two full baths, living room, dining room, large kitchen, laundry room and a family room with fireplace. In all, we have 2,000 square feet, plus an 80-square-foot balcony. The unit came with two garage spaces and two good-sized storage rooms. Amenities include a pool, tennis and bocci courts, putting green, well-equipped clubhouse, and beautiful grounds with ponds and walking paths.
There are nine buildings in the community. Each has three floors, with four condos on a floor. It’s quiet. Sound from above and below us is virtually nonexistent. Our building currently houses just four residents, as the snowbirds leave the cold of New Jersey and migrate south for the winter.
There are always rules. We can have pets, but a dog can’t weigh more than 50 pounds. Forget my dream of having an Irish wolfhound. Luckily, no weight limit applies to residents. There are also rules on deliveries and on which day of the week you can move in or out. Overall, the rules are commonsense.
Now for the big question: Is it a good investment? Honestly, I don’t care. Our decision was based on livability. Still, we’ve done well so far.
We bought our unit in 2018 for $580,000, which was less than the purchase price in 2011, when the unit was brand new. Today, units our size sell quickly for around $660,000. We live in one of the highest-tax states. Our property tax is $12,500, compared with about $14,500 for our old home a mile away.
The homeowner’s association (HOA) fee is $770 a month. Thus, our annual fixed costs are $21,740. Of course, that $770 offsets some of what we previously spent on house maintenance, lawn care, snow shoveling and so on. A few months before we sold our old house, the air conditioning (AC) went and we needed to remove a tree. Those two expenses were equal to six months of our current HOA fee. I haven’t done all the math, but not worrying about maintenance and repairs is worth it.
Condo living is not worry-free, though. We have our own heating, AC and hot water equipment. Turns out the builder didn’t go for the best quality, so many residents have had major repairs or replacement. We have an estimate to replace heating and AC for $12,500. Ouch.
The HOA fee is tricky. Some residents want no increase, while a few—like me—would prefer a modest increase each year to avoid sticker shock down the road. So far, the no-increase group has carried the day, but that won’t last.
At last month’s association meeting, we learned the irrigation system was mismanaged and we wasted thousands of dollars on water. A new landscaper is being hired at a higher cost than currently spent. Explaining money issues to some of us seniors is no easy task.
Complying with the COVID-19 rules on opening the community’s swimming pool would have cost $30,000, so it remained closed this year. Several people wanted to know if there was an HOA refund coming their way as a result. Apparently, they don’t understand fixed costs. A small group wanted fans installed on the clubhouse deck, where sitting was allowed this year. The association spent $3,000 on that, despite the fact the area has been used for nearly 10 years without fans.
Yup, even affluent seniors are challenged by the concept that things you want cost money. Living in a multi-unit community such as this means some of your expenses are controlled by others.
The dreaded assessment occurs when an association has a major expense and there are insufficient funds to pay for it. Fortunately, our association is keenly aware of that and actively seeks to avoid it. A few miles away, at a high-rise condo building, each unit was assessed $20,000 to be paid over 10 years (with interest) to cover the cost of external repairs on the aging building.
Condo living is not for everyone, but for us so far, so good. In any case, there’s no going back. Should my wife survive me, she has a home that’s both physically and fiscally manageable for her. And our children have a bit less to worry about.
Bottom line: We aren’t moving again, at least not voluntarily.
Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include The Late Show, For Your Benefit and A Seat at the Slots. Follow Dick on Twitter @QuinnsComments.
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