Jonathan Clements's Blog, page 311

Don’t Play Politics

WITH THE ELECTION just a month away, many investors are worried about what lies ahead. Does it make sense to lighten up on stocks now, in advance of the election? I see at least four reasons not to sell:

Despite the polls, we can’t be sure what the result will be.
As we saw in 2016, nobody knows how the market will react to that result.
Even if the market reacts negatively, the effect may be temporary.
Thanks to the pandemic, an already unpredictable situation is that much harder to assess.

To be clear, I fully acknowledge that the market could experience a downdraft over the next few months, so you want to be prepared for that possibility. I just don’t think selling stocks is the best way to prepare.

Instead, I would get ready by examining your finances the way analysts would evaluate a bond. They consider three key factors: an issuer’s leverage, its liquidity and its cash flow. That’s a great framework for evaluating our individual finances. After reviewing the questions below, you might decide it makes sense to sell some stocks. But I would only do that for a solid financial reason and not simply in response to the election.

1. Leverage

With interest rates at historic lows, have you conducted an inventory of your various debts? Most people focus on their mortgage—which makes sense—but don’t forget about student loans, business loans and even car loans, all of which can be refinanced.
Do you have any variable-rate debt? I have seen more than one person refinance an old adjustable-rate mortgage into a new fixed-rate mortgage at a lower rate.
Are there any debts that you could extinguish with cash on hand? The issue of whether to pay off debt, even when it carries a low interest rate, gets a lot of airtime in the personal finance world. I would encourage you to look beyond the math and consider the issue from all angles. For instance, it’s advantageous to reduce overhead expenses—and that’s what happens when you pay off a loan. Even if your debts are affordable today, reducing leverage can provide an invaluable margin for error in case of a rainy day.
Have you considered putting a line of credit in place, so you have easy access to cash in an emergency?

2. Liquidity

I don’t worry about the stock market over the long term, but anything can happen in the short term. If you were to experience an interruption to your income—or if you’re retired and regularly withdrawing from your portfolio—do you have sufficient assets outside of stocks to carry you through a market downturn? This is where a sense of market history can be helpful. In the past 10 years, the S&P 500 has dropped by more than 10% on eight different occasions. In two of those cases, it was closer to 20%, and this year, of course, it was more than 30%. Over that same period, the market has nearly tripled in value, which is great, but the long term is irrelevant if you have a problem in the short term. That’s why liquidity may be the most important of our three considerations.

3. Cash flow

Do you have a good handle on your household’s cash flow? For instance, do you have a sense of the breakdown between fixed and discretionary expenses, as well as how much goes each month toward debt payments?
Another key element of cash flow is your annual income tax burden. As recent years have proven, tax rules are not written in stone. If the president and Congress are aligned, a lot can change—and quickly. That’s why I recommend diversifying your assets in a way that allows you to hedge your tax bets. This means having at least some assets in each of the three major categories: taxable, tax-deferred and tax-exempt. (This last category includes Roths, 529s and health savings accounts). This is a good strategy regardless of who is elected in November, but it’s especially smart right now. Why? This year, the federal government will run its largest deficit ever: over $3 trillion, or more than triple what it was last year. It isn’t hard to imagine tax rates going up in the future. While some economists believe we can simply print money indefinitely, I’m not so sure—and I wouldn’t be comfortable staking my financial security on a theory that’s new and untested. What can you do? If you aren’t in your peak earning years, consider a Roth conversion in 2020 at today’s historically low tax rates.
If your assets are significant, also give some thought to estate taxes. The current estate tax rules are set to expire at the end of 2025. If there’s a political shift in January, that timeline could be accelerated. What to do? Call your estate planning attorney today and ask what steps you should take before the end of the year.

Adam M. Grossman’s previous articles include High Anxiety, When to Change and Just Say No . 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 .

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Pay It Forward

MINDFUL. INTENTIONAL. Purposeful. These are the buzzwords of our time—and they make me slightly queasy, with their whiff of self-centered, self-satisfied self-indulgence.

Yet it seems those are my goals.

On Monday, a moving van will arrive to take my worldly possessions to a house in Philadelphia that, I hope, will be my last. All this has made me ponder what I want from the years that remain. Three items top my wish list:

Do good work. My ambitions today are far more circumscribed than they were in my 20s. A few decades jousting with the world will do that to you. Still, I remain anxious to serve others as best I can—and HumbleDollar is my chosen vehicle.

Find some balance. A friend recently called me a workaholic. It’s a label I resist, because it’s my choice to log long hours at my laptop—and I do so because I love my work. Still, I readily concede my life is somewhat unbalanced, and I want to find a way to work less and spend more time exploring the world, whether it’s through books, encounters with others, on bicycle or via airplane.

Help my family. As longtime readers know, teaching my kids about money—and helping them financially—has been an enduring passion. In November, the list of family members I hope to help will grow by one, with the arrival of my first grandchild.

This is a key reason for my move to Philadelphia. My new home will be 10 blocks from my daughter and son-in-law. I want to help out as best I can with my grandson. (Yes, the sonogram says it’s a boy.)

For many, the world is a harsh place made yet harsher by the pandemic’s economic fallout. The government has an important role to play in taking the edge off that harshness. As someone who has benefited from an economic system that creates both winners and losers, I don’t begrudge the taxes I pay to support that government safety net.

Still, I don’t want my financial security to depend on a large, faceless bureaucracy—I can’t imagine many do—which is why I’m heavily focused on the safety net that family can offer. Got a spouse, parents, children and others who you consider close family? You are, I would argue, among each other’s greatest assets and liabilities.

How far would you go in helping other family members financially—and how much help would they provide you? This, I realize, is a topic where many folks have strong opinions. Some believe they shouldn’t provide too much financial assistance to their children or other family members, because they fear such help will dent ambition and create an unhealthy dependence. Similarly, others shy away from family loans, because they worry the money borrowed won’t get repaid and will leave all involved with bruised feelings.

Much, I suspect, should hinge on a clear-eyed assessment of your fellow family members’ money habits. My children, siblings and mother are all remarkably sensible about financial matters, and I wouldn’t hesitate to lend money to any of them. Indeed, I lent money to my daughter so she could buy her current home, and my mother has twice made me short-term loans to help with a house purchase.

Not inclined to make family loans, help your children fund Roth IRAs, subsize their 401(k) contributions or provide other direct financial support? Even so, I’d encourage you to ponder the concept captured by the title of this article: Pay it forward.

I won’t bequeath enough to my children for them to live in the lap of luxury, with no need to ever work again, and—even if I had that sort of wealth—I don’t think it would be desirable. But I’m endeavoring to give my kids something I consider even more valuable: a sense of financial security.

While I’m alive, they know I’d bail them out if financial misfortune befell them—and, upon my death, they should inherit enough to provide them with a healthy financial backstop. In other words, as harsh as the world can be, my kids should never suffer the full financial impact of that harshness.

I readily concede there’s an unfairness to this: Only those who enjoy some financial success have the opportunity to bequeath a sense of financial security to future generations. But I make no apologies. I’ve come to realize that financial happiness lies not in a bigger house or a faster car, but in knowing all will be okay, even if we’re hit with rough financial times. That’s my gift to my children. With the money they inherit from me, I hope they pay it forward to the generation that follows.

Latest Articles

HERE ARE THE SIX other articles published by HumbleDollar this week:

“I’m not against success and riches,” writes Joe Kesler. “But we should all ask ourselves, ‘How am I using my riches to bring true wealth into my life and the lives of others?’”
Brian White and his wife decided it was time to retire. But were they financially ready?
“For some, the expensive dream home, with all its attendant joys and burdens, may be the right choice,” concedes Andrew Forsythe. “Still, I’d suggest thinking carefully about what you’re getting into.”
Feeling uncertain about the election and its potential impact on your finances? Adam Grossman offers five key insights from the academic literature.
September saw the third-highest number of page views in HumbleDollar’s 45-month history. What drove traffic? Check out the seven most popular articles.
Do you think commissions equal trading costs, that all annuities are terrible investments, and that you should claim Social Security early and invest the money in stocks? Maybe it’s time to think again.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Seems So Easy, My Regrets and Playing Dumb. 

Do you enjoy HumbleDollar? Please support our work with a donation. Want to receive daily email alerts about new articles? Click here. How about getting our weekly newsletter? Sign up now.

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September’s Hits

LAST MONTH SAW the third-highest number of page views in HumbleDollar’s 45-month history—and, for that, I’m thankful to the site’s many contributors, who continue to crank out insightful, sprightly written blog posts. Check out September’s seven most popular articles:

SUVs. Tattoos. Eating out. Smoking. Video games. Pets. Lottery tickets. Soda. Richard Quinn looks at 10 ways that Americans could potentially cut spending—and finds an extra $870,000 for retirement.
How much could you save by favoring ETFs over index mutual funds? Dennis Friedman ran the numbers on a $1 million portfolio. The savings came to more than $20,000 over 25 years.
Kristine Hayes is approaching retirement age—and trying to figure out the best strategy for generating retirement income. Her biggest stumbling block: the overwhelming number of financial choices.
A sorry tale in which Rick Connor finds himself the unhappy owner of a timeshare, for which he blames himself—and the CFA Institute.
Got investments in your taxable account that you need to unload? Adam Grossman discusses how to sell—without losing too much to taxes.
There are three sound reasons to revise your financial plan. Something spouted by a TV talking head isn’t one of them, says Adam Grossman.
“In many cases, debt is merely convenient—not necessary—and it comes with costs that go far beyond the low, easy monthly payments,” writes Isaac Cathey, who details five key drawbacks.

What about our weekly newsletters? The two most popular were My Regrets and Playing Dumb. Meanwhile, among articles from prior months, the site saw large traffic for Much Appreciated, Making Time and Terms of the Trade. This last piece is widely used in high school economics classes.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Not Exactly True, Seems So Easy, Small Pleasures and Brain Candy. 

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The Path Not Taken

IN AN EARLIER article, I wrote about a catastrophic stock market loss that taught me—the hard way—about the benefits of diversification and the importance of managing my own investments. That loss derailed our plans to build a large and expensive home in the hills overlooking Austin, Texas.

We were heartbroken at the time. This had been our dream for several years. But it’s funny how life works out sometimes—and it may have been the best thing that ever happened to us.

As we planned our dream home, I knew it was going to involve taking on a huge mortgage, but that gave me no pause. I was young, ambitious and already accustomed to long, stressful hours at my job. It never dawned on me that I was putting myself on a path that I’d likely feel compelled to stay on indefinitely, or at least until that big mortgage was finally paid off.

And the mortgage was only part of it. A big expensive house also costs more to maintain, the property taxes can be a huge burden and it can propel you into a more expensive overall lifestyle. That last factor is worth special consideration. When you buy or build a home, you aren’t just acquiring a place to live. Rather, you’re becoming part of a neighborhood, a school district, and a group of friends and neighbors.

When that’s all on the upper end of the wealth scale, your finances will be affected in myriad ways. Even if you can resist the peer pressure, you’ll feel it through your kids, who will be much more susceptible. You’re basically locking yourself into a way of life. Consoling yourself with the thought that you can always change trajectory by selling the house? That’s much easier said than done, especially when the kids are at local schools and have neighborhood friends.

Ironically, when we were clobbered by the stock crash and our dream home went up in smoke, it may have been a blessing in disguise. We had been living temporarily in a more modest home, but one we had come to love. It was spacious, in a great school district, sat on a wooded acre with beautiful views and was close to a lake where our kids liked to swim. Although it was far from the city, meaning a significant commute for my wife and me, that also made it affordable. Not long after the stock crash, our landlords—fortuitously for us, but not them—went bankrupt. We had the chance to buy the home from the bank at a terrific discount and we jumped at the opportunity.

Looking back from almost 30 years later, we’re thankful this twist of fate kept us in the house. Our lifestyle hasn’t been fancy, but it has been comfortable. Our costs of homeownership have remained modest year after year. That enabled us to save and invest more, and we’re now happily retired with a healthy nest egg. The path we chose—or rather fate chose for us—has meant a sense of freedom, of not being held hostage by that huge mortgage and elite lifestyle we thought we wanted. My wife says that if we’d gone in the original direction, I’d likely be dead by now, the victim of a heart attack or some other stress-related malady.

Everyone’s different and there are many deep-seated psychological reasons for the choices we make. For some, the expensive dream home, with all its attendant joys and burdens, may be the right choice. Still, with the benefit of hindsight, I’d suggest thinking carefully about what you’re getting into.

Andrew Forsythe retired in 2017 after almost four decades of practicing criminal law, first as a prosecutor and then as a defense attorney. Along with his wonderful wife, kids and grandkids, he loves dogs and collecting pocketknives. His previous  article was Saved by a Crash.

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Not Exactly True

THERE ARE FINANCIAL issues on which reasonable people can disagree. This article is not about those issues. Instead, it’s about issues where people disagree—because one side has a fundamental misunderstanding.

These misunderstandings, I fear, are leading folks to shortchange themselves financially—and we’re talking here about some of the most important money decisions we make. Examples? Based on the comments I’ve received, here are three widespread misconceptions:

1. Commissions equal trading costs. If you think it’s free to trade stocks because you aren’t paying a brokerage commission, think again. Every time you buy or sell, you lose at least a little to the bid-ask spread, the difference between the higher price at which you can currently buy a stock (the ask) and the lower price at which you can sell (the bid). The difference is pocketed by Wall Street’s market makers.

The bid-ask spread means that if you bought a stock and sold it seconds later, you might lose a few cents per $100 on the very biggest publicly traded companies—and perhaps $3 or more on a micro-cap stock.

That brings me to a key decision that many indexers make: Should you buy index mutual funds or exchange-traded index funds (ETFs)? When you purchase an index mutual fund, you buy directly from the mutual fund company involved and get the price as of the 4 p.m. ET market close. When you buy an ETF, you put in an order through your brokerage firm and you can invest at any time during the trading day.

Consider Vanguard Group, which offers its index funds as both mutual funds and ETFs. The ETFs often have slightly lower annual expenses. But those lower ongoing costs come at a price: You get nicked for the bid-ask spread on your trades.

How much might you lose? During the trading day, check out the spread on funds like Vanguard’s S&P 500 ETF, Small-Cap ETF, FTSE Developed Markets ETF and FTSE Emerging Markets ETF. (Don’t look when the market is closed, because the spread often appears far larger than it is during market hours.) The Small-Cap ETF is no cheaper than Vanguard’s mutual fund version, while the other three funds are between 0.01 to 0.04 percentage point per year less expensive. Those annual savings would offset the spread—but, based on eyeballing the bid-ask spread over the course of a few weeks, you might need to hold the ETF for at least two or three years to come out ahead. The upshot: ETFs are typically a better bet for those with longer time horizons, but not for those inclined to trade.

A digression: Some readers have written to me, arguing that because you can put in a limit order for an ETF and thus you know what price you’re getting—assuming the order is executed—ETFs are superior to mutual funds, where you might put in an order at 3 p.m. ET and get a wildly different price when your buy or sell order is filled at the 4 p.m. market close.

I find this argument unconvincing. To be sure, with mutual funds, you don’t know precisely what price you’ll get. Sometimes, that price will be higher than when you put in the trade. Sometimes, it’ll be lower. Given that nobody can forecast what will happen to stock prices during the course of the trading day, I don’t feel this uncertainty is so terrible and, overall, the brief time lag probably helps as often as it hurts.

2. All annuities are terrible investments. Many folks hear the word “annuity” and immediately stop listening, which is perhaps what insurance companies deserve after decades of sales abuses involving variable and equity-indexed annuities.

Still, with their point-blank refusal to consider any annuity product, many retirees are missing out on one of the few remaining ways to generate a healthy amount of income in today’s low-yield environment. I am, of course, referring to my old favorite, immediate fixed annuities.

With an immediate fixed annuity, you and a bunch of other retirees contribute to a pool of money overseen by an insurance company. The insurer promises to pay you income every month for life. The income stream can be impressively large, in part because those who die early in retirement effectively subsidize those who live longer.

But what about the cost? Annuities are famous for paying fat commissions to the financial salespeople involved. But that isn’t true of immediate fixed annuities, where a salesperson might receive a commission equal to just 1% to 3% of your total investment—far less than the 5% to 8% that he or she might receive for selling a variable or equity-indexed annuity. Think of it this way: If you buy an immediate fixed annuity that ends up paying you income for the next 25 years and the salesperson gets a onetime 1% commission, that’s the same sum that many folks pay to a fee-only financial planner every year.

If immediate fixed annuities aren’t all that expensive and they remain one of the few ways for retirees to generate a healthy amount of income, why are they so unpopular? Even if folks better understood them, there will—I suspect—be one stumbling block that never goes away: People just hate the idea of an investment whose value hinges on them living a long life. That brings us to our third topic.

3. You should claim Social Security early and invest the money in stocks. Receiving Social Security is rightly compared to collecting interest from government bonds. Both involve a similar level of risk.

Suppose you claimed benefits at age 62, the earliest possible age, and invested those benefits in government bonds that had a zero inflation-adjusted return, which is a generous assumption these days. For that to be the right move financially, you need to be dead by your late 70s. If you live any longer—which the life expectancy tables say you should—you would have been better off delaying Social Security until age 66 and perhaps age 70, so you got the larger monthly benefit.

For those who think claiming Social Security early is a smart strategy, the notion of committing to an early death is no doubt a tad unpalatable. What to do? How about if they took benefits early and then put the money in stocks? Given the higher expected return from stocks, claiming benefits early suddenly looks like a smart strategy, even if folks live well into their 80s.

There’s just one problem: This scenario is total nonsense—unless the retirees in question have 100% in stocks. If they have at least some money in bonds and cash investments, and they live to their late 70s, they’d be better off spending down those conservative investments first, while they delay Social Security, because delaying Social Security would give them a higher effective return.

So why do folks cook up these convoluted justifications for claiming Social Security at age 62? It’s the same reason people won’t buy immediate fixed annuities. They simply hate the idea that they’ll postpone Social Security—and then fail to live long enough to get the benefit.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Seems So Easy, My Regrets and Playing Dumb. 

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Time to Retire

IN SUMMER 2012, my boss of 17 years announced he planned to retire the following year. I had enjoyed working for him and considered him both a mentor and a friend, and I had some trepidation about working for a new manager at this late stage in my career. While I enjoyed my job and was good at it, and I liked most of the people I worked with, it was a stressful, demanding position, particularly when budget cuts necessitated layoffs. I looked forward to not having to deal with those issues anymore. My wife and I started thinking seriously about when we might retire.

I was age 58 then and I had two more years to work before I could retire without taking a reduced pension from the State of North Carolina. The penalties for retiring early were fairly steep, so I didn’t want to quit work any earlier than age 60.

Medical insurance was also a consideration. Fortunately, North Carolina has good and inexpensive medical benefits for state retirees. My wife was working as a private practice clinical social worker, and she’d been covered by my state medical plan. I found out that I could continue to cover her once I retired, and it would cost even less once she went on Medicare.

I tried various online retirement calculators and those gave promising results, even with very conservative estimates of market performance. But the calculators I tried all assumed a constant level of spending over time and they didn’t factor in taxes. This left me with the sense I wasn’t getting the full picture.

By 2012, most of our money was at Vanguard Group, which would provide some limited free advice if you had a certain amount invested there. Several times, I spoke with a Certified Financial Planner for an hour or so. The Vanguard planner plugged our numbers into his own models, and he assured us that we were in good shape. He also suggested we might shift to a more conservative portfolio, since we had enough for our expected needs and might want to reduce risk—something I’d also been thinking about.

To feel comfortable, I wanted to see the numbers in more detail. Since spreadsheets are my forte, I worked up a large, complicated spreadsheet to calculate how our financial situation would change over time. With the spreadsheet, I could change spending and return assumptions to see how these would affect the outcomes. After reading Rick Ferri’s All About Asset Allocation, I looked up his 30-year market forecast. Using his estimates, I came up with a conservative expected after-inflation annual return of 2.4%, based on our planned retirement allocation of 40% stocks and 60% bonds.

I also read The Bogleheads’ Guide to Retirement Planning, which had a lot of useful suggestions. For example, to estimate the amount we would spend in retirement, I took our current expenses, and then subtracted those that would no longer apply in retirement, while also adding in new costs, such as increased travel, hobbies and other leisure activities.

My spreadsheet allowed me to factor in Roth conversions, large occasional expenditures like a new car or replacing the roof, and onetime sources of cash, such as from the sale of real estate. It also computed state and federal income taxes, as well as required minimum distributions. I lowered our estimated spending needs as our retirement progressed, on the assumption that we’d travel less and that our long-term-care insurance would handle most of the increase in medical costs.

It took months to tweak the spreadsheet just the way I wanted it. But after completing the first iteration, my wife and I were convinced we could retire comfortably in summer 2014. So that’s what we did.

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 were Limited Selection, Lesson Well Learned and Rookie Mistakes. 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 in the Chapel Hill senior center.

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True Wealth

YOU NO DOUBT remember Peter Lynch, the celebrated manager of Fidelity Magellan Fund. He quit Magellan’s helm when he was just 46 years old. His comment at the time: “You remind yourself that nobody on his deathbed ever said, ‘I wish I’d spent more time at the office’.”

Nothing brings more clarity to money’s limitations than consideration of our mortality. A few weeks ago, I thought about this truth as I lay awake all night, waiting to hear from my son. He and his wife had checked into a hospital to give birth to their first child. The plan was that we would receive regular text updates, regardless of the time. But the hours passed and no updates arrived.

My wife and I had an ominous feeling that something was wrong. As we agonized and prayed, we struggled to contain our fears, imagining all the things that could be going wrong. Why hadn’t our son kept us updated? Were mother and baby okay? Finally, a call came at 3:30 a.m.

Our fears were not unfounded. It was a traumatic birth—the baby initially had trouble breathing. But I’m happy to report that, thanks to incredibly talented medical personnel, our new grandson and daughter-in-law are doing fine.

For me, the difficult birth has triggered a time of introspection. Has my life been too focused on the accumulation of things that won’t last—or have I have been building true wealth? The word “wealth” comes from an old English word. Its meaning is closely related to happiness and to the wholeness that comes from a well-balanced life.

As we each examine our life, what traits should we look for if our goal is true wealth, rather than just lots of money in the bank? Here are eight things I view as valid metrics for measuring true wealth:

Family and friends. According to research, a robust support network is almost always a leading indicator of happiness. That network is even more important amid today’s COVID-19 isolation.
Community. The richness that comes from connecting with others through churches, civic groups and other forms of community engagement are at the core of civility. It’s what made my years as a community banker so rewarding.
Education and experience. If we suddenly took all the money in the world and gave everyone an equal share, there would be inequality again by the next day—because of our differing abilities to adapt and respond to the situations we find ourselves in. That, in turn, partly reflects the wealth we’ve accumulated in the form of education and experience.
Contentment. Growing up, I was surrounded by many lower middle-class families—and yet I rarely saw the envy and angst that destroy happiness. Instead, I saw that in the workplace, with its constant jousting over salaries and bonuses.
Health. If we lose our health, we can’t work, play or travel as much as we might desire. To compound that aggravation, we must budget more for medical expenses. Good health is a key part of true wealth, and it’s worth investing in through a healthy diet and regular exercise.
Spiritual peace. My daughter taught me a little about this when I visited her in South Africa. She was spending a gap year helping at an orphanage. Coming from an affluent American family, she assumed the people she’d be working with would be poor and unhappy. But as she explained to me, they were poor but happy. She saw the connection between their deep spiritual faith and their joy in life.
A generous spirit. It’s a wonderful feeling to give generously to others. Studies show that many people derive great happiness from giving to those less fortunate. As a banker, I met many wealthy people who couldn’t enjoy this sign of true wealth—because they had for too long failed to give.
Virtue. When we acquire our wealth by stepping on others or cheating, there’s ultimately a loss of joy in our riches. The Book of Proverbs says it well: “Ill-gotten treasures have no lasting value.” I looked at a lot of tax returns as a banker, trying to qualify customers for loans. When they didn’t qualify, many would admit that they didn’t report all their income and instead were often paid under the table. John Wooden, the great basketball coach for the University of California at Los Angeles, said it well: “The true test of a man’s character is what he does when no one is watching.”

I’m not against success and riches. But we should all ask ourselves, “How am I using my riches to bring true wealth into my life and the lives of others?” It is, I believe, a crucial question—and it took a family crisis to jolt me into giving it the serious thought it deserves.

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 article was Life as a Loan Shark.

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High Anxiety

DO ELECTIONS affect the stock market? Last week, I cited an analysis by Vanguard Group that attempted to answer this question. The study’s verdict: “It’s understandable to have concerns about the election. But as far as your portfolio and the markets are concerned, history suggests it will be a nonissue.” Specifically, Vanguard’s analysis cited evidence that investment returns are no different in election years than in non-election years.

I agree with Vanguard’s overall recommendation—to stay the course with your financial plan. I think it makes sense to avoid drastic action in response to the election, especially if you have a long time horizon. But despite the comforting historical data, many investors feel anxious because of this year’s unique circumstances, and I must confess to feeling some uncertainty myself.

While I can’t offer an antidote to uncertainty, I think it’s helpful to understand the concept better. Here are five observations from the academic research:

1. There may be nothing worse. Neurologist Archy de Berker once conducted experiments to measure people’s aversion to uncertainty. He did this (as scientists seem to enjoy doing) by administering mild electric shocks. His conclusion: “Knowing that there is a small chance of getting a painful electric shock can lead to significantly more stress than knowing that you will definitely be shocked.”

In other words, uncertainty about the potential for something bad is actually worse than the bad thing itself. If you’re anxious about everything that’s going on—and the potential impact on your finances—it’s understandable. But de Berker’s research tells us that the fear is usually worse than the reality.

2. The thing you’re most worried about may not be the thing most worth worrying about. Think back to the spring, when the pandemic started. You’ll recall how the stock market dropped like a rock, with the S&P 500 down 34% in a matter of weeks. And yet, over the subsequent six months, the market fully recovered. Why has it bounced back even though COVID-19 is still with us? One reason is that we have greater certainty now. The government stepped in to support the economy, while drug makers are busy working on vaccines.

Yes, COVID-19 still represents a big risk, but we have a clearer picture than we did six months ago. What this episode teaches us is that the things that present the biggest risk are the things that we aren’t currently thinking about—the things that catch us by surprise, as the pandemic did. Problem is, by definition, we don’t know what the next surprise will be. For that reason, I advise structuring your finances to weather all sorts of scenarios. That means being cautious, including rebalancing occasionally and maintaining a healthy emergency fund, even when such steps seem unnecessary.

3. Some of us are more bothered than others by uncertainty. In 1990, psychologist Arie Kruglanski developed the concept of “need for closure” and observed that people differ in this regard. While no one likes uncertainty, some dislike it more than others. Kruglanski developed a scale and an assessment tool to measure this. You can find these online. While any online assessment will be imperfect, I think there’s value in knowing where you fall on this scale—especially if you’re married and you find that the two of you are perceiving and worrying about current events differently.

4. Uncertainty nags at us. Think about a TV show that ends with a cliffhanger. TV producers do this because they know viewers will almost certainly tune in for the next episode. When something is left unresolved, we can’t stop thinking about it. This presents a problem for investors. The longer uncertainty lingers, and the more we dwell on it, the more we may feel compelled to take action. My advice: Even if you’re feeling a lot of anxiety, resist the temptation to act. Market timing rarely works out well.

5. Uncertainty is so unpleasant that we’re quick to latch on to explanations. Psychologist Daniel Crosby explains that uncertainty can push investors into one of two camps: Some assume the worst and engage in what he calls “catastrophizing.” Meanwhile, others become overconfident. For those in this second camp, Crosby says, “Our discomfort with uncertainty can make us just pretend that it doesn’t exist and pretend that we know exactly what’s going to happen.”

The reality: Neither camp knows what the future will bring. But because they’re speaking in extreme terms, their stories may sound convincing. My advice: As we get closer to the election, try to keep your feet on the ground—and avoid getting swept up in prognostications of any kind.

Adam M. Grossman’s previous articles include When to Change, Just Say No and  Eyeing the Exit . 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 .

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Seems So Easy

MANAGING MONEY is ridiculously simple—and unbelievably hard.

Figuring out what we should do with our dollars is typically straightforward: We should save regularly, diversify broadly, rebalance occasionally and so on. Instead, the tough part is getting ourselves to do what we intellectually know is right.

Take the notion of buying low and selling high. Every investor knows that’s the goal—and yet, when the S&P 500 slumped 34% earlier this year, many folks just couldn’t bring themselves to buy stocks. For these investors, the knowledge was there, but that knowledge proved no match for the instinctual fear triggered by plunging share prices and the accompanying narratives of doom.

Other examples? Here are nine basic financial strategies that many people struggle with:

1. Save diligently. What could be simpler than spending less than we earn? It’s the fundamental step on which almost all other financial success is built—and yet so many of us find it so very hard to do.

2. Rebalance occasionally. This is just a disciplined version of the buy low-sell high strategy, and many investors find it equally tough. It seems like madness to lighten up on what’s currently faring well and purchase more of what’s struggling. Yet this simple strategy keeps our portfolio’s risk level under control, while also potentially bolstering long-run results.

3. Diversify broadly. If we build well-diversified portfolios, we should always own a piece of whatever’s faring well, while inevitably ending up with some investments that currently appear to be duds.

But what will the future bring? That we don’t know—but that doesn’t stop us from extrapolating the recent past into the future, leaving us dissatisfied with our diversified portfolio and the investments that have lately fared poorly. For some, owning out-of-favor investments proves too emotionally uncomfortable and they end up ditching their laggards, often just before the market cycle turns.

4. Ignore the crowd. How many times have we been told that, to be successful investors, we need to stand apart from the mob and think independently? Whether it’s buying low, rebalancing or diversifying, we have to buck current market sentiment.

But this can be profoundly difficult. We take great comfort in doing what others are doing. If that means buying total market exchange-traded index funds (ETFs), there’s a good chance that things will turn out fine. If it means buying leveraged ETFs, not so much.

5. Focus on risk. If we gradually invest a lump sum in stocks, we take less risk, because we avoid the danger of buying all at once, only to see the market plunge.

But what about selling stocks gradually? Many folks also do that—and yet that’s the higher-risk strategy. We end up with more money in stocks for longer, thus increasing the risk we’ll get caught up in a market downdraft. So why do we sell stocks slowly? Consciously or not, it seems our overriding concern isn’t losing money, but rather pangs of regret—which we’d suffer if we made a big stock sale and the market immediately skyrocketed.

6. Take tax losses. In a regular, taxable account, the most tax-efficient strategy is to hang on to winners, so we don’t realize the capital gain, while selling losers, so we have realized losses that we can use to trim our annual tax bill. To be sure, this can potentially result in a lopsided portfolio, with too much invested in a few big winners. But most folks can keep their overall investment mix in balance by making offsetting tweaks to their retirement account holdings.

Yet many investors ignore this advice, preferring to sell their winners and keep their losers. Why? They feel a rush of pride as they turn their winners into cash. Meanwhile, they hate selling their losers, because that means admitting they were wrong, with all the associated pangs of regret.

7. Keep it simple. Both logic and the evidence make it abundantly clear that, if we buy and hold low-cost total market index funds, we’ll enjoy far better long-run results than the collective performance of folks who own actively managed funds, day-trade stocks, time the market, invest in hedge funds or pursue any of the other countless strategies considered clever.

True, some day traders and hedge fund investors will notch superior returns, so those with a fondness for lottery tickets may find themselves drawn to these long-shot strategies. But I don’t believe that fully explains the appeal of such strategies. Instead, it seems investors are drawn to complicated strategies because of their complexity. They like the sense they’re doing something “special” and they wrongly assume such “sophistication” is the key to better returns.

8. Be patient. Sometimes, we ought to act—such as fixing a badly diversified portfolio or rebalancing after big market moves. Most of the time, however, investing should be a patient buy-and-hold endeavor, as we sit quietly with our portfolios for decades and wait for the markets to reward us.

But for many investors, such patience is in short supply. During bull markets, we tend to trade too much, getting a thrill from all the buying and selling. In bear markets, we’re often consumed by a sense of crisis, and taking action can be far more emotionally comforting than simply sitting tight.

This sort of impetuousness spills over into how we spend. Indeed, I see a parallel between short-term trading and impulse shopping. Both deliver immediate gratification, but that gratification often later turns to regret.

9. Change when the facts demand it. As I noted in an earlier article, the financial world has changed substantially over the past three-plus decades, but often we’re far slower to change our thinking. Economists talk about the sunk cost fallacy—that, once we’ve put money into an endeavor, we’re reluctant to declare it a loss and walk away. But it isn’t just the money involved. We also become emotionally invested.

Examples? We assume active managers will save us from danger in a way index funds won’t, even though there’s no evidence active funds provide better bear market protection. We persist in favoring larger mortgages, despite the fact that the mortgage-tax deduction has all but disappeared. We continue to view bonds as a way to generate income, even though yields are now miserably low. We persist in worrying that stock market valuations will revert to their historical averages, despite the fact that valuations have been far above average for much of the past three decades. Still clinging to these ideas? Maybe it’s time to let them go.

Latest Articles

HERE ARE THE SIX other articles published by HumbleDollar this week:

“I called our venerable broker at home on a Sunday,” recalls Andrew Forsythe. “When I told him that we were counting on the stock to fund our dream home, and what could we do now, he replied, ‘Build a smaller house’.”
What’s the best rebalancing strategy? Rich Chambers settled on checking portfolios twice a month, but only rebalancing if investments have strayed 20% from their targets.
“No matter how much your career has meant to you, it’s ultimately a job, not your life,” writes Catherine Horiuchi. “Similarly, negotiating an exit package is a business deal. It isn’t a valuation of your worth as a human.”
All too many investors end up in mediocre mutual funds, because that’s what their employer’s retirement plan offers. Brian White’s advice: Diversify as best you can—and move quickly when better funds are added.
“Men wore suits in 100-degree Texas heat,” writes James McGlynn, recounting his early days as a junior stock analyst. “Twice a day, we could see stock prices on our Quotron machines.”
There are three sound reasons to revise your financial plan—and something spouted by a TV talking head isn’t one of them, says Adam Grossman.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include My Regrets, Playing Dumb and Small Pleasures. 

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The post Seems So Easy appeared first on HumbleDollar.

Back When

I BEGAN MY CAREER in investments as a junior analyst at a public endowment fund. It was 1980 and I’d just finished my last investment class at college, where I learned about Modern Portfolio Theory. Why, decades later, is it still called “Modern”?

The Dow Jones Industrial Average was below 1000, versus today’s 27000. Men wore suits in 100-degree Texas heat. We had individual offices. We researched companies by reading brokerage reports, talking to brokers and requesting annual reports from companies. Those requests were typed up by our secretary and mailed to each company’s investor relations department.

The Wall Street Journal had just one section. There was no electronic version. Brokerage firms were happy to provide us with “free” proprietary research, since trading commissions were extremely high. The arrival of fax machines was a real game-changer in delivering those research reports, which could be hugely valuable. Regulation FD hadn’t arrived, so brokerage firms often obtained information that hadn’t been fully disclosed to the public. If we liked a brokerage firm’s trade ideas, we’d buy or sell through the firm and its compensation was the commissions earned.

Twice a day, we could see stock prices on our Quotron machines, which also provided trading volume. A year or two later, our first personal computer arrived. This was before the internet. The only stock market TV program was PBS’s Wall Street Week with Louis Rukeyser, who broadcast from Owings Mills, Maryland. CNBC and Bloomberg Television were nowhere in sight.

Pensions were commonplace, while IRAs and 401(k)s were only just taking off. I remember sending checks to Fidelity Investments since its money market funds paid north of 15%. This was the era when Salomon Brothers’ economist Dr. Henry Kaufman warned us that budget deficits would lead to higher interest rates and President Reagan’s Budget Director David Stockman was a political force. Soon after I began my investment career, Federal Reserve Chairman Paul Volcker broke inflation’s back with sky-high interest rates.

Fast forward 40 years and the landscape has changed radically. Trading commissions are essentially zero. Brokerage firms that thrived on commissions, such as PaineWebber, Dean Witter and EF Hutton, have all but disappeared. Regulation FD puts individual investors on a level playing field with institutions, who now gather their information on public conference calls. Discount brokers like Charles Schwab, Fidelity and Vanguard Group are driving changes in Wall Street’s business model.

The focus is no longer on trading commissions, but instead on gathering assets and charging for financial advice. The late great Jack Bogle, founder of Vanguard, proved that index fund investing was a smarter way to save for retirement. Fund management fees—which used to be regularly above 1% of assets—are, in some cases, dropping to zero or close to it. Celebrated investment stars like Peter Lynch—everybody’s favorite example—have been replaced by robo-advisors, index funds and target-date funds.

Meanwhile, CNBC and Bloomberg provide constant stock tips, while showing rising prices in green and falling prices in red, all designed to stir up emotions. But it seems many investors have moved on from stock-picking. Now that indexing has replaced the need for individual stock selection and trading, the accumulation part of investing seems relatively simple. Going forward, the focus of financial advice will, I believe, be on creating lifetime income from retirement accounts in a low interest rate environment. Tax planning, guaranteed income through annuities, spending rates and health care planning are where the baby boomers are looking to get help.

Fidelity, Schwab and Vanguard are targeting just this sort of advice. They have Certified Financial Planners on staff, while often using investments as a breakeven proposition. It will be fascinating to see how financial advisors, who positioned themselves as investment managers, will compete against the planning advice managers at these large, low-cost financial firms. I suspect these big firms will link up seamlessly with insurance providers to deliver a one-stop retirement shopping experience. Over time, the percent-of-assets fee structure will probably shrink. Instead, I suspect financial advisors might begin to charge hourly fees, similar to lawyers and accountants.

James McGlynn, CFA, RICP, is chief executive of Next Quarter Century LLC in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of Retirement Planning Tips for Baby Boomers. His previous articles include Fatten That Policy, My Retirement and Early Decision.

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