Jonathan Clements's Blog, page 316

Getting Emotional

WHEN A FAMILY opts to purchase a Mercedes rather than a Subaru, the rest of us might think they’re being extravagant. But you likely won’t find many people saying, “How stupid is that? They could’ve got around town for half the price.” We accept that a car isn’t a strictly utilitarian purchase.

But we aren’t nearly so forgiving when it comes to “suboptimal” investment and personal finance decisions. Today’s contention: We shouldn’t be too quick to deride the money choices made by others—and, at the same time, we should concede there’s an emotional element to many of our own financial decisions and we should stop pretending otherwise.

For instance, many folks prefer to invest in companies that meet various environmental, social and governance (ESG) criteria. I have no problem with that—until these folks try to justify their investment by arguing that ESG criteria lead to better returns. The evidence on that one is mixed. But it’s also immaterial: This isn’t why these investors favor ESG companies. Instead, their investment approach is driven by their values. They’d own the stocks of ESG companies whether they offered better returns or not, so why not say so and be done with it?

Similarly, if you’re in good health, it typically makes sense to delay Social Security—and that’s doubly true if you’re married and you were the family’s main breadwinner. Yet many folks claim at 62, the earliest possible age, and then desperately try to justify their decision with absurd scenarios that typically involve stashing the money in stocks and then earning handsome returns. The reality: When people claim Social Security early, it’s often because they hate the idea that they’ll delay benefits and then head to an early grave, having got little or no money back after decades of payroll contributions. So how about just admitting that—and dropping the spurious justifications?

Among our many emotion-tinged financial decisions, perhaps the most important is settling on our portfolio’s basic stock-bond split. On social media, I’ve seen commentators lambast others for being too aggressive or too conservative. Such criticism presumes there’s an objectively correct asset allocation for everybody. But how could that be when we need to consider that tricky, subjective notion known as risk tolerance? When each person’s individual feelings about losses and gains factor into the choice, none of us should claim our asset allocation was solely a rational decision—and nobody should be attacking others for somehow getting it wrong.

This spills over into the debate over whether to invest a lump sum right away or instead spoon the money into the stock market over time. Because stocks go up most of the time, the gradual approach is dismissed by some as irrational. I disagree. What counts isn’t just the odds of success, but also the consequences of failure: If we invest a big sum right before a bear market, the financial fallout could be dire. On top of that, those who deride the go-slow approach are telling others that they’re being irrational—and yet we’re talking here about risk and, in the end, risk isn’t solely about volatility or probabilities. Instead, what also matters is the subjective emotional impact. How can we deride others for making a “mistake” when we don’t know how risk feels to them?

There are countless other financial decisions where emotional preferences loom large:

Many investors prefer stocks that pay dividends, because they like the idea that they’re regularly getting cash back. Yet, when those dividends get paid, the stocks involved drop by a comparable amount, plus taxable shareholders now owe money to Uncle Sam.
Families will buy second homes, touting the place as a good investment. Yet what they’re really doing is spending a heap of money on something that’ll give them lots of pleasure—but where they’ll likely break even at best.
Folks favor individual bonds because they like knowing precisely how much they’ll receive in interest each year and how much they’ll get back upon maturity. Yet, in return for that precision, they take on the uncertainty that comes with banking on a few individual bond issues. Indeed, if investors want confidence about their returns, bond funds—with their broad diversification—would be a wiser choice.
Many folks actively buy and sell stocks, claiming they’re beating the market. Yet often they have no idea how they’re performing compared to an appropriate benchmark index—and instead they’re trading simply because they enjoy it.

I’m not suggesting that we should always give in to our emotional preferences. Rather, when we make financial decisions, we should ask ourselves how much is driven by rational analysis and how much by emotion. And if the rationality is questionable but the emotional appeal looms large, we should ask whether it’s prudent to go ahead—or whether there’s some compromise that’ll sate our emotional side, without badly hurting our finances.

That might mean favoring dividend-paying stocks, but not with all of our nest egg. Or setting up a “fun money” account with maybe 3% of our portfolio, where we allow ourselves to trade stocks. Or claiming Social Security earlier, but at age 65, rather than 62. The bottom line: We should strive to recognize our emotional inclinations and perhaps accommodate them—but only if they don’t imperil our financial future.

Latest Articles

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

“The value of a good financial planner will often differ from the advertised services,” argues Robin Powell. “What people are paying for are guidance, peace of mind and an assurance that they’ll be okay.”
Should you refinance your mortgage to take advantage of today’s rock-bottom interest rates? Rick Connor shows you how to run the numbers.
“A prudent goal is to have no debt other than a home mortgage, and then pay off that mortgage as soon as feasible,” writes Tom Welsh. “I’d advise doing so even if it means you invest less in stocks.”
Want to protect your portfolio from rising consumer prices? Inflation-indexed Treasurys are an obvious choice—but keep six factors in mind, says Rick Moberg.
“I’m addicted to looking at daily investment performance,” concedes Dick Quinn. “I can tell you exactly how much is in my 401(k). Why? I’ve been trying to figure that out.”
Worried your next money decision will turn out badly? Adam Grossman offers six strategies that’ll help you keep your financial regrets to a minimum.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Risking My Life, Take the Low Road and Just Another Day.

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Do as I Don’t

MOST OF US DON’T attempt to make a living trading stocks. Instead, investing is a long-term effort. We’re accumulating wealth to sustain us in retirement. Well, at least some of us try.

To that end, we need to save regularly over many decades, reinvest interest and dividends, and keep our eye on the pot of gold at the end of our rainbow.

How come we find this so hard? We get distracted. We start thinking short term. We pay too much attention to our investments. Yes, I said it, too much attention. Americans are not good at long-term thinking.

Years ago, when I oversaw company 401(k) plans, an employee’s account balance was updated four times a year. Then we moved to monthly updates and, ultimately, we were seduced into daily valuations. Our mindset went from long term to immediate.

Workers began worrying about daily stock market changes. Many started thinking they could beat the market, they began acting on investment tips or—all too often—they simply threw out any long-term strategy in reaction to bad news or market declines. To make matters worse, we added a brokerage option to the plan, where investors could buy individual stocks. Investments and trading were then unlimited.

We had one employee who was especially successful. He traded daily between the stable value fund and the plan’s international stock funds, based on how foreign markets would likely react to that day’s U.S. stock market action. This was before the advent of fair value pricing. He accumulated $2 million in a relatively short time, but the mutual funds then complained about day trading, prompting us to impose a 90-day fund transfer limit for the stable value fund. I must admit, though, I wish I’d thought of the strategy.

Most employees who attempted to beat the market with short-term trading weren’t so fortunate. Heck, most didn’t know what they were invested in or why. My favorite: The folks who were in a target-date retirement fund designed to provide one-stop shopping—who then went and bought several other mutual funds.

Short-term thinking got a lot of people in trouble, as they reacted to market gyrations and locked in losses, when a longer-term perspective would have helped them to see those gyrations as buying opportunities. Once retired, such emotional trading doesn’t help, either, especially since the time to recover from mistakes has disappeared.

But who am I to talk? While I’ve resisted the sell-low strategy over the years, I’m addicted to looking at daily investment performance. I can tell you exactly how much is in my 401(k). Why? I’ve been trying to figure that out. Similarly, I’ve created a watchlist on Bloomberg for my nonretirement investments. I look at it not just daily, but often several times during the day. It tells me my total—as well as daily—gain or loss. As dividends and interest are reinvested, I update my watchlist.

I’m addicted, I admit it, but to no advantage. I look at the total daily gain or loss, and I’m elated and feeling prosperous, or depressed and feeling a sense of failure. It’s like playing golf. One birdie wipes out the memory of the six previous double bogeys.

I keep telling myself, “Take the long-term view.” But then I think, at age 77, is there a long-term view of anything? The best I can hope: Avoid doing something stupid with my money. So far, I’ve resisted those e-mails from a Somali prince who wants to trade $15 million for an airline ticket to the U.S.

I’ve concluded that my addiction has nothing to do with investing at all. It isn’t even about accumulating wealth. Rather, my account balances are just a measure of success or failure. It’s about not being average, a lifelong quest of mine. Perhaps that’s why I often compare my 401(k) balance with national data.

I talked to a psychiatrist friend to see if there’s a clinical definition for my condition. The closest he came was koinophopia, the fear of living an ordinary life.

Despite my condition, I really do know success and happiness in life is not about money. Still, I like being above average and, while I’ve been called many things, ordinary isn’t one of them—and I want to keep it that way.

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include About That 4%, Banking from A to F and It Took Decades. Follow Dick on Twitter @QuinnsComments.

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The Good Advisor

WHAT ARE PEOPLE paying for when they seek out a financial planner? Where’s the real value? The answers may surprise you.

Financial planners typically tout their advice on asset allocation, retirement planning, cash flow analysis, insurance, wealth protection, estate planning and so on. But is that really the benefit they bring to consumers?

Consider an entirely different business. When you take your car to get serviced, what are you paying for? Brake repair, transmission diagnosis, tire rotation, oil change?

Actually, what most people want is a car that gets them safely, reliably and efficiently from A to B. They want the car serviced in good time, they want a fair estimate of what it will cost, an itemized bill, and a guarantee on parts and repairs.

Likewise, the value of a good financial planner—at least in the eyes of most clients—will often differ from the advertised services. To be sure, asset allocation and portfolio advice are important components. But these are just means to desired ends.

What people are paying for, in the final analysis, are guidance to help them meet their goals, peace of mind, a sense of security, a feeling that someone has their back and an assurance that they’ll be okay whatever the world throws at them. People value having a sense of structure about their financial life and a grasp of the choices available to them.

The technical tools that a financial planner employs—knowledge of the tax system, what drives investment returns, the role of diversification, rebalancing techniques—are without doubt critical components in delivering those desired outcomes. But they aren’t what people are paying for.

In fact, good financial planners will play a number of pivotal roles for their clients, none of which is found on the typical job description. Here are seven of those roles:

Guide. Most people know what they want or, at least, know what they don’t want out of life. What’s often missing is a sense of how they can get there. A planner provides an independent plan, showing possible pathways and the tradeoffs involved in each.
Teacher. Many people’s sense of what drives investment returns comes from the day-to-day noise in the financial media.  It’s all about investment products and short-term returns. A good planner shows clients what drives long-term returns and connects this to their life.
Coach. It’s easy to make financial resolutions—to save more, to spend less, to grow wealth, to leave a legacy. It’s not so easy to keep them. At their best, financial planners will ensure goal accountability, keeping clients on their desired path and talking them off the ledge in anxious times.
Organizer. Our lives are busy. Jobs and family commitments leave little time for dealing with the minutiae of insurance, portfolio analysis, rebalancing, cash flow analysis and so on. A good advisor takes care of this complexity and frees you to focus on what really matters to you.
Filter. The problem right now isn’t gathering enough information. Instead, we’re overloaded with the stuff. The challenge is finding the right information for us in a form we can digest. A good advisor becomes a trusted source and an information filter.
Counselor. Few big choices in life are simple. There are always competing imperatives. Planners who can help you cut through the noise and focus on your underlying values are worth their weight in gold.
Sentinel. The best financial planners are not only looking at your circumstances as things stand today, but also what might be coming over the horizon to change all that. And they are mindful of your legacy—the welfare of future generations and how your wealth can keep working beyond your lifetime.

These seven roles aren’t exhaustive. There are other valuable services that a planner provides. But it gives you a taste of the sophistication and depth available.

Again, to use our car mechanic metaphor, good financial planners aren’t simply trying to fix your car, but rather they’re looking to ensure you and your family reach your desired destinations safely and reliably, while enjoying the journey along the way. That’s where the real value lies.

Robin Powell is an award-winning journalist. He’s a campaigner for positive change in global investing, advocating for better investor education and greater transparency. Robin is the editor of The Evidence-Based Investor, which is where a version of this article first appeared. Regis Media owns the copyright to the above article, which can’t be republished without permission. Robin’s previous articles include No Need for Prophets, Death by Lifestyle and Take Courage. Follow Robin on Twitter @RobinJPowell.

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Six Tips

WORRIED ABOUT inflation? You might be drawn to inflation-indexed Treasury bonds—officially known as Treasury Inflation-Protected Securities, or TIPS. These bonds protect you from unexpected inflation, plus there’s no risk of default.

Those features make TIPS attractive to investors who are concerned about rising consumer prices, and especially the impact of inflation on the bond portion of their portfolio. Intrigued? Before you invest, here are six factors to consider:

1. Hedging vs. speculating. TIPS can be used to hedge against inflation or to speculate on it. Most investors want to hedge inflation, so let’s focus on that.

The total return from TIPS has three elements: inflation adjustments to each bond’s principal value, the interest payments you receive and price fluctuations in the secondary market. Those price fluctuations represent a fly in the hedging ointment—because TIPS prices are volatile. Why? The volatility stems from supply and demand issues, changes in inflation expectations and real yields, speculative buying and selling, and periodic “liquidity events” that increase the appeal of Treasury bonds.

To hedge inflation with TIPS, your best bet is to buy individual TIPS and hold them to maturity. This removes price changes from the equation. But if you buy individual TIPS and sell them before maturity, or if you buy a TIPS fund, you’re exposed to price changes. Falling prices could wipe out inflation adjustments to the principal value of TIPS—which means they fail to provide the inflation hedge you were hoping for.

2. TIPS are complicated. Before you invest, you need to understand the mechanics of how TIPS work, including how they behave during inflationary and deflationary periods.

You also need to know how to buy individual TIPS. They can be purchased at Treasury auctions or in the secondary market. You’ll likely want to buy TIPS with maturity dates that match the goals you’re looking to fund. Be warned: An inflation-indexed Treasury with the right maturity may not be available.

Finally, you need to understand how TIPS are taxed if you hold them in your taxable account. Hint: It’s complicated.

3. Hedging comes at a price. TIPS protect investors from the adverse effects of high inflation, but at a cost. What cost? TIPS offer lower expected real yields than fixed-rate Treasury bonds of a similar maturity. Real yields are the return from an investment, adjusted for the effects of inflation.

Expected inflation is priced into nominal, fixed-rate bonds. Still, holders of these bonds are exposed to the risk that inflation turns out to be higher than expected. By contrast, holders of TIPS have no such worries: They’re protected against unexpected inflation because their bonds’ principal value will be adjusted along with inflation. The upshot: Nominal bonds are priced to deliver higher real yields than TIPS, because nominal bondholders demand to be compensated for taking more inflation risk.

Moreover, TIPS are expensive right now. In fact, their real yields are negative. This should give you pause. It means you’re only partially protected against future inflation. Also, the total return from TIPS could be negative if future inflation adjustments aren’t large enough to offset today’s negative real yields.

Finally, there’s deflation—the danger that sluggish economic growth causes consumer prices to decline. If there’s deflation, TIPS will always mature at their face value, providing some protection. Even so, you need to pay attention to deflation. Why? If you buy secondary market TIPS, their prices will reflect inflation adjustments since their issuance date. If deflation occurs after you purchase bonds in the secondary market, your principal value will fall along with declining consumer prices (though, again, it won’t fall below face value). A loss of principal value, coupled with negative real yields, would make for an expensive hedge.

4. Asset location is tricky. Holding individual TIPS in taxable accounts is problematic. Why? Each year, you have to pay tax on the inflation-driven principal adjustments, even though you don’t receive that value in cash until maturity. TIPS tax compliance is also tricky.

Holding TIPS in tax-deferred retirement accounts makes more sense. Problem is, TIPS aren’t subject to state taxes, and you lose that advantage if you hold them in a retirement account, plus not all 401(k) plans offer a TIPS option. Meanwhile, holding TIPS in Roth accounts may not be the best use of your Roth, where you might want to invest in stocks to take full advantage of a Roth’s tax-free growth.

5. TIPS may test your patience. Why? They’re a low-yield, high-volatility security. That’s a tough combination. Staying the course if TIPS prices fall precipitously could be psychologically challenging.

6. TIPS might be unnecessary. The Federal Reserve has done a good job of controlling inflation in recent decades, which suggests it may now have the knowledge and tools to prevent high inflation. Moreover, the stock component of your portfolio could provide the longer-term inflation protection you need, even if stocks prove to be a lousy inflation hedge in the short run.

Rick Moberg is the retired chief financial officer of a publicly traded software company. He has an MBA in finance, is a CPA and has a passion for personal finance. Rick lives outside of Boston with his wife. His previous article were Give Me Five and To Roth or Not.

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Five Lives

WE GO THROUGH phases in our financial life, just as we do in our biological life. There seem to be a least five financial phases that adults pass through, each with their own priorities, risks, opportunities and tradeoffs.

Here’s how I would think about those five phases:

1. Party Time (ages 25 to 30)

Yes, you’re starting a career, and you want to get ahead and make money. But in all likelihood, your focus is your social life—and so it should be.

Still, amid all the fun, throw in some sober financial management. Avoid digging a hole for yourself with high-cost consumer debt, notably credit card debt and car loans. Participate in your employer 401(k) plan at least up to the minimum required to get the full amount of any matching employer contribution. Finally, in your taxable account, try to save for the down payment on your first house using moderate-risk investments, such as investment grade bonds.

2. Early Career (ages 30 to 45)

Often, this is a time of rapid career advancement, plus you may be starting a family, with all the costs that that entails. Along with these comes the temptation of what I call classflation—borrowing to acquire large homes, expensive cars and other status symbols, so you appear a social class above what you can truly afford. A prudent goal in this phase is to have no debt other than a home mortgage, and then pay off that mortgage as soon as feasible. I’d advise doing so even if it means you invest less in stocks.

Understand that two huge industries disagree with this advice: the lending and investment industries. One wants you to borrow, so it can collect interest. The other wants you to carry that debt, while putting new savings into investments, so it can collect fees. Get ready for the mantra, “You’ll make more money in stocks.”

Why pay off your mortgage so fast? Think of paying off that loan as similar to buying a low-risk bond. Some 90% of taxpayers now take the standard deduction, which means the mortgage rate they pay is an after-tax cost. If you convert today’s low mortgage rates to a pre-tax level, that brings them close to the interest rate on a high-yield corporate bond.

But there’s a huge difference between the two. Paying off a mortgage gives you a guaranteed return, while buying a high-yield corporate bond involves significant default risk. Indeed, adjusted for risk, paying off a mortgage can be like buying a super-high-yielding Treasury bond. That’s hard to pass up. If you’re worried about a lack of liquidity, you can set up a home equity line of credit—and then hope never to use it.

Phase No. 2 is a complex, challenging financial period calling for many tradeoffs. But exercising some personal discipline here can make life far easier during the next three phases.

3. Late Career (ages 45 to 60)

If all goes well in this phase, you enjoy “peak earnings” at work. Meanwhile, at home, some parents offload college expenses onto their kids, by having their children take on student loans. In this phase, there’s little reason to carry debt of any kind. Now, thanks to those peak earnings, you can finally afford all that stuff you were tempted to buy with borrowed money when you were younger.

By largely or entirely getting rid of debt and debt service payments in phase No. 2, you potentially lower your monthly living expenses and hence have a stronger “free cash flow” to invest for the future. At last, you can indulge is that strategic long-term investment called stocks.

And, yes, you still have a long term—up to 35 years in phases three and four combined—to earn the higher expected return on stocks, while weathering the periodic 50% crashes along the way. You can also hedge against stock crash risk with some high-grade bonds. In short, the “late career” phase is an opportunity to migrate from eliminating debt to building a balanced portfolio.

4. Early Retirement (ages 60 to 80)

You stop working at some point during this phase. Gone is “layoff risk.” Now, you face a new, seldom discussed risk. Call it “prosperity risk.” Throughout our working careers, we like prosperity, with the rising paychecks it brings to many of us. But prosperity can be a double-edge sword.

When we stop working, we’re exposed to the backside of prosperity, which includes ever-rising consumer prices (as well as more traffic on the road). That’s why it helps to hold a significant amount of prosperity-loving stocks during this phase. Think of stocks as a way to hedge the threat that inflation poses to the fixed payments from your pension and bond portfolio. Review any “target date” investment products to see if they dump stocks too quickly. Beware of prosperity risk—because you may live a long time without a paycheck.

5. Late Retirement (age 80-plus)

Your priority has shifted from wealth to health. This is a time for most people to reduce their stock holdings, as their crash recovery time window is closing. For security, you want to hold low-to-moderate risk assets to cover basic living expenses through until age 95 or 100. Some are fortunate and may have stock assets beyond what’s needed for remaining living costs. In that case, you may choose to hold onto appreciated stocks, so future beneficiaries inherit them at a stepped-up cost basis, thus eliminating the embedded capital gains tax bill.

With any luck, successful management of the previous four phases has reduced money stress and now lets you enjoy family, friends, hobbies and fond memories—including memories of all those crazy things you did during phase No. 1.

Tom Welsh is a certified management accountant in Raleigh, North Carolina. He has been the chief financial officer at several manufacturing companies and is founder of   Value Point Accounting , where he helps businesses manage product and customer profitability. His previous article was Pay to Play . Tom can be reached at   tomgwelsh@valuepointaccounting.com .

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Refi or Not?

MY WIFE AND I bought our first home in the mid-1980s. We were thrilled to get an 8% mortgage, though we had to pay three points—an upfront fee equal to 3% of the loan amount—to get that rate. Many of our friends had bought a few years earlier and were paying 14%, a common occurrence back then, according to Freddie Mac data.

We kept our eyes open for opportunities to refinance our high rate. If I recall correctly, the prevailing rule of thumb said you needed a two-percentage-point reduction in interest rate—and you might need to stay in the home for another seven years—for a refinancing to make sense.

How times have changed.

My son and daughter-in-law purchased a home in May 2019. Thirty-year mortgage rates were 4.125%. When my wife and I bought our current vacation house in November 2019, rates had fallen to 3.375%. Now, they’re down around 3%. At these low rates, the two-percentage-point rule no longer makes sense. A little internet research indicates that a one-point reduction is the new rule of thumb. What about paying points to get an even lower rate? You rarely hear about that these days.

There’s a number of reasons to consider refinancing—including these four:

Reduce your monthly payment. This is the No. 1 reason people refinance. A lower interest rate leads directly to a lower monthly principal-and-interest payment, assuming you opt for a mortgage of the same length.
Switch from an adjustable-rate to a fixed-rate mortgage. Adjustable-rate mortgages, or ARMs, can reset to a higher rate, sometimes leaving homeowners with payments they can’t afford. If you plan to stay in your home, you may want to refinance into a stable, fixed-rate loan.
Reduce the term of your mortgage. If rates drop enough, it may make sense to switch from a 30-year mortgage to a 15-year loan. Your payment will likely go up, but you can save huge amounts of interest and you’ll be mortgage-free far sooner.
Access your home’s equity. A cash-out refinancing lets you tap into your home’s equity by exchanging your current mortgage for a new one with a larger loan amount. You might use the extra money borrowed to pay off higher-cost debt, cover the kids’ college costs or remodel your home. If you’re paying off high-interest debt, such as credit card debt, make sure you don’t fall into old habits and quickly amass another pile of consumer debt.

A key question when deciding whether to refinance: When will you break even on the refinancing costs? The breakeven point is calculated by adding up all refinancing closing costs and then figuring out how many years it’ll take to recoup those costs through your new, lower monthly mortgage payment. One danger: You move within a few years—and never make back the cost of the refinancing.

Another pitfall: Let’s say you refinance your current 30-year mortgage, which you’ve had for five years, with a new 30-year loan. That means you’re signing up for five more years of mortgage payments—and you may end up paying more in total interest with the new mortgage. Ideally, when you refinance, you take out a mortgage that’s the same length or shorter than the number of years left on your current loan. It’s also important to shop around to find the best deal on both the interest rate and closing costs.

If you make a down payment of less than 20%, you’ll be required to pay private mortgage insurance (PMI), which shows up as a fee that’s rolled into your monthly loan amount. It protects the lender if you’re unable to pay your mortgage. You can typically get rid of PMI when your loan balance is less than 80% of your home’s current value.

Freddie Mac’s website says that monthly PMI can range from $30 to $70 per $100,000 of mortgage. The exact amount depends on several factors, including loan value, interest rate, loan term and, most important, down payment. For example, a $100,000 30-year mortgage, with a 10% down payment and a 4% interest rate, requires PMI of $59 a month. Make that a 15-year mortgage at 2.5% interest rate, and the PMI falls to $30 a month.

How do you decide whether refinancing makes sense? Consider the table below. We’ll assume an initial $100,000 mortgage, 30-year term, 4% interest rate and 10% down payment. The monthly principal and interest for this loan would be $477. At the end of the first year, the loan balance would be down to $98,239.

Let’s also assume that, after the first year, the available rates are 3% for 30-year loans and 2.5% for 15 years. Replacing the original loan with a new 30-year 3% mortgage adds one year to the term, but drops the monthly payment by $63, a savings of $756 per year.

Alternatively, if you’re able to handle a higher monthly payment, you could dramatically reduce the term of your loan and the total interest paid by switching to, say, a 15- or 20-year mortgage. Let’s say you exchange the original mortgage for a 15-year loan at 2.5%. The monthly principal-and-interest payment increases by $178 to $655, but PMI falls by $29, for a net increase of $149 a month.

Your closing costs will vary depending on the new loan amount, your credit score, debt-to-income ratio, loan program and interest rate. Closing costs can range from 2% to 6% of the borrowed amount. Pay careful attention to closing cost quotes. Your costs may include prepaid real estate taxes and homeowner’s insurance. You should recoup some of this as a refund from the escrow account for your original loan, but you’ll be out of pocket in the meantime. In our example, let’s assume closing costs are 3% of the loan amount, or $2,947.

The table summarizes the results. Note that simply dropping the interest rate by one percentage point saves almost $17,000 in interest over the life of the loan and it takes about four years for the monthly savings to cover the closing costs. Meanwhile, switching to a 15-year mortgage would save more than $48,000 in interest payments, while shaving 14 years off the term.

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 Working the Numbers, Summer Job and Don’t Leave a Mess . Follow Rick on Twitter  @RConnor609 .

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Minimizing Regret

LAST WEEK, I learned the disappointing news that our nextdoor neighbors—possibly the nicest people in the world—have put their house on the market.

While I’m sorry to see them go, I understand their decision. With a growing family, they’re looking for more room. During the pandemic, in fact, many people are making changes of one sort or another. Will they be happy with their choices?

That brings me to a new project, developed by author Daniel Pink, called the World Regret Survey. The goal: to better understand the dynamics of decision-making and regret by collecting and cataloging regrets shared by people around the world. Interestingly, Pink has made his initial data available online. It is, in essence, a giant database of regrets. Many of them, as you might imagine, have to do with career and personal finance.

While some amount of regret in life is inevitable, there are certain strategies that can help keep it to a minimum. Here are six such strategies:

1. Rules. It’s commonsense that decisions made under stress generally have worse outcomes. But sometimes, decisions can’t wait and need to be made amid stressful circumstances. What’s the solution? In my view, it comes down to one word: rules. Or maybe two words: decision rules. To the extent possible, try to write out a set of financial rules for yourself.

For example, if the stock market declines again, what will you do—sit tight, rebalance, complete a Roth conversion or perhaps contribute to your children’s 529 accounts? While no one can conceive of every possible eventuality, you can still cover the big ones. This will make it easier to make logical decisions when the time comes.

2. Records. It might seem tedious, but there’s a lot of value in keeping a log of financial decisions. Whether a decision goes well or poorly, you’ll be able to revisit your initial thinking after the fact. Since no one’s memory is flawless, I’ve found logs like this to be helpful. In some cases, as you review your records, you’ll want to congratulate yourself. In other cases, you’ll want to beat yourself up. But either way, you’re almost guaranteed to learn something that will help the next time around.

3. Information. A month ago, mortgage rates were at all-time lows. Where are rates today? Even lower. Does that mean that, if you refinanced your mortgage a month ago, you should regret it? To be sure, it would be easy to regret not waiting a month, but no one could have known that rates would go lower—and they could easily have gone the other way.

That’s why I think it’s so important to exclude from decision-making what you think could happen in the future. If you make the best decision you can with the information available today, that’s the best you can do. And if you keep that information in your log, as recommended above, that will go a long way toward not second-guessing yourself later.

4. Devil’s Advocate (Part I). Psychiatrist Viktor Frankl advocated this approach to decision-making: “Live as if you were living a second time, and as though you had acted wrongly the first time.” In other words, to avoid regret after the fact, try to think through all of the possible outcomes of a decision before the fact. As I noted above, it’s impossible to see the future. But it is possible to make some educated guesses. Ask yourself: If something went wrong with the decision I’m about to make, what would it be? In a sense, you want to play devil’s advocate with yourself. You might not change your mind, but at least you’ll have considered a wider range of potential outcomes.

5. Devil’s Advocate (Part II). Two heads are better than one, or so the saying goes. But if you ask a friend to weigh in on a financial decision, take his or her response with a grain of salt—because what you may hear is some pithy aphorism. I’ve heard dozens during my career:

“Don’t fight the Fed.”

“Your first trade is your best trade.”

“Never try to catch a falling knife.”

“Trees don’t grow to the sky.”

“Don’t cut your flowers and water your weeds.”

“No one ever went broke taking profits.”

What’s dangerous about these sayings is that they sound wise—and, as a result, they can be convincing. But beware: Many of them just sound wise. In fact, there’s usually another equally pithy saying that perfectly contradicts many of these common sayings.

6. Quantify. To the extent possible, understand the type of decision you’re making. Specifically, try to quantify what the benefit might be if the decision goes well and what’s at risk if it goes poorly. You can’t know these numbers in advance with any precision. But I nonetheless recommend this as a thought experiment.

In racetrack terms, you want to understand the odds. With some investments, the potential risk and return are about even, but in other cases, it is skewed one way or the other. You might still choose to make some bets that are risky—and I’m not suggesting you shouldn’t—but I think it’s a good regret-minimization technique to at least go through this exercise.

As you read through this list, you might be wondering, “What if I’ve already made a decision I regret?” If you find yourself ruminating over a past decision, stay tuned. Next week, I’ll provide a set of strategies for managing regret after the fact.

Adam M. Grossman’s previous articles include Don’t Be That Person, Skewed Impression and What to Worry About. 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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Risking My Life

THREE WEEKS AGO, I wrote about my plan for generating retirement income, including my intention to make a series of immediate fixed annuity purchases. Immediate annuities are a profoundly unpopular product, so I was surprised when the article generated a slew of questions from readers.

Perhaps that interest reflects today’s miserably low bond yields, which have left immediate annuities as one of the few ways to generate a safe and sizable income stream. Intrigued? Here are answers to six of the questions I received:

1. Why the heck would you buy an annuity? Many folks hear the word “annuity” and instinctively recoil in horror. But if you’ve researched the topic, you’ll know there’s a huge difference between a plain-vanilla immediate fixed annuity and, say, a tax-deferred variable annuity or an equity-indexed annuity.

Ponder this: Finance professors are often big fans of immediate fixed annuities, because they leverage a key economic concept—risk pooling—to deliver a simple, relatively low-cost solution to retirement’s biggest problem, which is the danger that you’ll outlive your money. Meanwhile, insurance agents are not big fans of immediate fixed annuities. Instead, they’d much rather sell you a variable or equity-indexed annuity, because these products pay them far larger commissions. In fact, immediate fixed annuities typically pay the salesperson just 1% to 3% of the money invested.

In return for that money, you get an income stream you can’t outlive—and which could make your retirement far less financially stressful. Let’s say you’re a 65-year-old man. If you stashed $100,000 in an immediate fixed annuity, you might get $5,460 every year for life, according to a quote earlier this week from Saturday Insurance, the website run by Dennis Ho, a frequent HumbleDollar contributor. A 65-year-old woman would receive some 6% less, reflecting her longer life expectancy. Meanwhile, if you put that money in a total bond market index fund, you were recently able to get a 1.16% yield, or $1,160 a year for every $100,000 invested.

What would happen if you tried to live off the bond fund to the tune of $5,460 a year, thus matching the income from the immediate annuity? Not long after you turned age 85, the fund would be depleted, while the annuity would keep on paying. On the other hand, if you died before then, the bond fund would be the better bet, because the fund would still be worth something, while buying the annuity means kissing your $100,000 goodbye.

So is the annuity a good deal? Think of it this way: On average, a typical 65-year-old man can expect to live until age 84, while a healthy 65-year-old might live four years longer. That gives the annuity an edge, but not an overwhelming one—until you consider one additional advantage: You know the annuity will keep paying, no matter how long you live. Meanwhile, spending down the bond fund will be a nail-biting exercise—and there’s a risk you’ll either deplete your fund holdings or, more likely, slash your spending out of fear you’ll end up destitute.

2. What about inflation? The best inflation-indexed annuity available is delayed Social Security benefits. Indeed, for those looking for a healthy stream of guaranteed lifetime income, postponing Social Security should be their top priority, with immediate annuities viewed as a way to generate additional lifetime income.

Today, there’s no true inflation-indexed immediate annuity available. You can, however, purchase annuities where the annual payments rise at, say, 2% a year. For our hypothetical 65-year-old man, a $100,000 immediate annuity with a 2% annual income increase would kick off $4,320 in the first year, according to a recent quote. In terms of the total dollars paid out, this rising income annuity would catch up with a fixed $5,460-a-year annuity at age 88 and pull away thereafter.

What about other optional features? You can get guaranteed payments for, say, 10 or 20 years or, alternatively, the promise of a “refund” for your heirs if the annuity’s total income during your lifetime is less than your original investment. Problem is, these features can mean significantly reduced income, so I’d be inclined to skip them.

3. At what age should you buy? The older you are when you buy an immediate annuity, the more income you’ll get, thanks to your shorter life expectancy. Still, my plan is to make a series of immediate annuity purchases starting at age 60.

Why that approach? I see three advantages. First, by buying early in retirement, I have greater confidence I’ll get a fair amount of income back from my annuity purchases.

Second, by making multiple purchases, I eliminate the risk that I’ll make a big onetime annuity investment and then keel over a few months later. Instead, if I set out to buy a new immediate annuity every few years from age 60 to 70, I leave myself the option to stop the periodic purchases if my health deteriorates. A deterioration in my health would also prompt me to claim Social Security right away.

Third, with my multiple purchases, I can buy from a variety of insurance companies, thus reducing the fallout should any one insurer get into financial trouble. An added bonus: If interest rates head higher from today’s anemic level, that’ll give a boost to the income paid by the annuities I buy later on.

How much will I pony up for each annuity? I haven’t decided. But ideally, buyers should invest $100,000 or more, because they’ll have a larger pool of insurers competing for their business, says Saturday Insurance’s Dennis Ho. Still, it’s possible to pursue a multiple annuity strategy with far less money. He notes that there are insurers that sell annuities for as little as $5,000 or $10,000.

4. What insurance company rating should you look for? Ho advises sticking with insurers rated A+ or higher for financial strength by Standard & Poor’s, or with comparable ratings from A.M. Best, Fitch Ratings or Moody’s. “That’ll ensure you have a pretty high-quality company,” he says. “But also make sure it’s a big-name company. Make sure it’s been around 100 years,” so the insurer has a track record of navigating all kinds of economic environments.

Keep in mind that an insurance company’s financial strength isn’t the only thing standing between you and a worthless annuity. While little publicized, every state has a guaranty association that provides a safety net, should an insurer get in financial trouble. The amount of protection varies by state.

5. Which financial account should you use? You could potentially purchase an immediate annuity with money from a taxable account, a traditional tax-deferred retirement account or a tax-free Roth account. A taxable account purchase would give you annuity income that’s partly taxable each year and a Roth purchase would result in tax-free income. Meanwhile, an annuity purchased using your traditional retirement account would buy an income stream that’s 100% taxable.

Despite that, my plan is to purchase my immediate annuities using my traditional retirement account. Thanks to required minimum distributions, I’ll be compelled to spend down that account anyway. Meanwhile, I’d like to bequeath both my Roth and my taxable account to my two kids.

6. What about deferred income annuities instead? I’m buying immediate fixed annuities because I want regular income throughout my retirement, partly to cover living expenses and partly because it’ll free me up to invest more of my portfolio in stocks.

But Saturday Insurance’s Ho puts in a pitch for deferred income annuities, otherwise known as longevity insurance. This involves buying an annuity today that will start paying income later. There’s even a special tax provision that makes it advantageous to use a retirement account to purchase longevity insurance.

If our 65-year-old male opted for a deferred income annuity that begins paying at age 75, the income he’d receive in 10 years would be almost twice what he’d get today. “If you’re trying to maximize protection for your later years, a deferred annuity offers decent value,” Ho argues.

Latest Articles

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

“It seems we have critics saying that the 4% rule leads to both too little spending and too much,” notes Richard Quinn. “Neat trick, wouldn’t you say?”
The raconteur. The statistician. The gunslinger. The philosopher. Adam Grossman discusses four approaches to investing that seem promising, but often fail miserably.
This year’s tax season is over—finally. Want to get the most out of your 1040? Rick Connor offers five key questions to ask.
In the mid-2000s, commodity funds were all the rage. Today, they sport atrocious 10-year returns. Do they deserve a place in your portfolio? Mike Zaccardi offers his thoughts.
“I’ve often thought about how much my life would have changed if Ron had been successful in getting rid of me,” writes Dennis Friedman. “One dishonest person could have wrecked my life.”
It’s hard to beat the market. It’s far easier to buy the right home or figure out when to claim Social Security—which may explain July’s most popular articles.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Take the Low Road, Just Another Day and Almost Zero.

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Trust but Verify

WHEN I WAS in my 20s, I joined a large aerospace company. It was my first job out of college. I was an employee who thought all my colleagues were team players working toward the best interest of the company.

Back then, I’d never heard of the term “office politics.” But Ron, my boss, took it to a whole new level. He was an expert at manipulating people.

Ron joined the company a year after I did. He was outgoing and, at the time, studying to be a lawyer. But there was something about him that gave you an uncomfortable feeling. He was always trying to impress you and sometimes his comments seemed deliberately misleading.

One day, I approached Ron about a pay raise. I told him that, since I had assumed more responsibilities and exceeded all my workplace goals, I deserved more compensation. Ron agreed and said he would submit the paperwork for my pay raise.

After weeks went by, Ron informed me that Bill, the department manager, turned down my raise. Ron assured me, however, that he would keep trying. This went on for a while, with Ron telling me that Bill was refusing to sign off on the paperwork.

I was dismayed and frustrated with the way things were going, and I decided to resign. I felt that, since upper management wasn’t satisfied with my performance, I should seek employment elsewhere. Ron said he was sorry to see me go, but he understood.

A few days after I gave notice, I was approached by Bill about my resignation. He informed me that Ron never put me in for a pay raise. Clearly, Ron was trying to con me into quitting my job.

After my conversation with Bill, I received the pay raise. I also remained with the company for many years, while receiving a number of promotions along the way. I wasn’t aware that Ron was ever disciplined for his actions. He was my boss for a few more years, and then worked on special assignments for the department manager. He left the company after receiving his law degree.

Many years later, I learned Ron was convicted of owning and operating a mortgage modification company that falsely promised to save people’s homes during the Great Recession. He was sentenced to 7½ years in prison for charging upfront fees in return for mortgage modifications that seldom happened.

According to one report, his company took some $2.7 million from hundreds of clients and won mortgage modifications for less than 5% of them. Ron also claimed to be a lawyer, when actually he was disbarred.

I’ve often thought about how much my life would have changed if Ron had been successful in getting rid of me. I was a college graduate with a degree in history and no marketable skills. One dishonest person could have wrecked my life.

Have you ever heard the phrase “trust, but verify”? Trust is important, but blind trust can be abused. I learned that the hard way from Ron.

You should never blindly trust your boss, financial advisor, broker or anyone else who has some control over your financial well-being. For instance, when choosing a financial advisor, choose someone with reputable credentials, such as the Chartered Financial Analyst or Certified Financial Planner designation. Alternatively, look for someone who’s a member of the National Association of Personal Financial Advisors, the organization of fee-only advisors. Then monitor his or her performance carefully by reviewing your quarterly financial statements.

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 No Vacation, Changing My Mind and Error of My Ways. Follow Dennis on Twitter @DMFrie.

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Raw Deal

THE MID-2000s were my introduction to the investment world—and even today my thinking is heavily influenced by what was happening then.

Take a moment to recall the 2004-07 period. Stock prices were marching higher, foreign shares were crushing U.S. stocks, small caps were doing all right and you could get a decent interest rate on your savings account. Good times. Another feature of the mid-2000s market: a big bull run in commodities.

Back then, I never dabbled in commodities directly, but I admit to having a big emerging markets weight in my (little) portfolio. Emerging markets funds can be a commodity play by proxy, because developing countries are not only big producers of the world’s raw materials, but also big users of those materials when times are good. While my first investment was a target-date fund within a Roth IRA when I turned age 18, as I got older and savvier—at least in my 20-year-old mind—I tried my hand at some regional emerging markets exchange-traded funds.

Those did well for a time, thanks to the boom in commodity prices. Oil surged from below $30 per barrel in 2001 to above $140 at the mid-2008 peak. Gold shone for a decade starting in 2001. Copper was on fire, as China demanded more and more. Heck, even the cost to transport dry goods was soaring—check out the Baltic Dry Index. In fact, at that time, if you looked back at market history, commodities showed every sign of being a great long-term investment and a superb diversifier for stocks.

Then the party ended. First, the 2008 financial crisis hit. Then we had the 2014-2015 commodity collapse, resulting in a global economic slowdown. Perhaps the carnage culminated earlier this year, when oil prices briefly hit negative $40 per barrel. What happened to this once darling asset class?

At the cycle’s peak in the mid-2000s, you couldn’t flip on the financial news without seeing commercials for commodity plays. Academia was enamored with the strong returns from commodity futures funds, coupled with their low correlation with stocks. Mutual funds with a focus on commodities and real return strategies performed well during the 2000s, only to lose money starting around 2010, just as the U.S. stock market took off. Some commodity funds closed. Those that survived have 10-year annualized returns approaching -5%.

What can investors expect going forward? Here’s the problem: Commodities don’t generate cash flows and profits like a business. The most you can expect to earn from them over the long run is inflation or thereabouts—and that’s before considering fees and taxes. Historically, taking the risk of buying commodity futures has generated healthy gains, but those handsome returns appear to have evaporated as more investors crowd into the market.

Technology is another hurdle for commodity investors. For instance, while technological change might temporarily drive up the price of copper, a more tech-driven world will likely depend less on commodities over the long haul. Think about cars and their increasing fuel efficiency. We’ve seen this play out in the financial markets over the past 20 years, with the Nasdaq Composite index posting incredible returns, while energy stocks have suffered. The global economy continues to shift from one driven by physical assets to one based on knowledge and human capital.

But eventually something will tempt investors to try the commodity play again. It’s the market cycle. Commodities will get hot and commodity funds will attract money. Fear of missing out and herd mentality will take hold. We know how this goes and how it typically ends.

That said, maybe commodities do have a place in a portfolio. After all, bonds still have a role, even though we can be confident returns will be mediocre in the coming decades, thanks to today’s low starting yields. In fact, bonds may even lose out to inflation in the years ahead—and yet those with stock-heavy portfolios will still buy bonds, because they need some sort of cushion for times of market turbulence.

Likewise, stock investors may find commodities are a decent asset class to own. At the very least, they could deliver some diversification magic—and, hey, perhaps we’ll get lucky and catch one of those bullish market cycles.

Mike Zaccardi is a portfolio manager at an energy trading firm and a finance instructor at the University of North Florida. He also works as a consultant to financial advisors on an hourly basis, helping with portfolio analysis and financial planning. Mike is a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. His previous articles include Cooking Up a Story, Please Ignore This and Reading the Signs. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at MikeCZaccardi@gmail.com.

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