Jonathan Clements's Blog, page 318

Skewed Impression

THEY SAY A PICTURE is worth a thousand words. But what about a chart?

A few weeks back, I noted that the stock market had become unusually top-heavy, with just five companies—Alphabet (i.e. Google), Amazon, Apple, Facebook and Microsoft—accounting for 20% of the overall value of the S&P 500. A chart that appeared online last week illustrates the impact of that imbalance. What it showed, in a nutshell, is that the overall S&P 500 is around breakeven for the year, but only because of those five stocks.

In 2020, the five have collectively gained some 35%. What about the other 495 stocks in the index? As a group, they’ve lost money—down about 5%. In other words, the impact of those five is so outsized that they more than offset the other 495 combined, swinging the overall average from a loss to pretty much breakeven. It’s one simple chart, but I think there’s a lot to learn from it:

Explaining the inexplicable. The chart helps explain the stock market’s seemingly inexplicable rebound since March. After dropping 34% in the early days of COVID-19, the S&P 500 staged a quick recovery and has since rallied 44%. Many—if not most—stock market observers have been scratching their heads over this. With the economy in recession, thousands of companies shut down and millions out of work, how is it that the stock market has nearly reclaimed its prior all-time high?

This chart helps explain what’s going on. The reality is that most stocks are in rough shape and reflect the reality of the ongoing pandemic. As of Friday morning, more than 300 of the 500 stocks in the S&P 500 were down this year—some very significantly. Banks are down 20% and energy stocks 35%. Travel-related stocks are faring even worse: Marriott is down 42%, American Airlines 60% and Norwegian Cruise Lines 75%.

Through this lens, the market rebound is less irrational than it appears. Don’t get me wrong: The massive popularity of those top five (along with Tesla, which isn’t yet in the S&P 500) still concerns me. But as the chart makes clear, they’re just part of the story. Many other stocks provide a more level-headed reflection of the state of the economy.

Confirming the counterintuitive. A while back, I mentioned the results of a study by finance professor Hendrik Bessembinder. Over the prior 90 years, most stocks had been duds, delivering negative returns. Less than 4% of all stocks—a tiny fraction—had accounted for all of the stock market’s gains over and above Treasury bills, a striking example of what’s called skewness. When I first saw this, I found it hard to believe. But this year’s market, driven by those top five, helps validate Bessembinder’s findings. The surprising reality is that stocks, on average, aren’t such a good investment—but some stocks are great investments. 

This is why I’m such a strong believer in index fund investing. The fact is, in any given year, random events impact companies’ fortunes—some positively and some negatively. This year is just an exaggerated illustration of that fact. No amount of stock-picking expertise can change that, because no amount of research or spreadsheet analysis will enable a stock-picker to foresee the future. Since we can’t know the future, the best defense—in my view—is diversification, and the easiest and most cost-effective way to achieve that diversification is by buying the index. Sure, that means that you’ll own plenty of stocks that end up as duds—but it also ensures that you don’t miss out on the fraction that turn into stars.

Debunking the “rules.” This year’s unusual market also illustrates why rules of thumb should never be viewed as immutable gospel. When the pandemic hit earlier this year, conventional wisdom was that traditionally “defensive” stocks—such as Procter & Gamble, Clorox and General Mills—would provide investors with a safe haven. That’s because consumers tend to keep buying basics like paper towels, toothpaste and cereal, regardless of the economic environment.

That’s definitely what happened in the last recession. Between late 2007 and early 2009, when the overall market declined more than 50%, these stocks declined just 30%. But this time, it’s been the opposite. While defensive stocks have certainly done better than hotels and airlines, they have—as a group—lagged behind the overall market. Meanwhile, the traditionally riskier stocks of high-growth technology companies now appear to be the new safe havens. In short, the traditional rule of thumb has been completely turned on its head. 

The lesson: The stock market doesn’t follow a predictable playbook. Even when it seems to follow a pattern, that pattern is subject to change without notice. Result: Efforts to outsmart the market often turn into exercises in frustration. In my view, though, this is actually a benefit: It means that you don’t need to spend much time, if any, trying to stay ahead of the market.

Investment legend Peter Lynch said it best: “I think if you spent over 13 minutes a year on economics, you’ve wasted over 10 minutes. I mean, it’s not helpful. Everybody wants to predict the future, and I’ve tried to call the 1-800 psychic hotlines. It hasn’t helped. The only thing I would look at is what’s happening right now.”

King Solomon once wrote that “there is no new thing under the sun.” This certainly applies to the stock market. Sure, every year is unique in its own way. But at the same time, every time the stock market takes a new twist or turn, it seems to just reconfirm the same set of core principles: Keep things simple, keep costs low, don’t trade too much, don’t put faith in market seers—and diversify, diversify, diversify.

Adam M. Grossman’s previous articles include What to Worry About, Fed Up and Two Reasons to Worry.  Adam is the founder of  Mayport Wealth Management , a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter  @AdamMGrossman .

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Almost Zero

IT’S NEVER BEEN cheaper to build a globally diversified portfolio of index funds. In fact, today, you could invest $100,000 and pay just $10 in annual fund expenses—equal to the cost of two Big Macs and a large fries.

Moreover, you don’t need $100,000 to build that portfolio. Not even close. The funds in question—which are managed by Fidelity Investments—have no required investment minimum, which means your four-year-old could start investing with the contents of her piggybank. How’s that for a Happy Meal?

The fee-cutting war among index funds no longer garners headlines. Nonetheless, it grinds on, with small expense cuts here and there. To see the impact, I calculated the annual cost of owning a balanced portfolio consisting of 40% high-quality U.S. bonds and 60% stocks, with the stocks divided equally between U.S. and foreign shares.

I realize most folks aren’t comfortable putting that much in foreign markets, but that is—roughly speaking—how the global stock market is divvied up today and, indeed, that’s how I invest my own money. Below are six possible investment mixes built using funds from five major providers of index mutual funds and exchange-traded index funds (ETFs). Each fund’s annual expense ratio is listed in parentheses.

1. Fidelity Investments

30% Fidelity ZERO Total Market Index Fund (0%)
30% Fidelity ZERO International Index Fund (0%)
40% Fidelity U.S. Bond Index Fund (0.025%)
Portfolio’s weighted expenses: 0.01%
Annual cost: $10 per $100,000

2. iShares

30% iShares Core S&P Total U.S. Stock Market ETF (0.03%)
30% iShares Core MSCI Total International Stock ETF (0.09%)
40% iShares Core U.S. Aggregate Bond ETF (0.04%)
Portfolio’s weighted expenses: 0.052%
Annual cost: $52 per $100,000

3. Charles Schwab

30% Schwab U.S. Broad Market ETF (0.03%)
23% Schwab International Equity ETF (0.06%)
7% Schwab Emerging Markets Equity ETF (0.11%)
40% Schwab U.S. Aggregate Bond ETF (0.04%)
Portfolio’s weighted expenses: 0.0465%
Annual cost: $46.50 per $100,000

4. SPDR

60% SPDR Portfolio MSCI Global Stock Market ETF (0.09%)
40% SPDR Portfolio Aggregate Bond ETF (0.04%)
Portfolio’s weighted expenses: 0.07%
Annual cost: $70 per $100,000

5. Vanguard Group

30% Vanguard Total Stock Market ETF (0.03%)
30% Vanguard Total International Stock ETF (0.08%)
40% Vanguard Total Bond Market ETF (0.035%)
Portfolio’s weighted expenses: 0.047%
Annual cost: $47 per $100,000

6. Vanguard Group

60% Vanguard Total World Stock ETF (0.08%)
40% Vanguard Total Bond Market ETF (0.035%)
Portfolio’s weighted expenses: 0.062%
Annual cost: $62 per $100,000

You’ll notice that the portfolio built with State Street’s SPDR ETFs, and one of the Vanguard Group portfolios, includes a world stock index fund, which means you’re getting U.S. and foreign shares in a single package. I’m intrigued by these funds, because—by wrapping together all stocks in one fund—you’re less likely to have behavioral problems, where investors start second-guessing how much they have in U.S. stocks and how much abroad. The downside is that the world stock index fund category isn’t as competitive, so annual fund expenses are a tad higher.

Indeed, one reason the above portfolios have such low costs is because we’re looking at the most competitive part of the fund market. Vanguard’s declared goal is to operate its funds at cost, which means that—for the other fund companies—the funds listed here are either breakeven propositions or loss leaders, with Fidelity presumably taking the biggest hit.

As you’ll have no doubt noticed, the Fidelity portfolio is far cheaper than its competitors. It costs just $10 per $100,000, versus $46.50 for the Schwab portfolio, which is the next cheapest. Moreover, the Fidelity portfolio consists of index mutual funds. That means you buy and sell directly from Fidelity as of the 4 pm ET market close, and your trades take place at each fund’s per-share portfolio value, otherwise known as the “net asset value.” By contrast, the other five portfolios consist of ETFs. Because ETFs are listed on the stock market, every time you buy and sell you lose a little to the bid-ask spread, an added cost you don’t incur with mutual fund trades.

Does all this mean that Fidelity should be the first choice of every cost-conscious index fund investor? We’re talking about saving perhaps $40 a year on a $100,000 portfolio—and I readily concede there are many things I would do to save $40. That said, before you move all your money to Fidelity, or to any other firm’s funds, here are five other issues to consider:

1. Capital gains taxes. If you’re sitting with a collection of index funds in a taxable account and there are lower-cost alternatives, it simply isn’t worth changing investments if the move will trigger capital gains taxes. What if you’re dealing with an IRA? Swapping investments within an IRA won’t trigger any tax bill. Still, you could get hit with a fee if you move your IRA from one financial firm to another. Schwab, for instance, charges as much as $50 to transfer an account to another firm.

2. Tracking error. Over the 12 months through June 30, Fidelity ZERO International Index Fund beat its benchmark index by 0.18 percentage point, iShares Core MSCI Total International Stock ETF by 0.09 and Vanguard Total International Stock ETF by 0.37. A cause for celebration? I don’t think so. There’s every chance such tracking error could hurt rather than help.

For instance, the SPDR Portfolio Aggregate Bond ETF fell behind its benchmark by 0.21 percentage point over the past year. That sort of tracking error can easily swamp any tiny advantage you might gain by swapping to a lower-cost fund. My advice: Check how a fund’s net asset value performance (and not its market performance, assuming you’re looking at an ETF) compares to its benchmark index. Think twice before buying a fund that struggles to mirror its benchmark, especially if those struggles are evident over multiple years.

3. Sweep accounts. The flagship index funds listed above are making little or no money for Fidelity, iShares, Schwab and SPDR, which means they’re hoping to compensate by also selling you other products.  If you buy those other products, they’ll often be more expensive than what’s on offer at Vanguard, though not always.

If you stick with the low-cost offerings listed above, that won’t matter. But if these index funds above are just one part of your portfolio, it’s a bigger issue. For instance, if you not only opt for Fidelity or Schwab’s flagship index funds, but also choose to use their brokerage platform, pay attention to the yield on their sweep account—the place where money sits between trades.

For its sweep account, Vanguard uses a government money market fund that was recently yielding 0.1%. Fidelity also uses a government money market fund, but it only yields 0.01%, while Schwab parks customers’ cash at its banking affiliate, where the money was recently earning the same 0.01%. The yield difference among these sweep accounts was even larger before the Federal Reserve slashed short-term interest rates. (In case you’re wondering, iShares and SPDR don’t have retail brokerage operations like Fidelity, Schwab and Vanguard, so you’ll want to set up a brokerage account elsewhere to buy their funds.)

4. Customer service. We’re now firmly in the land of anecdotal evidence, a place I try to avoid. Still, I hear and read people raving about customer service at Fidelity and Schwab, while Vanguard’s service seems to prompt more grumbling.

5. Bait and switch. When the index fund fee-cutting war broke out a few years ago, I worried that Vanguard’s competitors would use the low fees to attract new investors and then later jack up expenses, milking profits from the assets they’d gathered. Yes, it’s happened before.

Today, I no longer think this is a serious risk. Because the competitive pressures are so great and the potential damage to their reputation so devastating, fund companies—I believe—would be profoundly reluctant to reverse their fee cuts. But if you’re worried about that possibility, stick with Vanguard.

Latest Articles

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

“Mental resilience is the ultimate contrarian strategy,” writes Isaac Cathey. “My family’s intuitive confidence—that the world wasn’t ending and that the market would surely recover soon enough—kept us on track.”
The Fed. The Dow. The daily market narrative. Mike Zaccardi lists his top five things that make the headlines—but which investors ought to ignore.
“It’s a myth that dies hard—the idea that a financial planner is a market prophet,” says Robin Powell. “The best planners will tell you they have no idea where the financial markets are headed.”
Claiming Social Security benefits at age 62 is often a mistake—but not always, as James McGlynn explains.
Sanjib Saha’s identity was stolen earlier this year. What did it take to make sure his financial life was safe? Hours and hours of work.
“Don’t get hung up on one type of risk,” says Adam Grossman. “Recognize that our brains are wired to do this. My advice: As much as possible, try to ponder the risks that may lie around the corner.”

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include My Four Goals, 15 Ways to Happy and Sunny Prospects.

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Crash Test

AS THE MARKET plunged earlier this year, I recalled the sage advice of billionaire investor Mark Cuban: “When you don’t know what to do, do nothing.” My wife and I are 100% in index funds, so doing nothing was easier for us than for more active investors. Still, we did take some action and, more important, learned some valuable lessons.

Examples? With the bear market apparently behind us, I decided to create a record of the steps we took, so I’d have a written reminder to guide me the next time the market falls out of bed. Here are 10 key lessons that I learned from the 2020 coronavirus crash:

1. A mental shift. It wasn’t fun, especially at first. The initial phase—the first 10% drop—was the most mentally taxing. Shifting from a “how high can we go” mindset to a value mindset was tough, but necessary and profitable. Once we could see the market drop as a discount, doubling down on our investments appealed to our frugal nature.

2. Save on taxes. While losses—realized or not—can be emotionally painful, it helps to know that the taxman is willing to share in your losses. I devised a rotating monthly trading schedule for three broad stock market exchange-traded index funds (ETFs) that provided the necessary separation between buy and sell dates to abide by the wash-sale rule. Although it was psychologically painful to see that much red, sticking to this schedule assured that my losses would be partially offset by generous tax savings.

3. Stick to the plan. As the market plunge got particularly nasty in mid-March, I realized that my wife and I had grown immune to volatility. Swings of 8% to 10% got our attention, but daily swings of 5% or less started to seem relatively minor. After some discussion, we recommitted ourselves to our 80% stock-20% bond asset allocation. We set our limit orders and bought all the way down to within 2% of the bottom. As the orders filled and our cash reserves dwindled, it took an iron stomach to keep going, but I’m proud today that we toughed it out.

4. On second thought, stick to the plan—but don’t be too hasty. One drawback of rebalancing aggressively on the way down is that, once you’re heading back up, the stock side of the portfolio grows. As the stock market bounced back and our asset allocation shifted increasingly toward stocks, we took a deliberately lazy approach to rebalancing, shifting some money back to bonds, but not fully rebalancing our portfolio right away. By doing this, we took advantage of the stock market’s upward momentum.

5. If possible, stay employed. Many were predicting that it would be a long slog out of bear territory, so I was thankful to be employed and able to pay the bills. Perhaps equally important, I was grateful to have my income as a source of new savings, allowing me to invest at depressed stock prices.

6. Stay on budget. In family financial discussions during the crash, it could go two ways. On several occasions, our daily losses were in the tens of thousands. What difference would it make if we blew an unbudgeted $50 on takeout, instead of cooking at home?

Enter the opportunity mindset: Every additional dollar we could squeeze out of our budget and invest had a higher expected return than it would’ve had just a month earlier. Spending $1 on March 23 was $1.51 in Feb. 19 stock market dollars, adjusting for opportunity cost. Put differently, we had a chance to pay only 66 cents for stocks that, just one month prior, investors worldwide agreed were worth $1. Choosing a mindset of opportunity helped us stick to our household budget, even as current events dwarfed its perceived significance.

7. Motivation matters. During the crash, the dollar losses were too huge to stomach. Perhaps the best thing to do was ignore them. But I’m a data-driven guy, so it was useful to find a new metric to motivate me.

For example, with each rebalancing trade on the way down, our cost basis fell. It was cool to see how low I could get my average cost and think, “Wow, these are 2016 prices.” Since the market will certainly set new highs at some point, it was fun to calculate what our portfolio value would rise to whenever that happens. Finally, since no one can control what the market does, it was encouraging to focus on a metric that we all get to control, at least to some degree: how much of our earnings we choose to save and invest. Whatever metric motivates you, find that silver lining and use it.

8. Cash isn’t trash. While it’s true that cash tends to create a drag on a portfolio’s overall return, having that cash to deploy as the crash deepened provided a psychological edge. Our stockpile of cash afforded the opportunity to do something productive—rebalance our portfolio.

9. Know thyself. This one Socratic aphorism sums up what, for me, was the most valuable takeaway from this market episode. In March and April, my YouTube feed filled up with videos of day traders touting their chart-driven strategies, bragging about their gains from shorting the market and declaring they could pinpoint the S&P 500’s bottom at around 1700.

Though I was tempted to engage in margin trading, derivatives, leveraged ETFs and other “advanced” strategies, the market rebound quickly validated my old school, simple, low-cost, broad-based approach. In fact, I’m certain that the deep discounts I enjoyed were courtesy of panicked day traders faced with margin calls, who had no choice but to sell to patient buyers.

10. Attitude matters. Mental resilience is the ultimate contrarian strategy. When the prevailing attitude is pessimism, optimists can benefit. My family’s intuitive confidence—that the world wasn’t ending, that this time wasn’t really different and that the market would surely recover soon enough—kept us on track. I’ve heard many investing champs say that successful investing has far more to do with temperament than knowledge or skill. Having experienced the first huge market drop of my investing lifetime, I can attest to that.

Isaac Cathey i s a public sector employee and professional pilot. The bulk of his financial knowledge comes from books by the likes of John Bogle and JL Collins. He spends his free time running, swimming, hiking, camping, biking with his children and doing DIY projects.

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No Need for Prophets

WHEN FINANCIAL planners are asked at parties what they do for a living, many hesitate to be specific. Why? Because the inevitable follow-up questions relate to where they think the stock market, the dollar, interest rates or the economy are headed.

It’s a myth that dies hard—the idea that a financial planner is a market prophet with special powers for foreseeing the next big boom or bust. To be sure, some advisors position themselves as smart forecasters or market timers.

The best planners, however, will tell you they have no idea where the financial markets are headed. They can’t tell you which will be the top- and bottom-performing stocks this year or what the Federal Reserve will do with interest rates.

Of course, lots of folks have an opinion on the economy, the efficacy of government policy or what the markets might do next. But good planners know that’s the sort of conversation best held at a local watering hole, not in the context of planning a client’s future.

A financial plan should not be shaped by market forecasts. Rather, it should be shaped according to the needs, goals, risk appetites and life circumstances of each individual client. In this sense, good financial planners are not experts in prophecy but in possibility.

They start by spending time with clients or prospects to learn about them. They need to know not only about their assets, liabilities, income and living costs, but also about their aspirations and expectations. From there, goals are set for the short, medium and long term.

The advisor connects those goals to a portfolio strategy that gives clients the best chance of both achieving their goals and sticking with their investments along the way. A short-term market forecast isn’t required. True, if the goal is long term, planners will need to assume a reasonable expected rate of return.

The key to earning that return is not market timing or stock selection, but diversification and discipline. The stock market will have more good years than bad, we know that. But there will be bad years, so a plan needs to accommodate those by including bonds and other defensive assets.

Not every sector of the market will perform well at the same time, which is why a plan will diversify across and within many stock market sectors. That means having exposure to large and small companies, value and growth stocks, and developed and emerging markets.

Cost is another determinant. The fees paid to fund managers can be a significant drag on the returns delivered to clients. The plan will consider the most efficient solutions. Taxes, too, can make a difference between the advertised returns of various strategies and what ends up in an investor’s pocket. A good financial plan takes account of that.

Finally, no plan is ever set in concrete and forgotten about. There are two reasons. First, markets are always changing. This can move clients’ portfolios beyond the bounds of their risk appetites.

Second, people are always changing. We change careers, relationships, build families, move house, and face periodic challenges with our health and external circumstances. Plans need to be reassessed, portfolios rebalanced and goals reset, if necessary, to accommodate all of that.

The point is that none of this requires making bets on the future. It requires a financial plan that accommodates a wide range of possible developments and builds strategies to deal with whatever arises—an economic recession, an industry restructuring, a marriage breakdown, a health crisis. Just life really.

A good planner knows that the investments, once structured and set, will largely look after themselves. They must be monitored and measured, of course. But the most important element is the clients themselves and their lives.

The many variables that make the nightly TV news—geopolitics, rising markets, falling markets, currencies, interest rates, commodities—are all very interesting and we can debate them until the cows come home. But none of that is within our control.

What a financial plan does is start from what we can control. It starts with understanding each client’s goals and preferences, building strategies that maximize the chance of meeting those goals, managing risk through diversification, controlling costs and taxes, exercising discipline and regularly rebalancing.

The controllable stuff may not be as interesting as the big political or market story of the day. But it’s here where your planner makes the real difference.

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 Death by Lifestyle, Take Courage and Why We Try. Follow Robin on Twitter @RobinJPowell.

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Identity Crisis

MAY 18, 2020, started as an ordinary Monday. I was busy with office work. An email from our human resources department hit my inbox. It said something about fraudulent unemployment benefits. I couldn’t pay attention right away, so I saved it to read later.

That evening, I found five letters from our state’s unemployment claims department in the mail. I’d never heard of such a department, but it reminded me about the email I got earlier. This time, I read the email more carefully.

It turned out that someone had filed for unemployment benefits using my personal information. Many coworkers were also affected. They’d had little luck in contacting the state’s unemployment claims department directly. On behalf of the impacted workers, our employer was working with the department to flag these claims as illegitimate. Needless to say, I was surprised and worried.

The letters from the state, dated between May 14 and 16, had bigger surprises. First, the department still seemed unaware that the claim filed on my account was fraudulent. Second, it appeared the department had started making payments without complete verification.

The third surprise was most disturbing. Sensitive personal information about my employment and wages were included in the letters. I couldn’t tell whether that information was also sent electronically to the fraudulent claimant. That would surely make me a target for future, possibly more sophisticated, cyberattacks.

I was curious about how this had happened, but first I needed to worry about my own vulnerability. My personal information had previously been exposed by a few of the well-known security breaches, including one involving my former mortgage lender. It had taken me months to sort out an identity-related tax fraud a few years ago. That experience was frustrating. The prospect of repeating that same drill was daunting. Sadly, I had no choice.

My first step was to confirm the fraud with the state. I tried to create an online account with the unemployment claims department. The system reported that my information was associated with a different email address—one I didn’t recognize. I reported this to the department and to the cybersecurity division of the state attorney general’s office.

Next, I looked for suspicious activity in other places. After my previous identity theft incidents, I had set up a credit monitoring service and an extended fraud alert. Neither had reported any unusual activity, but I wanted to check myself. I pulled a free credit report to review it thoroughly. As far I could tell, it was all clear.

The prior incidents had also increased my paranoia about online transactions. Not only did I set up two-factor authentication for most of my online accounts, but also I signed up for text alerts for all financial transactions and profile changes. On top of that, I had started routinely reviewing my credit card accounts, bank accounts and brokerage activities.

Nothing had stood out the last time I looked, but I wanted to be doubly sure. I spent a few hours going over all withdrawals and credit card transactions in recent months. While I was at it, I also changed the passwords for all my online accounts. I was relieved that everything looked normal.

The other places I checked were the Social Security Administration and the Internal Revenue Service. To protect my future Social Security benefits from ending up with cyberthieves, I’d created an online my Social Security account and adopted the agency’s security guidelines. I logged in to see if there was any suspicious activity. The next day, I called Social Security and got hold of a representative, who confirmed that there was no unusual activity in my account.

Similarly, per IRS guidance, I had opened a secure account that I used to periodically check my tax transcripts and account balance. Since I hadn’t filed my 2019 federal taxes yet, I logged into my online IRS account to verify that no fraudulent return had been filed. I made a mental note to stop procrastinating and file my tax return that weekend, which I did.

Once I’d exhausted my search for fraudulent activity, I reported the incident to the Federal Trade Commission. Next, I filed a police report online. I sent an identity theft affidavit to the IRS. I froze my credit with the three national credit bureaus, namely Equifax, Experian and TransUnion. I also sent them a written request to extend my existing fraud alert for another seven years.

Checking off these steps made me feel better, but the feeling was short-lived. A week or so later, I received another letter from the unemployment claims department. This time, the department asked me to refund the money that was supposedly paid out. Another letter, demanding a larger refund, followed soon after.

I was confused. So far, I hadn’t received any formal acknowledgment from the department about the fraudulent claims on my account. The department was unreachable by phone.

Some online research revealed that the department was battling tens of thousands of fraudulent claims. Cybercriminals had siphoned off hundreds of millions of dollars. Even worse, many legitimate claims were suspended while the department combated this large-scale fraud. I had little hope of a timely resolution. Thankfully, the department soon sent an email to all affected employees of our company—and possibly other firms as well—saying we didn’t owe anything.

Identity and privacy breaches have reached crisis level. One out of three Americans were compromised by the Equifax data breach alone. Personal information for over 1.2 billion people worldwide, compiled by People Data Labs and Oxydata.io, was leaked. These are just the tip of the iceberg. For many of us, it isn’t a question of if, but when, the next identity theft strikes. All I can do is to take a few practical precautions that help me sleep better. I suggest you do the same.

A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Triple Blunder, Freedom Formula and  Feelin’ Groovy . Self-taught in investments, Sanjib passed the Series 65 licensing exam as a non-industry candidate. He’s passionate about raising financial literacy and enjoys helping others with their finances.

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Early Decision

DELAYING SOCIAL Security until age 70 will get you the largest possible monthly benefit, and that’s the right strategy for many retirees. But what’s right for many folks won’t necessarily be right for you—and you may want to file at 62, the youngest possible age, so you maximize your total lifetime benefit.

If you’re single with no dependents, you should probably file at age 62 if you’re in poor health or your family doesn’t have great genes, and you don’t expect to live to age 80. Over this relatively short period, the smaller monthly benefit starting at age 62 will likely prove more valuable than waiting to get a larger monthly check. Similarly, if you’re single and have no other income to live on, by all means start Social Security at 62. In both instances—poor health or no other income—beginning at 62 should be the right decision, provided you don’t live into your 80s.

If you’re widowed, there may also be good reason to begin Social Security at age 62. Survivor benefits can typically start at age 60 and won’t get any larger if you delay beyond your full Social Security retirement age, which will be 66 or 67, depending on the year you were born. In some instances, a widow or widower might start her or his own benefit at age 62 and then switch over to survivor benefits at full retirement age, assuming the survivor benefit is bigger. Alternatively, those who are widowed might start survivor benefits at age 60 and then claim their own benefit—based on their own earnings history—at age 70, at which point it’ll be at its largest, thanks to the delay.

Whether you’re married or not, if you have dependents, you might be eligible for Social Security family benefits, on top of your own benefit. If you have dependent children under age 19, they might be able to collect 50% of your full retirement age benefit. The maximum total Social Security benefit is 180% of the parent’s full retirement age benefit.

I met a 62-year-old man who bragged to me about his 10-year-old twins—and how he could collect Social Security benefits for them. If you have adult disabled dependent children, you may also be eligible for family benefits, assuming the disability happened before age 22. In many cases, when there are dependent children or adult disabled children, filing at age 62 will maximize benefits.

A married couple might also decide to start Social Security benefits at age 62 as part of a strategy to maximize survivor benefits or to trigger spousal benefits. If both of the filers are in poor health—again, meaning not expected to reach age 80—then they should probably both file at age 62. If one of the couple is in poor health and the other is healthy, then the person with the smaller benefit should file at age 62 and the other should file at age 70, because—upon the death of the first spouse—the lower benefit disappears.

Another possibility: If one spouse was born before 1954 and the other, younger spouse has turned age 62, the younger spouse might file for benefits. That’ll allow the older spouse to file a restricted application for spousal benefits only. At age 70, the older spouse could then file for his or her own benefit. Note that this loophole, which has now been closed for most folks, remains open only for those born before 1954.

If the lower-earning spouse is much older than the higher-earning spouse, sometimes the higher-earning spouse will want to file at age 62. Until he or she files, the lower-earning spouse can’t receive spousal benefits. Let’s say the higher earner is eight years younger. If he or she waits until age 70 to claim benefits, the other spouse won’t receive spousal benefits until age 78.

Keep in mind two things about filing at age 62. First, if you’re still working and collecting Social Security benefits, there’s something called the earnings test that will reduce your benefit if your income exceeds $18,240 in 2020. Your benefit is reduced $1 for every $2 in excess of this amount. Once you reach your full retirement age, your benefit is adjusted upward for the benefits lost as a result of the earnings test.

Second, there’s a filing trick that few are aware of. If you file for benefits at age 62—or, indeed, at any age below your full Social Security retirement age—you’re able to suspend benefits at your full retirement age and then receive “delayed retirement credits” up to age 70. Perhaps you filed early to trigger dependent benefits for a few years, but now those dependents are no longer eligible because they’re too old. In that case, at your full retirement age, you might want to suspend your benefit until age 70 and collect the annual benefits increase of eight percentage points.

My general recommendation: Create your own online Social Security account. You can then run the calculations for your situation. The bottom line: Delaying until age 70 is often the right decision—but not always.

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 Your 10-Year Reward, Four Simple Tips and Filling the Gap.

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Please Ignore This

I RECENTLY WROTE about the market indicators I pay attention to. As a long-term, buy-and-hold investor focused on gradually building wealth, I downplay the importance of day-to-day market gyrations. Nevertheless, I can’t deny my fascination with charts and big market moves.

Back in college, I used to watch CNBC all the time. Now, I rarely have it on. The talking heads are constantly discussing matters that I believe are distractions. There’s a set of indicators that make headlines and are great fodder for financial journalists, but don’t mean much for investors. Here are five headline-grabbers that you can safely disregard:

The Fed. When it’s “Fed Day,” the major financial news networks don’t discuss anything else, or so it seems. The announcement finally comes in the afternoon—and the market reacts. Then the market reacts to the reaction. By the 4 pm ET close of trading, stocks and bonds may have had huge moves in both directions. What initially seemed like a “bullish” announcement often turns into a bearish reaction, and vice versa. It’s utterly unpredictable. Then, within a few days, everyone has moved on to some other topic.

On Fed Day, you’ll find me on the golf course.

The Dow. The Dow Jones Industrial Average has been around for more than a century. Everybody has heard of it. It’s a price-weighted index, meaning the stock with the highest price per share gets the biggest weight. Today, that stock is (drumroll, please) Apple. Apple’s 10% weight is only due to its $385 share price. Pfizer is the tiniest part of the Dow with a 1% weighting, since it’s just $36 per share.

What’s my go-to? I look at the S&P 500, which is “cap-weighted,” meaning the importance of a company in the index depends on its total stock market value. If I really want to get into the weeds, I see what’s happening with the S&P 500 “equal-weight” index, which is a better gauge of how the typical stock is performing.

The news. There’s a headline for everything. During 2019, how often did we hear “stocks rally on trade deal optimism”? Then, the very next day, we’d read “stocks fall on trade talk jitters.” The same goes in 2020 regarding COVID-19. In the financial media, stock market prices drive the narrative—and that narrative supposedly explains the behavior of all investors.

When I check out the newspaper or “Finance Twitter,” I look for cool charts and visuals, not the headlines.

Small caps vs. large caps. Analysts like to say that when smaller companies are outperforming large-cap stocks, it’s a sign that investors have a healthy appetite for risk, so the stock market should head higher. The problem: There’s little empirical evidence to support this idea.

That 1% of your portfolio. Maybe this last one is more applicable to us long-term investors. I’ve found that many investors are like me, with a bias away from simplicity. Perhaps it’s FOMO, or fear of missing out: We want to own a little bit of everything, just so we can say we got a piece of some big market move.

But in truth, a 1% position in just about anything won’t make a big difference. Sure, it could be the next bitcoin, going from $10 to $19,000—before falling below $10,000—but that’s unlikely. Instead of FOMO, try KISS, or keep it simple, stupid. Diversification is great, but don’t overdo it.

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 Reading the Signs, Inflection Point and Getting Back In. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at MikeCZaccardi@gmail.com.

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What to Worry About

IN RECENT WEEKS, I’ve focused on some of the growing risks in the financial system. In the stock market, there are day trading enthusiasts and their obliging brokers. In Washington, there’s a Federal Reserve that has served up a seemingly bottomless punch bowl of new money.

Result: Despite the current recession and 11% unemployment, the stock market is close to its pre-coronavirus all-time high, fueled in part by the Fed’s policies, which have driven income-starved investors to take greater risk. Meanwhile, the federal budget deficit has gone into the stratosphere—in June alone the deficit was $863 billion, up from $8 billion last year—and the Fed has printed about three trillion new dollars.

A reader asked which posed a bigger risk, an overeager stock market or an overspending government. My response: These risks aren’t the only risks. In fact, the worst risks are the ones we aren’t currently paying attention to. Risks that catch us by surprise are, by definition, the ones we’re least prepared for. Below are just a few examples. Some of these represent risks to the entire system, while others may impact us individually.

Cybersecurity. Talk to folks who work for financial institutions, and they’ll tell you that their computer systems are attacked every day. Fortunately, most attacks are unsuccessful. But I worry about a situation where a major bank’s systems are compromised. The result would be chaos, even if the problems were eventually sorted out.

Identity theft and other types of fraud. In the past, I’ve mentioned Peter Willmott, the former chief executive of Federal Express, whose own bookkeeper stole nearly $10 million from him. Ulysses S. Grant, a former president, found himself bankrupted by a Ponzi scheme late in life. Fortunately, these are the exception rather than the rule, but they illustrate that fraud can affect anyone.

Litigation. Travel down a highway in many states, and you’ll see billboards blanketed with ads for attorneys. “Injured? Call us!” If you’re a physician or a small business owner, litigation is a perennial risk. But the fact is, it can impact anyone who owns a home or drives a car.

Political risk. Ever since the 2000 election got hung up in litigation, I get a little nervous in election years. The reality is that financial markets are mostly agnostic to political parties, but they hate uncertainty. To have the Oval Office hanging in the balance may be the worst kind of uncertainty.

Tax risk. For high-income families, there are three taxes to fear. The first two—income taxes and estate taxes—are both scheduled to increase automatically in 2026, but a change of political power in Washington could easily accelerate that timetable. Meanwhile, the third tax—a wealth tax—doesn’t exist, but the concept has been getting more airtime in recent years. Two presidential candidates made it part of their platform this year. In Los Angeles, a teachers’ union promoted the idea in a white paper issued last week.

Beyond these somewhat conceivable risks are what many call “tail risks”—probably much less likely but potentially far more harmful. These include war, terrorism and the entire universe of unknown unknowns.

If this list seems a little overwhelming, that’s not surprising. The human brain has evolved to become very good at focusing on one thing at a time. Research, in fact, has shown that we’re terrible at multitasking. It isn’t realistic for anyone to simultaneously worry about the current pandemic, while also keeping an eye on the Fed, the election and the stock market—not to mention war, terrorism, climate change and everything else. (That’s probably why, in April, little attention was paid to a Pentagon statement acknowledging “unidentified aerial phenomena.”)

What’s the solution? As I said last week, there’s no magic bullet. But here are four things you can do:

As you think about your financial future, the most valuable thing you can do to protect yourself is to think in terms of scenarios, and specifically ranges of outcomes. Don’t make a single plan. Instead, plan for multiple contingencies.
When you’re building a portfolio, especially these days, it may feel inefficient to leave too much in bonds or cash. Because of inflation, in fact, you’d be losing money. But I think it’s useful to think about this part of your portfolio the way you think about insurance. In any year that you pay an insurance premium but don’t make a claim, you’ve “lost” money, at least in theory. But in reality, you paid a price for protection against a rainy day. I’m just as distressed as everyone else at the way the Fed has zeroed out interest rates, but I still see bonds and cash as a worthwhile holding.
Whenever prospective investment returns drop, alternative investments can seem more appealing. It might be gold, or Wall Street’s latest structured product, or high-yield bonds, or a complex insurance product. In all of these cases, I would urge caution. The mere fact that stocks and bonds have become less attractive doesn’t suddenly make these other products good products. It just makes them appear better.
Most important, don’t get hung up on one type of risk. Recognize that our brains are wired to do this—aided and abetted by 24-hour news coverage of the latest crisis. Without minimizing the severity of the current situation, I’d encourage you to think more broadly. My advice: As much as possible, try to ponder the risks that may lie around the corner.

Adam M. Grossman’s previous articles include Fed Up, Two Reasons to Worry and Too Slow.  Adam is the founder of  Mayport Wealth Management , a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter  @AdamMGrossman .

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My Four Goals

I’M PROBABLY a year or two away from regularly tapping my portfolio for income. That prospect—coupled with this year’s market turmoil—has led me to tinker with my investment mix and ponder how I’ll generate cash once I’m retired. One surprising result: I have more in stocks today than I’ve had at any time in the past three years, and I’m thinking of increasing my allocation even further.

Since 2014, I’ve thought of myself as semi-retired. I’m working harder than ever, but these days I only take on projects I enjoy. I earn just a third of what I made when I worked on Wall Street and I expect that to dwindle further in the years ahead.

That’ll leave me heavily dependent on my financial accounts. Currently, I’m 76% in stocks and 24% in bonds and cash investments. If I figure in the private mortgage I wrote for my daughter—which I consider comparable to a bond investment—the mix is more like 67% stocks and 33% conservative investments.

How am I going to take this mix of assets and generate income? I think in terms of four goals.

1. I want income I can’t outlive. The mortgage I wrote for my daughter pays me income every month. Assuming she doesn’t move or refinance, I have another 25 years of checks coming my way. At age 57, this is an income stream I hope to outlive—but I could be wrong.

I also want some income I’m guaranteed not to outlive. Research suggests our ability to manage money deteriorates as we age. Research also suggests that retirees with predictable income tend to be happier.

Where to get that predictable lifetime income? At the top of my list is Social Security, which I plan to claim at age 70. In addition, I intend to make a series of immediate fixed annuity purchases, possibly starting as early as age 60. By making multiple purchases over 10 years or so, I can buy from multiple insurers—thus limiting my exposure should any one insurer go belly up—and I’ll benefit if interest rates head higher from today’s anemic level.

I know many folks hate the idea that they’ll make a big annuity purchase, only to keel over a few months later. That’s why I like the idea of buying gradually. It lowers the stakes associated with each purchase and, by starting to buy at age 60, I’m confident I’ll get at least some income back, even if I do go to an early grave.

2. I want a pool of cash I can count on. As I buy more immediate annuities and once I claim Social Security, I’ll need less cash each year from my portfolio. But for the money I do need to withdraw, I want to be confident it’ll be there.

To that end, I’ve taken my already conservative bond portfolio and made it more so. In June, I swapped my intermediate-term inflation-indexed bond fund for a short-term inflation-indexed bond fund, and I sold my short-term corporate fund and replaced it with a short-term government fund. In other words, all my bond money is now in government bonds, and the duration is so short that it’s almost like holding cash investments.

All this reflects my evolving view of bonds. They’re no longer a good source of income. How could they be with yields so low? Instead, their sole role is to provide portfolio protection, acting as both a shock absorber and a place from which to draw spending money when stocks are struggling. My goal is to have at least enough in my two short-term government bond funds to cover my next five years of portfolio withdrawals.

Right now, I’m above that level. With 24% in bonds and assuming a 4% withdrawal rate, my bond holdings would cover six years of portfolio withdrawals. On top of that, I’m not even drawing on my portfolio today, because I have enough income coming in to cover my living expenses. That makes me wonder whether I should further reduce my bond holdings and invest more in stocks.

3. I want long-run growth. This, of course, is the reason to own stocks. If your goal is healthy long-run inflation-beating investment gains, stocks remain your best bet—and arguably you’re only one. And remember, even in a low-inflation environment, retirees most assuredly need growth. At 2% a year, inflation will increase our cost of living by 49% after 20 years.

Through February and March, I aggressively bought stocks, and then saw my portfolio’s stock allocation jump as the market rebounded. That meant I went from 66% stocks at the Feb. 19 peak to today’s 76%.

I readily concede that my current stock allocation will strike some readers as high. But it causes me no sleepless nights. I’m globally diversified and all in index funds, with a tilt toward smaller companies, value stocks and emerging markets.

Some parts of the global stock market will undoubtedly struggle in the decades ahead and most active managers will lag behind the market averages. But because I’m indexed and globally diversified—plus I’m over-weighted in some of the stock market’s least loved sectors—I figure the chances that I’ll suffer atrocious long-run performance are modest.

4. I want to help my kids. I have money in a regular taxable account, traditional retirement accounts and Roth accounts. Once retired, I plan to use my traditional retirement accounts to cover my spending needs and to fund my immediate annuity purchases.

Meanwhile, I hope to keep both my taxable and Roth accounts intact, and then bequeath them to my kids. My Roth accounts are 100% in stocks, and my taxable account is close to it, so I’m hoping the accounts will notch handsome gains between now and whenever I shuffle off this mortal coil.

Congress, alas, has nixed the stretch IRA for most beneficiaries, with the notable exception of a husband or wife. Still, non-spouse beneficiaries have 10 years to empty inherited retirement accounts—which means my children will get 10 years of additional tax-free growth after they inherit my Roths. Meanwhile, my taxable account holds two stock index funds with large capital gains. Ideally, I’d also leave them untouched. Why? Under current rules, a taxable account benefits from the step up in cost basis upon death, thus nixing any embedded capital gains tax bill.

Is all of the above set in stone? Far from it. If interest rates rose, bonds may once again become an attractive source of income. If my health deteriorates, I’d stop the immediate annuity purchases and claim Social Security right away. If retirement proves more expensive than I anticipate—or the markets less generous—I may need to tap my Roth and taxable accounts. But that’s how it is with plans: They give you a broad direction—but you almost always have to make adjustments along the way.

Latest Articles

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

Want to buy a second home? If you also plan to rent it out part of the time, check out the five tips from Rick Connor.
“I invested in these companies because I’d read about them, or because they seemed reasonably priced, or because they’d experienced significant drawdowns,” notes Marc Bisbal Arias. “None of these is a good reason to invest.”
Should they have a child? Anika Hedstrom and her husband weighed the financial and other implications—but ultimately realized that there would be uncertainty. Which proved prescient.
“I felt valued for the work I was doing,” recalls Kristine Hayes. “I was secure knowing that I’d found my career niche and my future was bright. Then everything changed.”
Fancy yourself as a stock market strategist? Mike Zaccardi talks about five of his favorite market indicators.
The Fed has once again helped to prop up the economy. “Aren’t zero rates and printing money great for everyone?” asks Adam Grossman. “My concern is that these policies distort economic behavior.”

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include 15 Ways to Happy, Sunny Prospects and Keep Your Distance.

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Known and Unknown

ON FEB. 12, 2002, Secretary of Defense Donald Rumsfeld took the stage at a press briefing to address escalating tensions between the U.S. and Iraq. A reporter asked him a question regarding evidence of Iraqi weapons of mass destruction.

Rumsfeld famously replied, “There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know.” As ridiculed as these remarks were, they provide a roadmap to action in the face of uncertainty.

Like deciding whether or not to have children.

For my husband and me, identifying and evaluating the known knowns was the easy part—things like the medical costs to give birth, maternity leave benefits, changes to savings rates, childcare and so on. Needed upgrades—larger car, bigger house and such—were also factors to consider, but fairly straightforward.

Peeling back the onion another layer was a bit more uncomfortable. The known unknowns sent my head spinning. What if something went wrong during the pregnancy? What if we had a child who needed way more than we were capable of? I asked myself—and my husband—every question imaginable, and then probably three times over. For some reason, running on this hamster wheel felt oddly productive. I was making progress and checking boxes that needed to be checked prior to such a life-altering decision.

The unknown unknowns weren’t as intimidating to me, because I couldn’t come up with the right questions to ask or even research, as they didn’t yet exist. I didn’t know what I didn’t know.

Ironically, there was a fourth category that elevated my ruminations and factored into our decision. In his book Think Like a Rocket Scientist, Ozan Varol describes the concept of unknown knowns—we think we know what we know, but we don’t. Varol states, “The illusion of knowledge, rather than ignorance, is the obstacle to discovery.”

When we’re willing to admit we don’t know, our egos deflate and our minds open up. Ultimately, what I was looking for didn’t exist. I wanted certainty, control, the right answers despite ambiguity and clarity despite complexity.

As Varol eloquently states, unknown knowns “requires a conscious type of uncertainty where you become fully aware of what you don’t know in order to learn and grow.” Ultimately, my husband and I decided to live an interesting, uncomfortably uncertain life and have a child.

Which turned out to be twins.

Anika Hedstrom’s previous articles include Trek to Retirement ,  Simple but Not Easy  and Betting on Me . An assiduous researcher, Anika Hedstrom is a Certified Financial Planner who writes on the motivational and behavioral aspects of financial planning. Follow Anika on Twitter  @AnikaHedstrom .

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