Jonathan Clements's Blog, page 322

Questions I’m Asked

TERM LIFE INSURANCE is popular not only because it’s a relatively cheap way to protect your family, but also it’s simple: You pay a premium for a chosen “coverage period” and, if you die during that time, your beneficiaries receive the policy’s death benefit.

Yet, despite its reputation for simplicity, term insurance comes with a surprising number of options. On top of that, there are now dozens of insurers offering the product. Yes, if you buy the cheapest 20-year term policy you can find from an insurer that’s rated A or better by AM Best, you’ll likely do just fine. Still, a bit of work upfront could help you get even more value out of your coverage. Want the right term policy for your family? Here are answers to the top four questions I get asked:

1. What’s a term conversion benefit? This allows you to convert your term insurance into a permanent, cash-value policy, such as whole life or universal life. The rates will be based on your age at the time of conversion, but you’re locked in at the health class you were approved for when you purchased the term policy, regardless of your actual health at the time of conversion.

This can come in handy if you need to keep coverage longer than you initially assumed, but your health has deteriorated so you’re unable to purchase a new term policy at a reasonable rate. Unfortunately, this happens much more frequently than most people expect, so a strong conversion benefit does have value.

The good news is, term policies from most top insurers come with free conversion options. But the benefits can vary a lot. For example, on a 20-year term policy, one insurer may require you to convert within the first 10 years, while another insurer might give you the whole 20-year term period to decide. Similarly, one insurer may allow you to choose from all the permanent policies it has available at the time of conversion, while another insurer might require you to select from a limited set of policies with potentially worse pricing.

The bottom line: When selecting a term policy, don’t just look for the lowest price. For the top two or three quotes you receive, get details on the conversion options. You might get a much stronger conversion option for just a few dollars more per month—well worth it in my opinion.

2. Should I ladder policies? In other words, should you buy multiple policies with different maturity dates?

Because most people assume their insurance needs will decrease over time, I often get asked if it’s worth splitting their purchase up into multiple policies of varying lengths. For example, if folks need $1 million of coverage today but expect their need to drop to $600,000 in 10 years, they might purchase a $400,000 10-year policy and a $600,000 20-year policy. Their total coverage starts at $1 million but would drop to $600,000 after year 10, when the $400,000 policy matures.

That brings me to a fact that many people are unaware of: Even if you purchase a 20- or 30-year term policy, most insurers will allow you to reduce your coverage prior to maturity—and your premium will be reduced proportionally. Take the example above. Even if you purchased a $1 million 20-year term policy, you could call the insurer in year 10 and request that the company reduce your coverage to $600,000. Your premium would then be adjusted accordingly.

The upshot: A laddering strategy may not save you as much money as you expect. On top of that, if you pursue a laddering strategy, you’re committing to a lower coverage amount in the future, which could leave you in a tough spot if your needs change but you’re unable to purchase a new policy.

I generally find that, if you’re under age 45 and in good health, a ladder saves very little, if any, money. In this situation, I’d much rather pay a few dollars more per month and have the flexibility to keep my coverage in place longer, if needed. On the other hand, if you’re facing higher premiums due to health issues or because you’re older, and you’re confident about your future coverage needs, a ladder could save you much more and it’s worth investigating.

3. Does term insurance still make sense in my 60s or should I go with a cash-value policy? If you need life insurance in your 60s, you might be tempted to consider permanent insurance. But the principle that applies in your 30s still applies in your 60s: You should only purchase permanent insurance if you need coverage for life.

Because people are living longer than ever, a 20-year term policy in your 60s is still much cheaper than lifetime coverage. For example, a healthy 65-year-old man could purchase $2 million of 20-year term coverage for about $700 per month, while a guaranteed universal life policy with lifetime coverage is about $1,700 per month.  Again, if your situation requires lifetime coverage, paying the higher premium for permanent insurance makes sense. But if your need is temporary, the 20-year term policy is generally a much better value.

4. How can some insurers offer “instant” term insurance online—and when does it make sense to buy it? You may have noticed websites offering “instant decision” term life insurance. It’s a tempting proposition: You fill out an online form and, like magic, you get approved instantly, with no medical exam required.

In most cases, I’ve found these offers to be bad value for consumers, because the convenience comes at a cost: Pricing is often 25% to 50% higher than coverage purchased the traditional way. For example, a 40-year-old woman in good health can get $1 million of 20-year term for $42 per month via the traditional route, but the cost on a popular instant coverage site was $56 per month. That’s a 33% difference, equal to $3,360 over 20 years.

Because the “instant offer” sites have less information about you, they need to be more conservative in their pricing, which means higher premiums. It doesn’t hurt to explore these sites to get a feel for pricing. But unless you absolutely need to have insurance in the next 30 minutes, you’ll likely be better off going the traditional route. Many traditional insurers have improved their underwriting processes, so healthy individuals can be approved in as little as a few days, with no medical exam. True, the traditional process is still nowhere near “instant.” But it’s worth being a little bit patient—because it could save you a few thousand dollars.

Dennis Ho is a life actuary and chief executive of  Saturday Insurance , a digital insurance advisor that helps people shop for life , disability and long-term-care insurance, as well as income annuities . Prior to co-founding Saturday, Dennis spent 20 years in the insurance industry in a variety of actuarial, finance and business roles. His previous articles include Retire That Policy, Care to Choose and Don’t Ignore It . Dennis can be reached via  LinkedIn  or at  dennis@saturdayinsurance.com . Follow him on Twitter @DennisHoFSA.

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Coming Up Short

I’VE BEEN LIVING with roommates since I graduated college two years ago. I decided it was time to buy my own place. I saved diligently and I figured I had enough for a down payment.

I also figured I could handle the monthly mortgage payment, which wouldn’t be much more than I was paying in rent. I was looking for a townhouse or condo, which might cost $250,000 to $300,000 where I live.

What I didn’t grasp, however, were all the other costs I needed to think about. When I added them up, I realized I simply couldn’t afford the sort of house I wanted. Here are all the expenses I learned about—and which made me delay my home purchase, while I saved up more money:

Closing costs. These include things like home inspection, title insurance and mortgage application costs—all the money you have to pay before the house is even yours. Closing costs often run 2% to 5% of a home’s purchase price.

Property taxes. These are generally calculated as a percentage of your home’s value. Property taxes would have added another $180 to $250 to my monthly costs.

Homeowner’s insurance. This isn’t just a good idea to protect a hugely valuable asset. Your mortgage lender will also insist you have coverage. For the sort of home I was looking at, homeowner’s insurance might cost $800 a year.

HOA fees. Townhouses and condos typically have homeowners’ association (HOA) fees to cover the community’s clubhouse, pool, yard service and so on. In my area, they generally run $100 to $700 per month. While condos and townhouses are usually cheaper than single-family homes, I didn’t appreciate that ongoing monthly costs can often be higher.

Utilities. Today, I split the utilities with my roommates. Those utilities come to around $75 per person per month. What if I bought a place? I’d have to shoulder the full burden, paying perhaps three to five times what I’m currently paying. Also, when you’re renting, the landlord sometimes covers some of the utility bills and provides services, such as wi-fi and cable.

Wear and tear. If you rent, the landlord pays for the regular maintenance and takes care of unforeseen problems like mold or water damage. While the cost varies from year to year, average annual maintenance costs might be 1% or more of a home’s value. On top of that, after you close on a house, there are often problems that weren’t spotted when the home was inspected. You could be stuck paying thousands of dollars to fix problems you didn’t know about.

Furniture and appliances. Today, I don’t have a lot of furniture and I don’t own any appliances. I knew I’d need to purchase things like couches, chairs, tables, a washing machine and everything else needed to make a home comfortable. But I didn’t realize just how expensive these things can be. After some research, I figured I might need at least $5,000 to furnish my new home—another reason I decided to delay buying a house.

Morgen Henderson is a writer from the beautiful mountains of Utah. Her previous articles were Saved by Borrowing and Last Questions. She covers a variety of topics, ranging from travel and lifestyle to tech and personal finance. When she’s not typing away at her computer, you can find her baking desserts and watching an excessive number of travel shows. Follow Morgen on Twitter @Mo_Hendi.

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Think Like a Winner

AS AN INDIVIDUAL investor, what’s the key to success? It’s a question I hear a lot, especially in volatile times like this.

The answer, I think, is that there isn’t just one key, but rather five. The most successful investors seem to be equal parts optimist, pessimist, analyst, economist and psychologist. Together, I call these the five minds of the investor. If you can develop and balance all five, that—I believe—is the key to investment success.

1. Optimist. When I think of financial optimists, I immediately think of Warren Buffett. Now, you might imagine that it’s easy to be an optimist when you’re a billionaire. But I think it’s precisely because Buffett is an optimist that he’s a billionaire. His secret—which really isn’t such a secret—is to bet on the long-term growth of the stock market. During his company’s recent annual meeting, Buffett stated, “The American miracle, the American magic has always prevailed, and it will do so again.”

Buffett sounded a similar note during the last recession. In October 2008, when things looked terrible as far as the eye could see, Buffett had this to say: “Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”

When the economy is in a recession, as it is today, with millions out of work, it’s easy to feel dispirited. It is scary, and I don’t want to diminish everything that’s going on. But as Buffett wrote in that 2008 article, “Fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”

Of course, you can’t have 100% of your money in stocks. That brings us to the role of the pessimist.

2. Pessimist. Many people view themselves as either a glass half-full or glass half-empty kind of person. But for investment success, I think you want to be a little of each. You’ll notice that Buffett referred to the stock market’s long-term potential. That’s an important qualification. As we’ve seen this year, things can—and do—happen that interrupt the market’s growth.

That’s why it’s important to pay as much attention to your inner pessimist as to the optimist. What’s the best way to accomplish that? It isn’t complicated: You just want to keep enough of your assets outside of stocks to help you weather these interruptions. That will give you both the financial ability and the mental fortitude to get through tough times.

3. Analyst. If the optimist believes that stocks will grow over time, and the pessimist knows that they can’t grow all the time, how do you balance the two? That’s where the analyst comes in. The role of the analyst is that of mediator—to consider the needs of both the optimist and the pessimist.

Your inner analyst should be dispassionate, focusing on the facts of your individual situation. This includes your income, expenses, assets, liabilities and goals. In short, the analyst’s job is to strike the right balance between optimism and pessimism to develop an investment strategy that’s the best fit for you.

4. Economist. As I’ve noted before, economics isn’t exactly a scientific field and anyone’s ability to forecast the future is necessarily limited. But successful investing does incorporate certain economic concepts. At a high level, these include fiscal policy (the government’s ability to set tax rates and spending levels) and monetary policy (the Federal Reserve’s ability to set interest rates).

It also includes, more recently, the Federal Reserve’s growing role as financial backstop of last resort. And finally, it includes a sense of economic history and financial cycles. None of this means you’ll be able to predict where the economy is going. None of us can. But it does mean you’ll be better equipped to respond to events as they occur.

5. Psychologist. Last week, I heard a well-known investor state that the stock market is in a bubble and that it will “end in tears.” This reminded me of a prediction from another well-known investor who, back in March, warned that “hell is coming.”

Whether they’re wrong or right is less important than the fact that such colorful commentary and dramatic predictions are all around us. That’s why the fifth, and maybe most important, ingredient for investment success is to channel your inner psychologist. Among other things, this will help you to understand the motivations—both conscious and unconscious—of others, and to see the subtext of what they’re saying and not saying. This will help you to tune them out, as needed, so you can stick to your plan.

Is investing easy? No, I don’t think anyone would (truthfully) claim that. But if you successfully balance these five ideas in your mind, I believe you’ll tilt the odds in your favor.

Adam M. Grossman’s previous articles include Looking for an Edge, Divvying Up Dollars and Less Than the Truth.  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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Farewell Yield

THEY’VE LONG BEEN endangered, but 2020 may mark their demise: After four decades of falling interest rates, it seems safe investments offering attractive yields have finally disappeared.

At 0.7%, the payout on 10-year Treasury notes is below the 1.2% expected inflation rate for the next decade. High-quality corporate and municipal bonds offer more generous after-tax income, but hardly enough to excite investors. In the years ahead, the yield-obsessed will no doubt turn to riskier fare—high-dividend stocks, preferred shares, junk bonds, Wall Street-engineered contraptions—and many will end up badly burned.

My advice: It’s time to say goodbye to the notion of a safe yield and confront its many implications. There are obvious steps, like lowering our return expectations, saving more to compensate and paying down debt. But here are four other possibilities:

1. Abandon bonds. As I argued back in early May, stocks are now the only option for long-term investors hoping to clock significant gains in the financial markets. Meanwhile, high-quality bonds not only offer after-tax yields that barely exceed the inflation rate and are sometimes below, but also there’s a risk of short-term losses as the economic recovery nudges interest rates higher and thus depresses the price of existing bonds.

That brings me to an idea advanced in 1989 by the late Peter Bernstein. Instead of the classic balanced portfolio with 60% stocks and 40% bonds, perhaps investors should opt for 75% stocks, with the other 25% in cash investments like money market funds and high-yield savings accounts. Bernstein found that the latter investment mix had a similar risk level to the classic balanced portfolio, but higher returns.

The appeal of the Bernstein portfolio depends, I believe, on what role we see conservative investments playing in our portfolio. If we’re in the workforce, we should probably lean toward bonds, and especially Treasury bonds. Those Treasurys will likely jump in value when the economy next contracts, unemployment rises and stocks crash. We could then sell those Treasury bonds either to rebalance into stocks or to pay for groceries if we find ourselves out of work.

Meanwhile, if we want a pool of money for upcoming spending that should never lose its nominal value, no matter what happens in the financial markets, cash investments are more attractive. My hunch: That pool of cash—perhaps equal to five years of portfolio withdrawals—could be especially appealing to retirees.

2. Delay Social Security. This has always been a smart idea. With bond yields so low, it now looks even more compelling. Imagine you were born in 1958, so you turn age 62 this year. For purposes of Social Security, your full retirement age is 66 years and eight months. If you were eligible for $1,000 a month at that point, you might instead opt this year for a reduced benefit of $716 per month or wait until age 70 and get a delayed monthly benefit equal to $1,267.

Suppose you postpone benefits. How long does it take to recoup the benefits you missed by not claiming at age 62? Let’s assume that, no matter when you claim Social Security, you invest your benefits in government bonds, which arguably involve similar risk. Those bonds earn an after-tax return equal to the inflation rate—a generous assumption these days.

The bottom line: Claiming at age 62 is the smart move if you’re dead by age 78. But if you live to that age or later, you’re better off delaying to your full retirement age of 66 and eight months. What if you wait until 70 to claim Social Security? By age 80, you’re ahead of where you’d be if you claimed benefits at 62 and, by age 82, you’re ahead of where you’d be if you had claimed at your full retirement age.

What’s the life expectancy of someone in their mid-60s? It’s age 85—somewhat less for men, somewhat longer for women. The upshot: Thanks to today’s modest bond yields, delaying Social Security looks even more attractive. That’s doubly true if you’re married, you were the family’s main breadwinner and hence you have the larger Social Security benefit. The reason: Even if you die early in retirement, your benefit may live on as a survivor benefit for your spouse.

Who shouldn’t delay? If you’re in poor health—or if you’re married and you’re both in poor health—claiming early likely makes sense. You might also claim right away if you’re that rare retiree who is 100% invested in stocks and thus claiming early means you can leave your stocks to grow for longer. But if you’re in good health and you’re claiming early so you can leave your bond portfolio untouched for longer, you’re likely making a mistake.

3. Bet your life. If delaying Social Security is unpopular with many retirees, buying immediate fixed annuities is a total anathema. But just as low bond yields boost the case for postponing Social Security, it also increases the appeal of immediate fixed annuities.

Why? Falling interest rates have hurt the payout on both bonds and immediate fixed annuities—but it’s hurt immediate annuities far less. As I explained in one of March’s newsletters, interest rates are just one element in the pricing of immediate annuities. The other key component is life expectancies, and those have barely budged. Result: While 10-year Treasury yields today are at less than half of year-end 2019’s 1.92%, payouts on immediate annuities have dropped only slightly, making them a good choice for retirees who need to squeeze more income out of their retirement savings.

4. Revisit tax efficiency. For years, the preferred strategy for minimizing taxes was to use retirement accounts to hold real estate investment trusts, taxable bonds, and actively managed stocks and stock funds. Meanwhile, for a taxable account, the top choice was to buy and hold tax-efficient stock investments, such as total market index funds.

But with bond yields so low, holding taxable bonds in a regular taxable account no longer looks like a mistake. Suppose you’re deciding whether to use your taxable account to hold Treasury bonds yielding 1% or an S&P 500 fund yielding 2%. Yes, the Treasury yield might be taxed at a federal income tax rate of 22%, while the S&P 500 fund benefits from the special 15% rate on qualified dividends. Still, the total annual tax bill on the S&P 500 fund will clearly be higher, plus those dividends will rise over time, which means an even larger tax bill down the road. Meanwhile, not only are Treasury yields lower, but also the interest avoids state taxes.

Is it time to ditch the old strategy? It depends on what sort of bonds you buy. Today, holding Treasurys in a taxable account would be less taxing than holding a broad stock market index fund. But that wouldn’t be the case if your taste runs to high-quality corporates, where you can still earn yields above 2%.

One other consideration: Suppose you foresee using your taxable account to hold broad stock market index funds until your death. If you do that, the funds will benefit from the step up in cost basis and thus the embedded capital gains tax bill will disappear. That means your heirs will receive the funds tax-free, unless estate taxes are owed. Indeed, bequeathing appreciated stock investments in a taxable account has become a more attractive strategy, now that the stretch IRA has been killed off.

Latest Articles

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

“We don’t know whether this is an inflection point, but it is a warning signal,” says Mike Zaccardi. “If you’re one of those folks whose portfolio is all S&P 500 or all large-cap growth, perhaps it’s time to diversify.”
After China’s crushing of Hong Kong’s independence, Bill Ehart decided he wanted to reduce his portfolio’s exposure to China. It wasn’t easy.
“Financial markets are complex,” notes John Lim. “They can’t be explained by a simple headline. So why are we drawn to these articles? Because humans are uncomfortable with uncertainty.”
Regrets? He’s had a few. Dennis Friedman discusses the money decisions he wish he could take back.
The January effect. Sell in May and go away. Sunspots. Researchers have identified countless stock market anomalies. But before you try to exploit them, ask whether they make logical sense, says Adam Grossman.
If you’re saving for a long and active retirement, make sure you’re healthy enough to enjoy it, says Robin Powell. “You don’t need to run marathons,” he writes. “Just resolve to move more.”
The pandemic quickly became a financial crisis for many. Want to be ready for the next money crunch? Dick Quinn advises preparing for eight “what ifs.”

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Knowing Me, The Road Back and Look Forward.

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Error of My Ways

“MONEY MAKES the world go round”—and that means we’re constantly making financial decisions. Almost inevitably, some go awry. Like everyone else, I’ve made a lot of financial mistakes over the years. Here are some I wish I could take back.

When I was age 23, I graduated from college with a history degree. It wouldn’t take long for me to realize it was a mistake. Early in my career, I was passed over three times for a promotion because I didn’t have a business degree. Tired of hearing the same response, I went back to school part-time and earned an MBA. Result: I lost the chance not only to draw a larger paycheck, but also to save more in my 401(k) and elsewhere during those early years.

Just as the stock market started to fall in 2000, I followed the advice of a financial talk radio personality and took a significant position in a tech-heavy exchange-traded index fund that’s now known as Invesco QQQ. The fund fell from my $71 average share price to just $20. It took many years for the QQQ to reach my breakeven share price.

During the 2000 bear market, I also failed to diversify my bond portfolio. After watching my stock portfolio get hammered, I panicked and sold the bonds at a loss when they started to lose value.

I received a phone call one day from the publisher of a magazine that I subscribed to. The sales representative talked me into forking over $350 for a new five-year subscription. It turned out the call wasn’t from the publisher, but from some outfit that was selling magazine subscriptions. Even though I complained to the Better Business Bureau, I lost my money and never received a single magazine issue. The company eventually filed for bankruptcy. Although it wasn’t a huge financial loss, it taught me an important lesson about doing financial transactions over the telephone.

Last year, I spent $10,000 repairing an 11-year-old car with 125,000 miles on it. I should have put that money toward a new or certified preowned car. Instead, I’m stuck driving an old, unreliable car during a pandemic.

But the money decision I regret the most was small in monetary value, but it had an emotional and psychological effect that haunts me to this day. After I graduated from college, I moved to San Diego, where I met another young man named Jim Evans. Jim and I became close friends. We worked for the same company, hung out together and even double-dated on a few occasions.

One day, a few employees were taking up a collection for Jim and his new bride Cheryl, who was pregnant with their first child. The money was to go toward a baby shower gift. I was more than happy to contribute and I signed the card, just like the other employees.

A few days later, Jim approached me and said, “I bet you gave a lot of money toward the gift.” After his comment, I realized I’d made a terrible mistake. I shouldn’t have contributed to a group gift, but instead bought Jim and his wife a gift by myself. I had treated Jim as if he were just another coworker, rather than one of my best friends. It was not only a terrible money mistake, but also a terrible relationship mistake. When you combine those two elements, it can be devastating—and my friendship with Jim was never the same.

After 41 years, I still feel terrible about how I handled that situation. Sometimes, I search online for information about Jim, hoping I could track him down and somehow erase the bad memory from my mind. I know it’s nearly impossible to find someone with a common name like Jim Evans, but I still try. One day, I was talking to a friend down at the gym. He was telling me about his son, a lawyer who works for the federal government. Since Jim eventually became a U.S. border control officer, I had this crazy idea that maybe his son could help me find him. No luck.

After all these years, I’ve pretty much given up trying to track Jim down. As far as I know, he might have moved to another state or even died. But this incident with Jim still influences how I handle my money. Every time there’s money coupled with friends and family, I make my intentions clear and I try to make sure there are no hard feelings.

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 Anybody’s Guess, Don’t Count on Me and Don’t Go It Alone. Follow Dennis on Twitter @DMFrie.

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Red Flags

CHINA’S CRUSHING of Hong Kong’s independence is just the latest aggressive move to raise my hackles—and make me question the wisdom of investing there, as well as in much of Asia. Which puts me in a tough position, since the Pacific Rim represents nearly 70% of the emerging markets indexes.

I hear you saying that politics shouldn’t factor into investment decisions. True, if returns are your only consideration, political and moral issues don’t belong in the conversation. But I believe values have a role to play, though we should also be aware that avoiding or limiting exposure to certain companies, sectors or countries may harm diversification and hold back returns.

In this case, I’m willing to take my chances. I modestly reduced my emerging markets exposure in early May, even before the subjugation of Hong Kong. I don’t want to avoid developing markets altogether, nor could I, without blowing up my portfolio of primarily index and target-date funds. Instead, I’ve managed to cut my stock allocation in emerging markets to a level somewhat below their weight in world markets. (I don’t mind the reduced exposure to Russia, Saudi Arabia and increasingly authoritarian Brazil, either.)

What precipitated this? Have I not been trying to build a set-it-and-forget-it portfolio?

I was shocked to discover recently, when I checked via Morningstar’s Instant X-Ray feature, that the Fidelity Freedom 2030 Fund in my 401(k)—my biggest holding—had 10% of its stock allocation in emerging Asia, versus that region’s 6% weighting in the world index. (The fund is actively managed; Fidelity’s target-date index funds are not available in my plan.) That disparity strikes me as a big bet for someone 10 years from retirement, and the opposite of my preference.

Exposure to other Asian economies like Taiwan and Korea comes on top of that. (Index keepers differ on whether Korea is an emerging market. Morningstar puts both it and Taiwan in the developed category.) They represent another 5% of the Freedom 2030 fund’s stock position.

It would be a big risk to avoid or sharply underweight China—which is the world’s second largest economy—or, indeed, the entire emerging markets asset class. That would smack of ego, as if Bill Ehart alone understands the investment risks involved, the nature of the Chinese regime and the chances of a confrontation with a distracted, internally divided U.S.

On top of that, for those of us who want a simple portfolio of broadly diversified funds, there are few good ways to reduce China exposure without slashing emerging markets generally. The country now represents 43% of the FTSE benchmark—the index tracked by the Vanguard Emerging Markets Stock Index Fund—and 37% of the MSCI index followed by the iShares Core MSCI Emerging Markets ETF.

If you own one of those funds, you could replace it wholly or in part with the iShares MSCI Emerging Markets ex China ETF. But the three-year-old fund has just $40 million in assets and average trading volume under 20,000 shares. Taiwan and Korea comprise 40% of the fund, followed by India (13%), Brazil (8%), South Africa (6%), Russia (6%) and Saudi Arabia (5%).

The upshot: Any effort to limit exposure to China and its Pacific neighbors, while maintaining a substantial emerging markets position, results in huge overweights in other emerging countries.

My own approach, to date, has been to take a modest chunk out of my overall emerging markets exposure, so that my holdings are a shade below that of emerging markets’ importance in the overall global stock market. I accomplished this in two ways.

First, I sold part of my target-date position in my 401(k). I put the proceeds, in similar proportion to the target fund, into a total U.S. stock market index fund, a developed foreign markets fund and an intermediate-term bond fund.

Second, I sold WisdomTree Emerging Markets SmallCap Dividend Fund in my IRA and folded the proceeds into the developed market WisdomTree International SmallCap Dividend Fund that I already owned.

It is, of course, my right to invest according to my values, and it’s my obligation to use my judgment. But I can never forget that what I see as judgment may just be the voice of my ego telling me yet again that I know more than everybody else.

That’s why my allocation moves have to be within limits. If I’m wrong, I’m only a little wrong. All-in or all-out approaches are where we get our heads handed to us. But the outsized China position in my target-date fund—and my refusal to accept it—has added hassle to what I hoped would be a hassle-free portfolio. Time will tell if the extra work is worth the effort.

William Ehart is a journalist in the Washington, D.C., area. Bill’s previous articles include Averting My Gaze, In and Out and April Fool . In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart .

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What If?

IT SEEMS THE WORST of this economic crisis may have passed, though the health risks will be with us for some time. What have we learned? For many people, long-discussed financial risks became all too real in 2020.

There are two words that should always be part of our thinking: what if. Those two words aren’t always associated with bad things. What if I win the lottery? I have a plan for that, which varies depending on how much I win and whether it triggers estate taxes. The chance of that plan being needed is, of course, nil.

Most “what ifs” relate to family, money and our future security. Could anything—short of a world war—have done more than today’s pandemic to heighten those concerns? And yet I suspect the current crisis will soon be a dull memory and most Americans will be back to their old financial ways. But for those who want to be prepared for the next crisis, here are eight “what ifs” to ponder:

1. You die unexpectedly. Do you have adequate life insurance? If you own a small business, what will happen upon your death? Are your beneficiary designations up to date? Does your surviving spouse know where to turn for income? Do you have an updated will? Have you prepared final instructions, so your family knows what to do and where important papers are located?

2. You suffer a prolonged illness. Do you have an idea of the income you could expect from employer or government benefits? Do you carry long-term disability insurance? For working people, disability is a greater risk than death.

3. You lose your job or your pay gets cut. Sure, we’ve been told about having a three-month emergency fund forever—and, for just as long, most people have ignored the advice. Has the current crisis been a wakeup call? There’s some evidence Americans are saving more. But will this last or is it just that these days it’s harder to spend money on nonessentials?

4. Your investments go off track. If there was ever a time for learning a lesson about the stock market, this is it. A rollercoaster has nothing on the Dow Jones Industrial Average. We knew—or should have known—that the stock market goes up and down, and that some industries are more affected by economic conditions than others.

What are the lessons? Don’t try to time the markets, think long term and be diversified. Most people should stick with index mutual funds and stay the course. In fact, if you’re still employed, your everyday spending may have gone down, so now is a great time to increase your savings.

5. You lose your health care coverage. Employers cover more than half of all Americans. But if you lose your job, you lose that coverage. Be aware of your rights under COBRA and of the coverage available through your state’s health care exchange. COBRA coverage is for a limited time, plus it may be more expensive than coverage bought through one of the exchanges, where you should have multiple policies to choose from and you may be eligible for subsidies. One other tip: If you have a high-deductible health plan, build up your health savings account (HSA). It’s a good way to cope with “what if” medical bills and premiums.

6. You can’t pay your credit card bill. Charging the minimum to your credit card each month is the best way to avoid this pitfall. Sometimes, doing without a few discretionary expenses is better than charging too much and not only risking your credit score, but also wasting money on credit card finance charges. Keeping your balances low also provides flexibility if you have to use credit to cover a financial emergency.

7. You’re hit with a major repair bill. Perhaps the car breaks down. Perhaps the roof needs to be replaced. It’s the same old admonishment: You need an emergency fund. Even if you have a job or a healthy amount of retirement income, there are unforeseen expenses that can throw your finances off balance and cause you to pull out that credit card. It’s much better to have a cash reserve to call on.

8. You’re unprepared for retirement. Perhaps because of a layoff, a cut in pay or the elimination of your employer’s 401(k) match, you won’t have enough retirement income. Is there a plan B? You shouldn’t be making that determination at the time you retire. Instead, you need time to make adjustments along the way. Increasing savings is the No. 1 option. You might sock away any year-end bonuses or overtime pay. You might also take a part-time job in retirement or find a way to turn a hobby into income.

“Frugality, my dear, frugality, economy, parsimony must be a refuge,” John Adams wrote to his wife Abigail in 1774, while away at the first Continental Congress and unable to find legal work. Adams also suggested Abigail eat more potatoes. Interestingly, Adams died with a substantial estate, while the high-living Thomas Jefferson died virtually bankrupt.

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include Despite Myself, Battle Over Benefits and Side Effects. Follow Dick on Twitter @QuinnsComments.

Limited time offer: Get the audiobook version of Jonathan Clements's "How to Think About Money" at the special pre-release price of $12—a 40% savings. For more information, click here.

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Death by Lifestyle

I LOVE BOOKS by Bill Bryson. If you haven’t read his latest, The Body: A Guide for Occupants, you should.

It’s an encyclopedia of the wonders of the human body. The overriding message, jumping out of every page, is how truly miraculous our bodies are.

Did you know, for example, that you are made of seven billion billion billion atoms? That if you laid all the DNA in your body end to end it would stretch 10 billion miles, beyond the orbit of Pluto? Or that your brain churns through more information in 30 seconds than the Hubble Space Telescope has processed in 30 years?

In many ways, the book is reassuring. The body is a master of self-defense. It’s estimated, for example, that every day between one and five of your cells turns cancerous, and yet your immune system captures and kills them. “There are thousands of things that can kill us,” writes Bryson, “and we escape every one of them but one.”

Just at this point in history, though, the human body seems rather fragile. The coronavirus just took my mother’s sister. She battled bravely in hospital for three weeks before finally succumbing. None us could be there to comfort her in the suffering of her final days. Thank goodness for the love and care of our medical services.

Auntie Joan was age 86. The vast majority of people who have died from COVID-19 have been over 75. But no one yet, as far as we know, is immune. The virus has claimed lives from every age group and will continue to do so.

The good news is, most of us will live far longer than our ancestors did. According to The Body, the human heart beats some 32 million times a year. At birth, the current life expectancy in the U.S. is 78.9 years. That equates, on average, to about 2.5 billion heartbeats per lifetime.

For most of our evolutionary history, Bryson explains, the typical human lifespan was nearer the average for mammals—around 800 million heartbeats. The reason we now live three times longer is entirely due to medical advances. The progress of medical science in the last 100 years or so has been astounding.

There is, however, a “but.”

“In 2011,” writes Bryson, “an interesting milestone in human history was passed. For the first time, more people globally died from non-communicable diseases like heart failure, stroke and diabetes than from all infectious diseases combined.”

He continues: “We live in an age in which we are killed, more often than not, by lifestyle. We are in effect choosing how we shall die.”

It’s a sobering thought. But what, you might be wondering, has any of this got to do with personal finance? I’d like to suggest three money-related takeaways from Bryson’s book:

1. Protect yourself — and your loved ones. Coronavirus notwithstanding, it’s increasingly unlikely you will die of an infectious disease. But don’t take unnecessary chances. Keep washing your hands. Make a will. Review your life insurance. Ensure your dependents are provided for in case the worst should happen.

2. Prepare for a long retirement. If medical science continues to develop at the same pace, who knows how long some of us may live? What if you make it to three or four billion heartbeats? Is your nest egg going to be big enough? The single most important thing you can do to avoid running out of money in retirement is to save more now. You should also investigate ways of funding long-term care.

3. To enjoy those savings, look after your health. Most of us need to take better care of our bodies than we do. Adult obesity rates are at or above 35% in nine states. A randomly selected American aged 45 to 54 is more than twice as likely to die as someone from the same age group in Sweden.

Retirement is a chance to have the time of your life. It’s a well-earned opportunity to spend your wealth, visiting places and enjoying experiences you always said you would. But you need to get there first—and to be in sufficiently good health to make the most of those final decades.

To increase your chances of doing that, the simple prescription is to eat sensibly and exercise regularly. You don’t need to run marathons. Just resolve to move more. As Bryson says, “What is certain is that in a few tens of years at most you will cease to move at all. So it might not be a bad idea to take advantage of movement, for health and pleasure, while you still can.”

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. His previous articles for HumbleDollar include Take Courage, Why We Try and Good for You. Follow Robin on Twitter @RobinJPowell.

Limited time offer: Get the audiobook version of Jonathan Clements's "How to Think About Money" at the special pre-release price of $12—a 40% savings. For more information, click here.

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Inflection Point?

MEGA-CAP TECHNOLOGY growth stocks were huge winners during the last bull market and even during this year’s coronavirus crash. But recently, they’ve lagged, while small-cap value companies have posted robust gains.

Indeed, after a decade of lackluster performance, diversified portfolios that contain sizable holdings of foreign, small cap and value stocks have started to perk up. Could mean reversion finally be taking place? Are we at an inflection point?

It could be—or it could be just another twitch in the market, a head fake, as it were. After all, value stocks performed relatively well at times in 2019 and international shares had a great 2017. But those turned out to be just blips on the radar. What makes this time different?

COVID-19 crushed small and value stocks. Those companies were—and are—bearing much of the brunt of the pandemic’s economic fallout. We’re talking about outfits like restaurants, airlines and real estate investment trusts.

Meanwhile, firms that sell online have benefitted from the shift away from physical contact and toward staying at home. In addition, mega-cap technology companies had massive amounts of cash on their balance sheets, so they were able to weather the storm better. The typical American family may not have had an adequate emergency fund, but these companies sure did.

Maybe COVID-19’s stock market drubbing was the final washout after years of underperformance by small, value and foreign stocks. The recent flush also brought about attractive valuations.

According to data from Topdown Charts, U.S. stocks are trading at about 27 times their 10-year average earnings. That’s about one standard deviation above the average since the 1980s. By contrast, foreign stocks are at 14 times 10-year average earnings, or about one standard deviation below the long-term average. What about value versus growth? Like foreign shares, value stocks are at historically cheap levels relative to growth.

Near-term relative returns have also improved. Since mid-March, small-cap value is up 50%, outperforming large-cap growth’s 37% gain. The U.S. versus foreign gap is less startling. But since mid-April, Vanguard Group’s total international stock index fund has beaten the firm’s total U.S. stock market index fund by a small amount.

We often hear that the time to buy is when there’s blood in the streets. The same idea holds true for portfolio allocation decisions. Foreign stocks have seemingly never been more out of favor, while small-cap value sentiment is maybe the worst ever, thanks to COVID-19.

I’m not encouraging anybody to engage in market timing. But I know many U.S. investors suffer from home bias and recency bias, and that’s led them to hold risky, undiversified portfolios focused on large-cap U.S. growth stocks. My point: We don’t know whether this is an inflection point, but it is a warning signal. If you’re one of those folks whose portfolio is all S&P 500 or all large-cap growth, perhaps it’s time to diversify.

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 Getting Back In, Riding the Bear and Stepping Up. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at MikeCZaccardi@gmail.com.

Limited time offer: Get the audiobook version of Jonathan Clements's "How to Think About Money" at the special pre-release price of $12—a 40% savings. For more information, click here.

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My Bad

HUMANS ARE WIRED in ways that, alas, aren’t conducive to achieving our financial goals. Indeed, thanks to research by academics focused on behavioral finance, we now have a much better handle on the money mistakes that many of us regularly make. Want to become a better investor? Here are three insights into ourselves, compliments of behavioral finance:

The illusion of understanding. Once you’re aware of this illusion, you start seeing it everywhere, especially in the financial media.

In his book The Black Swan, Nassim Nicholas Taleb relates what happened in the financial markets on the day Saddam Hussein was captured. Bond prices initially rose, prompting Bloomberg’s news service to post the following headline: “U.S. Treasuries Rise; Hussein Capture May Not Curb Terrorism.” Thirty minutes later, bond prices fell. Bloomberg came out with a new headline: “U.S. Treasuries Fall; Hussein Capture Boosts Allure of Risky Assets.” Same news, two different headlines. Hmmm.

Financial markets are complex. Most of the time, they can’t be explained by a simple headline or story. So why are we drawn to these articles? Because humans are uncomfortable with uncertainty and complexity. We want a simple narrative. We need the world to make sense, to be coherent. The media simply supplies what we crave.

The illusion of understanding is not only powerful, but also dangerous. When we start to believe the stories that we tell ourselves—based on half-baked truths—we greatly oversimplify reality. In so doing, we can fall prey to two biases, one pertaining to the past and the other to the future.

First, we delude ourselves into thinking that we knew it all along. “Of course, the financial crisis of 2008-09 was inevitable. I saw the writing on the wall.” Or perhaps: “I just knew the market was vulnerable in early 2020. If only I had acted on my intuition.” Such hindsight bias prevents us from learning the lessons of the past. It also leads us to regret our earlier actions or inaction.

Second, our simplified narratives delude us into believing that the future is more knowable than it is. I’ll call this the forecast bias. Forecast bias explains why we hang on every word uttered by financial gurus, particularly their predictions. Hindsight bias and forecast bias both feed another of our behavioral shortcomings—overconfidence.

Wisdom begins with intellectual humility, namely understanding the boundaries of our knowledge. We could all learn from the approach of physicist Richard Feynman, who said, “I think it’s much more interesting to live not knowing than to have answers which might be wrong.”

Regression to the mean. In Thinking, Fast and Slow, Daniel Kahneman offers the following bit of wisdom: Success = talent + luck, while great success = a little more talent + a lot of luck.

One of the hardest concepts for people to grasp—but also one of the most important—is regression to the mean. It’s a slippery concept, and also totally counterintuitive. Without delving into statistics, I’ll simply posit the following: Any time the correlation between two events is imperfect, there will be regression toward the mean.

Kahneman relates a story about teaching flight instructors from the Israeli air force. He told them that rewards for improved performance work better than punishing mistakes. (Parents will likely find the same applies to child rearing.) One flight instructor countered that his teaching experience suggested the opposite. The flight instructor observed that, when he praised a cadet’s outstanding performance one day, the next day the cadet’s performance would usually suffer. Meanwhile, if he scolded a cadet for lousy performance, the following day the cadet would show improvement. In other words, criticism led to better performance and praise to worse results.

How does this relate to regression to the mean? Day-to-day performance is not perfectly correlated. Performance = talent + (some) luck. One day a cadet just nails it. The next time he attempts the same maneuver, he is likely to do worse, simply because of regression to the mean. The converse is also true. A particularly bad performance one day is more than likely to be followed by a better one. The flight instructor was finding causality between feedback and subsequent performance where none existed. It was simply a case of regression to the mean.

Seeing causality where none exists, while failing to appreciate regression to the mean, can also be found in the world of investing. For instance, years of outperformance by a mutual fund manager should be followed by years of subpar performance, but that isn’t what we expect. We assign far too much weight to the manager’s talent and too little to luck. Result? We buy funds after hot streaks and sell them after performance inevitably cools, the opposite of what we should do if we understood regression to the mean. We repeat this mistake with asset classes, market sectors and individual stocks. A better understanding of regression to the mean would do wonders for investor behavior.

Narrow framing. How information is framed has a huge impact on how we behave. Humans are narrow framers by nature. We focus on the trees and ignore the forest. This manifests itself in many ways, but I’ll focus on just one example—how we look at our portfolios.

We narrow frame our portfolio in the dimension of time. What do I mean by that? Rather than view our performance over long time periods, such as five or 10 years, we might focus on the monthly statements we receive. Many of us—me included—also look at our portfolio on a daily or weekly basis.

But work by Shlomo Benartzi and Richard Thaler has found that when investors are shown long-term rates of return, they invest more of their retirement savings in stocks. In other words, risk tolerance is directly affected by how frequently we check our portfolio. This effect has been termed myopic loss aversion. By taking a wider frame, we would be more willing to accept greater risk and ultimately garner higher returns.

We also narrow frame when we examine our portfolio’s individual holdings. While our overall performance is certainly of interest to us, we are often drawn to specific holdings, our eyes frequently focusing on the “losers.” This preoccupation is an example of loss aversion: Losing investments give us greater pain than our winning investments give us pleasure.

Loss aversion can lead us to tinker with our portfolio, dumping the laggards and adding to the winners. But the truth is, a well-diversified portfolio will almost always have both losers and winners. This lack of correlation among our holdings—which leads to a calmer overall portfolio—is exactly what we’re seeking when we diversify, but narrow framing blinds us to proper portfolio management. One of the (many) advantages of target date funds: By giving us a diversified portfolio in a single mutual fund, they prevent such narrow framing.

John Lim is a physician and author of How to Raise Your Child’s Financial IQ, which is available as both a free PDF and a Kindle edition . His previous articles include Six Lessons, Risk Returns and  Crash Course . Follow John on Twitter @JohnTLim .

Limited time offer: Get the audiobook version of Jonathan Clements's "How to Think About Money" at the special pre-release price of $12—a 40% savings. For more information, click here.

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