Jonathan Clements's Blog, page 323

Looking for an Edge

EVERY YEAR, when spring rolls around, investment folks trot out a favorite catchphrase: “Sell in May and go away.” This is based on the idea that the stock market lags during the summer, as people go on vacation.

While it may sound hokey as an investment rule, it’s hardly the only one. There’s also the January effect, which says that stocks do better just after the new year. Its cousin, the January barometer, stipulates that the market will have a good year if it has a good January. There’s also an October effect, a Friday effect, a Monday effect and many more. My personal favorite is the Dogs of the Dow strategy, which involves buying the highest dividend-paying stocks in the Dow Jones Industrial Average. Collectively, these are known as stock market anomalies.

Belief in these anomalies is nothing new. In fact, in one of his novels, Mark Twain poked fun at the notion, with one of his characters saying, “October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.”

What should you make of stock market anomalies? Was Twain right to dismiss them as silly folk tales or do they have validity? It turns out that they all have some kernel of truth. For instance, on average, markets have historically performed better in the winter than in the summer, supporting the dictum to sell in May.

Renowned hedge-fund manager Renaissance Technologies has reportedly profited from these strategies for decades. In The Man Who Solved the Market, which chronicles the firm’s history, author Gregory Zuckerman writes, “[The researchers] discovered certain recurring trading sequences based on the day of the week. Monday’s price action often followed Friday’s, for example, while Tuesday saw reversions to earlier trends.” Thanks in part to these strategies, Renaissance has achieved the best track record in the industry. These anomalies clearly shouldn’t be dismissed out of hand.

Still, you need to be careful. Before you base any investment decision on an old adage, keep in mind the following:

Coincidence. Anyone with statistical skills can perform what’s known as data mining, which is to sift through historical data looking for relationships. Invariably, if you look for long enough, you’ll find correlations. But as any statistics teacher will tell you, correlation doesn’t always mean there’s causation.

You might find something that looks like a profitable trading strategy, except it’s just a coincidence. A famous example is the relationship between sunspot activity and stock market gains. Yes, there’s data to back this up, but does that really mean that sunspots somehow cause the market to go up?

As recently as last week, I came across an article showing that the most profitable stocks to own over the summer are those of utilities and technology companies. In this case, and in others, I don’t doubt that the data is there. But if it makes no sense, it’s likely just a coincidence and not a viable strategy.

Friction. Another issue with any strategy like this is what economists call “friction.” If you really want to start buying on Fridays and selling on Mondays, you’ll be incurring significant trading costs. Even if your broker no longer charges trading commissions, there’s the bid-ask spread. On top of that, of course, there are taxes. And all this assumes you have the time and patience to devote to trading.

Probability. With all these strategies, there is the caveat that they work only on average. There’s no guarantee that they’ll work every time. In fact, a Renaissance employee once noted that the firm’s trades are profitable just 50.75% of the time.

This year provides a perfect case in point. Since May 1, when the maxim says you’re supposed to sell, the S&P 500 has gained 13%. The upshot: If you want to pursue strategies like those described above, it isn’t easy. You need to roll the dice a lot of times and put a lot of money behind it.

Persistence. In economics, there’s the “five-dollar bill theorem.” The idea is that you’ll rarely find money just lying on the ground. That’s because someone else will have already picked it up. It’s the same with investment markets. Whenever a trading strategy starts to work, others take notice and jump on board, and that tends to make the profit opportunity disappear. At Renaissance, in fact, employees are reportedly always changing the firm’s models because of this. The upshot: Even if a strategy worked in the past, there’s no guarantee that’ll continue.

What should you do? As always, my advice is to keep things simple. In my opinion, the best investment for most people, most of the time, is a simple total market index fund.

But I’m not an absolutist. As I said, there is an element of truth to most market anomalies. If you want to incorporate them into your portfolio, here are my six recommended precautions:

1. Be sure there’s logic underpinning the strategy. In other words, make sure it isn’t a case of correlation without causation. Please don’t bet on sunspots.

2. Use funds. It’s hard enough to make these strategies work. You definitely don’t want to also be buying and selling hundreds of individual securities.

3. Keep your bets small. Many people—me included—believe that small-cap and value stocks will deliver better performance over time. Still, I recommend just a modest tilt toward these stocks when building a portfolio. Never put all your chips on one corner of the market, no matter how compelling the historical data.

4. Be selective. Some of these anomalies run counter to each other—like putting on a coat and then turning on the air conditioner. Be careful if you’re thinking of adding more than one to your portfolio.

5. Manage taxes. If you’re buying a fund that pursues any kind of active trading strategy, be sure to hold that fund in a retirement account, where there won’t be a tax impact.

6. Be patient. The worst thing an investor can do is to make a bet and then sell out when the bet starts to sour. When you’re betting on anomalies, you should expect periods of underperformance—potentially long periods. That’s another reason to keep your bets small. That way, your losses should never be large enough to force you into selling at an inopportune time.

Adam M. Grossman’s previous articles include Divvying Up Dollars, Less Than the Truth and No, I’m Better.  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 .

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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Knowing Me

DOES OUR PERSONALITY help determine our financial success? It seems it does, or so says academic research.

Psychologists have zeroed in on five key personality traits: extraversion, conscientiousness, agreeableness, neuroticism and openness to experiences. Think of each trait as a spectrum from, say, very conscientious to not at all. Each of us sits somewhere on the five spectrums. Maybe we’re a bit of an extravert, somewhat inclined toward neuroticism, and extremely open to new experiences and ideas.

There’s a host of websites where you can take a relatively quick quiz and get scored on the five dimensions, including FiveThirtyEight, OpenPsychometrics and Truity. You don’t have to pay or give your email address to get the results at these three websites, though Truity has a more in-depth report that’s available for purchase. My scores from the three sites were remarkably similar, so taking just one test will likely suffice. What should you make of the five traits?

Conscientious individuals are organized and disciplined. They don’t leave their clothes on the floor or the dishes in the sink.
Openness measures our willingness to embrace new experiences and ideas. Those who score high in this area tend to be more curious and imaginative, while those with low scores are inclined to resist change and new ideas.
Agreeable individuals aren’t posting snarky comments on the internet or barking at you because you are—or aren’t—wearing a mask. Instead, they’re friendly, trusting, upbeat, concerned about others and slow to criticize.
Folks who score high on neuroticism aren’t necessarily “neurotic” in the colloquial sense. Rather, they struggle with emotions such as moodiness, sadness, anger and anxiety. At the other end of the spectrum are those who are emotionally stable and even-tempered.
Extraverts are the ones you hear talking at parties. They’re exactly what you would expect: They’re outgoing, sociable and enjoy being the center of attention.

No doubt all of us recognize some of these traits in ourselves and in those around us. But I’d pay particular attention to whichever trait seems to be most pronounced. Understanding who we are—and the mistakes we’re inclined to make—won’t necessarily prevent us from messing up, but it’s clearly a step in the right direction.

So what do our key personality trait or traits mean for our career and how we manage money? I pulled insights from a fistful of academic studies, including papers from 2008, 2011, 2012, 2015, 2016, 2017 and 2018. These studies don’t always 100% agree with each other, though their findings largely line up. Here’s what I learned:

Neuroticism is linked to less career and financial success, longer periods of unemployment and lower levels of happiness. Meanwhile, more even-tempered individuals tend to have high career earnings, perhaps because these folks are drawn to more stressful, but also more lucrative, occupations.
Like neuroticism, agreeableness tends to hurt career and financial success. It seems, alas, that nice guys really do finish last. Why? Perhaps those who are most agreeable don’t push hard enough to get pay raises, they’re too trusting of Wall Street salespeople and they simply don’t care enough about amassing money. There’s also evidence suggesting that the most agreeable among us tend to borrow too much and save too little.
Openness to experiences is associated with higher salaries. People who score high on openness may not be as meticulous as those considered conscientious, but perhaps they’re more proactive, tackling work tasks with energy and imagination. Openness may also lead to higher spending, because these folks may be more inclined, say, to go to concerts or to travel.
Extraversion is associated with higher salaries and greater happiness, no doubt because extraverts are good at building strong connections with colleagues and friends. Extraverts also tend to favor riskier investments. But like those who score high in agreeableness, extraverts tend to borrow too much and save too little, perhaps because they’re concerned with outward appearances—the old pitfall of “keeping up with the Joneses.”
Conscientiousness is associated with career and financial success, including lower levels of debt, shorter periods of unemployment and (no surprise here) planning for the future. Indeed, conscientious individuals typically express satisfaction with their life, though they don’t seem to be as happy as extraverts. Still, if the goal is a successful, contented financial life, this appears to be the most desirable personality trait.

Indeed, I suspect that those who are conscientious are likely best able to manage their own money. What if you’re best described by one of the other four traits? You may want to seek out advisors, coaches or mentors to help with your career or your finances, and perhaps both. That said, those who score high in agreeableness should be especially careful about who they turn to for advice. The reason: These folks tend to be too trusting—not always a good idea when dealing with Wall Street.

Latest Articles

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

“Personal finance isn’t about optimizing every dollar,” writes Adam Grossman. “It’s about optimizing happiness and peace of mind. If you’re considering two reasonable choices, you don’t always need to do what the math says is best.”
If you’re new to the stock market, how do you keep yourself from panicking during a bear market? Marc Bisbal Arias discusses the six strategies that have helped him.
“Each state has unclaimed property that it holds, waiting for the owners to come forward,” notes Rick Connor. “I recently found almost $1,000 in my father’s name.”
Looking to get your financial life better organized? Check out the four tips from James McGlynn.
“If you have debt, pay it off now,” advises John Goodell. “If you owe 18% on your credit cards, zeroing out that debt is virtually guaranteed to be the best return you can get.”
What caught readers’ attention last month? Check out HumbleDollar’s seven most popular articles.

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

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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Treasure Hunting

MANY OF US have found ourselves with free time on our hands. I’ve read that folks are filling their days with shopping, baking, exercising and binge-watching TV. May I suggest another activity, one that may prove profitable?

Over the past few years, I’ve found significant amounts of money in unlikely places. These treasures often come not just with monetary benefits, but also great memories. Here are four places to look:

1. Forgotten savings bonds. I’m old enough to remember when paper savings bonds were a common gift for birthdays and holidays. Many companies also had savings bond buying programs, encouraging employees to invest and pitching it as an act of patriotism. If you signed up, the money to be invested was taken out of your paycheck.

Paper bonds were then mailed to you and you’d dutifully tuck them away for the future. I’ve been organizing my financial documents lately and I came across an envelope with a bunch of Series I savings bonds. I entered the required information in the Treasury Direct savings bond calculator and, much to my surprise, found they were worth nearly $10,000. I’ll bet many folks have old savings bonds hidden in the back of desk drawers.

2. Lost assets. Each state has unclaimed property that it holds, waiting for the owners to come forward. I haven’t checked every state, but I can attest to Pennsylvania’s efficiency. I recently found almost $1,000 in my father’s name. There were funds from an insurance company’s demutualization, an old savings account and the return of a security deposit from the Philadelphia Gas Co. Most of these were from the 1950s and 1960s. My father died in 1999, so the funds were divided between my two brothers and me.

A decade or so ago, we also found almost $17,000 in my wife’s aunt’s name. They were shares she received in 1984 from the breakup of the Bell telephone companies.

Searching for and claiming lost assets takes a little effort. You’ll want to try variations on your and your relatives’ names. I’ve seen claims with and without middle names. It helps if you know relatives’ old addresses. Be prepared to prove your right to inherit. We’ve had to supply death certificates and have our signatures notarized.

3. Gift certificates. I recently found several hundred dollars in unused gift certificates. Some were for local restaurants. There were also a few iTunes gift cards. I checked and all are still valid. I’m looking forward to a nice brunch with family after things reopen.

4. Spare change. Perhaps the most prosaic of hidden treasure, spare change is often ignored or forgotten. When my father-in-law died, we cashed in several huge bottles of change. It was about $900, which more than paid for the post-funeral luncheon.

My wife and I have an old coffee can we fill with spare change. Right now, it easily contains $100 or more. While a student at Penn State, our son got involved in THON, a fantastic student-led charity. The charity is renowned for raising millions by collecting change, so we dedicated the contents of our coffee can to that cause. A bit of unused change added up to a nice donation.

I’ve noticed that members of the Greatest Generation often hide cash in their homes. Why? Many were immigrants or the children of immigrants. They also grew up during the Great Depression and knew hard times. If your parents are still around, you might ask if they have a hidden stash. Got a stash of your own? Perhaps you should let your children know—before it’s too late.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles include Taking the Hit, Buyer Take Care and Numbers Game. Follow Rick on Twitter @RConnor609.

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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The Upside of Down

MANY INVESTORS endured their first stock market crash this year. But what if you’ve never before invested in stocks? How do you know what your risk tolerance is—and how do you keep yourself calm?

There are no easy answers. Questionnaires aren’t a great way to find out our risk tolerance. They ask us about hypotheticals when we’re calm, but we act and think differently when the storm hits. Instead, the only sure way to find out our risk tolerance is to weather a storm or two.

As a relatively new investor, I had no idea how I’d react to 2020’s bear market. March gave me my first real test. At the beginning, I struggled not to panic when some of my investments were down more than 50%. As the turmoil continued, however, I did my best to make the most of a painful time, including coming up with strategies to handle my emotions. Here are six of those strategies:

1. Reframe the situation. Market downturns will keep happening. It’s up to us to view them not as losses, but opportunities. Say we bought stocks in January, before the selloff. Why shouldn’t we buy more when shares plunge 30%?

Yes, the market could indeed fall further, but nobody has a crystal ball. We know, however, that stocks are cheaper today than a few months ago—and that they should generate higher returns if we buy at lower valuations. If we were buying when stocks were higher, we should be even more enthused now that prices are lower. If anything, we should increase the amount we invest each month.

2. Consider your time horizon. If we’re investing in the stock market, we most likely don’t need that money for the foreseeable future—maybe not even for decades. Bear markets are temporary. Most of the time, investing in the stock market is the smart long-term choice, especially if we buy at times of crisis. If we’re young, we should be grateful for the chance to buy at today’s lower prices—and that we have many years ahead of us for our stock market investments to appreciate.

3. Focus on the amount you invest. Early in life, the savings we put away matter much more than the investment returns we get, while the reverse is true as we grow older. For instance, if we have $10,000 invested today, losing 30% shrinks our portfolio by $3,000—a hit that we might be able offset with a few months of savings. Fast forward three decades and imagine we have $1 million invested. A 30% drop would knock $300,000 off our portfolio’s value—a loss we couldn’t possibly make up simply by saving more in the months ahead.

4. Remember that your net worth is more than just your stocks. We may have a house, bonds, bank deposits and other assets, as well as our income-earning ability. A 30% decrease in the stock market doesn’t mean our total wealth falls 30%—it’s far less than that.

5. Curate your news consumption. Not all financial content is created equal. We’d do well to dedicate time to reading, watching and listening to advice that calms us and helps us control our emotions, rather than to news that fixates on plunging stocks and forecasts about the end of the world.

As share prices tumbled, I consumed a lot of information that helped me navigate the situation and stay calm. But you might opt to disconnect from the financial news entirely. For extra points, forbid yourself from monitoring your investments on a daily basis.

6. Have a plan. All of the above is easier said than done. Pondering these things before we experience a market crash isn’t the same as living through one, but it helps to prepare us. When the next crisis hits, we may not stick to our carefully drawn up action plan—but we certainly can’t stick to our plan if we don’t have one in the first place.

Marc Bisbal Arias holds a bachelor’s degree in business and economics,  and is a Level I candidate to become a Chartered Financial Analyst. He started his professional career at Morningstar, performing research and editorial tasks, and is currently employed by Dow Jones in Barcelona, Spain. Marc’s previous article was Setting Boundaries. Follow him on Twitter  @BAMarc .

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My Five Truths

MANY MEMBERS of the military live in a crisis-like state. They’re frequently deployed to dangerous places. Their families often have to move every few years.

Today, that sense of crisis is shared by many others. In fact, with 23.1 million Americans unemployed as of April, a government paycheck seems stable by comparison. How can families prep their finances for ongoing economic instability? Here are five of the money principles I advocate in my work counseling soldiers, veterans and their families:

1. Instead of expecting 7% to 10% annual investment returns—which may have occurred historically but will likely be less for the foreseeable future—try reducing your living costs by 7% to 10% and investing the difference. The compounding effect on your family’s wealth will be powerful. You’ll “need” (a word folks use when they actually mean “want”) less to cover your living costs when you’re older, because your expenses will have already come down.

2. If you have debt, pay it off now. If it’s credit card debt, you’re nearly certain to do better paying down that debt than by investing in the stock market. As Warren Buffett recently noted in his surreal online shareholder meeting, we don’t know where the economy or the market is headed in the short term, but the math is irrefutable: If you owe 18% on your credit cards, zeroing out that debt is virtually guaranteed to be the best return you can get.

3. A paid-off house is better than one with low interest rate payments spread out over time. (In fact, I think it often makes sense for Americans to rent not buy, but that’s a different topic). In the recent bull market, when we enjoyed historically low interest rates, I saw many people take out mortgages so they could invest more in the stock market, because they believed stock returns would likely be higher. Often, that leverage works—but sometimes it doesn’t. And when it doesn’t, the results can be scary.

In addition, a paid-off home gives you options that money in the stock market doesn’t. If times are prosperous, that paid-off home means you’re free to pursue the career you want without worrying about a steady paycheck. What if times are hard and you’re laid off? You can write the next sentence yourself.

4. Build an emergency fund equal to three-to-six months of living expenses. For unemployed Americans, right now is an emergency. Don’t think it can happen to you? My personal black swan event: My physician wife’s pay was slashed recently, while she continues to provide care for COVID-19 patients. Anything can happen, so be prepared.

5. If you’re fortunate enough to have the ability to invest in a retirement plan today, don’t get cute with your contributions. Slow and steady wins the race. If the world’s best investors struggle to time the market, we mere mortals are best served by contributing monthly to an S&P 500 index fund. Sitting on the sidelines waiting for the market to drop further will likely mean missing out on the long-term gains that come from investing in America’s phenomenal capitalist engine.

During this year’s Berkshire shareholder meeting, Buffett talked in an unusually somber tone, but his message was clear: Never bet against America over the long term. From my foxhole, I constantly find myself in awe of the people from all over our country with whom I serve. My firm belief: America’s sons and daughters—whether they wear the uniform or they contribute to our country in other ways—will forge a path forward for our nation and our economy, together leveraging our collective talents to great success.

John Goodell is a government attorney who has spent much of his career advocating for military and veterans on tax, estate planning and retirement issues. His biggest passion is spending time with his wife and kids. Follow John at HighGroundPlanning.com and on Twitter @HighGroundPlan. His previous articles include At Ease, Income Isn’t Wealth and Average Is Great. The opinions expressed here aren’t necessarily those of the U.S. government.

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Four Simple Tips

FORCED TO SHELTER in place, I’ve used the time at home to organize my finances. I’d already read Marie Kondo’s Tidying Up. But I needed her new book, Joy at Work, to motivate me to organize my digital life. Sometimes, it helps to have a step-by-step guide to prod you to deal with such drudgery. Here are four tips I used to get myself organized:

1. Consolidate fixed costs. One way to simplify your finances is to put all fixed expenses on one credit card. True, not every bill can be put on a credit card. But I was able to charge a majority of my monthly bills to a single card, including electric and water utilities, phone, Netflix, internet, cable, electronic toll road pass, gym membership, auto insurance and home security.

Result: I have one bill monthly that’s easy to pay, plus it allows me to track my fixed monthly expenses, so I can gauge how much income I need to cover those costs. Earning credit card rewards is a nice bonus. I leave my “essentials” credit card out of my wallet, so it only gets used for this one category of expenses. Meanwhile, I use a different credit card for discretionary expenses, where I also earn rewards.

2. Simplify investment accounts. For the past few years, I’ve had multiple brokerage accounts, so I can compare their research and ease of us, and also to diversify financial institutions, just in case 2008 returned. But the elimination of stock trading commissions has triggered a consolidation among brokerage firms, leaving us with a handful of stronger financial entities that aren’t dependent on commissions. That’s prompted me to move my holdings to one firm. By consolidating, I even received a discount when I recently refinanced my mortgage through that firm—and it means I can monitor the mortgage and my investments through a single website.

3. Organize financial emails. I set up a separate email account to receive all financial correspondence, including monthly utility bills, credit card bills, loans statements, health savings account reports, bank statements and investment account information. My new email address also has the advantage of being spam-free—so far.

Like the idea of a separate email address for financial information? You might give the password to your spouse or children in case you’re incapacitated or die suddenly. I’ve heard too many times that a deceased relative had unknown financial accounts, as well as bills that kept getting paid automatically, because the children had no idea about the deceased’s finances.

4. Track the mail. I still like to get copies of my various bills through the mail. But if I don’t feel like walking to the mailbox—or if I want to know if an important piece of mail has arrived—I check my “informed delivery” account at USPS.com. The post office takes a photograph of every letter and package for law enforcement purposes. Result: I can preview if a bill has arrived, rather than waste a trip to the mailbox. The service is free.

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 Filling the Gap, Four Opportunities and Gifts That Give Back.

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May’s Hits

AS STOCKS RALLIED last month, readers remained intensely interested in the financial markets—or so it seems from the articles they were reading. Here are May’s seven most popular blog posts:

The formula for investment success is very simple: Buy stocks. Diversify broadly. Wait patiently.
“Since the fall of 2018, the stock market has dropped 20%, gained 30%, dropped 35% and then gained 30% again,” notes Adam Grossman. Result? Ample opportunity for investor regret.
Sitting in cash but wanting to buy stocks? Mike Zaccardi discusses five strategies he uses to minimize his anguish when pulling the trigger.
It’s a topic that’s much debated: Should you convert your traditional IRA to a Roth IRA? To find out, take a few minutes to answer Rick Moberg’s five questions.
Want to make better financial choices amid all of today’s uncertainty? Adam Grossman offers 10 strategies.
How can you get the most out of your retirement accounts in 2020? Peter Mallouk lists seven things you should—and shouldn’t—do.
We all make financial mistakes. Dick Quinn lists 10 of his more memorable decisions.

Meanwhile, the two most popular newsletters were No Alternative and Take Heart.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include The Road Back, Look Forward and We Need to Talk.

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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Divvying Up Dollars

IF YOU HAVE a surplus in your household budget, what’s the best use for it? Does it make more sense to pay down debt or to invest those extra funds? With interest rates at such low levels, this is a question I’ve been hearing with increasing frequency.

Suppose your mortgage rate is 3.5%. If you pay down that debt, it’s like earning 3.5%. By contrast, if you invested in the stock market, your annual return would be uncertain. You might earn more than 3.5%, but there’s also the possibility you could earn less—this year being a case in point.

Historically, the U.S. stock market has gained 10% a year, on average. Even if the market did just half as well in future, you’d still be doing better than 3.5%. It seems like there’s an easy answer to this question: The rational choice would be to invest any extra money you have.

That’s the logical answer—and it’s hard to dispute—but I don’t think it’s the only answer. Instead, I see this as a question with a lot of nuance. I would also consider the following five issues:

1. Taxes. If you’re doing a calculation like the one above, be sure to adjust for taxes. Most debt doesn’t carry a tax deduction, but mortgage debt does (up to $750,000, or $1 million for home purchases prior to 2018). That means that, if you itemize your deductions on your tax return, a 3.5% mortgage might be costing you little more than 2%—or even less if you’re in a high federal tax bracket, plus you live in a higher-tax state like California.

Similarly, every investment has a different tax profile: Some stocks issue dividends, while others don’t. And in the bond world, some pay interest that’s subject to income tax, while other bonds don’t. Bottom line: If you’re doing a comparison, be sure to compare apples to apples.

2. Leverage. When I was in school, I remember learning an economic theory called the Modigliani-Miller theorem, which stated that companies should be agnostic as to how they raise money. Whether they issue shares or take on debt, it shouldn’t make a difference, even if that means the company ends up highly indebted. When I first heard this concept, I thought it was crazy, and I still do.

That’s because debt matters. To put it in simple terms, companies with no debt can’t go bankrupt. The same is true of individuals and families. During good times, debt may be very manageable. But this year is a good example of how life can throw financial curveballs. Even when the math says that you’re better off investing, it’s worth reviewing your overall balance sheet and asking whether it would, nonetheless, be worthwhile to reduce your debt load.

3. Liquidity. It’s important to think about your overall debt load, but it’s also important to think about the relationship between indebtedness and liquidity. If you pay down a dollar of debt today, that may give you more flexibility in a rainy-day scenario. But if you keep that same dollar in the bank, you’ll have more flexibility for other things. That might include an unexpected expense or maybe an investment opportunity. There’s no scientific way to strike this balance, but it’s usually prudent to avoid going to either extreme.

4. Personal preference. Let me describe two people I know: I’ll call them Joe and Sam. Joe has lived in the same house for 20 years, and yet he has virtually no home equity. This is intentional, and he’s proud of it. Over the years, Joe has refinanced his mortgage more than 10 times, often taking money out. Joe’s view: With rates so low, he’s happy to continue rolling over this debt, and this gives him the flexibility to use his money in other ways. He plans to do this for as long as he can. In his words, “If I don’t ever have to pay for my house, why should I?”

Now let’s look at Sam. He has also lived in the same house for 20 years. He started with a 30-year mortgage, but has been making extra payments all along and is nearly done paying it off. Who’s right, Joe or Sam? To be sure, you could do the math and maybe prove that one or the other made the better choice. But there’s something else going on, and that’s personal preference.

Some people just don’t mind living with large amounts of debt, while others are the opposite—they dream of not owing a penny to anyone. Most people fall somewhere in the middle. But if you’re clearly a Joe or a Sam, the math might not matter as much as your personal preference—and I think that’s perfectly okay. Personal finance isn’t about optimizing every dollar. It’s about optimizing happiness and peace of mind. To be sure, you shouldn’t make choices that jeopardize your financial security. But if you’re considering two reasonable choices, you don’t always need to do what the math says is “best.”

5. Market valuations. I often talk about the dangers of market timing—trying to predict whether the stock market will go up or down. But there’s a big difference between trying to predict where the market is going and simply reacting to what it’s already done.

If you have a surplus in your budget, you might opt to invest more when the market is down than when it’s flying high. You might do this formulaically, such as tying the size of your investments to the level of the S&P 500, or you could do it informally. Either way, depending on where the market stands, stocks may be more or less attractive—and you might invest accordingly.

Adam M. Grossman’s previous articles include Less Than the Truth, No, I’m Better and A World of Problems.  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 .

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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The Road Back

WHEN I WAS a teenager and bathroom walls were the equivalent of today’s Twitter, you’d often read that “100,000 lemmings can’t be wrong.”

It turns out that the bathroom scribblers were misinformed and that lemmings aren’t, in fact, given to mass suicide. Still, the scribblers’ confidence in the wisdom of crowds was spot on. If 100,000 lemmings did indeed commit mass suicide, there would likely be a good reason.

Which brings us to today’s stock market.

Millions of investors are sending a message: The global economy will soon recover, and corporate earnings won’t be far behind. That doesn’t mean we won’t get many more coronavirus-related deaths. But investors are betting that those deaths won’t stop the recovery, which is why they’ve bid up the stocks in the S&P 500 by 36.1% since the March 23 low.

These investors may collectively be wrong, but I’m not inclined to argue with them. Their combined grasp of the economy is undoubtedly far better informed than anything I could muster sitting here at my dining room table. The upshot: Amid this remarkable rally, here are five things I wouldn’t do:

1. Don’t doubt the recovery. The market’s rise may reflect the collective wisdom of millions of investors, but there have been naysayers every step of the way, and that’ll continue. The media loves a good debate, so bearish strategists and money managers will get a fair amount of airtime.

And every so often, they will seem prescient. We’ll have bad days and weeks in the stock market when news about the economy or COVID-19 disappoints. Indeed, the speed of the economic recovery remains a huge unknown—and developments that suggest it might be slower than expected will dent share prices. But the setbacks will likely prove temporary. The issue isn’t whether the economy and hence the stock market will recover, but when.

2. Don’t sell too soon. After the stock market’s shellacking over the four-plus weeks through March 23, many investors are no doubt relieved to have recouped much of their losses—but also fearful that the rally could go into rapid reverse. Tempted to sell? Blame it on the old “get even, then get out” mentality.

To be sure, a little selling could be justified. If your portfolio targets are 60% stocks and 40% bonds, and you rebalanced back to those percentages earlier this year when share prices were depressed, you likely now have significantly more than 60% in stocks—and you’ll want to rebalance at some point. I can’t tell you when’s the best time to do so. It’s a tradeoff: Postpone rebalancing and your portfolio will perform better if today’s rally continues, but you’ll also suffer more if share prices falter.

Of more concern to me are those who, both scared and scarred by this year’s slump, decide to radically reduce their stock holdings now that they feel they’re back to even. We got a taste of stock market risk earlier this year: If folks sell now, they’ll have suffered through that risk—without ever getting their long-run reward.

3. Don’t bet only on the S&P 500. On this one, I feel like a broken record. For the past decade, owning the large-company stocks in the S&P 500 has been pretty much a one-way ticket to wealth. Even this year’s bear market was surprisingly painless: Yes, the S&P 500 fell 33.9% from peak to trough, but it now sits just 10.1% below its Feb. 19 all-time high. Other areas of the global stock market have been punished far more.

Will large-cap U.S. stocks continue to dominate—or will smaller U.S. companies, emerging markets or perhaps developed foreign markets shine over the next decade? U.S. small company stocks—especially small-cap value—have posted impressive returns during the recent rally, and some think this might herald a long-term resurgence. Will it? I have no clue, and nor does anybody else. Faced with our lack of clairvoyance, the smart move is to diversify, making sure we have a healthy sum in both foreign markets and smaller U.S. stocks.

Not inclined to diversify globally? If your only stock holdings are the S&P 500 companies, ask yourself, “What would be the consequences if I’m wrong?” Over the past 90 years, U.S. stocks have outpaced foreign shares in four decades, while international markets had the edge in the other five.

If you look at each of the nine decades, the performance gap between U.S. and foreign stocks ranged from 1.4 to 13.9 percentage points a year. In other words, you could invest solely in U.S. stocks and risk massive underperformance over the next decade—or you could own a globally diversified portfolio and have greater confidence that your returns will be respectable, no matter which parts of the global market sparkle.

4. Don’t look at valuations. In 2019, the S&P 500 companies generated reported earnings of $139.47. This earnings figure is adjusted so it’s comparable to the level of the S&P 500 index, which closed yesterday at 3044.31.

For 2020, the folks at S&P Global are expecting reported earnings of $93.88, a 32.7% decline from 2019’s level. If the stock market simply treads water for the rest of this year, its price-earnings ratio would leap to 32.4, well above the 50-year average of 19.4. That shouldn’t frighten you (but I’m sure some bearish commentators will try). If all goes well, corporate earnings will recover in 2021—and surpass 2019’s level.

5. Don’t get too comfortable. While I think stocks remain the best bet for long-term investors—and my hunch is that diversifying beyond the S&P 500 will pay dividends—I’m still surprised at the strength of the current rally and that the S&P 500 is down just 5.8% for the year to date. Think about that 32.7% hit to company profits. That’s a big chunk of corporate earnings that shareholders won’t benefit from—and which arguably justifies today’s lower share prices.

To be sure, we shouldn’t look at stocks in isolation. In 2020, interest rates have fallen to rock bottom levels, making bonds and cash investments an unappealing alternative. Indeed, I think a globally diversified stock portfolio will handily outperform bonds and cash in the decade ahead. But make no mistake: As bad corporate news trickles out the in the months ahead, there will be days when that forecast looks utterly foolish.

Latest Articles

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

“The best measure of performance is whether you’re on track to meet your own financial goals—and that means you should worry less about how your portfolio matches up against some arbitrary benchmark,” writes Adam Grossman.
What’s so great about real estate investment trusts? Gary Karz offers seven reasons to overweight them in a portfolio.
“Investing will fill all the time you’re willing to give it, and yet it can also be done—and often done better—with relatively little effort,” says Bill Ehart.
When John Goodell’s army friend died from injuries suffered in Afghanistan, he had just decided to get divorced. But he hadn’t yet changed the beneficiary on his life insurance.
“Financial freedom is frugality, multiplied by simplicity, compounded by patience,” writes Sanjib Saha, who explains how to work this formula to your advantage.
Modern Portfolio Theory. The VIX. The Nobel prize in economics. Impressed by such things? Don’t be, says Adam Grossman.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Look Forward, Take Heart and No Alternative.

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.

The post The Road Back appeared first on HumbleDollar.

Averting My Gaze

“TAKE FIVE” is jazz great Dave Brubeck’s most popular and enduring number—but it’s also a darn good piece of decision-making advice.

A few weeks ago, my son was struggling with exams and papers ahead of his graduation from the University of Pennsylvania. Though he would go on to graduate magna cum laude, he was in a dark place. I said, “Imagine a time two weeks from now when you’re back home and can relax, recharge and rethink.” 

That’s when it hit me, and not for the first time: My advice was best directed at me. I needed a break from the stock market drama of the past three months. As of this writing, I’ve gone two weeks without checking my portfolio or even looking at where the market closed. Along the way, here are five things I’ve learned:

1. In obsessing over the market, my main motivations had been ego, greed, anxiety and a hunger for instant gratification. It’s not like I’m ever going to make a name for myself as an investor. Yes, I have an obligation to invest shrewdly, but that doesn’t mean I should vainly devote my life to it.

Shortly before taking my sabbatical, I (for the umpteenth time) toted up the value added from all my efforts to buy the March dip and then later reposition my portfolio, taking profits in some cases. All that stress—Is this the bottom? Is it a dead-cat bounce?—and countless hours of analyzing investment options had added less than one percentage point to my portfolio’s value.

Don’t want to tie your identity to your investment results? Trust me, it’s a lot easier to separate the two when you stop counting your money every day. 

2. If you let it, the market will drive you nuts. Investing will fill all the time you’re willing to give it, and yet it can also be done—and often done better—with relatively little effort.

Through Yahoo Finance, I track a portfolio of the exchange-traded funds (ETFs) I own, as well as many that I don’t. My conceit: By following corporate bonds, real estate investment trusts, Treasurys, emerging and developed foreign market stocks, and so on, I can be ready to pounce on the best opportunities. 

How far are corporate bond ETFs from their 52-week highs? Is now the time for a little more credit risk?

Throughout the day, I was scanning my list of two dozen ticker symbols, sometimes more than once per hour. But you know what? Opportunities to adjust exposure to different asset classes based on performance cycles or valuations unfold not over days, but years. If you see yourself as an opportunistic investor and want to play such cycles with modest allocation adjustments, you probably don’t need to check more often than once every three months.

3. Ignoring the market reinforces buy-and-hold discipline and reduces the temptation to second guess yourself. If you aren’t a trader—and none of us should be—you have no need for constant updates on things like whether the developed foreign market small-cap ETF you just bought is outperforming the emerging market small-cap ETF you sold to buy it. How about you give it a look in six months?

4. It’s easier to multitask when you have one less task to worry about. Many of us are working from home. But that means we’re often juggling several work projects at any given time, along with responsibilities to children and parents and friends and pets and communities. Constantly checking the market left me feeling like I was barely touching the surface of the rest of my life.  

5. Eventually, you find more productive uses for your time. After a few days, the awkward moments when you’re holding your cell phone, wishing you could check the market, begin to pass. There are essays on current events to read, friends and family to chat with, projects to do, walks to take.

No, during my market sabbatical, I haven’t written War and Peace. I couldn’t even finish reading it. But hey, I wrote what you just finished reading. And look at that—the sun is out.

William Ehart is a journalist in the Washington, D.C., area. Bill’s previous articles include In and Out, April Fool and Different This Time . 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 .

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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