Jonathan Clements's Blog, page 335

Don’t Lose It

HERE’S THE LEAST surprising thing you’ll read this week: You can’t control the financial markets. They’re driven by news—and we simply don’t know what news we’ll get in the weeks and months ahead, whether it’s about the spread of the coronavirus, its impact on the global economy or something else entirely.

But don’t despair: There’s also much that we can control, including how much we save and spend, the amount of investment risk we take, how much we pay in investment costs, our portfolio’s tax efficiency and—most critically at a time like this—our own emotional reaction to market ups and downs.

Indeed, if you were going to design a laboratory experiment to test investors’ mettle, this past week would provide a nearly perfect template. Think about it: We have a virus without a vaccine that’s spreading rapidly—but nobody knows how rapidly—which is damaging the global economy—but nobody knows how badly—at a time when many U.S. stock investors were already anxious after an extraordinarily long bull market that has pushed valuations to worrisome levels.

Feeling unnerved? It would be shocking if you weren’t. Think about all the ways that this year’s market action has messed with our heads.

Recency bias. In 2019, the S&P 500 stocks were up an impressive 28.9%, excluding dividends. This year, they’re down a fairly modest 7.8%. Which number are we focused on? You already know the answer. Instead of celebrating the huge gains enjoyed over the past decade, investors are fretting about the relatively modest losses suffered this year. Our thinking, alas, tends to be heavily influenced by whatever’s happened most recently.

Extrapolation. The S&P 500 has given up 12% over the past six trading days. The temptation is to take the past week’s losses and extrapolate them into the future. But that would be a classic investor mistake: We imagine we can forecast returns simply by looking at past performance.

Loss aversion. Recent stock losses—and our sense that more damage may lie ahead—is enough to cause many folks to panic. We simply loathe losing money. Indeed, experts in behavioral finance suggest we get at least twice as much pain from losses as pleasure from gains.

Anchoring. As of yesterday’s market close, the S&P 500 had fallen back to levels last seen in mid-October. If somebody had told you in mid-October that U.S. share prices would tread water for the next four months or so, you likely would have shrugged. But instead, we’re anchored on the S&P 500’s Feb. 19 all-time high and the 12% decline since then.

Hindsight bias. Because the current bull market has lasted so long and because stock valuations have been significantly above historical averages, many investors have been expecting a bear market for many years—and they’ve been badly wrong. Despite that, there’s a risk that these folks will decide they predicted the current market decline. That, in turn, may bolster their confidence in their own financial acumen, leading them to make big investment bets.

Unstable risk tolerance. Will those big investment bets involve stashing more in stocks or bailing out? Which way folks jump will likely depend, in part, on how recent market action has affected their tolerance for risk. In theory, we’re supposed to figure out how much risk we can stomach and then build a portfolio that reflects that. In practice, our appetite for risk tends to rise and fall with the financial markets—and right now a lot of investors are likely discovering they aren’t nearly as brave as they imagined.

Illusion of control. Faced with danger, often our instinct is to act. That can make us feel more in control of our destiny—but it may not be good for our financial future. Most of us hold a portfolio built to help us pay for retirement and other goals in the decades ahead. Should we mess with that investment mix simply because of a few rough days in the market? To ask the question is to answer it.

Latest Articles

HERE ARE the six other articles published by HumbleDollar this week:

“When an advisor asks about your risk tolerance, think seriously before answering,” says Richard Quinn. “What actions did you actually take during the stock market collapse of 2008-09?”
If you’re itching to make some short-term trades in response to the stock market’s plunge, Mike Zaccardi has two pieces of advice.
What should investors do amid the coronavirus, economic uncertainty and wild financial markets? Here are five thoughts.
Looking to budget for a wedding, vacation, housing or some other goal? As Rick Connor discovered, there’s a free spreadsheet available for that.
“There’s no question that U.S. valuations are higher than those in other parts of the world,” says Adam Grossman. “But that doesn’t mean there’s a mathematical certainty that U.S. valuations will fall.”
Bitcoin could be worth far more than today’s price—but first it has to solve some key problems, says Mike Zaccardi.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Four Questions, Rule the Roost and Nobody Told Me.

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Know Your Demons

I’M WRITING this just before 6 a.m., following a few days during which world stock markets caught their own version of the flu. Frankly, I can’t sleep thinking about what’s happened—and especially about the investors who panicked and locked in their losses, just like so many folks did in late 2008 and early 2009.

It took me a few minutes to muster the courage to look at my 401(k). When I did, there was no shock: Yes, my balance had dropped. Then I checked the difference from Jan. 1. It’s hardly changed. Perhaps I’ll sleep tonight.

My good fortune—so to speak—resulted from my mix of 40% stock funds and 60% bond funds. I’m 76 years old and have been retired 10 years, but I don’t rely on my 401(k) for income, because I have a pension, as well as Social Security. I like growth, but I dislike going backwards even more. Hey, this diversification thing seems to work.

My 401(k) is less than half my investment funds. The rest includes a few stock mutual funds, two utility stocks and some municipal bond funds. An expert looking at my investment choices might have a “what is he thinking?” moment. I’ll admit to running on instinct. Still, my seat-of-the-pants strategy has allowed my 401(k) to grow by more than 50% since I retired, even after those darn required minimum distributions.

Could I have done better? Perhaps. But I could also have done far worse.

Few retirees these days are in the desirable position of living on a pension and Social Security. Likewise, not many people would follow my investment strategy, nor should they. When it comes to investing, especially the retirement kind, we’re all unique. The guidelines for investing that use things like age and years to retirement are fine, but they don’t consider the illogical factors that influence all of us. I once blindly followed professional advice, and my wife and I ended up with some deferred annuities that I still don’t fully understand.

That said, I believe most people could benefit from some professional guidance. But you need an advisor who understands you—and you need to understand yourself:

When an advisor asks about your risk tolerance, think seriously before answering. What actions did you actually take during the stock market collapse of 2008-09? Did your actions match your supposed risk tolerance? My sense is that most investors have very little tolerance for seeing their money disappear, regardless of what they claim.
Walk away from any advisor who doesn’t take the time to understand you personally before he or she makes investment recommendations. Even if the advisor’s suggestions are perfectly logical, they’re no good if they ignore your hopes and fears.
Much of the general advice available is for the average or typical person. If you ever meet one of those, let me know. One size does not fit all. We vary enormously in how we think about money, our spending priorities, how we define necessities, and what makes us happy and fearful.
Work hard to develop a long-term view of investing. What happens day to day, month to month and even year to year shouldn’t, by itself, trigger investment changes. I still feel employers did a great disservice to their workers when they not only went from monthly to daily valuations in 401(k) plans, but also allowed employees to trade every day.
Above all, keep calm and carry on, whether you’re 26 years old or 76. Panicking at any age can be costly.

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include Brain Meets Money, Count the Noncash and It’s a Stretch. Follow Dick on Twitter @QuinnsComments.

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Scratching That Itch

AS A TEENAGER, I started to invest by buying a boring old target-date retirement fund. But from there, I became an avid watcher of CNBC while studying finance in college. Indeed, my first financial love was technical analysis. Even today, when markets turn volatile, I’m as susceptible as the next investor to turning on financial cable TV to check out the supposed carnage.

Still, as time has worn on, my perspective has grown longer term and away from day-to-day market movements. In the college finance classes that I now teach, I always try to convey to my students the benefits of documenting their long-term financial goals. I encourage them—as well as others—to draw up an investment policy statement that details what their financial goals are and how they plan to reach them.

Yet I understand that many of my students have the same trading itch and market fascination that I had when I was in their seat. Do you feel the urge to “play the market” every so often—and especially right now, amid the whole coronavirus scare?

Let’s start by putting things in perspective. The typical year sees at least a few daily drops of 2% or more, while the average peak-to-trough decline for U.S. stocks during a calendar year is 13.8%, according to J.P. Morgan Asset Management’s Guide to the Markets. In other words, what we’ve experienced so far this year is entirely normal.

But we’ve all heard that before—and, depending on how you’re invested, it may not be all that comforting. We’ve seen a wide variation in the performance of different national stock markets over the past two years. While there have been plenty of recent headlines about all-time highs in the U.S. stock market, many international stock funds are down 15% to 20% since January 2018.

Itching to act? I’m not going to preach the extreme and say investors should avoid all short-term trading. Nobody will listen. But I do have two suggestions.

First, if you feel compelled to do some trading, try to confine it to a small portion of your portfolio. That way, if you get it wrong, the damage to your financial future will be limited.

Second, do your trading in a regular taxable account. This runs contrary to conventional wisdom, which says it’s best to confine any trading to a retirement account. The rationale behind conventional wisdom: If you trade in, say, an IRA, you avoid having to report all your investment sales to the taxman, plus you won’t have to pay taxes at ordinary income tax rates on any short-term capital gains.

Nonetheless, I still favor trading in a taxable account—because that way the government shares in the risks you take and you effectively lower the volatility of your returns. How so? If you have realized gains, you will owe taxes on those gains, which will reduce your profit. But if you have realized losses, it isn’t quite as bad, because you can offset those losses against any realized capital gains. What if you have a net investment loss for the year? You can use that loss to trim your taxes on up to $3,000 of other income.

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 were Good as Gold, Keep On Keepin’ On and If Only. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn, email him at MikeCZaccardi@gmail.com and check out his blog at Zmansmoney.com.

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Cheat Sheets

WHEN MY YOUNGEST son graduated college, he had two solid job offers. One would have allowed him to live at home for free and the other was halfway across the country. Guess which one he picked?

In fairness, the job far from home was more interesting to him and provided a great start to his career. I remember him sitting down with his mother and me, and telling us he was planning to move to Texas. We discussed the job, benefits and salary. Then he asked a question I’ll never forget: How do I know this is enough to live on?

I was working in the same industry, so I knew it was a good offer. But that doesn’t tell you what it takes to live in a different part of the country. I asked him to give me a few days to look into it.

My first instinct was to create a budget in Excel and research costs in the Dallas-Fort Worth region. But instead, I searched for existing budget templates—and discovered Microsoft had templates available for free on the web. I downloaded a monthly budgeting template and got to work.

It was logically constructed and easy to use. My son is an IT professional, tech savvy and way smarter than me, so I knew he would easily take to it. It had defined income and expense sections. The expense section was broken down into useful categories and easily customized.

Being an engineer, I had to improve it. I added a separate worksheet that mimicked his future paystub, so he could see the impact of taxes, 401(k) contributions and other deductions—such as those for medical and dental insurance—on his take-home pay. I sent it to my son, and he added data on housing costs, utilities and so on. It showed he would be fine. We used the data to discuss how much to save in his 401(k) and how he should set up automatic transfers to an online savings account. It all worked out well and has led to a successful savings program for him and his wife. The spreadsheet he built to track their wedding budget was a thing of beauty.

Recently, I did a similar search for a budget template. If you go to Microsoft Office’s online portal and search on “financial management,” you’ll find a slew of free templates. They span the range from personal to family to business budgets. With further searching, you can even find templates for specific items, like college, vacations, weddings, and lawn and garden. Many have graphics, so you can quickly grasp what the data show.

There’s a simple but surprisingly effective retirement planner spreadsheet. It takes in standard retirement inputs, projects your nest egg through to retirement and then details the potential annual payout over your defined retirement period. The data is presented in a graph that shows the growth up to retirement and then the drawdown as you spend your portfolio. True, it’s simplistic, but it allows users to rapidly and graphically see the impact of savings rates, rates of return, and delaying or accelerating retirement. That’s plenty of information to help prod a 22-year-old into starting to save 10% or more of income.

I’m a big fan of creating an annual family balance sheet. Sure enough, there’s a simple one ready to use. Have credit card debt? Use this calculator to find out how many months and how much interest you can save by making larger monthly payments.  Getting married? If you search the template section for “wedding,” you not only get multiple budget templates, but also templates for guest lists, save-the-dates, seating charts and more.

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 Choosing Life, Step by Step and What Are the Odds . Follow Rick on Twitter  @RConnor609 .

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Stand Your Ground

IMAGINE the coronavirus caused the U.S. economy to shrink 4%. What sort of drop in share prices might this trigger?

As it happens, we already know the answer. Over the 18 months through mid-2009, U.S. inflation-adjusted GDP slipped 4%. Investors—panicked over what the future might bring—drove down the S&P 500 stocks by a jaw-dropping 57%.

In retrospect, this seems like a bit of an overreaction.

To be sure, late 2008 was a wild time. It felt like the global financial system was on the verge of total collapse. Today, we’re dealing with the same sort of uncertainty, only of a different nature. And investors hate uncertainty.

The fact is, nobody knows how widely the coronavirus will spread, how many people will die, how much it will disrupt the global economy or how long it will take to develop an effective vaccine. Trust me: No matter how much you fret over these issues, you will not come up with answers that will help you make more sensible investment decisions. So what should you do? Amid today’s market mayhem, I’d focus on five key points.

First, if history teaches us anything, it’s that great investment gains go to those who are diversified, optimistic and patient. In other words, if you spread your investment bets widely, favor stocks and have a long time horizon, good things should eventually happen.

Second, everyday investors have a huge advantage over the professional investors who dominate the financial markets. It’s those professionals who have been dumping stocks today and snapping up Treasury bonds, so the yield on the 10-year note is on track to finish the trading day at a record low. Why are the pros selling? Because they’re judged on short-term performance.

But you aren’t. You won’t be meeting with clients later this year, who will ask you to justify the investments you own. In fact, the only person who might call you to account is your spouse, and he’s probably clueless. That’s a huge plus: If you’re happy with your portfolio, you can sit tight and wait out the storm, no questions asked.

Third, the only folks who should feel any pressure to sell are those who have money in the stock market that they’ll need to spend in the next five years. If you’re in that camp, you’ve clearly made a mistake by investing short-term money in long-term investments. Should you lighten up tomorrow, next week or next month? I have no clue, because I can’t predict the market’s short-term direction—and nor can anybody else.

Still, things could be far worse. Which brings me to my fourth point: If you do need to sell, you’re likely pocketing handsome gains. As I type this in the middle of Monday’s trading day, the S&P 500 is back to around where it was on Jan. 31. This is not exactly a bloodbath. In fact, the S&P 500 is still up some 380% since the March 2009 market low—and that excludes dividends. Planning to sell? You shouldn’t fret over your market losses. Instead, worry about how much you’ll lose to capital gains taxes.

Finally, if today’s uncertainty over the coronavirus drags on, expect the stock market to overreact, just like it did in 2008 and early 2009. The short-term results will be painful. But the long-run gains will likely be bountiful for those who stand their ground and courageously continue to buy.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Four Questions, Rule the Roost, Nobody Told Me and Great to Gone.

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Good as Gold?

MY THREE FAVORITE words in response to questions about investing and trading: “I don’t know.”

Nothing underscores that sentiment more than bitcoin and other cryptocurrencies. I work on a trading floor, where it pays to have an opinion on just about every tradable asset. But I’m the oddball on the floor. I roll my eyes when I hear blanket market predictions and the latest hot stock tip. I’m even on a personal crusade to remove CNBC from the TVs at work. But let’s leave that for another day.

I don’t have money on the line in bitcoin or any other crypto. I don’t have even mild feelings about where bitcoin is headed. I do, though, have a keen interest in investments. After all, I’ve dedicated years of my life to learning security analysis and portfolio management.

I find that while I have little interest in picking stocks or other assets for my own portfolio, due to my awful behavioral biases, I actually enjoy going through the grunt work of analyzing data and trends to come up with investment recommendations for others. I feel I’m less biased when I don’t have skin in the game.

So what does the future hold for bitcoin? I take a fear and greed approach to fundamental analysis, then weigh the evidence to come to a conclusion. Let’s start with fear. I have three concerns with cryptocurrencies:

Volatility. There needs to be some form of stability, or at least a cushioning mechanism in place, so individuals have confidence they won’t wake up one day to find their net worth down 20% simply due to trading action.
Security. In the crypto world, there have been too many instances of accounts being hacked and even an entire exchange going kaput. Perhaps the blockchain can help with this down the road, but we don’t appear to be there yet.
Consolidation. There are too many digital currencies out there, and there seems to be a new one every few weeks. The market needs to settle on which are legitimate.

If you recall from your econ 101 days, there are three facets that define a currency: as a medium of exchange, as a store of value and as a unit of account. For cryptocurrencies to truly take hold, arguably they need all three qualities:

Medium of exchange. I find it ironic that the most fervent investors in bitcoin are also those least prone to using the currency as a medium of exchange, because doing so is essentially selling. Think about it: You have three bitcoins and you want to buy a new car. You must sell the digital currency and buy the car.

Obviously, we have not yet reached the stage where you can simply walk up to a merchant and pay with bitcoin. Maybe there are a few who are accepting payment with crypto, but let’s just say I can’t yet visit Target and buy my weekly groceries with bitcoin.

Store of value. A benefit to a cryptocurrency is that it isn’t physically perishable. Still, we have seen instances of bitcoin vanishing from people’s accounts, so I don’t think it yet counts as an adequate store of value.

Unit of account. Maybe bitcoin meets this hurdle. Maybe. We can quote the cost of an item in bitcoin. For example, in my new car reference above, a fully loaded Toyota Camry might cost upward of three bitcoins. The problem is, a month from now, it may be two bitcoins or four. Quite a swing. That kind of volatility can exacerbate buyer’s remorse and create other behavioral traps. I know I’d feel awful if I exchanged bitcoins for goods and services, only to see bitcoin double in value over the next few months.

Now, let’s analyze the greed aspect of bitcoin. The adoption of a new technology has been described as having five stages. As investors, we want to make money, which means we want to be early to the party—and we want to be confident that the party is far from over.

If bitcoin can solve the issues outlined above, there will likely be significant price appreciation. How much appreciation? Cryptocurrencies don’t pay dividends or generate free cash flow. The financial analyst in me gets frustrated knowing there’s no discounted cash flow valuation to do.

We can, however, approach the valuation question by comparing cryptocurrencies to other assets. With bitcoin’s current market capitalization near $180 billion—and the entire crypto market cap at around $250 billion—bitcoin is worth about 2% of gold and barely registers when compared to all the money in the world.

Bitcoin is also worth a paltry amount compared to the largest companies in the S&P 500. With all the news of the latest “trillion-dollar club” stocks, bitcoin resides far from that psychological round number. It would seem that, if bitcoin gained more legitimacy, it could certainly close the total valuation gap versus gold and other assets.

The move away from metal and paper currency is clearly happening. Just look at Visa and Mastercard. Those companies crushed it during the 2010s, with their stocks returning 545% and 671%, respectively. The next logical step would be for us to carry not physical credit cards, but instead have some form of electronic storage of our credit. But will bitcoin be it?

Mike Zaccardi is a portfolio manager at an energy trading firm and a finance instructor at the University of North Florida. He also works as a consultant to financial advisors on an hourly basis, helping with portfolio analysis and financial planning. Mike is a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. His previous articles were Keep On Keepin’ On and If Only. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn, email him at MikeCZaccardi@gmail.com and check out his blog at Zmansmoney.com.

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Don’t Tinker

“FOLLOWING the market’s recent banner year, should we just sell everything and get out?” I got that question recently, and it’s entirely understandable. Since hitting bottom in 2009, U.S. share prices are up fivefold, including the S&P 500’s 31.5% total return in 2019. 

Individual investors aren’t alone in asking this question. A few weeks back, at an industry conference, James Montier delivered a presentation in which he compared the U.S. stock market to “Wile E. Coyote—the hapless adversary of Roadrunner—having run off the edge of a cliff only to realize the ground is no longer below his feet.”

Montier is no armchair critic. A senior strategist at the investment firm GMO, his presentation was thoughtful and well argued. His message: Get out of U.S. stocks, where valuations are “in the realm of disbelief,” and move your savings into emerging markets and other assets, where prices are much more reasonable. That, he noted, is exactly what his firm has done, owning “essentially zero” U.S. stocks. Montier supported this argument with detailed facts and figures.

As an individual investor, what should you make of these arguments? Is now the time to sell out of U.S. stocks? I have four concerns with this idea:

1. Yes, the market might fall—but it might go higher first. You don’t have to look too far back in history to find an example. Let’s say it’s the beginning of 2017 and you feel that the market is pricey. At that point, it would have been reasonable to predict a downturn. After all, the market had already tripled over the preceding eight years.

Suppose you sold all your stocks at the beginning of 2017. Well, you would have been proved right: The market did subsequently fall. In 2018, the market hit several potholes and was negative for the year. But here’s the problem: When the market dropped in 2018, it fell to levels that were still higher than those at the beginning of 2017. Result: Even if you’d correctly predicted a dip in the stock market, you still would have been worse off. The lesson: Timing is everything—and it’s very hard to time the stock market. History can serve as a guide, but not as a crystal ball.

2. My second concern is related to my first point: What action would you take after selling? Would you plan to buy back in? If so, at what level? And what if you got a repeat of 2017, in which the market did subsequently decline, but not to a level any lower than when you’d sold? You might find yourself stuck in cash while the market continued to march higher.

3. If you sell assets out of your taxable account, what would be the tax impact?

4. Valuation is not a science. There’s no question that U.S. valuations are higher than those in other parts of the world. But that doesn’t mean there’s a mathematical certainty that U.S. valuations will fall or that valuations in other parts of the world will rise.

The reality is, the U.S. is home to a longer list of bigger, more innovative and more profitable companies than anywhere else. Consider just the top five companies by market value: Microsoft, Apple, Alphabet (a.k.a. Google), Amazon and Facebook. You’d be hard pressed to find equivalents of these companies anywhere else in the world, let alone all together in one country.

If you look at other major economies, I think you’ll find good reasons for this. In Europe, cultural norms discourage entrepreneurship. In Japan, they’re contending with a shrinking population. And in China, the government’s posture makes it hard for creativity and innovation to flourish. In other words, I don’t think it’s any accident that the U.S. tends to breed more innovation than anywhere else. Maybe there’s good reason U.S. stocks carry higher valuations—and will continue to do so.

Could things turn out the way Montier is predicting? Certainly. But they might not. What’s important to understand is this: Montier’s argument is perfectly logical, but you could just as easily construct an argument to support the exact opposite view. That being the case, I’d argue the best approach is the simplest: Structure a portfolio that’s sensibly diversified among global markets in a way that acknowledges these uncertainties. Then leave it alone. Unless your financial circumstances change, don’t tinker.

Adam M. Grossman’s previous articles include Adding the Minuses, Believe It or Not and Portfolio Makeover . 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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Four Questions

AFTER YEARS of handwringing, you finally concede that it’s all but impossible to beat the market over the long haul, so you shift your portfolio into index funds. Next up: the truly tough decisions.

Almost every writer for—and reader of—HumbleDollar is a fan of indexing, and there’s no doubt that index funds are a wonderful financial tool. But how will you use that tool? Let the bickering begin.

The differences of opinion show up among the articles we run on HumbleDollar. As the site’s editor, I strive to make sure the pieces we publish are well written and well argued. But there’s no official party line. Consider four burning investment questions:

1. Where should you hold your bonds? Conventional wisdom says bonds should be kept in a retirement account, where you don’t have to pay taxes on each year’s interest. Meanwhile, stocks should be held in a regular taxable account, so you benefit from the low tax rate on qualified dividends and long-term capital gains.

But in a recent, feisty article, Dan Danford took issue with this standard advice, arguing that stocks should be held in a retirement account, because you want to defer taxes on what should be your highest-returning asset. He argued that conventional wisdom is “kind of dumb.”

Earlier this month, Dan got partial agreement from Adam Grossman. Adam noted that holding bonds in a taxable account might make sense for younger investors. That way, the money will be available for unexpected expenses, plus the tax hit should be modest, given today’s tiny bond yields.

While I have great respect for both Dan and Adam, I’m sticking with conventional wisdom. The fact is, if you buy and hold broad stock market index funds in a taxable account, you get tax-deferred growth—just like you would with a retirement account—and, should you sell, those sales will benefit from the preferential long-term capital gains rate.

On top of that, if you hold these investments until death, your heirs will get the step-up in cost basis, thus nixing the embedded capital gains tax bill. Indeed, now that the SECURE Act has killed off the stretch IRA for almost all beneficiaries, except spouses, saving your taxable account for your heirs is looking like a much smarter strategy.

2. Should you even own bonds at today’s tiny yields? Back in October, Bill Ehart sang the praises of balanced funds, which typically hold 60% stocks and 40% bonds. Adam Grossman doesn’t believe a 60-40 mix is right for everybody. But in January, he made a strong case for owning U.S. government bonds, even at today’s low yields, because they’ve consistently proved to be a great diversifier for stocks. I’m inclined to agree with Bill and Adam, though I prefer to limit my interest rate risk by favoring shorter-term bond funds.

Last week, however, John Yeigh countered that he has little appetite for bonds at today’s low yields. Instead, he favors substituting cash investments. What if you’re retired? John advocates keeping enough in cash in to cover three-to-five years of portfolio withdrawals, and then stashing the rest in stocks.

3. Is it okay to stray from 100% index funds? My investment portfolio is entirely in index funds, with the exception of an inflation-indexed bond fund. (I know, I know, it’s confusing: The bonds are indexed to inflation, but the fund itself is actively managed.) When I was at The Wall Street Journal and then at Citigroup, I owned a little company stock. But other than that, I haven’t bought anything but mutual funds for two decades.

Other HumbleDollar writers are less dogmatic. John Yeigh has a thing for dividend-paying stocks and writing covered calls. Sanjib Saha has also dabbled in options. Adam Grossman has occasionally offered guidelines for those inclined to take an investment flier and has noted the value of individual stocks in teaching his kids about money.

Indeed, over the years, I’ve met many index-fund aficionados who stray from the straight and narrow. They might have a “fun money” account for trading individual stocks or they might vary their mix of stocks and bonds, depending on market valuations. And, within reason, I think that’s okay. Messing with 5% of your portfolio isn’t so terrible, especially if it satisfies your urge to play market Nostradamus and it means you’re happy to stash the other 95% in index funds.

4. How much should you invest abroad? I suspect that, if you could peek inside the portfolios of your fellow indexing devotees, you’d immediately be struck by two huge variations in their holdings. First, there would be big differences in the stock-bond mix. That, however, is no great surprise: We’re all at different life stages and have different appetites for risk.

More notable would be the second difference: You’d see enormous variations in the stock portfolio’s allocation to foreign shares. I have roughly half my stock portfolio invested abroad. Why? I believe in piggybacking on the collective wisdom of all investors and, today, investors are saying that U.S. and foreign stocks are roughly equal in value.

But I’m clearly an outlier. For instance, Bill Ehart is 38% in foreign stocks, while Adam Grossman recommends just 20%. Who’s right? If you judge by the past decade’s performance, I’ve badly blundered. And, no, I’m not going to puff out my chest and insist that my day will come.

Rather, I’d ask readers to remember that, while we have only one past, we face all kinds of possible futures—and nobody knows which future we’ll get. Faced with that uncertainty, I favor spreading a portfolio’s investment bets widely. Some of those bets will turn out to be duds and, eventually, we’ll know their identity—but only after the fact.

Latest Articles

HERE ARE the six other articles published by HumbleDollar this week:

“Forget trying to figure out the ideal moment to get in or out of the market,” writes John Goodell. “Instead, what really matters is the time spent sitting around in stocks.”
How much life insurance do you need, what type should you buy and where should you buy it? Rick Connor offers some pointers.
“Just 28% of people with $1 million to $5 million in assets consider themselves wealthy,” notes Richard Quinn, “and yet the median U.S. net worth is $97,300.”
John Yeigh wants to convert IRA money to a Roth. But he also needs to tap his IRA to pay living expenses, and the result is heaps of taxable income. His solution: borrowing against his home.
“I take solace from knowing that not every area of the market is rocketing along like a runaway freight train,” writes Mike Zaccardi. “If they all were, I would feel like a crash everywhere was imminent.”
Got a high-expense mutual fund that generates big tax bills each year? Adam Grossman helps readers figure out the total cost—and whether they ought to sell.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Rule the Roost, Nobody Told Me and Great to Gone.

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Bankrolling Roth

IN EIGHT YEARS, my wife and I will be age 72—and we’ll be locked into required minimum distributions from our retirement accounts for the rest of our lives. Nearly all of our savings are in tax-deferred accounts.

At that juncture, we’ll also have begun Social Security payments. The upshot: Our tax rate will jump significantly and, thanks to the combination of required minimum distributions (RMDs) and Social Security, our income will easily exceed our expenses.

Meanwhile, we have relatively little money in taxable accounts. That means that, each year, we typically have to tap retirement accounts to help cover living expenses. That brings me to our dilemma.

For folks with large tax-deferred accounts, a popular strategy to reduce future RMDs is to convert traditional IRAs to Roth IRAs before those RMDs kick in. But for my wife and me, those Roth conversions could trigger a big tax hit, because we also need retirement account distributions to help cover living expenses, and the one-two punch would push us into a higher tax bracket. To avoid that tax hit, we need to either live like paupers for the next eight years—or find some way to generate cash without driving up our taxable income.

Our solution: borrowing. This is an aggressive yet potentially smart strategy for folks, like my wife and me, who are under age 72, want to make Roth conversions and know they’ll soon have more income than they need, thanks to RMDs. A loan might also allow retirees to delay the start of Social Security payments, thus capturing the 8% annual increase in benefits.

To understand how this might work, let’s say you and your spouse have five years until RMDs begin and, in the interim, you need additional cash to help cover living expenses. You borrow $100,000 against your house, either by taking out a new mortgage or setting up a home equity line of credit.

Let’s assume you opt for a 15-year, fixed-rate mortgage, which today would charge some 3% in interest. To cover the next five years of mortgage payments, you set aside $40,000 from the $100,000 loan and stash it in cash investments. This frees up $60,000 to help cover living expenses.

If, instead, you had to get that $60,000 in spending money from a traditional IRA, you’d need to withdraw around $82,000, assuming a combined 27% marginal federal and state income-tax rate. But thanks to the loan, you can instead convert that $60,000 to a Roth, while also pulling out an additional $22,000 to pay the resulting tax bill—and be no worse off from a tax standpoint.

How does this strategy help you? The Roth conversion has reduced your tax-deferred account balance by at least $82,000 and likely more, because of subsequent investment growth. That means your RMD at age 72 will be reduced by $3,200. This trims that first year’s RMD tax bill by around $900 and perhaps even more if today’s low tax rates sunset in 2026, as they’re currently slated to do. Since RMD withdrawal rates increase with age, the tax savings will likely grow each year thereafter.

The biggest advantage of the strategy: Instead of $82,000 in tax-deferred money, you now have $60,000 in a Roth IRA growing tax-free. On top of that, you won’t have to take RMDs from the Roth, plus the Roth makes a better inheritance for your beneficiaries, especially under the new SECURE Act.

To be sure, at the end of five years, you also have the outstanding mortgage balance of about $71,000. You can pay that down with the RMD distributions you’re now compelled to take, plus the Social Security payments that have also kicked in. And remember, you always have the option to cash in your $60,000 Roth—which, by then, may have grown as big, or bigger, than the mortgage balance.

John Yeigh is an engineer with an MBA in finance. He retired in 2017 after 40 years in the oil industry, where he helped negotiate financial details for multi-billion-dollar international projects.  His previous articles include Losing My Balance, Our To-Do List and Death and Taxes.

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Brain Meets Money

HOW OFTEN DO you think about money? Hey, you just did. Seriously, we think about money every day and sometimes every hour. Some studies say we ponder financial matters even more often than the old standby: sex.

We’ve been thinking about the stuff for a long time. Money goes back about 3,000 years. Paper currency can be traced to China in 700 BC. They didn’t fool around: Their currency stated that all counterfeiters would be decapitated. I’m guessing counterfeiting was rare.

Today, it costs two cents to manufacture a penny and almost eight cents to make a nickel. Result? Each year, we taxpayers lose about $85.4 million on the production of pennies and $33.5 million on nickels.

Gee, at that rate, those of us on Social Security could receive a $2-a-year raise if they made cheaper money. Who needs pennies anyway? Money is no more than a piece of metal or paper—basically worthless, except you can get stuff for it because the people who sell you stuff can get other stuff with the money you give them.

Does money make us happy? Benjamin Franklin didn’t think so. “Money never made a man happy yet, nor will it. The more a man has, the more he wants. Instead of filling a vacuum, it makes one.”

The evidence suggests Ben was right, but try telling that to addicted lottery players. I recall a TV show depicting the impact of winning the lottery on people. Instead of making the winners happy, it often messes up their lives, mostly because they’re ill-prepared to handle the money and because they thought spending would make them happy.

One winner stands out in my memory. He bought several pieces of used heavy construction equipment just to have. He didn’t know the tax withholding on his winnings wouldn’t cover all of the tax he owed. He eventually lost all of his prize possessions and a great deal more to the IRS.

Another family lived in a trailer and, instead of moving, expanded it, bought each child their own ATV and gave each an allowance of $1,000 a month. The kids were ostracized at school and had to leave.

“The conviction of the rich that the poor are happier is no more foolish than the conviction of the poor that the rich are,” offered Mark Twain. Indeed, if you Google the subject of happiness and money, you will find assessments from every point of view. But none concludes that money buys permanent happiness, only fleeting pleasure perhaps.

On the other hand, money can relieve stress—or create it. If you don’t have enough to pay the bills, more money will help. But if you have plenty of money, the fear of losing some may be stressful. One study found that happiness increases with income up to $75,000 per year and then plateaus. Given that the U.S. median household income is about $75,500, is half the population unhappy? I don’t buy it.

At some point, money becomes a game. Most people will never get to that point. But if you have lots of money, adding further to your wealth is simply a mark of achievement. You don’t need more money. Instead, you’re just proving that you can accumulate more.

Our society often equates the accumulation of money with success. Don’t we want to earn more than our neighbor and, if we don’t earn more, should we feel inadequate? I’m not claiming that’s a valid yardstick. But, for better or worse, that’s how many folks think.

Sometimes, you can feel better by giving money away. There are almost 1.6 million nonprofit organizations in the U.S. Most are public charities. Americans give more than $1 billion a day to charity, with some 80% of that money coming from individuals. Is all that giving the result of empathy, guilt or tax deductions? The answer is “yes.”

Our view of money is highly relative. Just 28% of people with $1 million to $5 million in assets consider themselves wealthy, and yet the median U.S. net worth is $97,300.

I’ve never felt wealthy, but the data say otherwise. I do feel fortunate—and I don’t feel guilty about that good fortune, perhaps because it’s taken more than 70 years to reach that lofty status. I try to explain our relative good fortune to my wife, but she isn’t buying it. She’s even more skeptical than I am.

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include Count the Noncash, It’s a Stretch and Going Without. Follow Dick on Twitter @QuinnsComments.

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