Jonathan Clements's Blog, page 369

Rolling the Dice

IN JANUARY 1946, a man named Stanislaw Ulam found himself confined to a hospital bed, having suffered an encephalitis attack. A brilliant scientist and a veteran of the Manhattan Project, Ulam wasn’t the type to sit idly while he recuperated. Instead, after playing innumerable games of solitaire to pass the time, Ulam began to examine the statistical aspects of the game.

Among the questions he asked: How can you accurately estimate the probability of winning a game? To answer this question, Ulam ended up devising a novel statistical technique that he dubbed Monte Carlo analysis. Today, this approach is broadly accepted and widely used in everything from engineering to biology to financial planning to meteorology���and��even basketball.

How exactly does Monte Carlo analysis work? The idea is this: As long as you know the basic dynamics of how something works���whether it’s weather patterns, card games or anything else���you can use a computer to simulate an experiment thousands of times and then simply count up the frequency of various outcomes.

How is Ulam���s technique applied to financial planning? Knowing how the stock market has performed in the past, and the degree to which it varies from year to year, you can simulate the market’s future performance. But instead of focusing on the stock market’s average��annual return, Monte Carlo analysis focuses on average��multi-year returns. This allows financial advisors to reassure their clients with confident-sounding statements such as: ���I’ve tested 10,000 scenarios and can tell you that your retirement plan has a 90% probability of success.��� To see what a Monte Carlo simulation looks like, check out Vanguard Group’s retirement nest egg calculator.

While Monte Carlo analysis is widely used in financial planning, I would advise caution, for two reasons:

1. Subjective inputs. Monte Carlo simulation works well when forecasting physical or mechanical processes���things that act in predictable ways or, at least, within known limits. A card game, for example, can develop in numerous ways. Still, it’s always played with a fixed set of rules and an identical deck of cards. While you don’t know which card will come up next, you do know there will never be five aces in a deck. As a result, the set of possible outcomes is necessarily limited.

When it comes to the stock market, though, the opposite is true: An infinite combination of political and economic events���coupled with human emotions���can drive the market in unpredictable ways. In a card game, it’s difficult to know what will happen next. In the stock market, it’s��impossible��to know. And it’s not just the stock market. Lots of other variables impact the success of a retirement plan, including inflation, tax rates, interest rates and potential changes to Social Security and Medicare.

Try this thought experiment: Tomorrow morning, pick up the newspaper and ask yourself, ���How many of these stories could I have predicted five or 10 years ago?��� Not many, I suspect���and yet that���s what we are doing when we expect Monte Carlo analysis to help us forecast multi-decade retirement scenarios. To be sure, the past serves as a guide to the future, but it’s just��a guide. That’s why any simulation of the stock market rests on shaky ground, simplistically assuming that the future will mirror the past.

2. Less-than-useful output. If the inputs to a Monte Carlo analysis are subjective, the outputs are even more troubling.

First, Monte Carlo output is normally expressed as a percentage���a 90% probability of success, for example���but what exactly does ���success��� mean? It means simply that you won’t run out of money. That sounds logical. Problem is, it���s defined very literally. If a Monte Carlo simulation determines that there will be even $1 left at the end of someone’s life, that is defined as success. For a computer, that may make sense. But for a real person seeing their funds rapidly approach zero late in life, that hardly sounds like a pleasant or successful outcome. But because this is the way Monte Carlo simulations work, they may lull people into a false sense of security or, alternatively, scare the daylights out of them, when neither reaction may be warranted.

The second problem with Monte Carlo output is that, if you dig into the results, it provides a range of potential outcomes so wide that it borders on the absurd. Use a typical Monte Carlo program to simulate the growth of a $1 million portfolio over a 30-year retirement, for example, and it will unhelpfully project that your assets will fall somewhere between zero and $29 million. While this may be statistically accurate, personally I don’t find it very useful.

To be sure, Monte Carlo analysis has its place in scientific disciplines. But when it comes to retirement planning, I would urge you to be skeptical. Always look at the numbers behind the numbers���and never let any one analysis drive your financial decisions.

Adam M. Grossman���s previous articles��include Get a Life,��Higher��Taxes��and�� Moving Target . 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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45 Steps to Success

WHAT DOES a good financial life look like? Here���s a quixotic roadmap���comprised of 45 steps:

Stuff part of your babysitting or lawn mowing money in a Roth IRA. Suggest to your parents that they should encourage this sort of behavior���by subsidizing your contributions.
Get a credit card when you head off to college, charge $5 every month and always pay off the balance in full and on time. You���ll soon have an impressive credit score.
Spend two years���but not much money���at community college, before transferring your credits to the college you want to graduate from.
Live at home for a few years after college, so you can mooch off the free food and accommodation.
Sign up for your employer���s 401(k) as soon as you join, rather than waiting for automatic enrollment to kick in, and stash everything in a target-date retirement fund. Contribute at least enough to get the full employer match. If there���s a Roth 401(k) option, favor that, because the tax-deduction on the traditional 401(k) won���t be worth much at your current modest income.
Skip the new car���and accompanying auto loan���and buy a used car for cash.
Stash money every month in a high-yield online savings account. Think of it as your emergency fund, future house down payment and let���s-not-live-paycheck-to-paycheck account.
Turn down the chance to buy cash-value life insurance from your old high school buddy.
On the third date, steer the conversation to money���and make sure your future spouse shares your financial values.
Ponder which charities you care most about. Get into the habit of regularly sharing a slice of your financial success.
Fund a Roth IRA. Again, stash that money in a target-date fund, choosing one that invests in index funds.
Ask your parents whether you can have a less lavish wedding���and let you use the cost savings toward a house down payment.
Get a will. Change the beneficiaries on your IRA and 401(k). Purchase term insurance. Prod your new spouse to do the same.
Stretch a little to buy a home that���s big enough not just for you and your spouse, but also for the kids you expect.
Now that your latest pay raise has pushed you into the 24% tax bracket, switch your regular contributions from the Roth 401(k) to the traditional 401(k).
As soon as the baby���s Social Security number arrives, open a 529 plan.
Buy more term insurance���enough to cover the kid���s education and pay off the mortgage.
You���re maxing out your 401(k), plus funding a Roth or backdoor Roth every year. Next up: Buy a total U.S. stock market index fund and total international stock index fund in your taxable account.
Take the two kids to Disney. Try to contain your shock at how much it costs.
Buy company stock every year through the employee stock purchase plan to take advantage of the 15% discount���but unload the shares as soon as you qualify for the long-term capital gains rate, because you don���t want the risk.
Add $100 every month to the monthly mortgage check. Think of it as another way to buy bonds.
At dinner, occasionally tell family stories that illustrate your financial values. Talk about how much you earn, where the money goes and how you invest. Ask the kids if they have any questions.
Raise the deductibles on your auto and homeowner���s insurance to reflect your burgeoning wealth.
Remodel the kitchen. Tell anybody who will listen that it���s a terrible investment, but you still think it���s worth it.
Drop some of your term insurance, because you figure that���between the remaining coverage and the savings you���ve amassed���your family would be okay if you went under the next bus.
Talk to your high school freshman about how much you can help with college costs. While you���re at it, discuss how much you���ll assist with other major costs, like the kid���s future wedding and house down payment.
Now that you���re 50, take advantage of catchup contributions to your 401(k) and IRA.
Every year, allocate a little more of your retirement account to bonds.
Get powers of attorney drawn up for both you and your spouse���covering both financial and medical decisions.
Consider buying long-term-care insurance, but then realize that���come retirement���you���ll have enough socked away to self-insure.
Let your oldest move home after college���on condition that the money saved on rent ends up in a savings account.
Use your year-end bonus to pay off the mortgage.
Draw up a list of all the things you want to do in retirement. Stick it on the refrigerator. Revise often.
Drop your remaining term insurance.
Decide you have enough.
Use your early retirement years to convert part of your rollover IRA to a Roth.
Continue to work part-time, largely because you enjoy it���but, hey, those modest paychecks are sort of comforting.
Take the kids and grandkids on vacation. Somewhere other than Disney.
Delay Social Security to age 70.
Write your own obituary. Think about the accomplishments you���re most proud of���and whether there are any more you���d like to add to the list in the years ahead.
Downsize to a smaller home���which forces you to empty the basement. It���s your junk. Why should your kids have to deal with it?
Make occasional financial gifts to your adult children.
Identify a fee-only financial advisor you trust���to help your spouse, should you die first, and as a precaution, in case your mental capacity slips.
Cut yourself some slack: Fly business class.
Hire a local kid to mow the lawn. Advise her to put the money in a Roth.

Follow Jonathan on Twitter�� @ClementsMoney ��and on Facebook .��His most recent articles include Got to Believe,��Labor of Love��and�� Mixing It Up . Jonathan’s ��latest book:��From Here to��Financial��Happiness.

HumbleDollar participates in��Amazon‘s Associates Program, an affiliate marketing program. If you click on this site’s Amazon links and then purchase books or other merchandise, you don’t pay anything extra, but we make a little money. HumbleDollar has no other affiliate marketing relationships.

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Applying Pressure

TO BORROW from the movie Casablanca, we are all “shocked, shocked��� at the college admissions scandal recently uncovered by the FBI. We are seemingly united in condemning the extremes that these wealthy���and sometimes famous���parents went to, as they sought college admission for their children. We���re talking fraudulent inclusion on sports teams, submitting fake standardized test scores and outright bribery.

But the idea of parents gaming the system for their child���s benefit is nothing new to those of us in high school education. Over the past several years, the ���helicopter parents������those hovering and monitoring their child���s every step���have given way to ���steamroller parents,��� who actively intervene to make sure the road to success is smoothly paved and even guaranteed for their scion (while bolstering their own reputation as successful parents).

I���ve seen a wide range of liberties taken in college applications over the years, some egregious, some minor offenses that we now just shrug at and say, ���It���s part of the system.��� Parents have been securing untimed and alternate testing for their children when it isn���t needed, giving them an advantage over kids who take exams under standard conditions. Parents encourage their children to lie and apply for college entrance based on a major that increases their chances of admission, and then later switch. And, of course, people will condemn ���affirmative action��� admissions programs, demanding that they be ���merit based.��� Meanwhile, they ignore the fact that the most common non-merit entrance qualification is a child who wisely chose to be born into a family that had alumni and thus is a ���legacy.���

As a parent, I understand the desire to give your children every advantage, including help getting into the best possible college. But as an economics teacher and as someone who has watched what this gamification does to young people, I caution parents that they aren���t doing a complete cost/benefit analysis in going to such lengths���and the result is often poor, ill-informed decisions.

The benefits aren’t worth it.��Many people are enamored with going to ���the right college.��� But that just doesn���t matter as much as ability. Make a list of the people you admire based on achievement���and then list which college they went to. In many cases, you won���t know and, for the rest, the list is likely varied.

Even attending a well-known school often has less impact than you might imagine. In many fields, such as business or law, having local connections from going to an in-state school proves more valuable than having an Ivy League name on the diploma. Quality education is about a teacher igniting the fire within a student. Sometimes, that���s easier to do in a small classroom in a small school, rather than in a large, impersonal lecture hall in a stately building.

The costs are too great.��Let���s be clear: When parents have their child fake his or her interests, activities, abilities or game the system in some other way, that child doesn���t get into college. Instead, the fake persona does. That student now has to either assume that persona���giving up his or her true self and knowing all advancement is built on a lie���or else have the lie come crashing down later.

And, believe me, children get the message that they, as they truly are, are not good enough. They play along because they are powerless. But I have seen them be frustrated, cry and get eaten up by the realization that, when it counts, their parents insist that ���success��� requires them to not be true to themselves, despite what they have been told by teachers, school counselors and even their parents. It is the essential, summative lesson on choosing between core values and getting ahead.

There���s also the opportunity cost of having your child face rejection, realize the world doesn���t end and then find a ���Plan B.��� In a world where people lament the lack of grit in our young and their inability to figure out a ���work-around,��� perhaps the greatest lesson of the college experience is bypassed by parents who wants to make it easy ���just this once.���

So where do we draw the line? That���s for every parent to decide. Certainly, parents should have a vision of what success looks like for their children, and even encourage and nudge their children toward it. But just like wise investing requires us to be flexible in our goals and the path to those goals, we should be flexible and broadminded in conceiving of our children���s ���success��� and the path that leads to it.

And that���s the objective, isn���t it? Ultimately, it isn���t the parents��� path. Instead, it���s our children���s, so we should let them own it���along with something more valuable than success: happiness in knowing they achieved what they did by being themselves.

Jim Wasserman is a former business litigation attorney who taught��economics and humanities for 20 years. His previous articles for HumbleDollar were Five Mistakes,��Spoonful of Advice��and��Under the Influence. Jim���s three-book series on teaching behavioral economics and media literacy,���� Media, Marketing, and Me , ��is being ��published in 2019.��Jim lives in Granada, Spain, with his wife and fellow HumbleDollar contributor, Jiab. Together, they write a blog on retirement, finance and living abroad at�� YourThirdLife.com.

HumbleDollar participates in��Amazon‘s Associates Program, an affiliate marketing program. If you click on this site’s Amazon links and then purchase books or other merchandise, you don’t pay anything extra, but we make a little money. HumbleDollar has no other affiliate marketing relationships.

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Beefing Up Security

MANY OF US have little more than a weak, reused password standing between our financial assets and a remote attacker���one armed with powerful tools and a database of passwords from security breaches. This is a losing battle. It���s the most likely way for weak computer security to put our finances at risk.

Think this can���t happen to you? I���ll bet you have at least one password taken in a big security breach. A quick way to find out is entering your email address at Troy Hunt���s HaveIBeenPwned site. My address turns up in almost a dozen big cyberattacks.

We are notoriously bad at creating strong passwords and remembering them. When you decide to create stronger, unique passwords for each site, you quickly discover that managing dozens of randomly generated, site-specific passwords by hand is a headache.

Don���t fret. Password managers like LastPass,��Dashlane��and 1Password make short work of it. A password manager puts all your passwords in an encrypted vault, leaving you with just one password to remember. You want to make this��password really��strong and unforgettable. The password manager then fills in the right password for mobile apps and websites whenever you use them.

What can you expect from a good manager?

Up-to-date access to your password vault on all devices, regardless of the device���s operating system.
Updates to your vault as you create new accounts or update existing passwords.
A random password generator that creates really strong, unique passwords. Those passwords will meet each site���s requirements for length and allowed characters.
A security challenge which guides you through the work of replacing existing poor passwords���those which are known to be compromised, weak or easily guessed, or which you���ve used more than once.
Emergency access to your vault by someone you choose, as well as password sharing with, say, family members for your Amazon Prime or Netflix account.
Two-factor authentication for extra vault security.

Some of these are only available in paid versions of the service.

Despite knowing better, I procrastinated in evaluating password managers. That changed the day I tried to picture life for my spouse after I leave this vale of tears. I visualized the chores I handle: Banking, bill paying and investment management all involve online accounts. That brought my password problem into focus. A list of passwords in a binder, next to our wills, isn���t secure and it���s a pain to keep up.

After experimenting with a free trial, I bought a family subscription. Moving my password vault from low-ranked to the top 1% took a couple of weekends. Each weekend, I���d spend an hour or two changing passwords, guided by the security challenge and with help from the password generator. Do this on your home PC or Mac, not an office computer.

I started with high-value accounts: email, cellular carrier, and then banks and brokerages. Why email? Most web sites let you reset a password by emailing a link to the address on file. If hackers have access to your inbox, they���ll use it to access every online account. The cellular account is also important if you���ve enabled two-factor authentication that triggers text messages with secure codes.

What if someone hacks into your password manager���s vault? If you pick a great vault password, the odds of this are low. But when you have all your eggs in one basket, you want to ensure that basket stays safe. That���s what led me to the YubiKey 5��series hardware keys.

When you use a YubiKey with a password manager, the manager encrypts your vault twice, once with your vault password and again with a secret it gets from the YubiKey. For convenience, I���m using two models of YubiKey. I use YubiKey 5 Nano with my PC and Mac. Meanwhile, YubiKey 5 NFC stays on my keyring for use with my phone. The latter should work with an iPhone 7 or newer, as well as an Android phone with NFC (near field communication).

David Powell has written software or led engineering teams for 35 years. He enjoys work, vegan fine dining, cycling and travel with his spouse. His previous article for HumbleDollar was Playing Defense.

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What I Value

A WAR IS RAGING. On one side of this conflict is the individual and, on the other, society and culture. To the victor goes your attention and your money.

I submit you���ll win through intentionality���and you���ll lose if you let society determine what���s of greatest value to you. I was on the losing side for many years.

As an undergraduate, I thought I wanted to be a lawyer. Why? Not because I had a deep passion for the law. Rather, I wanted to dress in flashy suits and attract attention to myself. I thought being a lawyer would help me get there.

Although not through the practice of law, I continued the pursuit of the things that would get me the attention I craved: BMWs, expensive clothes and watches, happy hours and more. Those were the things I valued. I had been programmed.

Now I���m married with a family and my life is almost completely different. Three things catalyzed the change: Within a single month, I moved to southern California, the Great Recession hit and I met my wife.

For me, going from small town Minnesota to Scottsdale, Arizona, was a culture shock. Continuing on to Newport Beach, California, blew my mind. Exotic cars and multi-million-dollar homes, and what appeared to be limitless affluence, made me shake my head in disbelief. I couldn���t understand how so many people could afford that lifestyle. I couldn���t see how it was sustainable for anyone, including me.

With the help of my now wife, I began to realize that my values shape my perspective���and that, in turn, became the lens through which I viewed the world. That was when I began to consider what was of greatest importance to me. What did I believe in? I began to clarify and crystallize my personal values.

I turned age 30 during this process. Today, at age 40, I can proudly tell you that my core values are friendship, justice and learning. It���s through that lens that I make decisions on how I spend my time and money, and what I give my attention to. The result has been greater contentment, better finances and increased overall productivity. I���ve got a long way to go and my desire for learning drives me to continue improving, but I���m on the right track.

If you aspire to be the best steward of your resources and to become the best possible version of yourself, clarifying and crystallizing your values is essential. Like setting goals, too few of us do it���and even fewer write them down. Take the time to put pen to paper. If you don���t, you may be living someone else���s version of your best life.

George Grombacher is the Chief Community Officer of Money Alignment Academy, as well as the host of the Money Savage��podcast.��He works to help people lead happier and more contented lives, with a special focus on money. Follow George on Twitter @GLGrombacher.

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Bracketology

EVERY YEAR, the NCAA basketball season concludes with the March Madness playoffs. Many Americans engage in bracketology���trying to figure out which teams will get knocked out in each round and which will advance. Warren Buffett even offers an annual bracket-picking challenge, where Berkshire employees can win $1 million a year for life.

This year, however, Americans with substantial retirement accounts might also want to try another form of bracketology: studying the 2017 tax law���and asking whether it offers a unique opportunity to convert hefty amounts of traditional IRA money to a Roth IRA.

For most middle-income Americans, the 2017 tax law lowered their marginal income tax rates by three or four percentage points. The rate cuts are great, though there are some offsetting lost tax benefits, such as the new limit on state and local tax deductions and the loss of personal exemptions.

How does all this affect Roth conversions? There are two important considerations. First, suppose you���ve accumulated a sizeable sum in all your 401(k)s, IRAs and similar tax-deferred accounts, including those of your spouse. Once each of you turn age 70��, you���ll be required to draw down those accounts and pay income taxes on the distributions.

For instance, if you have a combined $1.5 million in retirement accounts at age 75, the required minimum distribution (RMD) would be $65,502. Add that distribution to any pension, Social Security and other income, and your total income could rise above $100,000 and move you into higher tax brackets.

That brings us to the second consideration: 2017���s tax cuts are scheduled to end in 2025���and they could disappear after 2020���s election. That means there���s a brief but potentially unique opportunity to take advantage of today���s unprecedented low marginal tax rates.

In 2017, under the old law, a couple filing jointly paid tax at a 25% marginal federal rate once their taxable income was above $75,900. That marginal rate rose to 28% for income above $153,100 and 33% above $233,350. By contrast, in 2019, a couple can have taxable income of up to $321,450 and still be in the 24% bracket. While $321,450 is an income level normally associated with the top few percenters, even those of us with more modest incomes can take advantage of today���s extended low tax rates���by undertaking relatively large Roth conversions. Indeed, relative to 2017���s tax rates, the tax savings for a couple would be nine percentage points on Roth conversions that pushed their incomes into the $233,350-to-$321,450 range.

What if you���re a single individual? The tax savings aren���t quite as impressive, but they���re still large. In 2017, the 25% bracket started at $37,950. This year, single individuals can remain in the 24% bracket with taxable income of up to $160,725.

All this raises a crucial question: Before the current favorable tax rates are potentially rescinded, should you seize the opportunity to convert large amounts out of your traditional retirement accounts? This will trigger up to 24% in federal income taxes on the sums involved���but it will get the money into a Roth, where it���ll grow tax-free thereafter. That could be a savvy move if you suspect that the alternative is to pay taxes at an even steeper rate in later years, especially once you start RMDs.

If you do opt for large Roth conversions, make sure you have enough money set aside to cover the resulting tax bill. Ideally, you should try to avoid dipping into your retirement accounts to pay that bill���and you certainly don���t want to be doing so if tapping your traditional retirement accounts triggers tax penalties as well. Those over age 63 should also remember that a large Roth conversion could result in a potential Medicare premium surcharge two years later.

Beyond the tax-free growth, Roth IRAs offer other advantages: You aren���t required to take RMDs from a Roth IRA. If a Roth conversion today results in less taxable income in retirement, you may also end up with lower future Medicare premiums. What about the tax on your Social Security benefit? If your traditional retirement accounts are so large that your withdrawals could push you into a steep tax bracket, you are���alas���probably destined to get taxed on the maximum 85% of your Social Security benefit, even if you undertake substantial Roth conversions today.

What if you don���t spend down your Roth during your lifetime? There could be one final bonus: An income-tax-free Roth IRA is perhaps the best asset your family could hope to inherit.

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 were Don’t Concentrate,��No Free Ride��and��Other People’s Stuff.

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Head Games

AS I DRIVE around town these days, I notice a lot of cars with temporary license plates���an indication they were recently purchased. What���s the reason? When I turn on the TV, I see a commercial for a local car dealership that���s offering to accept your tax refund as the down payment on a new car. Now it starts to make sense.

The dealership knows consumers are about to receive an influx of cash. It wants to make it as painless as possible to buy a new car. Meanwhile, you���the consumer���view your tax refund as a windfall, making it seem like a painless way to purchase the car you���ve been eyeing for the past few months. I���ve seen furniture stores use the same strategy.

This type of financial behavior is known as mental accounting. Nobel Laureate Richard Thaler defined it as ���the set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities.��� In other words, mental accounting refers to how you assign funds to different categories, often based on the money���s origin. The easiest example: People spend the money in their wallet differently from, say, the money in their savings account.

We use mental accounting throughout our daily lives. There���s nothing wrong with that. In fact, it can help you make better financial decisions���and avoid big mistakes. Here are three ways I use mental accounting:

1. Reinvesting dividends.��Rationally, I should view the dividends I receive from my investments in the same way I view my earned income. But I don���t and, indeed, I don���t give myself the option to spend those dividends. Instead, I reinvest them automatically, so I am purchasing shares throughout the year without any effort. This small step will help increase my wealth over time.

2. Deploying windfalls.��Individuals will typically use a windfall to purchase luxury goods���like the cars I���ve recently seen around town. I���m not going to claim that I���ve never spent a windfall on a luxury good that I normally wouldn���t buy. I am human, after all.

Still, I try to take a thoughtful approach to the windfalls I receive. My favorite strategy is to break them up like this: 25% to my emergency fund, 25% to my investment account, 25% toward a fun luxury and 25% to charity. With this approach, I buy a little happiness���but also bolster my net worth.

3. Bucketing money. My earned income goes directly into my checking account every month. In the days immediately after, I have automatic transfers set up to accomplish several goals, including paying off my credit card in full, setting aside money for self-employment taxes, contributing to my Roth IRA and growing my emergency fund.

Each of these financial accounts is also a mental account. They help me keep my finances organized���and keep me focused on my goals.

Ross Menke is a certified financial planner and the founder of�� Lyndale Financial , a fee-only financial planning firm in Nashville, Tennessee. He���s passionate about helping folks make financial decisions that reflect their true purpose. Ross���s previous blogs include Full Speed Ahead,��Up to You��and��No Money Down. Follow Ross on Twitter�� @RossVMenke .

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Get a Life

IN MY ROLE as a financial planner, I hear a lot of stories. By far the most appalling and upsetting relate to life insurance. All too often, insurance salespeople leave clients with policies that are simultaneously overpriced, inadequate and inappropriate.

Are you evaluating a policy? Here���s a quick summary of the most important considerations:

What type of coverage should I have?��Life insurance comes in two primary flavors: term and permanent. Term insurance, as its name suggests, provides coverage for a fixed term, such as five, 10 or 20 years. Permanent insurance, on the other hand, is designed to cover you for your entire life. You’ll often see permanent insurance referred to as whole or universal life; these are types of permanent coverage.

In virtually every case, I recommend term insurance���for four reasons:

1. Since everyone’s probability of dying within their lifetime is 100%, permanent insurance ends up being��much more��expensive than term. The insurance company knows you���ll eventually die, so it prices these policies accordingly.

2. You probably don’t need life insurance for your entire life. Most people need life insurance only during their working years and only when they have dependents. If you’re retired, with your mortgage paid off and your children out of college, you may not need coverage at all. Why continue paying steep premiums to cover a need you don’t have?

3. Permanent insurance is so expensive that families often end up underinsured. Everyone buys what they can afford, but because permanent insurance costs a fortune, most people don’t buy enough. The solution is easy: Opt for term insurance, where you can secure much more coverage for a much lower premium.

4. Permanent insurance usually includes a ���cash value��� component, which is essentially a savings account bolted onto the side of your insurance contract. These policies are virtually impossible for a layperson to understand���and that provides plenty of cover for insurers to layer on fees and commissions.

A final note: You may run into a product called ���Term 80.��� This is term insurance that covers you for��almost��your entire life���until age 80. I find this product particularly insidious because it costs a lot, like permanent insurance, but it isn’t actually permanent. Die at 81 and your family will receive nothing in exchange for all those years of pricey premiums.

Are there situations in which permanent insurance does make sense? Yes, but I believe they are rare.

How much coverage should I have?��For most people, the answer is, ���It depends.��� That’s because your need for life insurance will vary over time. When you’re young and single, your need for insurance is probably zero (a reason why I see this��famous product��as particularly unnecessary). When you have children, a mortgage and college tuition in front of you, your insurance need will be significant. But as you put these obligations behind you, your insurance need will decline again. To calculate your life insurance need at each stage of life, I suggest this three-part formula:

1. Income replacement. If you have a family that depends on your income, the most important thing will be to replace your income with a pot of money large enough to sustain them going forward. A simple rule of thumb is to multiply your household expenses (excluding any debt or tuition payments) by 25. For example, if your expenses are $100,000 per year, you’d want to consider buying $2.5 million of coverage. Of course, you may already have savings. If that’s the case, then you’ll need that much less insurance.

2. Debt payoff. If you have student loans, a mortgage or other debts, you’ll want your family to be able to pay off these debts.

3. Education expenses. If you have school-age children, you’ll want your family to be able to meet future tuition obligations���but, again, your insurance need will be less if you have money in 529 plans or other earmarked accounts.

Which insurance company should I choose?��One of the ironies of insurance is that you can’t personally evaluate the quality of the coverage until you have a claim. But here’s what I would look for:

1. Longevity. Look for a company that has been around a long time. Many insurers have been in business for 100-plus years. That’s obviously a good sign.

2. Ratings. Most insurers receive financial strength ratings from four independent agencies: Standard & Poor���s, Fitch, Moody’s and A.M. Best. As you evaluate your options, ask your salesperson about ratings. Keep in mind, though, that each of these agencies uses a different rating scale. Be sure you understand where an insurer’s rating falls on each scale. It’s not what you would expect. At S&P, for example, an A+ rating, which sounds like it ought to be the best, is only the fifth-best, behind AAA, AA+, AA and AA-.

3. Pricing. Many insurance companies have the word ���mutual��� in their name. This means the policyholders are the owners of the company. While you might assume this is a good thing, be careful. Just as there are many mutual insurance companies that charge very high rates, there are many for-profit, public companies that offer very low prices. Don’t judge a company by its name.

Adam M. Grossman���s previous articles��include Higher��Taxes,��Moving Target��and��No Free Lunch. 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.

The post Get a Life appeared first on HumbleDollar.

Newsletter No. 45

AS THE SAYING goes, “If you don’t stand for something, you’ll fall for anything.” So what do HumbleDollar’s readers stand for? What are the key principles that should govern how we manage our money? In recent weeks, I’ve been drawing up a manifesto for the site.

It’s a work progress. I’ve included a dozen of the principles in our latest newsletter���and, in the months ahead, you’ll find further additions appearing every few days on the homepage. Our mid-March newsletter also includes a recap of the 13 blog posts that we’ve published over the past two weeks.

Follow Jonathan on Twitter��@ClementsMoney��and on Facebook.��His most recent articles include Labor of Love,��Mixing It Up��and Eight Questions. Jonathan’s��latest book:��From Here to��Financial��Happiness.

HumbleDollar participates in��Amazon‘s Associates Program, an affiliate marketing program. If you click on this site’s Amazon links and then purchase books or other merchandise, you don’t pay anything extra, but we make a little money. HumbleDollar has no other affiliate marketing relationships.

The post Newsletter No. 45 appeared first on HumbleDollar.

Got to Believe

AS I’VE BUILT out HumbleDollar.com over the past few years, I���ve come to view the site not merely as a place where folks can learn about financial issues, but as a community that thinks about money in a unique way.

This shows up repeatedly in articles from guest contributors, with their focus on topics like spending thoughtfully, helping family, behavioral finance, indexing and achieving financial freedom. It���s a community where folks are trying to be rational about money, but are also acutely aware of the human dimension.

That got me thinking that HumbleDollar ought to have a manifesto���key principles that should govern how we use and think about money. Last week, I added Manifesto��as a regular feature on the site���s homepage. Here are a dozen initial principles���with more to be published on the homepage in the months ahead:

Our financial life involves endless tradeoffs. We usually have a good idea of what our dollars are buying us. But to be good stewards of our wealth, we should also ponder what we���re giving up.
It takes years to achieve full financial freedom. But we can quickly escape much financial worry���if we live beneath our means, pay off credit card debt and build a cash cushion.
Good savings habits are the greatest of the financial virtues. If we aren���t good savers, it���s all but impossible to grow wealthy. What if we are? We���ll likely prosper, even if we���re mediocre investors.
We should focus relentlessly on what we want from our financial life. That���ll motivate us to save, drive our investment strategy���and help ensure we pursue the goals we care about most.
Retirement may be our final financial goal, but we should always put it first. Why? It���s easily our most expensive goal, so it takes decades of savings and investment gains to amass enough.
We spend too much time fretting over our investments���where there���s limited room to add value���and too little on other financial issues, like taxes, insurance and estate planning.
Paying down debt may not be our best investment, but it���s almost never a bad idea. It reduces our life���s financial risk���and earns us a rate of return equal to the debt���s interest rate.
Very few of us need life insurance for our entire life. That���s why term insurance makes sense and cash-value policies are usually a mistake���despite what insurance agents say.
Investing is best when it is simplest. If we own costly, complicated products, we���re filling Wall Street���s coffers���at our own expense. Don���t understand an investment? Don���t buy it.
Our odds of beating the market averages over a lifetime of investing are so small they���re hardly worth considering. Overconfident investors insist on trying. Rational investors index.
Our goal shouldn���t be more time to relax, but rather more time to pursue our passions. Working hard at things we care deeply about is among life���s greatest pleasures.
Frugality isn���t just the key to financial success. It���s also no great sacrifice, because spending often brings only fleeting happiness���and sometimes even pangs of regret.

Back Home

THE NEW Manifesto��feature joins HumbleDollar���s increasingly busy homepage. In addition to new blog posts pretty much every day, the homepage includes a slew of regularly updated features:

Insight. Stripped across the top of the homepage, this pithy comment endeavors to make readers think���and occasionally smile.
Numbers��offers intriguing statistics pulled from surveys, government data and elsewhere.
Archive gives readers a second chance to read some of the site���s most popular articles from 2018 and earlier.
Money guide.��The heart of HumbleDollar is our comprehensive and continuously updated money guide. Every��day, one of the guide���s sections is featured on the homepage.
Act�� suggests ways to improve our money management.
Think recaps crucial financial ideas.
Truths��details things we can say with reasonable certainty about the financial world.

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Don’t focus on the sum you need saved by retirement, because it’s simply too daunting���and you might give up in despair. Instead, focus on how much you should save each month, advises Ross Menke.
“Just because an investment carries the word ‘index’ in its name doesn���t make it a good investment,” writes Adam Grossman.��“There are thousands of index funds���some good, some��terrible���so always know exactly what you’re buying.”
When you take on debt, you borrow not from others, but from your future self. ��“In effect, you���re betting that the money is worth more to you today than it is to your future self,” explains Jim Wasserman.
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“Instead of spending money on a fancy restaurant, how about spending it to hire someone to handle an unpleasant chore?” suggests Dennis Friedman.��“Avoiding an unpleasant experience can be just as satisfying as enjoying a pleasant one.”
Index funds are a great investment, but that isn’t enough, says Ross Menke. “You need to put safeguards in place, so you protect yourself from yourself���from making panicky decisions.”

Follow Jonathan on Twitter�� @ClementsMoney ��and on Facebook .�� HumbleDollar participates in��Amazon‘s Associates Program, an affiliate marketing program. If you click on this site’s Amazon links and then purchase books or other merchandise, you don’t pay anything extra, but we make a little money. HumbleDollar has no other affiliate marketing relationships.

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