Jonathan Clements's Blog, page 384

Ignore the Signs?

IF THIS IS THE START of a bear market, share prices have a lot further to fall: The S&P 500 is down just 9.4% from its all-time high—and yet one of the most important lessons may have already been learned.

No, I’m not going to mock those who have lately proclaimed that stocks are the only investment worth owning. I don’t intend to belittle those who assume that U.S. shares can defy investment theory, and somehow be both safer and higher returning than their foreign counterparts. I’m not going to dwell on the silliness of chasing yield with junk bonds, which offer stock-like risk to unsuspecting investors.

I’ll also avoid mentioning the FAANG obsession—Facebook, Amazon, Apple, Netflix and Alphabet’s Google—and its conflating of great companies with great stocks. I’m not even going to rant about bitcoin or hold it up as a leading indicator of the speculative fervor that has recently taken hold of the financial markets.

Instead, the lesson, and the implicit criticism, is directed at myself—and the millions like me—who have been expecting a stock market decline for years. Take my first newsletter, published in September 2015. There, I wrote that “to get enthusiastic about stocks, I’d like to see the S&P 500 off 25% from its high.”

Since then, it’s climbed 36%.

I don’t make short-term market predictions—at least not publicly—and yet I’ve spent the past three years fretting about future stock market returns. That sense of prescience was based on valuations—a seemingly objective, rational reason to worry. U.S. stocks are greatly overvalued if you look at dividend yields, Tobin’s Q, cyclically adjusted price-earnings ratios and many other market yardsticks.

One exception: price-earnings (P/E) ratios based on trailing and forecasted earnings. According to markets.WSJ.com, the S&P 500 is trading at less than 23 times the past year’s reported earnings and at around 17 times expected operating earnings—expensive, but hardly outrageous. Those P/E ratios, however, may be misleading. Why? Corporate earnings have been pumped up by the long economic rebound. If the economy slows and those heady profits slip away, P/E ratios will look far less attractive.

But even if we dismiss today’s P/E ratios as misleading, and we agree that U.S. stocks are indeed overvalued, there’s still a fundamental problem: Valuations tell us nothing about short-run results and surprisingly little about long-run returns.

Consider a 2012 study by Vanguard Group. It analyzed how effective different market indicators—such as dividend yields, the Fed model and P/E ratios—were in explaining subsequent returns. The upshot: None had any success in predicting the market’s short-run results and most did a lousy job of forecasting 10-year after-inflation stock returns. Even the most effective measure, the cyclically adjusted price-earnings (CAPE) ratio, explained just over 40% of 10-year returns.

Moreover, even the much-lauded CAPE seems to have lost its mojo in recent decades, as another Vanguard study noted. The S&P 500’s CAPE ratio has been elevated for much of the past 30 years, and yet that hasn’t stopped the S&P 500 from clocking 10.6% a year, while inflation ran at 2.5%. The Vanguard study argues that today’s heady CAPE ratio looks somewhat less worrisome, once you factor in falling inflation and declining bond yields.

Where does that leave us? Should we simply ignore valuations? Call me stubborn, but I continue to believe that today’s rich valuations mean we’ll get modest returns over the next decade. I could, of course, be wrong. Still, I think it’s prudent for retirement savers to assume low investment returns and sock away extra money to compensate—and I believe it’s wise for retirees to stand ready to cut their spending for a year or two, should the markets go against them.

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook . His new book, From Here to Financial Happiness , can now be ordered from  Amazon  and Barnes & Noble . Jonathan’s most recent articles include Thinking About Money,  The Other Half ,  A Good Life  and  Jack of Hearts .

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As the World Turns

OVERSEAS STOCK markets have lagged badly over the past five years, climbing just 4.4% a year, while the S&P 500 has soared 14%. Are you questioning why you have money invested abroad? Check out my latest article for Creative Planning, where I sit on the advisory board and investment committee.

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Stepping Up

LONG EMBEDDED in the federal tax code is a provision that provides important advantages for people who sell inherited stocks, real estate or other investments that have appreciated in value and are held outside retirement accounts.

In tax lingo, the basis (the starting point for measuring gain or loss) of inherited assets “steps up” from their original basis (cost, in most instances) to their date-of-death value. It’s as if the inheritors had bought the assets that day. There’s even a limited exception for executors of estates: They’re allowed to choose an alternative valuation date for inherited assets—the value six months after the date of death.

Put another way, inheritors of, say, a stock portfolio sidestep taxes on the shares’ increase in value while they were owned by the person who bequeathed them. An example: Assume that Aunt Emma left you shares of Icarus Airlines. She paid $10,000 for Icarus shares that were worth $250,000 at her death. Subsequently, you unload them for $300,000.

How does a stepped-up basis benefit you? Your basis for the shares automatically increases from $10,000 to $250,000, their market value at the date of her death. A basis of $250,000 for the shares shrinks your taxable profit to just $50,000—their increase in value between the time Emma died and the time you sell them for $300,000.

You forever escape capital gains taxes on the $240,000 increase in value between the time Emma bought the shares and the time she died. In short, the amount she paid for the shares is irrelevant.

With that kind of scenario in mind, here are some reminders for both Emma and you. Emma’s financial advisor should remind her that a stepped-up basis trims taxes. That should prompt Emma to remind the executor of her will to determine the date-of-death value of the Icarus shares. Finally, the executor should remind you—the inheritor—to avail yourself of the stepped-up basis in determining gain or loss whenever you sell the shares.

Emma and her advisor shouldn’t think that their work is done. They also ought to discuss how best to determine date-of-death values for her other holdings. Let’s say Emma owns substantial amounts of property that, unlike shares traded on exchanges, aren’t sold on a regular basis.

Such property might include shares in closely held companies, a main residence, a second home, rental property, other kinds of real estate, jewelry, artwork, antiques and other collectibles. These kinds of assets might require appraisals. Appraisals obtained at the time of Emma’s death for relatively modest amounts might avoid hefty payments later on to attorneys, accountants and other advisors to resolve disputes with federal and state tax collectors.

J ulian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator). His previous blogs include Give and Receive, Hitting Home and No Touching. Information about his books is available at JulianBlockTaxExpert.com. Follow  Julian on Twitter @BlockJulian.

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Heading Home (III)

WHAT SORT of house should I buy? My first consideration was budget. While I’d been preapproved for a $403,000 loan, I knew I wasn’t going to borrow that much. Doing so would mean spending well over half my net income on my mortgage. Instead, I figured out how much cash I had for a down payment—$80,000—and then decided to take out a loan of not more than $300,000. That way, I’d be making a 20% down payment and could avoid buying private mortgage insurance.

With a price range in mind, and a preapproval letter from my credit union in hand, my house hunting began in earnest. I first put together a list of “wants.” A single-level home was important to me, but the overall size wasn’t. I’d been living in a one-bedroom, one-bath apartment for several years. I was, however, hoping to find a three-bedroom, two-bath home, because I felt it would prove to be a better choice when it came time to sell.

Location was also an important consideration. Ideally, I wanted to find a house in the same neighborhood where I’d been living for the past six years. I’d grown fond of the location and all its amenities, including a wonderful community center, a well-stocked library and several parks with walking paths. It also happens to be the same neighborhood my mother lives in. In my book, having a puppysitter nearby is a huge plus.

In addition, I wanted a house that didn’t require a lot of work. While I’ve owned—and completely remodeled—two homes in my lifetime, I’m now at an age where spending my weekends working on a house isn’t as appealing as it once was. I knew I couldn’t afford a newly constructed house, but I was hopeful I could find something built within the last 40 years.

Once I had an idea of my ideal home, I began searching online listings and eventually enlisted the help of a real estate agent. After a couple of weeks of searching, it became apparent there might not be any homes that met all my criteria. Housing costs in my neighborhood were high compared to surrounding areas. I realized tradeoffs would need to be made.

In another neighborhood, I found a home that met nearly all of my wishes, but it would have added 30 to 45 minutes to my daily commuting time. I also found an 80-year-old “fixer” home in my price range and in my neighborhood, but it needed several thousand dollars of work to make it livable. I began to think my chances of finding the “perfect” house were just about zero.

Kristine Hayes is a departmental manager at a small, liberal arts college. This is the third in a series of articles about her recent home purchase. Her previous blogs include Heading Home (I), Heading Home (II) and  Happy Ending

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Garbage In

IN THE MID-1990s, Federal Express had a problem. Though the company’s safety record was exemplary, regulators had proposed new rules that would have posed an operational nightmare for the giant shipper.

The company flew Boeing 727 air freighters that each accommodated eight containers. Though they had never had a problem, the government’s concern was that if two heavier-than-average containers were loaded next to each other, it could cause the plane to become dangerously unbalanced.

To assess the risk, the company hired a statistician to estimate the probability of a “double-heavy” situation. According to his analysis, the risk was extremely low—about 3%. Then the company asked the statistician to analyze a sampling of actual container weights. What he found surprised everyone: While the probability was indeed 3% virtually everywhere, it turned out to be much higher in one place: Austin, Texas. There, double-heavies occurred nearly every day.

The company took a closer look at Austin and quickly found their answer: A fast-growing local company was mailing an increasing number of heavy boxes each day. The company in question: Dell Computer, which is based in nearby Round Rock. This was in the days before lightweight laptops and flat-screen monitors. As a result, all those Dell shipments ended up pushing the frequency of double-heavies flying out of Austin far above 3%.

I heard this story, when I was in school, from the expert who solved the puzzle. Though he was a professional statistician, he liked to share the story with students as a cautionary tale that illustrates the limitations of statistics. His message: While textbook statistical methods often approximate the real world, you need to be awfully careful with those cases that don’t. Statistics might tell you that package sizes will be evenly distributed in most places, and that might be a reasonable assumption most of the time. But as the Dell case proves, you always need to look beyond the numbers.

In my view, there’s a popular corner of the investment world where it’s also important to look beyond the numbers: high-yield junk bonds. In recent months, investors have been piling into junk bonds, according to mutual-fund industry data. But while the numbers suggest that junk bonds are an attractive investment, I would urge caution.

Here’s what the statistics say: Over the past 15 years, high-yield bonds have delivered returns virtually on par with the S&P 500 Index of large-cap stocks, but with much lower volatility. Better still, in recent years, the default rate on high-yield bonds has averaged just 2% a year, compared to an historical average closer to 4%. In bond parlance, a “default” occurs when a bond issuer fails to make a scheduled payment.

In short, high-yield bonds appear to offer attractive returns with modest risk. But in my opinion, we need to look beyond these rosy statistics. I see three issues:

1. It’s true that recent high-yield bond default rates have been around 2%. But it makes no sense to assume that the recent past will predict the future. Go back 10 years, to 2008, and you’ll find that annual default rates suddenly quadrupled, inflicting double-digit losses on investors. Go back to 2001, and you’ll find that 11% of junk bond issues defaulted. And the 1980s were particularly bad for junk bonds. Nearly 50% of the junk bonds issued between 1980 and 1985 eventually defaulted. The fact that default rates are currently low doesn’t mean that they will always be so.

2. Since 1980, we’ve seen three major hiccups in the high-yield market. It could be even worse the next time. The period since 1980 has been unusually favorable for bonds, because of the nearly nonstop decrease in interest rates over that stretch. But today, we’re in uncharted territory. Because high-yield bonds barely existed prior to the 1980s, no one knows how they’ll perform if rates increase for multiple years in a row.

3. The amount of junk-bond debt is far larger than ever before. According to the credit rating agency Moody’s, the proportion of companies now in junk status has increased by nearly 60% since 2009, to its highest level ever. In fact, in an ominous statement, Moody’s warned that “a number of weak issuers are living on borrowed time while benign conditions last.”

The bottom line: I would be skeptical of the rosy statistics—and steer clear of high-yield bonds.

Adam M. Grossman’s previous blogs include All Too Human, Stepping Back and When to Roth . 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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Newsletter No. 34

HOW CAN WE GET the most out of our income and savings? Two years ago, in a slim volume called How to Think About Money, I offered my answer. Earlier this month, a new edition of the book came out, geared toward a global audience. To mark the new edition’s publication, I’ve devoted HumbleDollar’s latest newsletter to How to Think About Money’s 12 key recommendations.

The newsletter also includes a promo code that can save you money, if you order the new book direct from the U.K. publisher. In addition, the newsletter has brief descriptions of HumbleDollar’s latest blogs, along with links to those articles.

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook . His other new book, From Here to Financial Happiness, can now be ordered from Amazon and Barnes & Noble. Jonathan’s most recent articles include The Other Half, A Good Life and Jack of Hearts.

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Thinking About Money

I HAVE SPENT 33 YEARS writing and thinking about money. I’m not sure it’s the most uplifting way to spend one’s life, but it’s kept me busy and—for the most part—out of trouble.

Two years ago, I took some of the financial ideas that have especially intrigued me over the past three decades, and I brought them together in a slim volume called How to Think About Money. The book proved surprisingly popular, so I recently updated it for a global audience.

How to Think About Money touches on topics such as happiness research, our rising life expectancy, behavioral finance and the importance of our human capital—and then teases out the implications for our financial lives. Here, pulled from the book’s final chapter, are 12 suggestions for how to get the most out of our money:

We favor possessions for their lasting value, but often we get greater happiness when we spend our money on experiences. Forget the new car. Instead, take the family to Paris.
We should use our dollars, pounds or euros to create special times with friends and family. Take the kids to a sports event and your spouse to the theater. Have dinner out with friends. Book a trip to see the grandchildren.
We should design a life for ourselves where we can spend our days doing what we love. To that end, we should save every penny we can early in our adult life, so we quickly buy ourselves some financial freedom. In our 40s or 50s, we might use that freedom to switch into a career that’s perhaps less lucrative, but which we may find more fulfilling.
We should worry less about dying early in retirement, and more about living longer than we ever imagined. Faced with that risk, most of us should delay Social Security to get a larger monthly check, and also consider buying immediate annuities that pay lifetime income.
Our investment time horizon is measured not in months and years, but in decades and decades. We should strive to look beyond the market’s short-term turmoil and instead aim to collect the staggering gains that can accrue to those who hold globally diversified stock portfolios for 30 or even 50 years. Indeed, while a long bear market can impoverish retirees who don’t have enough in bonds and cash investments, it can be a great gift to young adults who are good savers, because it offers the chance to buy stocks at bargain prices.
We should hold down our fixed monthly costs, such as the sum we devote to mortgage or rent, cars, utilities, groceries and insurance premiums. Those low fixed costs will give us additional financial breathing room, which can ease our sense of financial stress, leave us with more money for discretionary “fun” spending—and allow us to save voraciously.
Good savings habits don’t come naturally, so we need to make socking away money as painless as possible. That means signing up for payroll contributions to our employer’s retirement plan and setting up automatic investment plans, where money is pulled from our bank account each month and invested directly into the funds we choose. It also means adopting easy-to-follow financial rules, such as always adding $50 or $100 to the monthly mortgage payment and always saving financial windfalls, including tax refunds and income from a second job.
The harder we try to beat the market, the more likely we are to fail, thanks to the hefty investment costs we incur. To avoid that fate, we should stop trying to outsmart other investors and instead embrace humility—in the guise of a globally diversified portfolio of low-cost index funds.
We should never forget that stocks have fundamental value. For a diversified stock portfolio, that fundamental value will change much more slowly than market prices. To keep ourselves grounded, we should focus on the dividends and earnings we buy with every dollar, pound or euro invested, we should have a handle on the market’s likely long-run return, and we should think like shoppers, viewing market declines with the same enthusiasm that we view a sale at the local department store.
Chronologically, retirement might be our life’s final financial goal, but we should always put it first. Retirement is the most expensive of our goals, and hence we need to save and collect investment gains for many decades to amass enough money. Retirement is also distinctly different from other goals, like buying a home or paying for our children’s education. What’s different? Retirement won’t be optional for most of us and we can’t expect to pay for it out of our paycheck, because at that point we won’t have one.
We should take a broad view of our finances—and the unifying notion should be the income from our human capital, or the lack thereof. The paychecks we collect over our lifetime are like a bond that generates 40 years of fairly steady income. That income stream can diversify a portfolio that’s heavily invested in stocks, provide the savings we need to set aside for retirement, and allow us to take on debt early in our adult life and then repay it by the time we retire. We also need to protect our human capital, by ensuring we have adequate health coverage, and sufficient disability and life insurance.
The goal isn’t to get rich. Rather, the goal is to have enough money to lead the life we want. We shouldn’t put that at risk by incurring excessive investment costs, straying too far from a global indexing strategy and failing to buy insurance against major financial risks.

Pounds Lighter

WANT A COPY of the new international edition of How to Think About Money? You can purchase it directly from the U.K. publisher, Harriman House, for £12.99, equal to around $17.

Problem is, if you’re outside the U.K., Harriman will likely charge you £4.50 for international shipping. To offset that cost, I asked Harriman for a special discount for HumbleDollar readers. If you buy from the Harriman website, you can use this promo code during checkout: H2TAMoffer. That’ll save you £4.50. The promo code is good through Nov. 5.

Latest Blogs

“I know of a retiree who says he’s quite happy living in a trailer on $1,300 a month,” writes Richard Quinn. “How does that square with the conventional wisdom that, once retired, you need 80% of preretirement income?”
Should you convert your traditional IRA to a Roth? As you wrestle with the question, Adam Grossman suggests working through five key steps.
“I think of my low fixed expenses as a wall protecting me from disaster,” says Dennis Friedman. “Reducing expenses can be a first responder that saves you in a financial emergency.”
Volunteers for charitable organizations can deduct their unreimbursed out-of-pocket expenses—though there are limits to the IRS’s generosity, warns Julian Block.
“Is the giant turkey leg you’re chomping on, while waiting in line for that next Disney attraction, really worth paying 20% interest?” asks Richard Quinn.
Half of Americans—and likely more—are at risk of failing to maintain their standard of living once they retire. What to do? Here are five super-simple strategies that everybody could benefit from.
 “My co-workers knew I had a financial background, so they often came to me with their statements,” recalls Tony Isola. “High-fee variable annuities and loaded mutual funds littered the crime scene.”
Crisis? What crisis? John Lim argues that bear markets offer three huge financial benefits.
“If you conclude that a change is in order for your portfolio, don’t worry that it’s too late,” says Adam Grossman. “Yes, stocks are down from where they were trading in recent weeks. But recognize that those were all-time highs.”
Jiab Wasserman calculated that she and her husband could retire in Spain on just $30,000 a year. So they packed their bags and went for it.
“I kept thinking that someday I’d come around to more bonds, but not now,” writes Dennis Quillen. “The years went by. I took early retirement at age 62 and still had zero dollars in bonds.”
It’s difficult to recognize progress, including our own financial progress. Ross Menke’s advice: Keep reminders of your achievements, find an accountability partner—and track your net worth.
“While the market is still near its all-time high, check your asset allocation,” advises Adam Grossman. “Even if you have a view on the way things will turn out, make sure you’ll be okay if it goes the other way.”

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook . His other new book, From Here to Financial Happiness, can now be ordered from Amazon and Barnes & Noble. Jonathan’s most recent articles include The Other Half, A Good Life and Jack of Hearts.

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Slow Going

HAS THE PERCENTAGE of individuals across the world living in extreme poverty remained the same, doubled or halved over the past 20 years? If you answered halved, give yourself a pat on the back. According to Gapminder.org, you’re among just 9% of respondents who answered the question correctly. Despite what you hear on the news, the world is gradually becoming a better place.

It’s difficult to recognize progress, including our own financial progress, when it happens slowly over long periods of time. We want to see progress right away, but it’s the incremental progress over the years that adds up to the big improvements we seek.

Want a better handle on the progress you’re making? Try these four steps.

1. Track key indicators. When I think about improving my financial situation, I focus on my net worth. Every month, I update my net worth using a basic spreadsheet that lists my personal assets and liabilities. Without this regular tracking, I would guess that my net worth hasn’t changed over the past three years, as I don’t feel any wealthier today than I did then. In looking at the spreadsheet, however, I see that my net worth has more than doubled over that time, thanks to regular saving and investment gains.

2. Increase your knowledge. What’s the last book you read? Warren Buffett is known as a voracious reader, viewing knowledge as another form of compound interest. I have adopted this practice and read upwards of 25 books per year in a range of genres. I keep track of all the books I read, so I can recognize this steady progress.

One book may or may not change my life, but 100 books over a few years will make a difference. In particular, The Millionaire Next Door by Thomas Stanley and William Danko was formative in helping me appreciate the importance of living below my means and living a financially sound life.

3. Find accountability partners. Your personal finances may not be a topic you want to discuss with everyone. But having someone you can confide in goes a long way. The massive progress you’re trying to make over the course of your career can seem daunting. The help of an objective individual may be what you need to stay the course. I share my financial priorities with my mentor, so he can keep me accountable to my stated goals. Others to consider include a friend, family member, your significant other or a financial planner.

4. Keep reminders of your progress. I live a fairly minimalist life and am quick to throw things away. But I hold on to signs of progress and achievement. For me, these include graduation cards, “thank you” notes from clients and colleagues, and diplomas from college and advanced certifications. When I feel like I’m not improving, I’ll look through these items and recognize the progress I’ve made over the past decade.

We all have goals we’re trying to achieve—and long-term financial goals can be among the most discouraging, which is why it’s important to recognize the slow and steady improvement in our lives. Progress may be hard to feel in real time. But regular reinforcement can help you appreciate the massive improvement you’re actually making.

Ross Menke is a certified financial planner and the founder of Lyndale Financial, a fee-only financial planning firm in Nashville, Tennessee. He strives to provide clear and concise advice, so his clients can achieve their life goals. Follow Ross on Twitter @RossVMenke.

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Won in Translation

RETIREMENT IN America can be like plodding through a long, dark tunnel, with seemingly no light at the other end. I found, however, that if one looks sideways, there’s an escape hatch: retiring abroad.

For my husband and me, our search led us to Spain, having heard it had a low cost of living, excellent health care and a good climate. We visited a few times and fell in love, particularly with the city of Granada. The next logical step: determining if we could swing it financially.

I used Numbeo.com to compare the cost of living in the U.S. and abroad. It’s the world’s largest database of user-contributed data about cities and countries, and it provides timely information on general cost of living, housing, health care, traffic, crime and pollution. Numbeo provides six indices: cost of living (excluding rent), rent, cost of living plus rent, groceries, restaurants and local purchasing power.

The overall index is relative to New York City, which is set at 100. If another city has a rent index of 120, it means that city’s rents are an average 20% more expensive than New York’s. Conversely, if a city’s rent index is 70, that means the city’s rents are an average 30% lower than New York’s.

I was particularly interested in the cost of living plus rent index—not counting health care—using our then-resident city of Dallas as a comparison point. The Numbeo indexes showed New York at 100, Dallas at 55 and Granada at 33. Granada was thus 67% cheaper than New York. Even comparing Granada and Dallas was astounding. Consumer prices including rent in Dallas were 67% higher than in Granada, even before factoring in health care.

I dove further into the details and used Numbeo’s cost-of-living estimator for Granada. There are quite a few detailed questions one has to answer, including about one’s household (rent/purchase, members), spending habits (clothes, gym, cars and travel) and entertainment spending (movies, clubbing and alcohol consumption). My results showed that we would spend $2,100 per month living in Granada—and that included the traditional tapas bar hopping.

Next, we had to figure out health care. Spain has one of the best health care systems in the world. It’s ranked No. 7 by the World Health Organization. By comparison, the U.S. comes in at No. 37.  We would have to shop for private insurance for our first year. But after that, we could sign up for public health insurance, which would cost us—wait for it—zero. Thanks to a recent change in Spanish law, all residents receive free health care.

We decided to go with one of the most highly recommended health insurance companies in Spain for expats. The plan is $193 per month for both of us. This is a comprehensive plan, even considered an expensive one, with no copay, no deductible and includes basic dental services. The plan also includes worldwide emergency coverage of up to $14,000. We pay an extra $1.75 a month to increase emergency coverage in the U.S. to just over $35,000.

Putting it all together, using a combination of our actual numbers and Numbeo’s estimates, I calculated that it would cost just over $30,000 per year for us to live comfortably in Granada. Bottom line: The numbers said we could potentially retire immediately, in our early to mid-50s, and live very well.

We didn’t want to spend our healthiest years planning for the future, always saying “someday,” while our lives passed us by. We would have to give up things, like cars and a large house. But we would gain so much more: walks in the mountains, fresh Mediterranean food, siestas.

So we packed our bags and went for it.

Jiab Wasserman recently retired at age 53 from her job as a financial analyst at a large bank.  She and her husband, a retired high school teacher, currently live in Granada, Spain, and blog about financial and other aspects of retirement—as well as about relocating to another country—at YourThirdLife.com.

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Reality Check

CAN YOU LIVE on Social Security alone? The answer is a big fat “it depends.”

I was recently taken to task by a reader, who stated he and his wife live just fine on their combined $30,000 in Social Security benefits. I also know of a retiree who says he’s quite happy living in a trailer out west on $1,300 a month. How does that square with the conventional wisdom that, once retired, you need 80% of preretirement income, let alone with my unconventional wisdom that you should strive for 100% income replacement?

It all boils down to how you want to live. If you say you can live comfortably on just your monthly Social Security check, you’re saying that, on the day you retire, you can absorb a 60% cut in income for the rest of your life. The reason: Social Security is designed to replace 40% of income, and for many it’s less.

The median income for seniors age 65 to 74 is $36,320. If you’re over 74, that drops to $25,417, according to the U.S. Census Bureau. Indeed, 12% of those 65 and older are living at the poverty level.

I could not survive on $30,000 a year. My property taxes alone are more than half that amount. But even if I could make do with $30,000, paying for basic necessities with nothing left over sounds grim. Even most hobbies cost money.

So what are the components of “it depends”?

Are you willing and able to relocate to a less costly area?
Do you have assets to fall back on, if only for a financial emergency?
How modestly are you willing to live? Is it just a matter of surviving—or do you seek more from retirement, such as travel?
Will you be debt-free at retirement, especially from a mortgage and any credit card debt, or will you need additional income to cover your borrowing costs?

Even if you figure you can get by on Social Security alone, you should probably ask yourself two additional questions:

If you live on just Social Security and you’re married, could the surviving spouse live on perhaps two-thirds of that income?
Are you comfortable leaving your entire income to the whims of the folks in Congress?

The Social Security Administration estimates 21% of married couples and 44% of single seniors count on Social Security for 90% or more of their income. Clearly, people do manage to live on Social Security alone, but it can’t be much fun.

For the vast majority of Americans, there’s no reason to do so.  Even modest saving and investing can make a big difference to your retirement years. If you’re still in the workforce, get time on your side. Save whatever you can and leave it to grow. Your future, retired self will thank you.

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous blogs include Under Construction, Get Me the Doctor and Mini-Golf, Anyone. Follow Dick on Twitter @QuinnsComments.

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