Jonathan Clements's Blog, page 407

In Your Debt

THESE BEING the times they are, I frequently field queries from clients who are asked for loans by relatives or friends. These would-be borrowers plead their inability to come up with the down payments for homes or who want to launch “can’t fail” business ventures. Suppose, as so often happens, the loans go sour and the borrowers’ last messages mention their entry into witness protection programs.

I remind wannabe lenders who intend to stake friends or relatives to familiarize themselves beforehand with long-standing tax rules. The rules make it difficult to take deductions for bad debts. While the IRS allows deductions for worthless loans if there’s no likelihood of recovery in the future, it prohibits write-offs for outright gifts.

Lenders should expect the agency to look closely at their deductions for bad debts when they’re related by blood or marriage, or have other ties, to the borrowers. The burden is on the lenders to prove that what they characterize as “loans” weren’t really gifts.

There are steps lenders can take before making loans that will help in case the IRS questions their write-offs. The key to success: Set up the transactions with the same care as any loan made for business reasons.

Lenders should ask borrowers to sign notes or agreements that, among other things, do the following: specify how much they’re borrowing; explain when and in what amounts they’re supposed to make repayments; and require them to pay realistic interest charges––say, the rates lenders would receive from savings accounts if their funds weren’t loaned. Lenders also should arrange for witnesses to sign the notes if that’s a legal requirement in their state.

Some clients voice their concerns that imposing interest charges and other requirements are a rough way to deal with their friends or relatives. I remind them that it’s the only way if they want to deduct bad debts later. IRS examiners routinely throw out deductions for handshake deals.

When can lenders deduct unpaid loans? Only in the year that they become worthless. The IRS doesn’t require lenders to wait until the loans are past due to determine whether or not they’re worthless; loans becomes worthless when there’s no longer any chance that they’ll be repaid.

The IRS will want good evidence that the loans are actually worthless and will remain so in the future. While the IRS expects lenders to take reasonable steps to collect loans, it doesn’t require them to hound debtors into courts, provided they can show that judgments, if obtained, would be uncollectible. Still, lenders should at least send letters asking for repayment. Generally, if debtors declare bankruptcy, that’s a good indication that the debts are at least partially worthless.

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 Moving Costs, Anti-Social Security and Execution Matters. Information about his books is available at JulianBlockTaxExpert.com. Follow  Julian on Twitter @BlockJulian.

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Truth Be Told

I WASN’T COMPLETELY honest when I wrote a recent blog. HumbleDollar’s editor asked why I reduced my stock position in 2017 from roughly 50% to 25%. He suggested I should mention it in my blog. My answer: “At the time I made these changes, I was losing confidence in the sustainability of the bull market and wanted to reduce my risk.” That was true—but it wasn’t the whole truth.

There’s another reason I initially left out the explanation for reducing my stock exposure: I’m simply not comfortable discussing my finances in great detail. There are only two things I will not talk about: my sex life and personal money matters. And it isn’t necessarily in that order. It’s one reason I write mostly about my life experiences that don’t reveal too much about my money. I did write a blog that revealed a little more financial information than I would like. It was uncomfortable. But I thought it was necessary.

Some of my friends are very open about their money. I sit there like a bump on a log, amazed at what they are telling me. I feel guilty. But I just can’t share my personal financial information with them. It’s not because I’m stingy and trying to hide my money from my friends. When I go out with them, I usually pick up the tab or pay a portion. I have also helped friends who were going through difficult times with their finances.

To be honest, I don’t want to know about their financial situation. When I hear them talk about their money, it sometimes makes me jealous. I feel that I’m not doing as well financially as I should. But in truth, I shouldn’t be comparing myself to them. It’s a shame, because I find myself avoiding them. I use the same approach that I use with my favorite baseball team, the Cleveland Indians. When they lose, I avoid reading articles about the game.

There is only one person who knows about my financial affairs. It’s my close friend, with whom I’m planning to spend the rest of my life. I feel she needs to know, because we are in this together. She is the only person with whom I’m an open book. I think it is important that your spouse or significant other knows your financial life. If something should happen to you, he or she needs to know where to go to access the assets to support him or herself.

I have given a lot of thought to my reluctance to reveal information about my finances. I haven’t come up with a good answer. I do, however, know this: In our society, we are sometimes judged by the type of car we drive, the house we live in or how much money we have. Maybe I just don’t want to be judged.

Dennis Friedman retired at age 58 from Boeing Aerospace Company. He enjoys reading and writing about personal finance. His previous blogs include Mind Games, Looking Forward and More Than Money.

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Stress Test

IN THE FIELD of epidemiology, researchers have long used the term “tipping point” to describe how epidemics occur. At first, an ordinary disease moves slowly, not gaining much attention. But then, seemingly overnight, it snowballs into something far larger.

Within the world of public health, this concept is well understood. But about 20 years ago, the author Malcolm Gladwell took a closer look and pointed out that tipping points can be found in a whole host of other situations far beyond epidemiology.

That includes finance. Consider Lehman Brothers. In June 2007, it reported a profit of more than $1 billion, a company record. And yet, just 15 months later, it was bankrupt and sold for scrap. Despite its sterling reputation, established over 158 years, the firm unraveled virtually overnight.

With the benefit of hindsight, there had been some early warning signs. In its writeup about Lehman’s record profit in mid-2007, The New York Times mentioned a loss related to subprime mortgages—but it wasn’t until the eighth paragraph of the story. Even then, media reports quoted Lehman executives describing the issue as “small” and “contained.” There was no indication that this “small” issue would bring down the entire company just a year later.

Why spend time talking about Lehman? While the details may not be generally applicable, it’s an example—and not an isolated one—of a financial tipping point. It’s worth studying for the same reason we study the 1929 stock market crash and the Great Depression: These were unusual events, but they remind us to take steps today to avoid financial stress tomorrow. To that end, here are five ideas to help you fortify your own finances for the long term:

1. Gather the facts. In the past, I have talked about the “Big Four”—your income, expenses, assets and liabilities. If you know these four numbers, you’ll have a solid grasp of your financial situation and you can answer most money questions. If you don’t have these numbers readily available—and don’t have time to gather them—consider hiring a bookkeeper to pull together the information for you.

2. Once you know the big four, ask yourself two questions. Am I okay now? And will I be able to handle upcoming financial obligations, such as a home purchase, college tuition or retirement? To find out, make a simple set of financial projections. It can be eye-opening. In my experience, this kind of exercise often ends up leaving folks sleeping better, not worse.

3. If you’re employing one of the retirement rules of thumb, such as the 4% rule or the 80% income replacement rule, be sure they apply to your situation. These rules can sometimes be too simplistic, especially when they’re age-based. Should Bill Gates really follow the same financial roadmap as every other 62-year-old? I think not.

4. If you want to guarantee you’ll never run out of money in retirement, there is one way to do it. Each year, simply limit your spending to a fixed portion of your portfolio’s value as of the end of the prior year. For example, if you had $1 million at the end of last year and your spending rule was 5%, you would withdraw $50,000 this year and no more.

This is the way schools and colleges operate. As long as they stick to their spending rules, it serves them extremely well. But in exchange for this near guarantee, there’s a catch: If your portfolio declines in value in any given year, you have to be willing to take a pay cut the following year.

5. Recognize that there are escape valves in our financial system if things aren’t panning out. In Lehman’s case, their financial mess was beyond human comprehension. But when ordinary folks run into a simple cash crunch, there are lots of solutions.

If you have federal student loans, you could explore an income-driven payment plan, forbearance or refinancing. If tuition for your children is crushing your budget, call the bursar’s office. Colleges are businesses and they will negotiate—even if they say they won’t. If you have bills that end up with a debt collection agency, you may be able to settle the obligation for less than the full amount owed. Even the IRS will be flexible: It has programs that allow you to pay both income and estate taxes over time.

Adam M. Grossman’s previous blogs include All of the Above, Not My Thing and Nothing to Chance . 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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Not So Predictable

I’M STILL WAITING. Along with many others, I have spent much of my investing career expecting five key financial trends to play themselves out—and yet they’ve stubbornly refused to do so.

Sure, these predictions could still come true. But I have my doubts. Maybe these five financial forecasts aren’t the slam dunk they appear:

1. Stocks will revert to average historical valuations. Whether you look at price-earnings ratios, cyclically adjusted price-earnings ratios, dividend yields or Tobin’s Q, today’s stock market is expensive. But this isn’t exactly news.

Indeed, if investors were going to sell because of sky-high valuations, they would have done so long ago. Stocks have been pricey for much of the past quarter century, and yet share prices show no signs of returning to their 100-year average of 16.5 times trailing 12-month reported earnings. It seems that, in our increasingly wealthy world, we simply have too much capital pursuing too few investment opportunities.

This doesn’t mean valuations don’t matter. With P/Es so high and dividend yields so low, stock returns over the next decade will likely be modest—unless shares get yet another big boost from rising valuations. It could happen. But I wouldn’t bank on it.

2. Interest rates are headed higher. Two decades ago, when I was at The Wall Street Journal and the 10-year Treasury note’s yield was double today’s level, I recall talking to a financial advisor about immediate fixed annuities. “I could see buying them for clients,” the advisor allowed. “But I’d want to wait for higher interest rates.”

For many investors, that waiting game has been going on since at least the 1990s. To be fair, interest rates have moved somewhat higher. The 10-year Treasury is now at 2.96%, up from the low of 1.37% in July 2016.

Still, absolute interest rates remain grudgingly low, so nominal bond returns will almost certainly be modest in the years ahead. But just because interest rates are low doesn’t guarantee they’ll go higher. It’s always dangerous to assume that market prices, which reflect the collective wisdom of all investors, are wrong and that you know better. Instead, I would take the market at its word: Whatever interest rates are, that’s the best indicator of where they ought to be.

3. Inflation is coming back. One reason interest rates are low is because inflation, too, is at modest levels. Will it come roaring back?

If the 1930s forever colored the financial attitudes of those who struggled through that miserable decade, I think the same is true—to a lesser degree—for those of us who were around during the 1970s. It was a decade of high inflation, gas shortages, high interest rates and tumbling stock market valuations, and we worry that all of those will return. But will they? History may repeat itself if circumstances are similar—but it doesn’t repeat just for repetition’s sake.

4. Taxes are going up. Along with many others, I’ve long assumed tax rates are unsustainably low and will eventually rise. We already have a $900 billion federal budget deficit and face ever-growing federal expenditures on Social Security and Medicare. Offsetting these fiscal headaches are low interest rates, so servicing the ballooning federal debt hasn’t proven to be too much of a burden—so far.

The upshot: Instead of federal income-tax rates rising, they keep getting cut. True, those falling rates are often accompanied by the loss of other tax goodies, so it’s never quite clear whether folks are better off. Still, what we haven’t seen are big tax increases, despite all the gnashing of teeth over the federal deficit.

5. We’re facing a retirement savings crisis. There’s long been handwringing about the demise of traditional pension plans and the failure of workers to make good use of the 401(k) plans that replaced them.

While I think the concern is justified, I also think we recall a golden era that never existed. For instance, a Social Security Administration study found that among the oldest baby boomers, those born between 1946 and 1950, just 50% of households have traditional pensions—which means 50% don’t. The reality: There was no glorious past when all Americans happily retired with generous monthly checks from their former employers.

My contention: It isn’t that today’s workers are wholly unprepared for retirement. Rather, the problem is that they need to be much better prepared than earlier generations—because they face far longer retirements. This isn’t just a personal finance problem confronting every U.S. household. As I discussed in a recent newsletter, if folks continue to retire in their mid-60s, we’ll have a nation—and, indeed, a world—with too few workers and too many retirees, and we simply won’t be able to produce the goods and services that society needs.

Somehow, we need to persuade Americans to stay in the workforce for longer, not just for their own financial sake, but for the sake of society. We could likely achieve that through some unappetizing combination of higher tax rates, higher inflation, wretched investment returns, and cuts to Social Security and Medicare.

That, of course, touches on all five of the long-expected developments discussed above. But maybe none will come to pass. Maybe, instead, many folks—for a mix of financial and other reasons—will decide they want to work into their late 60s and perhaps even their 70s. That’ll mean more goods and services are produced, and more taxes are paid. That, in turn, will help to restrain inflation and interest rates, while also boosting corporate profits and hence share prices. Result? We may never have to reckon with the five great reckonings that have long been predicted.

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook . His new book, From Here to Financial Happiness, will be published Sept. 5 and can now be preordered through Amazon.

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Jump Start

IF YOU’RE IN COLLEGE right now, saving for retirement probably isn’t even a blip on your radar screen. Yet this is the time in your life when every dollar squirreled away will reap the most bang. Raising your eyebrows in disbelief at the thought of saving for retirement, while in the midst of struggling to cover tuition? My two children are in college and currently making money from summer internships. Here are the five things I tell them:

1. The most important reason to start isn’t what you think. Sure, the financial gains could be astonishing. The main reason to begin now, however, is to start a life-long habit—one that’ll help you reach your dreams far faster.

Look at the happiest, most fulfilled, purpose-driven people you know. There’s a high probability that they know the value of delaying a bit of gratification today to enjoy a more meaningful life later. By structuring your life during college so that you sock away a modest amount monthly, you will greatly increase the odds of achieving your aspirations, including new ones that will emerge in the years ahead.

2. You can’t beat the compounding. Because of the time stretching ahead of you, you have a luxury that your parents’ generation envies. A college sophomore who invests a $1,000 in a Roth IRA and parks it there, without adding another penny, will have more than $9,400 by age 65, while someone who waits until 45 will have around $2,650, assuming 5% compound interest. To see this for yourself, try the Securities and Exchange Commission’s online calculator.

3. There’s a hidden benefit you can’t appreciate yet. By saving now for retirement, you insulate yourself against rough times. The optimism of your age group is uplifting, but it may cloud your appreciation of this. By regularly setting aside a small part of your income now, you will greatly soften the blow when times get seriously—and sometimes frighteningly—lean. Once ingrained, living beneath your means will set you apart from your peers and be a lynchpin in your life happiness.

4. It’s cheaper than you think to get started. For $50 a month in automatic contributions, you can get things rolling. To begin, set up automatic monthly contributions into a separate savings account at your hometown bank or credit union. Once you have $500 in hand, establish a Roth IRA at your bank. When your stockpile reaches $1,000, you’ll have enough to open an account at many mutual fund companies. Transfer your $1,000 to a low-cost stock index fund in a Roth IRA at a respected company and continue your monthly automatic contributions.

I trust Vanguard Group the most because of its founding principles, long-term performance, extraordinarily low fees, and the wonderful mix of U.S., foreign, large and small-company stocks in its target-date retirement index funds. Other respected companies include Fidelity Investments and Charles Schwab.

5. What if you have big plans ahead? Thinking you might need cash someday to start your own business? Or for a down payment on a home? Or to take a year off to travel the world? Keeping your savings accessible is a valid concern—one I hear in my own household.

This, however, is yet another reason to fund a Roth IRA. Any money you stick in a Roth IRA is available to you at any time. You can’t take out your investment gains without triggering taxes and penalties, but you can withdraw your contributions whenever you want. My guess: Thanks to the good habits you’ve learned, you’ll set up a separate savings program for your other plans—and you won’t rob your Roth.

Ultimately, this isn’t just about retirement savings. It’s about a strategy for a better life. Start this month—and you’ll set yourself on a path that’ll put you far ahead of your fellow classmates.

Amy Charlene Reed is a science and energy writer who lives near Oak Ridge, Tenn. Her previous blog was Baby Steps.

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Mind Games

I FEEL LIKE there is a death cloud hovering over me. I have been retired for nine years. I have lost my father and two of my best friends to cancer. I have seen aunts, uncles and cousins pass away. I have watched my mother struggle every day to do simple activities. When I talk to my friends, it usually ends in a discussion about our aches and pains or latest doctor’s appointments.

I’m not looking for sympathy or pity. I feel lucky that my father lived to age 90 and that my mother is going to be 95 this year. As you grow older, it’s only natural that you start losing family members and friends at an increasing rate. What’s important is how you deal with it.

I have found that, in retirement, your mental outlook is as important as your finances. You might find yourself as a caregiver to a loved one. Taking care of an elderly person can be stressful and mentally exhausting. Waking up and knowing a good friend is gone can leave a hole in your life.

But I have also found there are things you can do to deal with these issues and give yourself a more positive outlook on life. As I mentioned in a previous blog, having a good social network of friends is important. You need, however, to diversify your friends, as you would your investment portfolio.

For instance, you need to have friends who are younger: These friends will give you a different outlook on life and will outlive your older friends. I find talking to my younger friends refreshing and invigorating.

You might feel there’s less need for friends because you have a large family.  But according to a study in the journal Personal Relationships, having a supportive network of friends in old age has greater benefits than having robust family connections. You tend to do things you enjoy with your friends, while many of the things you do with family might be out of a sense of obligation.

A healthy lifestyle can also help you maintain a positive state of mind. Exercising and eating a healthy diet are two ways to improve your mental and physical health. Don’t wait until you retire: You need to start early in life, just as you would your retirement savings plan. An added bonus: You could save thousands of dollars in retirement by being a healthy version of yourself. Health care is one of retirement’s biggest expenses—and those costs are increasing faster than inflation.

Dennis Friedman retired at age 58 from Boeing Aerospace Company. He enjoys reading and writing about personal finance. His previous blogs include Looking Forward, More Than Money and Leap of Faith.

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By the Numbers

AROUND THE TIME of my birthday each year, I request a copy of my Social Security Statement. This year, as l reviewed my report, I realized many life stories lie behind the numbers that appear in my earnings record.

The first year I had taxable earnings was 1985, the year I graduated high school. Minimum wage was $3.35 an hour and my annual income that year was $861. My earnings over the following seven years were meager, at best. I was attending college fulltime, earning both a bachelor’s and master’s degree, before becoming a member of the paid workforce.

The first year I hit a five-figure salary was 1993. I’d started working part-time in a research laboratory, while I finished my graduate studies. I made almost $11,000. After years of living on a student budget, it seemed like a substantial sum.

The following year, I was offered a fulltime position in the same lab and my earnings grew to just over $24,000. I purchased my first car that year—a Honda Civic for $9,999—but still took a bus to work, because I couldn’t afford to pay to park it. Two years later, my annual salary took a $3,500 leap. I received a promotion after my supervisor found out I was contemplating leaving the lab for a better paying position. The promotion kept me happy for a few months.

But the lure of a more lucrative salary—and the accompanying chance to improve my lifestyle—eventually proved irresistible. In 1997, after becoming fully vested in a state pension plan, I left my research position and took a job at a local hospital. My salary jumped to $37,000, but it wasn’t long before I missed the various benefits I’d grown accustomed to at my academic job. The hospital’s sole retirement benefit was a 401(k) plan with a 3% match. The amount of paid time-off was also substantially less. It was then that I became keenly aware of the trade-off between salaries and benefits. After working for 15 months at the hospital, I began looking for another job.

In June 1998, I was hired as a departmental manager at a small liberal arts college. I took a $3,000 pay cut to take the job, but the school offered a generous retirement benefit: an employer-funded account equal to 10% of my annual salary and immediate vesting. Two years after starting the job, my salary had climbed back to what I’d been making when I left the hospital, and my retirement account already had a balance of nearly $8,000.

My salary continued to climb steadily until 2005, but stagnated from 2006 through 2011. A number of factors contributed to the slowdown in taxable earnings. My husband took a job that didn’t include health care benefits, so I began covering him—and paying his premiums—through my employer’s plan. Lower cost of living adjustments, combined with higher health care costs, took a toll on my annual taxable earnings.

By 2012, my salary was on the rise again and, in 2013, my earnings record shows a nearly $8,000 increase. A divorce, and subsequent purging of my ex from my health insurance plan, resulted in a large wage increase for me. From that point forward, my salary steadily increased, the result of receiving annual cost-of-living adjustments and merit awards.

In 2017, I made nearly $70,000. Those wages came from the income earned from my primary job, as well as money from two different freelance writing side hustles.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Oregon. Her previous blogs include Happy Ending,  Material Girl  and Homeward Bound .

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All of the Above

A QUESTION FOR YOU—a trick one, I admit: Should you invest in technology stocks, such as Apple?

My answer: Yes, certainly.

Another question, also a trick one: Should you invest in the stocks of entertainment companies like Netflix?

My answer: Again, yes, of course.

A third question: Should you invest in energy companies, such as ExxonMobil?

My answer: Again, yes.

You might wonder why I’m asking these questions and why I’m answering “yes” to all of them. Does that mean that technology, entertainment and energy companies are my favorites? Do I see an advantage that they hold over others?

No, I have no favorites—which is the topic I want to address here.

Folks will often ask me a question along the lines of one of my trick questions above: “Should I invest in…?” I am always cautious when answering. To be sure, each inquiry is grounded in observable facts: Smartphone usage continues to drive growth for Apple. Consumers love the original programming on Netflix. And a recovery in oil prices has enabled Exxon to shake off its four-year slump.

All of these things are true—right now. But you don’t have to go too far back to find a time when each of these companies was not the stock market’s golden child. Apple nearly went out of business before Steve Jobs came back. In 2011, a strategic blunder caused Netflix to lose 800,000 subscribers and 75% of its market value. And a 2014 decision by OPEC caused Exxon’s sales to get cut in half.

These aren’t anomalies; things like this happen all the time. In just the past few months, we’ve seen a tech company face a congressional inquiry, a drug company suffer a rejection from the FDA and a car maker contend with a fatal malfunction. In each case, the company saw its stock price dip. Companies frequently recover from such episodes. But in the midst of it, it can be awfully hard to know how things will pan out.

In recounting this history, I’m likely not telling you anything you don’t already know. But these stories carry an important lesson: We all understand the risks inherent in individual companies, and this unpredictability is the reason I don’t recommend buying individual stocks.

As an alternative, however, I sometimes see people opt for sector index funds, which own only companies from a given industry. For example, they might buy Vanguard Financials Index Fund, which offers a bundle of 422 financial stocks in one package, or Fidelity Real Estate Index Fund, which owns 104 real estate stocks. Because of the apparent diversification, and because the word “index” appears in the name, funds like this might appear to be good—and even safe—investments.

But I urge you to use caution. These funds carry significant risk. That risk may not be as obvious as the risk involved in buying individual stocks. But bear in mind that all of the companies in a given industry will be subject to the same external forces. Oil prices impact all energy companies, interest rates impact all banks, regulation impacts all health insurers, and so on. And when they strike, these forces will often impact all of the companies in that industry.

To be sure, the impact will not be evenly distributed. But the stocks will tend to move pretty much in unison. Result: The diversification benefit offered by a sector index fund may be far more limited than you assume. In short, while sector index funds are less risky than owning just one company from that sector, they aren’t a whole lot safer.

This is why I have no favorites and believe so strongly in owning total market index funds—those funds that own every company in every industry. While this may limit your potential gains, it will also limit your losses. I see that as a fair tradeoff.

Admittedly, even with a diversified portfolio, you can always count on the stock market to deliver moments of rollercoaster-like terror. But by avoiding overly concentrated bets on individual stocks and individual industries, you’ll be better placed to limit those unpleasant moments—and improve your odds of collecting healthy long-run gains.

Adam M. Grossman’s previous blogs include Not My Thing, Nothing to Chance and  In the Cards . 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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Piling On

FORGET XBOX and PlayStation. If you’re an investment nerd, nothing beats playing with a financial calculator, especially running scenarios that combine dollars, investment returns and great gobs of time. Here are six mathematical musings—not all of them happy:

Got a newborn daughter or granddaughter? If you invest $1,000 on her behalf and the money notches 6% a year, she’ll have almost $106,000 at age 80. That 6% is my assumption for long-run annual stock returns. But that 6% also assumes 2% inflation—and 2% inflation for 80 years would slash the spending power of that $106,000 to $21,700. That’s not as impressive, but it isn’t bad.
If you buy actively managed stock funds, you’re likely to lag behind the market by some 1.5 percentage points a year. Result: Instead of earning the 6% annual return you’d collect if you bought index funds with rockbottom annual expenses, you might notch 4.5%. Now, imagine you socked away $5,000 a year for 40 years. Active funds would leave you with $559,000, versus $820,000 if you indexed.
Suppose you entered the workforce at age 22 and saved $1,000 a month for the next 10 years. Assuming 6% investment returns, you’d have close to $165,000 at age 32. What if you then stopped saving, but left the money to keep growing? At age 70, you would have $1.5 million, or $583,000 after adjusting for 48 years of 2% annual inflation. That would be enough to generate $23,300 a year in retirement income, figured in today’s dollars and assuming a 4% portfolio withdrawal rate.
Imagine you socked away $100—and somehow ensured it remained untouched and untaxed for 250 years. Using the above investment and inflation assumptions, your heirs or designated charity would have $212 million, or $1.5 million after adjusting for inflation.
Time is our ally when we invest, but it’s our enemy when we’re in debt. Want to limit the damage? Let’s say you took out a 30-year, fixed-rate $300,000 mortgage costing 4.5%. Your monthly principal-and-interest payment would be $1,520. What if you put an extra $480 every month toward paying down the principal, so you were sending the mortgage company $2,000 a month? You’d drastically reduce the interest charges you incurred—and pay off the mortgage in 18 years and five months.
Imagine you racked up $5,000 in credit card debt while in college. You never paid down the balance and, indeed, the credit card company let you add the 20% annual interest to the account balance. After 40 years, you’d receive a credit card statement showing more than $7.3 million owed.

Don’t own a financial calculator? You can do most of the above calculations with the Investment Returns calculator at Dinkytown.net and the Mortgage Calculator at Bankrate.com. Want to read more about compounding? Check out our money guide’s chapter on investment math, as well as The Tipping Point, one of HumbleDollar’s most popular blogs in 2018.

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook . His new book, From Here to Financial Happiness, will be published in early September and can now be preordered through Amazon.

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Hot Topic

IT WAS 90 DEGREES—and we were the unfortunate owners of a broken, 18-year-old heat pump. After evaluating our system, one heating, ventilation and air conditioning (HVAC) contractor recommended replacement at a cost of $7,472.

Reluctant to spend that chunk of change, we opted for a second opinion. Company No. 2 spent an hour and a half at our house, changed out a capacitor, added refrigerant and treated the system with “stop-leak,” all for $837.99. The unit has been functioning smoothly ever since.

All of which raises an obvious question: What accounts for the radically different approaches to the same problem?

Aging technology affects many conveniences of modern life, from home appliances to computers to automobiles. These items often function in the background, quietly doing their jobs while keeping us comfortable—until they break. At that juncture, most homeowners have no clue what they’re dealing with, as I belatedly discovered when I asked my father—an HVAC contractor with 40 years of experience—about our heat pump repair.

Heat pumps work by moving heat into or out of our homes, depending on the season. In the winter, they sequester heat from the outside air and pump it inside, heating our homes. In the summer, the reverse process occurs, as they remove heat from inside and pump it out. A refrigerant inside the heat pump mediates both the heating and cooling cycles.

“Freon,” a term trademarked initially by DuPont, is now known as R-22. It’s the time-honored refrigerant used in heat pumps. By the 1990s, Freon was associated with ozone depletion. As a result, the Environmental Protection Agency mandated that manufacturers phase out R-22 by 2020. A substitute refrigerant, MO-99, evolved as an alternative and can be used in older heat pump systems.

Meanwhile, a decade ago, a new style of heat pump appeared, which utilizes a completely different refrigerant, known as 410. This refrigerant is incompatible with older systems, due to an inherent pressure differential. Got all that?

Back to the classic dilemma we faced: repair or replace? HVAC professionals split into two camps. The repair camp buys into the importance of maintaining what we own. They tend to be more frugal and more patient with the uncertainty of the troubleshooting process. They also tend to be more creative when considering possible solutions. Meanwhile, the replacement camp emphasizes the definitive fix, arguing that upgrading now will avoid future costs associated with further deterioration of the older system.

But margins also play a part here. In general, it’s more profitable for the HVAC contractor to replace a unit than repair it. The markup on a new unit installation is generally 50% to 100%. If the wholesale cost of a new unit is, say, $2,200, the cost to the homeowner can be well over $4,000. This lack of price transparency leaves considerable room for unsound ethics: HVAC professionals have the upper hand, thanks to the knowledge gap between them and homeowners.

That doesn’t mean repairing will necessarily be a bargain. It can take hours to troubleshoot a broken heat pump. Also, in our state, there is a 6.75% tax on service work—but this tax isn’t charged on new installations, so it further discourages repairs. In addition, wholesale refrigerant prices influence HVAC repair bills. As of this writing, prices for refrigerants in North Carolina ranged from $4 to $15 per pound, depending on the refrigerant type. As a line item on any HVAC bill, refrigerant can be subject to an almost unlimited markup.

So what should homeowners do? Should you patch up your old heat pump system—or change it out for a newer one? As you tackle the question, information is power. When systems break, a working knowledge of heat pumps and refrigerants can help homeowners ask intelligent questions of HVAC contractors—and simply asking the questions may prod contractors to offer you the most cost-effective solution.

Back to that $837.99 bill for our repair. After digging deeper, we were likely overcharged. A capacitor is a $2 part. Stop-leak runs about $60. I don’t know which refrigerant was used in the repair, because it was listed only as Freon on the bill. The upside: The system has been cooling without a problem since the repair and, with any luck, it’ll keep chugging along for many years to come. My father says he services a system that’s been around for 40 years.

Brian Downs is a writer, physician and surgeon. You can read more of his writing at CognitiveBuffer.com.

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