Jonathan Clements's Blog, page 408

Taking Stock

SO WE’RE ALL POORER, RIGHT? The S&P 500-stock index has fallen 10.2% over the past nine trading days. Yet all we’ve done is give back a sliver of the huge gains notched since 2009. My contention: Not only is much of the handwringing unjustified, but arguably it’s also wrongheaded.

Seasoned investors don’t get nervous when the market declines. Rather, they get excited by the prospect of buying shares at much cheaper prices. So far, there hasn’t been much to get excited about because valuations remain rich. One indication: Despite the 10% slide, stocks are still trading at 23.5 times 2017’s reported earnings, 22% above the 50-year average of 19.2 times earnings.
Yes, stocks have surrendered a tenth of their value. But the reality is, our stocks and stock funds are typically a small part of our overall net worth. We might also have bonds, cash investments like savings accounts and certificates of deposit, our future Social Security benefits, any traditional pension plan we’re entitled to, our home and our income-earning ability. Add it all up, and you’ll likely find your net worth has barely declined over the past two weeks.
For those of us still in the workforce, our most valuable asset is usually our so-called human capital—our ability to pull in a paycheck. Often, when stocks tumble, it’s triggered by fears of recession, so we potentially face the risk of losing our jobs, even as we lose money on our stocks. But that isn’t the fear this time around. Quite the contrary: With unemployment at 4.1%, some pundits are worried the economy may overheat, driving up inflation and interest rates.
Even as we admire all our assets, we should acknowledge our debts. Those subtract from our wealth—and leverage any gains or losses in the value of our holdings. Suppose you have $600,000 in total assets, comprised of $300,000 in stocks and a $300,000 home, but also a $250,000 mortgage, so your net worth (assets minus debts) is $350,000. If your stocks lost $100,000 of their value, your $600,000 in total assets would fall 17% to $500,000, but your $350,000 net worth would drop 29% to $250,000. This sort of leveraged loss isn’t necessarily a problem, provided you keep your job. That will allow you to continue servicing the mortgage, so there’s no risk you’ll be forced to sell stocks to make the monthly house payments. What if you fear you could get laid off? It may be time to beef up your emergency fund and deleverage your financial life.
For 48% of American households, the past two weeks have been a nonevent, because they don’t have any money in the stock market. Instead, for most Americans, their biggest “investment” is their house. Some 64% of families own their home and, as best I can tell, the housing market remains buoyant.
If we’re employed, we have paychecks ahead of us. Those paychecks are a source of future savings, which we can think of as a chunk of cash that’s yet to be invested. Once we factor in that cash, our portfolios may be far more conservatively positioned than we imagine—and a big market drop could be a huge plus, because it’ll allow us to invest those future savings at lower prices.
It’s hard to be so sanguine if we’re retired or close to it. When markets tumble, our emotional time horizon often shrinks, and we obsess over every rise and fall in the market averages. My advice: Add up the money you have in bonds and cash investments, and compare that sum to the income you need each year from your portfolio. In all likelihood, you could go many years without selling stocks. Still not comforted? Also ponder what expenses you might cut, should shares continue to tumble. That would give you additional financial breathing room—and even less reason to fret over swooning stock prices.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. Also check out his blog from earlier this week about 2018’s market decline.

The post Taking Stock appeared first on HumbleDollar.

Five Steps to a Better 401(k)

TED BENNA, THE INVENTOR of the 401(k) retirement plan, famously once stated that the system he created should be “blown up.” Why? It isn’t the fundamental structure, which he still believes in. What he doesn’t like is the complexity and costs that characterize today’s typical 401(k).

The original 401(k)s, he likes to point out, had just two fund options. Today, it’s more like 20. Because of that, it’s all too easy for bad investments and high fees to sneak in. That’s what Benna doesn’t like.

In my work as a financial planner, I often see the innards of different 401(k) plans. While each has its pros and cons, last week I saw a particularly glaring example of what Benna dislikes so much.

In the retirement plan of one of Boston’s preeminent institutions, the only cash investment option is a money market fund that charges 0.37% per year. While that may sound like a tiny number, such seemingly small fees can have a destructive effect on our wealth.

To assess the fee’s fairness, we should ask, “What portion of the fund’s profits did the fund managers take for themselves—and how much did they leave for investors?” After fees, this fund’s return last year was 0.67%. If we add back the fee of 0.37%, we can calculate that the fund gained 1.04% before costs. That was the total amount of profit that was available to split between the fund manager and the fund’s shareholders.

The fund manager took 0.37 of that 1.04. As a percentage of the total profits, that translates to 36%. That’s a galling figure—the kind of thing you’d expect to see in a hedge fund, not in a simple money market fund and certainly not in a retirement account.

It gets worse. When I pointed out this fee imbalance, the employee contacted the firm that runs the fund. The firm’s response: That fee, a representative said, is “relatively normal.” This I found particularly surprising. Instead of acknowledging that the fund isn’t a great deal, the rep tried to explain it away as normal. Or relatively normal. I suppose if you’re riding in a clown car, it’s relatively normal for the guy next to you to be acting like a clown. But that’s certainly not who you want safeguarding your retirement savings.

If your employer won’t protect you from such fee-gouging, how can you protect yourself? Try these five strategies:

1. Look for index funds. Yes, some actively managed mutual funds can outperform, but only a minority do. By favoring index funds, you stack the odds in your favor.

2. Find out what each fund costs. It isn’t enough for a fund to be an index fund; It has to be an appropriately priced index fund. Often, the cost information—called an “expense ratio”—is listed only in supplemental documents, but your HR department can provide them to you.

3. Get the ticker symbol for each fund you’re considering. This is important, because many funds have similar sounding names, but the ticker symbols are unique. This will allow you to research funds using objective, third-party resources like Morningstar, which has a free, online database.

4. Be cautious of target-date funds. While these are great in theory, fund companies also know how much consumers like them. As a result, I often find them loaded with fees. You can often achieve the same objectives as a target-date fund, but at much lower cost, by combining two separate, simpler funds.

5. Don’t settle. In many cases, a 401(k) menu will offer a handful of good, low-cost funds, but not enough to create an ideal portfolio. That’s okay. Just buy what you can within your 401(k) and then compensate with supplemental purchases in another account outside your 401(k).

Adam M. Grossman’s previous blogs include Five Ways to Diversify, About That 22% and Your Loss, Their Gain . 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 Five Steps to a Better 401(k) appeared first on HumbleDollar.

A Most Morbid Game

THERE ARE MANY WHO CLAIM TO SPEAK with authority on Social Security.  I am not one of them. But I’m nothing if not curious. I recently set about testing some notions I have heard with regard to Social Security retirement benefits. A family member had asked for help understanding her Social Security statement, so I had some real numbers to work with. The statement predicted that her monthly benefits would be as follows, depending on when she begins benefits:

$1,907 at age 62. This is the earliest opportunity to claim retirement benefits.
$2,749 at age 67. This is considered full retirement age (FRA) for this individual, as defined by Social Security.
$3,431 at age 70. This is the latest age at which she and everybody else can start benefits, assuming they’re still alive.

It occurred to me that this was the most morbid game of chance ever devised. I have heard it stated that there is roughly an 8% increase in benefits for each year you delay, so I reached into a forgotten corner of my brain to see if I could confirm or deny. The 8% claim appears, even with my limited math skills, to have some attachment to reality, at least for this individual. In fact, for those born after 1943, the Social Security Administration promises an eight percentage point increase for each year you delay from FRA to age 70.

The next question that came to mind: If we apply the 4% withdrawal rule, what is the value of this income stream? The 4% rule is anything but universally agreed to, but it is certainly as durable an idea as you will find in the world of personal finance. It is held by many to be the sustainable rate of withdrawal from a 50% stock-50% bond portfolio through a 30-year retirement. If you start your withdrawals at 4% of your nest egg’s value in the first year, and thereafter increase the sum annually for inflation, you are very unlikely to run out of money over the ensuing three decades.

$1,907 a month at age 62 translates to $22,884 per year, which is 4% of $572,100.
$2,749 a month at 67 is $32,988 per year, or 4% of $824,700.
$3,431 a month at 70 is $41,172 per year, or 4% of $1,029,300.

In other words, in the above situation, if you claim benefits at age 70, you’d have a Social Security benefit equal to what might be sustainably withdrawn from $1 million in cash, an increase of $457,200 over the age 62 amount. This seems like a pretty good deal, merely for missing out on eight years of benefits. You will have an 80% larger stream of inflation-adjusted income to carry you through a potentially long retirement, easing your financial worries and making you less dependent on your portfolio’s investment performance.

Of course, you have no access to the assets that produce this income—and you must be blessed with sufficient health to make it reasonable to delay benefits. If some dreaded disease were contracted at age 62 or beyond, it would certainly lead me to claim benefits sooner rather than later.

Is this something you can influence? Maybe. Almost everybody has room for improving their health probabilities through lifestyle. Even then, longevity is something of a crapshoot. Healthy people of all ages die due to causes that would be difficult to predict or prevent. Sorry, but this is one that’s not entirely in our control.

For most of us, the presence of other income sources will be required to delay benefits. All but the most fortunate will need some source of income prior to age 70. If you have constructed a plan that will meet your spending needs without Social Security, you will have the option to delay benefits. This is the factor, I would suggest, over which we have the greatest influence. Reducing fixed costs, increasing retirement contributions and keeping your human capital fresh—while not the sexiest of plans—is still the one most likely to succeed.

If you are married, there are additional considerations: Even if you’re in poor health, you may want to delay claiming benefits if you had been the family’s main breadwinner, because your spouse would then receive a larger survivor benefit. There are also variables involving taxes that can make the math trickier than it appears at first glance. But the bottom line is: Delaying your benefit, if you are healthy, gives you very good odds of maximizing your lifetime payout from Social Security.

When not paddling, biking or shooting, Phil Dawson provides technical services for a global auto manufacturer. He, his sweetheart Donna and their four extraordinary daughters live in and around Jarrettsville, Maryland. His previous blogs include DaveRamsey.com, Making Your Case and Course Correction . You can contact Phil via LinkedIn .

The post A Most Morbid Game appeared first on HumbleDollar.

The Morning After

WHEN MARKETS GO CRAZY, financial writers feel compelled to dust off the keyboard and cook up profound insights. But I am writing this at 5 a.m., while still ingesting my first cup of coffee, so I’m setting the bar a little lower. Here are 13 modest observations following yesterday’s 4.1% plunge by the S&P 500:

1.  I don’t know. You don’t know. Nobody knows. The market turmoil of the past six trading days feels like a sea change after 2017’s remarkable calm. Our instinct is to try to divine what it means for the months ahead. But the reality is, nobody can forecast the stock market’s short-term direction.

2. Keep it in perspective. What we’ve suffered so far is a minor 7.8% dip after an astonishing run that saw the share prices of the S&P 500 companies climb 292% from March 9, 2009, through their collective all-time high, set just six trading days ago, on Jan. 26. Losing almost 2,300 points on the Dow Jones Industrial Average over six trading days may feel like a big deal, but it isn’t a big percentage.

3. There’s isn’t one strategy for everybody. We’re all at different stages of our lives, have different goals and different personal tolerances for risk, and we have different portfolios—some of us underweighted in stocks and wanting to own more, others over-weighted and wondering whether to sell.

4. Instead of fretting about where stocks are headed, focus on risk—with a particular focus on two questions. First, do you have money in stocks that you’ll need to spend in the next five years? For instance, do you have dollars in stocks earmarked for your teenager’s college education or for the next five years of your own retirement? Seriously consider moving those dollars to a money-market fund or a high-quality short-term bond fund. With stocks within spitting distance of their all-time high, you’re likely still booking hefty profits. In fact, you’ll be selling at the handsome prices that were on offer as recently as December.

Second, has the market drop made you realize you’re less brave than you imagined? If this is a true bear market—and I’m not predicting it is—prices could potentially fall far further. As I’m fond of saying, it’s much better to sell in a panic when stocks are close to their all-time high, rather than waiting until they’re 30% lower. It isn’t “too late” to sell. Far from it.

5. If you’ve been sitting on cash, waiting for a great buying opportunity, you’ll have to wait longer. Better still, stop waiting and start buying—slowly. Figure out how much you want in stocks, divide it into 24 or 36 equal sums, and then spoon that money into stocks over the next two or three years. If share prices drop 15% from their Jan. 26 high, double the size of your monthly purchases. If the market falls 25%, triple your monthly investment.

6. If you’re more than 15 years from retirement, you have two tasks. First, pray mightily for a major market decline, so you can buy stocks at cheaper prices. Second, step up your savings rate to compensate for what will likely be modest long-run stock market returns.

As I noted in HumbleDollar’s latest newsletter, over the past three decades, share prices have climbed 3½ percentage points a year faster than economic growth, thanks to widening corporate profit margins and rising price-earnings ratios. This could, I suppose, continue—but it’s unreasonable to expect it, so protect yourself against modest returns by saving at least 12% of pretax income every year toward retirement and preferably 15% or even more.

7. Even if you’re happy with the portfolio you hold, you’ll want to take advantage of the market decline—assuming it continues—by rebalancing back to your portfolio’s target percentage for stocks. Many folks rebalance once a year. But you might decide that you’ll rebalance earlier if, say, the market declines 20%. Write down your trigger for rebalancing and stick it on the refrigerator.

8. In fact, write everything down and stick it on the refrigerator. What’s your plan? What target mix of U.S. stocks, U.S. bonds and foreign shares are you aiming to hold? Which investments will you buy? How much will you save per month and at what market level will you rebalance? As markets gyrate, it’s all too easy to “revise” our decisions if they exist only in our heads. It’s tougher when we’re confronted with our own words on a piece of paper.

9. Two hoary Wall Street clichés have been trotted out in recent weeks: that bull markets don’t die of old age and that stocks don’t go down simply because they’re overvalued. Yet the two popular explanations for why stocks have declined—because of inflation fears and rising interest rates—seem pretty thin.

After all, as I type this, the 10-year Treasury note is at 2.72%, not much higher than the 2.41% at year-end 2017. This seems like a classic example of investors cooking up a simple story to explain complicated markets driven by millions of individuals making disparate decisions.

10. Pundits talk reassuringly about the strength of the U.S. economy, including last year’s fairly decent economic growth and today’s low unemployment rate, with the recent tax cuts layered on top of that. All that is true. Problem is, investors look forward, not back. The economic news seems likely to stay good for at least another year—but maybe investors sense it won’t be good enough to justify current share prices.

11. The S&P 500 is trading at 32.1 times its 10-year average inflation-adjusted earnings—otherwise known as its cyclically adjusted price-earnings ratio or Shiller P/E—well above the 50-year average of 19.9. I’m not predicting that share prices will fall back to that average. But don’t let anybody tell you that U.S. stocks are cheap.

12. Foreign stocks, including emerging markets, are better value, and investors seem to be recognizing that: After a long stretch of wretched performance, developed foreign markets finally outpaced U.S. stocks last year, while emerging markets have now had two years of outperformance.

Back in the 1980s, U.S. investors might have kept 10% or 20% of their stock portfolio abroad. Today, I think 40% and perhaps even 50% overseas makes sense, both for diversification and because of valuations.

Over the past year or so, a tumbling dollar has made foreign shares more valuable for U.S. holders. But imagine the roles were reversed—and you’re a foreign holder of U.S. stocks. Not only have U.S. share prices lately looked shaky, but also you’re losing money on the currency. An open question: If the market turbulence continues, will foreign investors rethink their allocation to U.S. stocks and bonds, and could that add to the selling pressure?

13. Cheer up, things could be worse: Instead of owning stocks, you could own bitcoin.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

The post The Morning After appeared first on HumbleDollar.

This Week/Feb. 4-10

SET A FLOOR FOR FINANCIAL PAIN. Suppose you have $400,000 saved. What’s the minimum value below which you never want your portfolio to fall? Let’s say it’s $300,000, or $100,000 less. Divide that $100,000 by 0.35 and you get $286,000. That’s the maximum sum you should have in stocks. Why 0.35? In a bear market, the average loss is 35%.

The post This Week/Feb. 4-10 appeared first on HumbleDollar.

February’s Newsletter

IT’S BEEN A ROUGH WEEK for stocks, but a great 30 years. Result: My generation has earned stock returns that far outstrip the results merited by the economy’s performance. This has been good for us, but not so good for our adult children. To save for their retirement, they’re buying the overvalued stocks that we’re selling to pay for our retirement.

To make matters worse, those in their 20s and 30s are facing a tougher employment market, where getting a good job often requires more than just a bachelor’s, and yet all that time in college and university is also leaving them with crippling amounts of student loans. I tackle this conundrum in two articles in HumbleDollar’s latest newsletter, which also includes our usual list of the past month’s most popular blogs.

The post February’s Newsletter appeared first on HumbleDollar.

Think of the Children

I FEAR I AM GROWING WEALTHY at my children’s expense. My investing life began in the late 1980s. Yes, there have been stock market bumps since then, notably the 2000-02 and 2007-09 market crashes, and even a minor hiccup over the past week. But if you look at the broad trend, it’s been three decades of rising stock market valuations.

From year-end 1987 to year-end 2017, the S&P 500’s price-earnings multiple climbed from 13.8 to 24.6, its cyclically adjusted price-earnings ratio jumped from 13.4 to 32.3 and its dividend yield declined from 3.7% to 1.8%.

And, no, this isn’t distorted by the start date. Despite the October 1987 crash, 1987 was a winning year for the S&P 500, with stocks gaining 5.3%, including dividends. Indeed, the increase in valuations looks similar if you use 1988 as the start date.

Those rising valuations helped propel the S&P 500 to an 8.3% annual share-price gain over the past 30 years. (Add dividends, and the total return was 10.7% a year.) That 8.3% annual share-price gain ran far ahead of economic fundamentals. Over the 30 years, the economy’s nominal growth was 4.7% a year and earnings per share climbed at 6.3%, while inflation notched 2.6%.

If share prices had merely tracked earnings growth, annual returns would have been two percentage points lower, and if they’d tracked nominal economic growth, the results would have been three-and-a-half points lower. Think of it this way: My generation has contributed to an economy that’s done okay, but not great—and yet we’ve pocketed stock-market rewards worthy of economic superstars.

There are all kinds of possible explanations for the market’s heady performance. Our economic fears have subsided and our appetite for investment risk is far greater, thanks to the long post-World War II period of prosperity. We have an abundance of capital sloshing around the globe, chasing limited investment opportunities. Interest rates are far lower today than 30 years ago, making bonds and cash investments less attractive. Sluggish wage growth and lower corporate tax rates have fattened company profit margins. Shrinking investment costs have made the financial markets more appealing.

Whatever the reasons for the market’s spectacular performance, I’m now sitting with a portfolio that will easily pay for retirement. I reaped the reward of the long rise in valuations—and I even got a couple of nice market crashes that allowed me to buy stocks at bargain prices. I’m startled by my good fortune, but also aware that it could slip away, so I have been gradually easing out of stocks and purchasing more bonds, especially inflation-indexed Treasury bonds. I’ve won the game, so I see less reason to keep playing.

Meanwhile, my adult children are buying. The stocks that I’m selling to pay for my retirement, and which strike me as overpriced, are the ones they’re purchasing to pay for their retirement.

Over the next three or four decades, my children will likely make decent money in stocks. But given today’s starting valuations, I suspect their returns will be far lower than mine.

But what choice do they, and others in their 20s and 30s, have? Stocks may generate lackluster results, but they should perform better than bonds and other more conservative investments. My advice to my children: Save as much as you can, allocate 40% and perhaps even 50% of your stock portfolio to foreign shares, with their more reasonable valuations—and hope for tumbling markets, so you can buy at much lower price-earnings multiples.

January’s Greatest Hits

HERE ARE THE SEVEN most popular blogs from January:

Price vs. Value
DaveRamsey.com
Second Childhood
More for Your Money
The Price Is Slight
About That 22%
Hitting Refresh

January’s newsletter also attracted a slew of readers, as did two blogs from late December, Changing Seats and Best Investment 2018. Indeed, last month saw the highest number of page views in HumbleDollar’s brief 13-month history.

Think of the Children (Part II)

ALMOST EVERYBODY SAYS THEY’RE MIDDLE CLASS, so the term has lost almost all meaning. What’s the alternative? Instead of middle class, I think of myself as part of the investing class—with “investing” used in the broadest sense. I want to use the money I’ve saved not only to maintain my financial position, but also to give my children and stepchildren a leg up and (whenever they show up) their children as well.

To be able to do so is a privilege. Many parents barely have the wherewithal to support themselves, let alone help their children.

But to do so is also increasingly difficult. For earlier generations, simply getting the kids into college was the key to continued family prosperity. Now, not only is a bachelor’s degree typically a costly endeavor, but often it also isn’t enough. To stand out in the work world and thrive financially, those in their 20s and 30s may need advanced degrees, as well as parental help with other goals. All this raises three key questions:

1. Should you help? If you provide financial assistance to your adult children, there’s a danger you’ll kill their ambition with kindness.

But I suspect that, whether you help or not, the damage is probably already done. Simply growing up in a comfortable household will often squelch children’s financial ambition. Why would they worry about having enough money if they never saw their parents worry?

You could try to instill that financial ambition by, say, deliberately depriving your kids from an early age. But that strikes me as harsh and undesirable. Instead, I would worry about a bigger issue: making sure your children have some ambition, even if it isn’t financial ambition. You don’t want your kids meandering through life and missing out on the great pleasure that comes with working hard at something they’re passionate about.

To avoid that fate, encourage your children to find a purpose that will make their lives fulfilling and make the world a better place. That purpose may not make them rich. But it should enrich their lives.

2. How much help can you afford to give? You won’t be doing anybody any favors—yourself or your children—if you provide substantial assistance to your kids, only to discover later that you don’t have enough for your own retirement.

My recommendation: Give serious thought to how much financial support you can offer and which goals you want to help with, and then have occasional frank conversations with your children. You want to manage their expectations, so they know what help they will receive and where you’ll draw the line.

Try to have that first serious money conversation when your children are high school freshmen. You should talk to them about how much help you can offer with college costs, so they know whether they can aspire to ritzy private colleges or should look instead at state universities and community colleges.

If they’ll need to take on student loans, that should be part of the conversation. Talk to those in their 20s and 30s with education debt, and many will readily admit they didn’t understand what they were getting into. As a responsible parent, you should discuss likely career earnings and hence how much your children can reasonably borrow.

Ideally, your children will opt for colleges that leave them with little or no debt. There’s mounting evidence that student loans put young adults at a lifelong financial disadvantage, with many struggling to buy homes and save for retirement.

3. How can you leverage your dollars? If you’re like me—part of the investing class but still financially constrained—you should think not only about how much help you can provide, but also how best to use both those dollars and your parental influence to get your children on the right track financially.

To that end, consider seeding your adult children’s financial future. That might mean helping them set up accounts for different goals, such as a Roth IRA for retirement, high-yield savings accounts for emergency money and for their future house down payment, and 529s for the grandchildren.

You could provide the initial investment for these accounts and then encourage your children to contribute regularly thereafter. By doing so, you emphasize the goals you think they should focus on—and you get a chance to pass on your financial wisdom, by picking the right accounts and selecting appropriate investments.

You might also encourage your children to think longer-term, so they fund retirement accounts and buy stocks. But how? You could reassure them that you stand ready to help in the short-term if, say, they lose their job or get hit with surprisingly large medical bills. With your backing, they might be comfortable raising the deductibles on their various insurance policies and keeping a somewhat smaller emergency fund. That, in turn, will give them additional money to sock away toward longer-term goals.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

The post Think of the Children appeared first on HumbleDollar.

The $121,500 Guestroom

I HAVE A WIFE, TWO CHILDREN, TWO DOGS, and the need for three bedrooms and two bathrooms. In March 2015, I purchased a four bedroom, 3½ bath, 3,000-square-foot house in a nice neighborhood with quality public schools.

The fourth bedroom was largely unnecessary but, like many people, we occasionally get visitors and feel it’s nice to have an extra bedroom for them, instead of spending money on a hotel room. This is the story of how that fourth bedroom cost me more than $121,500, far more than it would have cost to get hotel rooms for our occasional visitors.

The Guestroom. The guestroom and its accompanying full bathroom are approximately 600 square feet. We bought the house for $140 per square foot, meaning that this extra room and bathroom cost me $84,000. Where I live, you can get a decent hotel room for $100 a night.

In other words, I could have purchased 840 nights in a hotel room. I don’t think we’ll ever have 840 overnight guests, unless we stay in this house for a very, very, very long time. In addition, we have a very comfortable, queen-size Lazy Boy sleeper couch that could have substituted for the guestroom.

Running total: $84,000

The HVAC Incident. “The way they installed this, I don’t even think I can fix it.” That is not what I wanted my HVAC (heating, ventilation and air conditioning) repairman to say, but that is what he said. The guestroom did not have its own HVAC zone and, because it is above the garage and the insulation is not what it could be, the guestroom is always too hot or too cold. If you are going to have a guestroom, it needs to be comfortable, right? Some $5,000 later, the guestroom had its own wall-mounted HVAC unit and zone.

Running total: $89,000

The Exchange Student. Because we have an $89,000 extra room with a bathroom and its own HVAC, we hosted a Spanish exchange student during the past school year. Hosting an exchange student was a great experience for both my family and me, expanding our horizons and hopefully forging a lasting relationship with someone for us to visit in Spain.

The student, though skinny as a rail at 5’8” and 110 pounds, ate way more than I would have expected. I have no idea how much it cost me.

Running total: $89,000, plus whatever it cost me to feed a skinny but hungry 16-year-old boy for a school year.

Despite the fact that he was of driving age, he was not allowed to drive in the U.S. This, of course, led to…

The Manny Van. As of August 2016, I had a wife, two kids, two dogs and an exchange student. It was going to be tough to get around and do the traveling we like to do in our Toyota Prius and Ford Fusion Hybrid. Having a 12-, 15- and 16-year-old in the backseat, while technically feasible, was not going to be fun for anything other than the shortest of trips. Plus, we like to bring the dogs.

Enter the $32,500, 2015 Toyota Sienna minivan, which I like to call the “manny van” when I’m driving. It enabled me to haul all living beings I was responsible for in the manliest of vans.

Running total: $121,500, plus whatever it cost me to feed a skinny but hungry 16-year-old boy for a school year.

The Moral of the Story. One of the classic financial mistakes that people make (including me, apparently) is spending too much money, including buying too expensive a car and too large a house. Sometimes, something as simple as wanting a guestroom can lead to unintended and expensive consequences. If we didn’t have a guestroom, I would probably have an extra $121,500, a school year’s worth of food—and I wouldn’t be driving a “manny van.”

Joel M. Schofer, MD, MBA, is a Commander with the U.S. Navy’s Medical Corps. He blogs about personal finance at MilitaryMillions.com and can be reached at Still-In@MilitaryMillions.com. The views expressed in this article are those of the author and do not necessarily reflect the official policy or position of the Department of the Navy, Department of Defense or the United States Government.

The post The $121,500 Guestroom appeared first on HumbleDollar.

Five Ways to Diversify

IN 1952, A YOUNG GRADUATE STUDENT named Harry Markowitz wrote a paper that sought to prove, mathematically, the old maxim “don’t put all your eggs in one basket.” Through his work, Markowitz taught investors how to diversify their investments effectively, something that was not well understood at the time.

For instance, he explained that the number of stocks you hold is far less important than the number of types of stocks you own. A portfolio of 60 stocks might appear to be diversified. But if all 60 are technology stocks, there is still quite a bit of risk. Today, this might seem like commonsense, but at the time it was a major revelation.

Markowitz ultimately won a Nobel Prize for his work, and there’s no question it was brilliant. Today, however, there’s even more you can do to manage risk in your financial life. Here are five ideas to help you think more comprehensively about diversification:

1. Diversify your tax rates. If you’re saving money through a traditional retirement account, like a 401(k) or an IRA, you’re already doing this, by choosing to pay taxes at future rates rather than today’s. That’s a great move, but don’t stop there. There are other accounts which can also help you diversify your tax exposure.

For example, under the new tax laws, you can now use the tax-free growth offered by 529 savings accounts to pay K-12 expenses. Some states even offer an income-tax deduction for 529 contributions.

Tax-free growth is also available from Roth IRAs and 401(k)s, thus providing a hedge against higher future tax rates. Don’t have a Roth 401(k) at work and don’t qualify for a Roth IRA? Check out the “backdoor” Roth IRA, which may allow you to contribute to a Roth regardless of your income level. And don’t forget Health Savings Accounts, which are triple-tax-advantaged for those who are eligible.

2. Diversify your investment products. In Markowitz’s time, the investment world was much simpler, consisting primarily of stocks, bonds and a modest number of mutual funds. Today, you can choose from a much broader array of investments, some with remarkably low costs.

But you also need to be careful. Exchange-traded funds, for example, have become extremely popular since they were invented in 1993, but they have also exhibited weaknesses. In the “Flash Crash” of May 2010, the prices of many ETFs briefly fell to a penny per share for no explicable reason. With that history in mind, I recommend diversifying the investment products you hold. Don’t own just ETFs or just mutual funds. Instead, own a broad enough mix to protect yourself against the sort of extreme and unexpected events that occur from time to time.

3. Diversify your financial relationships. If you’re from New York, you may remember the blackout of 2003. Among other effects, ATM machines and credit card networks went dark, making it difficult to buy food. The root cause turned out to be a malfunction at an electric utility in Ohio.

For many, this was a reminder that our financial system has vulnerabilities. Today, that includes the risk posed by hackers. As self-defense, I don’t think it’s unreasonable to maintain accounts at more than one financial firm. You might arrange things so that your bank account, credit cards and investment accounts are with different institutions.

4. Diversify the timing of your purchases. Clients often ask me if it’s wise to invest in stocks right now. Unfortunately, no one can predict whether the market will see a decline any time soon—or whether it will continue to rise.

Got excess cash? I recommend investing it on a fixed schedule, such as one-tenth each month for ten months. If the market keeps going higher, you will be glad you didn’t wait. And if the market goes down, you’ll be happy you didn’t invest it all at once.

5. Diversify the timing of your sales. If you are in retirement and taking required distributions from your IRA, you may wonder what the best strategy is for making those withdrawals. I apply the same rationale to sales as I do to purchases. Because we don’t know how markets will perform in the short-term, I would ask your IRA custodian to issue your annual distribution in equal monthly installments over the course of the year.

Adam M. Grossman’s previous blogs include About That 22% , More for Your Money and Your Loss, Their Gain. 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 Five Ways to Diversify appeared first on HumbleDollar.

This Week/Jan. 28-Feb. 3

CHECK YOUR BENEFICIARY DESIGNATIONS. Your retirement accounts and life insurance will typically pass to the beneficiaries specified on those accounts, not the people named in your will. If your family situation has changed, or you simply don’t remember who you listed, take a moment to review your beneficiary designations.

The post This Week/Jan. 28-Feb. 3 appeared first on HumbleDollar.