Jonathan Clements's Blog, page 410

Hidden Gems

AS AN OBSESSIVE ORGANIZER, I like having everything tidied up before the start of the new year. I spend considerable time reviewing my finances and making sure my retirement plan is on track. As I was filling out my financial notebook this year, I added a new section: a list of lesser-known “benefits” I’ve recently discovered and intend to use more frequently in future.

For instance, after publishing a blog post about car ownership, a HumbleDollar reader suggested my insurance company might provide a more reasonably priced roadside assistance program than my current AAA coverage. A quick email to my agent revealed that I could indeed get roadside assistance added to my current policy for just over $10 per year—a savings of nearly $50 compared to AAA.

When I wrote about earning credit card rewards, it prompted me to take a closer look at the benefits included with my card of choice: the Costco Citi Visa. I discovered I have access to the card’s price rewind benefit. If I purchase an item using my Citi card and it goes on sale within 60 days, I can receive a refund of the price difference. I also discovered my card provides me with extended warranty coverage on many purchases, as well as rental car insurance.

Earlier this year, when I decided it was time to come to grips with estate planning, I contacted the employee assistance program available through my job. I was able to get a simple will, as well as medical and financial powers of attorney, drawn up for $150. In addition to offering legal referral services, the program provides other benefits, ranging from financial coaching to discounted gym memberships.

Amazon continues to impress me with the number and variety of perks included with its Prime membership program. In addition to getting access to thousands of television shows, movies, books and songs, Amazon now offers a 2% rewards program for members who reload their gift card balances using a checking account. The program is currently offering a $10 bonus for members who reload their gift card accounts with $100.

I frequently take advantage of Amazon’s free two-day shipping for Prime members, but recently I’ve had two instances when an item didn’t show up on the day it was promised. Both times, I sent a quick email to Amazon’s customer service department to tell the company about the delay. I was rewarded for my efforts with a one-month extension of my Prime membership for the first incident and a $10 Amazon credit for the second.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Oregon. Her previous blogs include Keeping It Private, A Rewarding Experience and Driving Down Costs .

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Odd Couple

THEY SAY OPPOSITES ATTRACT. In many ways, this is true of my husband and me. When we met, I was very frugal. My husband was on the other end of the spending spectrum. But we’re still together 21 years later—and we have managed to make this work in a way that’s been good for both of us.

We both well remember that first visit to the grocery store. Before we moved in together, I would go down the aisles with coupons in hand, looking for the best bargains to be had. My goal was to exit the store as quickly as possible with only the items on my list.

On my first visit with my future husband, however, shopping for sale items wasn’t necessarily on the agenda. The perusal of the shelves struck me as painstakingly slow. My husband enjoyed the journey down each aisle, plucking items off the shelves, regardless of cost. He especially enjoyed the hunt for new products. It became clear, after a few joint visits to the grocery store, that it was best for me to stay home.

Fast forward to two decades later, and you will see how we have both changed. There was never a time when we sat down together to discuss money management. It just evolved over time. Nor was there ever a confrontation. We were disappointed with one another, him toward me for not wanting to spend the money on something I really wanted, and me toward him for coming home with yet another piece of art pottery. Now that we are in the third decade of our relationship and we have moderated our spending habits, combining finances would be fine. But it was clear that doing this at the beginning, as we settled down to living together, would probably not have been a wise move.

My purse strings have loosened over time, especially in recent years. I have noted in earlier blogs that, while I remain reluctant to buy material goods, I increasingly find happiness in using my money for experiences enjoyed with family and friends, such as dinners out and travels through Mexico. In addition, I am more inclined to spend on myself. Cycling is a passion and I don’t have much hesitation in buying what I need to enjoy the sport. Meanwhile, my husband has reined in his spending. New pieces of art pottery no longer magically appear on the walls or shelves. He has now managed to build a retirement nest egg that, along with Social Security and his pension plan, should ensure he can sustain his current spending habits for the rest of his life.

I recall a moment a few years ago when I was visiting my in-laws. While I was resting one afternoon, my father-in-law came into the room. I could see that something was on his mind. He proceeded to thank me for helping his son better manage his money. It was true, I had encouraged him to control his spending and put away money for retirement. But for the most part, we both learned to manage our money better simply by watching the other.

Nicholas Clements is one of Jonathan’s older brothers. He is retired and lives just outside Washington, DC. His previous blogs include Hunting for Happiness and Help Wanted . Follow him on Twitter @MDScaper .

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This Week/Dec. 3-9

LOOK FOR INSURANCE GAPS. Many folks agonize over whether their policies are too large or small. A bigger danger: Not having coverage at all, because your life has changed but your insurance hasn’t kept up. Just had kids? It’s time for life insurance. Grown wealthy? Consider umbrella liability insurance. Started working for yourself? You may need disability coverage.

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December’s Newsletter

IF A PICTURE IS WORTH a thousand words, what would our finances look like over the course of our lives? Unfortunately, I have no talent when it comes to drawing. But when I imagine an idealized financial life, I conjure up a chart with five lines. In HumbleDollar’s latest monthly newsletter, I describe those five lines—and discuss when folks might follow a different path.

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Timely Tale

IMAGINE AN IDEALIZED CHART that summarizes our finances over the course of our lives. What would the chart look like? Picture these five lines:

Our nest egg grows, slowly at first and then ever faster, hitting a peak of around 12 times our final salary when we retire.
Our portfolio in our 20s stands at perhaps 90% or even 100% stocks. We dial down our allocation in the years that follow, especially during our final decade in the workforce, so upon retirement we have maybe 50% or 60% in stocks.
Our debts spike in our 20s and early 30s, as we take on student loans, car loans and a mortgage. But the sum borrowed dwindles from there, allowing us to retire debt-free. At that point, we have clear title to a valuable asset: our home.
Our insurance costs rise sharply through our 20s and 30s as we buy cars, purchase homes and have children. That necessitates auto, homeowner’s and life insurance, in addition to the disability and health coverage we should already have. But thereafter, the premiums we pay diminish, as our growing wealth allows us to raise the deductibles on our home, health and auto insurance, and possibly drop our life and disability coverage. By the time we retire, we might have just high-deductible auto and home coverage, plus perhaps umbrella-liability insurance, a Medigap policy and long-term-care coverage.
Our human capital—a fancy term for our income-earning ability—is at its peak value when we enter the workforce and pull in the first of 40 years’ worth of paychecks. But its value fades over time and eventually goes to zero when we quit the workforce and stop earning money.

While I listed human capital last, it’s arguably the thread that connects everything else: It provides the income to service our debts and fund retirement accounts, while freeing us up to invest heavily in stocks. But as our stream of paychecks peters out, and we approach the day when we’ll live off savings, we can’t afford to invest so aggressively or carry so much debt.

Should everybody’s financial lives follow the five trajectories outlined above? Not necessarily. You might chart a somewhat different course, depending on your personal situation.

Save 12 times income. What’s the rationale behind this number? Suppose you make $100,000 a year. If your nest egg upon retirement is equal to 12 times that income, or $1.2 million, you could reasonably withdraw $48,000 in the first year of retirement, assuming a 4% portfolio withdrawal rate. That $48,000 would replicate almost half your final salary. Add Social Security benefits, assume all debt is paid off and you’d likely be set for a comfortable retirement.

This presumes Social Security replaces 20% or so of your final salary. But for those on lower incomes, the percentage is often significantly higher. The upshot: Instead of aiming for 12 times income, you might be able to retire comfortably with savings equal to, say, eight times income. At that level, a 4% withdrawal rate would replicate 32% of your final salary. If Social Security replaces another 30% or more, you would likely be in good shape.

This is not to suggest that eight times income is an easy goal. Most retirees don’t have anything close to that amount. The National Institute on Retirement Security calculates that 60% of all households headed by someone age 55 to 64 have a net worth equal to less than four times income—with almost 26% of all households at less than one times income. Moreover, the measure of net worth used includes home equity, which can only ever be a partial source of retirement income and only if we’re willing to trade down to a smaller home or take out a reverse mortgage.

Buy bonds as we age. While almost everybody should earmark more for bonds as they grow older, the precise allocation will vary depending not only on personal appetite for risk, but also on each investor’s individual circumstances. What circumstances? At issue are the bond lookalikes in the rest of our financial lives.

“Even if we retire from the workforce, we shouldn’t ever retire from the pursuit of a fulfilling life.”

For instance, our paychecks can be viewed as similar to collecting interest from a bond, which then frees us up to invest heavily in stocks. But some workers’ paychecks aren’t so bond-like—think of folks who work on commission or have poor job security—and they should probably compensate by investing their portfolios more conservatively.

Meanwhile, for others, their holdings of bond lookalikes might go way beyond their paycheck. Let’s say you expect to receive not just Social Security retirement benefits, but also a traditional employer pension. With that handsome stream of reliable income to fall back on, you might keep a high percentage in stocks, even after you retire. What are these income streams worth? You can find out by checking what it would cost to buy income annuities that pay comparable amounts of income.

Retire debt-free. As you’ll have gathered, there’s no firm rule on how much folks need for a comfortable retirement or how much they should allocate to stocks. Debt is different: It rarely makes sense to carry loans into retirement.

Why not? At that juncture, most folks will have substantial sums allocated to bonds and other conservative investments—and the after-tax interest earned on these investments will almost always be less than the after-tax interest charged by their debts. The smart move: Instead of buying bonds, get rid of all debt.

Moreover, by paying off debt before leaving the workforce, we reduce the amount of income we need to generate each year to cover our retirement living expenses. That lower taxable income can, in turn, result in lower Medicare premiums and lower taxes on our Social Security benefit.

And let’s not forget the biggest benefit of all: Paying off all debt, especially mortgage debt, can sharply reduce our cost of living, making retirement more affordable. One rule of thumb says that we can retire comfortably on 80% of our final salary because, at that point, we no longer have to pay Social Security and Medicare payroll taxes and, of course, we no longer have to save for retirement.

Shedding all debt can further slash our retirement income needs, to maybe 60% of final salary. Indeed, for many folks, sending off that final mortgage check is the signal that retirement is finally affordable.

Trim insurance over time. As our wealth grows, we can shoulder more financial risk—and hence there’s less need for insurance. Suppose you have $1 million or more socked away. You likely need little or no life, disability and long-term-care coverage, and you can also cut your premium costs by raising the deductibles on your health, auto and homeowner’s policies.

But not everybody can take so much risk. If you have less than $1 million saved, the financial perils of suffering a disability or needing long-term care will loom large and you’ll need to continue carrying substantial insurance, even into retirement. In fact, retirement could involve not only hefty premiums for long-term-care and Medigap insurance, but also significant out-of-pocket medical costs.

Call it quits. Even if we retire from the workforce, we shouldn’t ever retire from the pursuit of a fulfilling life. After four decades at the beck and call of others, retirement is our chance to take up activities that we’re passionate about and consider important. These activities may bring a newfound sense of purpose to our final decades.

But don’t rule out getting that sense of purpose from work itself. Once retired, if we can find enjoyable paid employment that takes up maybe a day or two each week, we won’t just make our retirement more fulfilling. We’ll also continue to wring some income out of our human capital—and that extra income could make our retirement far less financially stressful.

Spending It

AS YOU MERRILY SHOP this holiday season, how about supporting our website and newsletter? You can do that by clicking through to Amazon and other retailers from HumbleDollar, and by buying Jonathan’s books. You could also purchase other books, including those recommended by HumbleDollar blogger Adam Grossman in two articles—a roundup of his favorite personal finance guides and his list of money books for those seeking a deeper understanding of financial issues.

November’s Greatest Hits

HERE ARE THE SEVEN most popular blogs from last month:

Number One Number
Ten Financial Principles
All the Right Reasons
Three Keys to Happiness
Life After Amazon
Money Well-Wasted
Keeping It Private

Last month also saw heavy traffic for the online version of last month’s newsletter and for We Know Jack, a blog from October devoted to insights from Vanguard Group founder John Bogle.

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Too Late?

WITH LOWER TAX RATES in the offing, many of my clients tell me they’ve heard it pays for them to accelerate deductions for 2018 into 2017. How, they ask, does that tactic benefit them?

They beam when I alert them to two breaks. First, they qualify for deductions one year sooner. Second, they lose less to the IRS when they apply their deductions against higher-taxed 2017 income, instead of lower-taxed 2018 income.

I decide to prolong our chat and caution them not to take their eyes off the calendar when they write checks at year’s end. Their efforts to offset write-offs against 2017’s income, rather than 2018’s, could be thwarted by longstanding IRS rules.

I’ve long ceased being surprised by how many clients, scrambling for last-minute write-offs, mistakenly believe that just writing “Dec.  31” on checks automatically entitles them to claim 2017 deductions for business expenses, charitable contributions, medical bills, interest expenses, state and local taxes, and the like. Wrong.

What does an adamant IRS insist taxpayers do? They must put their payments in mailboxes in sufficient time for letters to be postmarked by midnight Dec. 31. I assure clients that as long as they do that, the agency couldn’t care less that their checks reach recipients in 2018.

The IRS also remains unconcerned when taxpayers use credit cards issued by third parties like American Express and Visa. It concedes that taxpayers qualify for deductions as soon as they authorize charges, even if AmEx doesn’t bill them until 2018. But they might be unable to shift write-offs from 2018 to 2017 when they pay with credit cards issued by stores who bill them directly. No deductions, warns the IRS, until they pay the bills.

Another no-no: The IRS deep-sixes deductions for 2017 if taxpayers mail checks that are postdated to prevent cashing until 2018. The IRS and the courts agree that it makes no difference that taxpayers mailed them by Dec. 31.

Consider the Tax Court’s homily in a decision that held the IRS correctly disallowed a deduction for the year of mailing: “A postdated check is not a check immediately payable but is a promise to pay on the date shown. It is not a promise to pay presently and it does not mature until the day of its date, after which it is payable on demand the same as if it had not been issued until that date, although it is, as in the case of a promissory note, a negotiable instrument from the time issued.” Put more plainly, fuhgeddaboudit.

As a parting reminder, I also alert my clients to what’s likely to happen if IRS computers bounce their returns for examination. They should expect IRS auditors to look closely at large year-end checks that are dated Dec. 31 and are made out to charities, doctors, tax collectors and others. And why shouldn’t the auditors contend that the payments ought to be deducted on 2018’s 1040 form, rather than 2017’s, especially when the recipients may not have sent the checks to their banks until well beyond 2017’s close?

My clients ask for guidance on what they might do beforehand to placate the IRS. I advise them to use certified mail to send their payments, request certified mail receipts, and staple the receipts to their canceled checks.

Julian 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 A Year for Generosity and This Year or Next?  This article is excerpted from Julian Block’s Year-Round Tax Savings, available at JulianBlockTaxExpert.com. Follow Julian on Twitter @BlockJulian.

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Grossman’s Eleven

I AM AMAZED OUR SCHOOLS don’t require kids to learn three important life skills: the basics of nutrition, a thing or two about parenting, and how to handle money. I’m no expert on nutrition and my parenting is a work in progress. But I do have a background in personal finance: When folks ask me what to read to deepen their financial knowledge, I have a ready list of titles.

Recently, however, someone asked me for a more advanced list—a “201” level reading list, so to speak. In response, I drew up this list of 11 favorites:

If you want your portfolio to grow over time, you need to own stocks. Intuitively, we all know this. But to see the supporting data, read Jeremy Siegel’s Stocks for the Long Run. It’s a long book. But you don’t need to read beyond the chart on page six to appreciate Siegel’s central point: For more than 200 years, stocks have delivered far better returns than any other asset class.
While most investors accept this fact about stocks, an adjacent debate rages fiercely: Is it possible to do even better than the overall stock market averages? In Winning the Loser’s Game , Charley Ellis argues that, while this used to be possible, it no longer is. The reason: competition. As Ellis puts it, “The problem is not that investment research is not done well. The problem is that research is done very well by many.” Read this book before you invest a dollar in the stock market.
In Fooled by Randomness , Nassim Nicholas Taleb provides another reason it’s so hard to beat the market: the frustrating unpredictability of the market. Taleb explains that financial markets, unlike the physical sciences, are hardly scientific. First, they are comprised of people, who are by nature emotional. In addition, stocks are influenced by far too many variables to be predictable in any scientific way. Taleb has his critics—but I think that’s because he is so accurate in his observations.
While it’s hard to pick individual stocks that will reliably beat the market, it turns out that there’s another approach that has indeed worked: In The Little Book That Beats the Market , retired hedge fund manager Joel Greenblatt points out that there are types of stocks that historically have exhibited demonstrable outperformance. His recommendation: Build a diversified portfolio of these kinds of stocks, and you might have a shot at outperformance.
If you want to understand more of the history behind this debate about beating the market, check out Peter Bernstein’s Capital Ideas , a book that focuses as much on the personalities behind the theories as it does on the theories themselves. Among them: Alfred Cowles, who in the 1930s was arguably the first person to begin systematically studying whether stock-pickers could beat the market. His conclusion formulated more than 80 years ago: “It is doubtful.”
If you like Capital Ideas, you’ll love David Dreman’s Contrarian Investment Strategies: The Psychological Edge . In a lot of ways, he picks up where Bernstein leaves off, providing a solid introduction to the psychological biases that make investing such a maddening challenge. Dreman has been writing about behavioral finance since the late 1970s and his work is as entertaining as it is informative.
A close cousin of Dreman’s work is More Than You Know by Michael Mauboussin. One of the most thoughtful people on Wall Street, Mauboussin offers a deep dive into the intersection of markets, history, psychology and statistics. It’s an informative and enjoyable read, incorporating examples ranging from chess to horse racing to cave paintings.
The debate about beating the market is interesting and important. But it’s equally important to understand the debate that surrounds the subject of risk—including the question of how to define it. To delve into this topic, there is no better guide than another book by the late Peter Bernstein, Against the Gods .
Wall Street has received quite a bit of criticism since its 2008 meltdown. But it doesn’t seem like a whole lot has changed. In part, that’s because the inner workings of the finance industry are so complicated. Enter John Kay’s Other People’s Money , which does a masterful job helping readers understand how and why the sausage is made, and what we can do about it.
As a financial planner, I’ve noticed that oftentimes people underestimate the value of Social Security. While the system isn’t perfect, all you need to do is speak with a few retirees to appreciate the peace of mind that comes with a guaranteed monthly check. But to maximize your benefits, you need to understand your options. For that, check out Get What’s Yours by Laurence Kotlikoff, Philip Moeller and Paul Solman.
The final book on my list is one that has received, in my view, undue criticism: The Millionaire Next Door by Thomas Stanley and William Danko. The basic premise is that ordinary people living on ordinary incomes can become millionaires if they manage their household budgets smartly. In other words, drive a dull car and end up with an exciting bank balance. Critics have attacked the book for its imperfect statistical methods. Still, I think it’s important to grasp the book’s fundamental message: The best investment strategies in the world can’t help you if your expenses are preventing you from saving sufficiently.

Full disclosure: If you purchase any of the above books by clicking on the links provided, HumbleDollar earns a small referral fee from Amazon. 

Adam M. Grossman’s previous blogs include Ten Financial Principles and Right but Wrong . 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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This Week/Nov. 26-Dec. 2

FIND A WELL-RUN CHARITY. There’s a host of sites that can help you identify top-notch charities, including CharityNavigator.org, CharityWatch.org, GiveWell.org, GuideStar.org and MyPhilanthropedia.org. The most efficient charities spend less than 10% of their donations on administration and fundraising, so more ends up with the folks they aim to help.

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Three Keys to Happiness

SELF-DETERMINATION THEORY posits that we have three basic psychological needs: the need for competence, relatedness and autonomy. When these needs are satisfied, we’re more motivated and experience a greater sense of well-being.

To this, you might reasonably respond, “What the heck are you talking about?”

As I see it, self-determination theory provides a useful framework for thinking about the connection between money and happiness. We tend to be happier and more enthused about our daily lives if we’re engaged in activities we feel we’re good at (competence), we’re doing them because we want to, rather than because we’re being forced to (autonomy), and we aren’t socially isolated (relatedness). Along the same lines, I believe that, if we’re smart in how we handle our finances, we can use money to boost our happiness in three ways.

First, money can ease our financial worries and help us achieve a sense of financial freedom (autonomy). Many folks fervently believe that money will buy happiness and are often disappointed when it doesn’t.  My hopes for money are somewhat more modest: While having lots of money won’t necessarily make us happier, not having enough could make us extremely unhappy. If we can get to the point where money isn’t something we regularly fret about, we’re probably enjoying the bulk of money’s potential benefit.

Second, money can allow us to spend our days doing what we’re passionate about and what we think we excel at (competence). This is the promise of retirement, when we can spend our days as we wish, without worrying about collecting a paycheck. But with any luck, we can also get to this point during our working years. If we get our financial house in order early in our adult lives, we may have the financial freedom to work fewer hours or to swap into a career that’s less lucrative, but which perhaps we might find more fulfilling.

Third, money can make it possible to have special times with friends and family (relatedness). This is a key reason that experiences tend to deliver more happiness than possessions. Experiences, such as concerts, vacations and meals out, are often enjoyed with others, and that brings extra pleasure to these occasions.

The above blog is an edited excerpt from Jonathan’s latest book, How to Think About Money.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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A Thanksgiving Prayer

ADAM RORABAUGH LEFT THE SHORES of his German homeland at age 36, together with his wife Maria and five children, and landed in America in 1831. Two brothers also accompanied him on a stormy, 77-day sailboat voyage across the Atlantic. Driven off course during the trip, they landed at Havre de Grace, Maryland, in the Chesapeake Bay. After making their way to New York City, it is presumed the three brothers parted, never to meet or hear from each other again.

Adam’s grandson, Henry Rorabaugh, left his home and family in 1910 for the nearby railyard in Conemaugh, Pennsylvania. One day, he was assigned as engineer of Pennsylvania Railroad Engine No. 32, moving freight to Altoona, near the famous Horseshoe Curve. The boiler of his engine failed in a horrific explosion, raining tons of mangled steel on the adjacent rail beds. There were many injuries. Henry was killed instantly, along with two of his associates. This rendered Henry’s wife Emeline a single mother of seven children. Photos of the family after Henry’s death tell a story of hardship and poverty that are impossible for me to comprehend. Henry’s son Blaine, who was six years old at the time of the accident, would be my grandfather.

Exploration of my family history through tools like Ancestry.com has introduced me to numerous stories of heartbreak, scarcity and struggle. Many involve tiny coffins. Most are in remote areas of Appalachia or Virginia’s Tidewater region, and many removed by just two or three generations. When I am tempted to despair over some modern inconvenience, it is helpful to glance back to a time when hope did not look far past survival.

Of course, there are places where these stories are playing out today, such as Syria, Puerto Rico and Sudan, and in numbers that are difficult to grasp. We watch on our plasma televisions with pity, drenched in our insular virtue.

My prayer for my family and yours this Thanksgiving is that we each find some historical and global perspective for our truly abundant blessings. Our western culture has offered us prosperity and comfort that few outside our tiny window of time and space could imagine. As we consider this, I hope we are moved—no, compelled—to bless others in their time of need. That to their scarcity, we can add some of our abundance. In their fear, we can offer safety. In their pain, we can provide comfort. In their struggle, we can show hope. And that all this will create a virtuous cycle of gratitude and compassion in our own families and our communities.

World Vision and Samaritan’s Purse are two of my favorite organizations that provide relief in places of great need.

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. You can contact Phil via LinkedIn. His previous blog was Life After Amazon.

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