Jonathan Clements's Blog, page 413

Winning the Game

BY ALL ACCOUNTS, I’ve won the game. I know the income my family needs to live our desired lifestyle. I have an inflation-adjusted Navy pension in my future. I have two children and two GI Bills, one for each child. My house is paid off and I’m debt-free. Combine all of this with the 4% rule, and it seems I have enough to produce our desired income for the rest of my life. I have “won the game.”

William Bernstein. In one of HumbleDollar’s recent newsletters, noted investment manager, neurologist and author Bill Bernstein recommends that—once you’ve won the game—you should stop playing. What exactly does that mean? Bernstein suggests you dramatically reduce the risk you are taking with your retirement portfolio. To him, there’s no sense in taking risk you don’t need to take.

Easier Said Than Done. Although his advice makes sense, I find it hard to implement. First, I won the game by playing. I’m used to playing. I like playing. I want to play more. I’m only 42 and too young to stop playing. If I stop playing, I’ll be bored.

Maybe I Have Stopped Playing. As I mentioned, I have an inflation-adjusted military pension coming my way. The pension has no principal left over after my wife and I die, but it is a government guaranteed, inflation-adjusted source of income. What exactly does Bernstein mean when he says “stop playing”?

How to Tell You’ve Won the Game. In a 2015 article that Bernstein wrote for The Wall Street Journal, he said, “You’ve won when you’ve acquired enough assets to provide your basic living expenses for the rest of your life.” Simple enough. My military pension, investments and Social Security seem to meet this requirement. I guess I’ve won.

How to Stop Playing. To stop playing, you reduce the risk you’re taking with your retirement portfolio. Once you’ve accumulated enough to support your retirement, Bernstein suggests you purchase a TIPS ladder. TIPS are Treasury Inflation Protected Securities, government-issued bonds that increase in value along with inflation, while also paying a little interest on top of that. You can create a TIPS ladder by buying individual bonds at TreasuryDirect.gov.

For example, if you needed $40,000 per year for your basic expenses, you might take five years of required spending—or $200,000—and buy five $40,000 TIPS, with one maturing in each of the next five years. When one matures, you’d use that money for your expenses for the next year. At the same time, you’d purchase another $40,000 bond that matures five years from now. Rinse, wash and repeat.

If you didn’t want to buy individual bonds and were okay with the small fees they charge, you could likely get the same effect by investing $200,000 in Vanguard Group’s short-term inflation-protected bond fund or a similar low-cost offering at another investment firm. Bernstein doesn’t recommend this, because of the fees.

Apparently, I’ve Stopped Playing. I’ve decided my inflation-adjusted military pension is the equivalent of a TIPS ladder, which means I’m no longer playing, even if a part of me still is. Got a decent-size Social Security check in your future? Maybe part of you isn’t playing, either.

Joel M. Schofer, MD, MBA, is a Commander with the U.S. Navy’s Medical Corps. His previous blogs for HumbleDollar were Getting Used and The $121,500 Guestroom . He also 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.

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Age-Old Myths

DESPITE RHETORIC to the contrary, Social Security isn’t going anywhere. Today’s workers will eventually collect benefits. Today’s seniors will continue to receive the benefits they’re entitled to.

But that doesn’t alter the fact that the program faces fiscal problems, is misunderstood, and is used as a political tool to mislead and scare people, especially seniors who depend heavily on Social Security benefits. I regularly scan social media to better understand how everyday Americans view Social Security. Here are five of the many myths I see repeated:

1. “I paid for my benefits and nobody should mess with them.” In truth, you paid for the benefits of earlier generations with your payroll taxes—and today’s workers are now covering your monthly check with the taxes they’re paying.

But what about the money “saved” in the Social Security trust funds? Yes, that also partly pays the benefits of today’s retirees.

Until 2010, payroll taxes exceeded the amount necessary to pay benefits. The excess was placed in a trust fund earmarked for Social Security retirement benefits and used to purchase Treasury bonds. Today, there are three main sources of money to pay benefits: the payroll tax, income taxes paid by retirees on their Social Security benefits, and the interest collected on the bonds held by the trust.

2. “If Congress hadn’t stolen from the Social Security trust fund, there would be plenty of money.” Nobody stole the trust money. The trust fund balance held in special U.S. Treasury bonds is currently about $2.9 trillion. The basic problem facing Social Security isn’t malfeasance, but demographics.

Here’s what the Census Bureau says: “With this swelling number of older adults, the country could see greater demands for healthcare, in-home caregiving and assisted living facilities. It could also affect Social Security. We project three-and-a-half working-age adults for every older person eligible for Social Security in 2020. By 2060, that number is expected to fall to two-and-a-half working-age adults for every older person.”

Put simply, more Americans will be collecting benefits in future—even as there are (relatively speaking) fewer workers paying taxes to fund those benefits.

3. “If the Social Security trust fund was paid interest, there would be no fiscal problem.” The Treasury bonds pay the trust interest on a regular basis—the effective interest rate is more than 3% a year—just as all government debt pays interest. In 2016, the trust earned $87 billion in interest. Without that interest, there would be a shortfall—meaning either benefits couldn’t be paid in full or the federal government would need to find the money elsewhere.

4. “Social Security has a surplus, so there’s no reason benefits can’t be increased.” Proponents of expanding Social Security often claim it’s easily done, because the program is running a surplus. That is not true. There is no surplus. Today, 100% of the payroll taxes collected are used to pay the benefits of current beneficiaries. In 2016, payroll taxes equaled $678.8 billion, while the benefits paid, along with other expenses, came to $776.4 billion.

The resulting deficit was covered by the $31.6 billion in income taxes paid on Social Security benefits and, even more important, by the $87 billion in interest collected on the trust’s bonds. Without that bond interest, the program would have been running a deficit since 2010.

I’m in favor of expanding Social Security benefits, but let’s talk about that after we figure out how to make current benefits sustainable. People talk about the Social Security trust fund—singular. But in fact, there are two trust funds. The disability insurance trust fund’s reserves are projected to run out in 2028, while the trust fund for retirement benefits is expected to be depleted in 2035.

5. “If it wasn’t for the president and Congress, we’d have got a larger annual increase.” Not true. The law contains a formula that determines each year’s cost-of-living increase for Social Security benefits. Congress and the president neither determine the amount each year nor vote on it.

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous blogs were For Your Own Good and Choosing Badly. Follow Dick on Twitter @QuinnsComments.

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Four Numbers

IT’S PROBABLY NO surprise I gravitated toward a career in the sciences: I love compiling data. My master’s thesis was 150 pages of charts, graphs and tables that summarized two years’ worth of research.

When it comes to my finances, I’m equally compelled to gather data. I do so, in part, to create a set of documents that are more tangible than the pixels that make up the account balances on my computer screen. I also use the information to gauge my progress toward achieving financial independence. Over the past few years, I’ve found four calculations especially useful:

1. Net worth. I calculate my net worth—my assets minus any debts—at the beginning of each calendar year. Over the last four years, I’ve enjoyed seeing a sizable increase in the bottom line: My net worth has grown by over $150,000 to nearly $400,000. The growth of my various account balances motivates me to limit my spending and increase the sum I save.

2. Retirement savings. In his book Your Money Ratios, Charles Farrell suggests using a capital-to-income (CIR) ratio to determine if you’re on track for retirement. Farrell’s ratios are based on the assumption that, if you have savings equal to 12 times your gross income at age 65 and you’re eligible for Social Security, you should be able to generate enough retirement income to maintain your standard of living after you quit the workforce.

Using Farrell’s CIR equation, I recently calculated my own ratio based on my income, age and total account balances. Since I have no debt, I divided my current savings ($397,000) by my gross salary ($68,000) to arrive at a ratio of 5.8. Farrell suggests a ratio of 5.2 at age 50, and 7.1 at age 55, so I fall right where I need to be as I approach my 51st birthday.

3. Tipping point. Until I was in my early 40s, I didn’t contribute any of my own money to a retirement account. Instead, I relied entirely on the automatic contribution my employer made on my behalf—an amount equal to 10% of my gross salary.

When I decided to try and retire before age 65, I started contributing an increasingly large percentage of my income to a pretax retirement account. In 2000, I began saving $100 a month. By 2014, I’d increased my contribution to $500 a month. This year, I’m socking away $2,000 a month. Combined with my employer contribution, I’m now adding just over $2,500 each month to my primary retirement accounts.

In 2017, the combined contributions to my main retirement account totaled $24,500. The earnings in that account added an additional $47,000 to my balance. I realized I’d reached the tipping point, the moment when my earnings were finally exceeding the amount of my own contributions.

4. Housing expenses. Having recently added a second dog to my household, I decided to move to a two-bedroom apartment to give all of us a bit more room to move around. A general rule of thumb is that housing expenses shouldn’t exceed 30% of total income. Even with a $150 increase in my rent, my $1,300-a-month expenditure still falls within this range.

My current plan is to purchase a home before I enter fulltime retirement. By keeping my housing expenses in check for the next few years, I should be able to save enough to make a sizable down payment on a modestly-priced home.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Oregon. Her previous blogs include My Five Mistakes, Fueling the Fire and longevity.Stanford.edu.

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All Thumbs

EVERYBODY WANTS easy answers. But often, things aren’t so simple, especially when it comes to financial conundrums. Consider the four common money questions below—and the rules of thumb that folks frequently rely on.

Question No. 1: How much do I need saved for retirement? Type this question into Google and most of the answers will recommend that you save some multiple of your income. Some suggest eight-to-10 times income, while others recommend as much as 25 times.

My take: A better way to think about retirement savings, I believe, is to focus on your expenses, not your income. Why? When you’re in your peak earning years, you are likely making much more than you spend. Suppose you earn $200,000 per year. You might spend just $120,000, with the balance going to taxes and savings. In that case, you would need to focus on replacing only $120,000 in retirement, not $200,000.

There are two reasons for this. First, once you’re retired, you don’t need to save for retirement. Second, as I have pointed out before, your tax rate may be much lower once you stop working.

On top of this, your expenses could decrease sharply in retirement. Your children may be out of college and your house might be paid off. In addition, you’ll probably have extra income, in the form of Social Security. Put it all together, and you’ll likely end up with a far different target nest egg than if you focused simply on replacing your income.

Question No. 2: How much should I have in stocks vs. bonds? We’re often told our portfolio’s percentage in stocks should equal 100 minus our age. For example, when you are 30, you should have 70% in stocks, but when you’re 70, you should have just 30% in stocks.

My take: There is some logic to this rule of thumb. For most people, it does make sense to take less risk as they get older. Still, we need more than a one-size-fits-all formula. Let’s say your assets are substantial relative to your spending needs, or you have a pension, or you work part-time in retirement. These are all reasons you might choose to take more risk than somebody your age who doesn’t have these same resources. The upshot: I would disregard this rule of thumb and instead structure your investment portfolio around your own individual income needs, regardless of age.

Question No. 3: How much life insurance do I need? Many employers provide coverage equal to some multiple of your salary, generally between one and five times your pay, and lots of people assume that’s enough.

My take: Your current pay is a poor guide to your family’s total financial needs. In fact, your life insurance needs might actually be inverse to your income. If you are early in your career and have a young family, that’s when you’ll want to have the most insurance—to pay off student loans and the mortgage, and to cover ongoing living expenses and college tuition.

Meanwhile, as you progress in your career, you will likely need much less insurance. That’s because some of those large expenses will be behind you, and also you will have accumulated savings along the way. This is sometimes called becoming “self-insured.” Once you reach that point, I think you can drop your life insurance.

By the way, this dynamic of becoming self-insured over time is another reason I recommend only term life insurance and never whole life. Except in rare cases, you just don’t need insurance for your whole life.

Question No. 4: How much disability insurance should I have? Disability insurance is typically capped at 60% of your income, so that’s what folks often default to.

My take: On the surface, the purpose of disability insurance is similar to that of life insurance. If something were to happen to you, you would want insurance to help pay the bills. But there is an important difference: Disability insurance doesn’t provide a lump sum. Instead, it provides the equivalent of a monthly paycheck and, with most policies, those checks stop around age 65.

For that reason, in calculating how much coverage you’ll want, you need to include three components: your family’s regular household expenses, major future expenses such as college tuition, and your need to save for retirement. Of these, the need to continue saving for retirement is often overlooked.

One more thing: Be sure to understand who is paying the bill for your disability coverage. It might be you, it might be your employer or it might be your employer with the premiums imputed as income to you. That makes a huge difference: If you didn’t pay the premiums—either directly or indirectly—any benefits you receive will be taxable. If you end up disabled, that could have a big impact on your family’s standard of living, depending on your family’s total income and hence what your tax bracket is.

Adam M. Grossman’s previous blogs include Looking Sharpe, Anything but Average and Losing It. 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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Where’s the Party?

WE HAVE CRAZY stock market valuations in the U.S.—and yet investors don’t seem especially crazed, at least compared to the two great buying manias of recent decades.

Six months before the housing market peaked in mid-2006, I remember attending a New Year’s Day party where real-estate investing was—no exaggeration—the sole topic of conversation. I recall colleagues walking into open houses and, after quickly looking around, bidding above the asking price. I remember emails belittling my intelligence for cautioning readers about the likely return from real estate.

And I’m hardly the only person with such stories. Homeownership is so widespread—even today, 63.7% of U.S. families own their house—that it’s hard to find anybody who doesn’t have a housing bubble tale to tell.

Stock ownership is less widespread—it’s now around 51.9%—and the late 1990s are starting to seem like ancient history, so the tech-stock bubble isn’t quite so firmly lodged in our collective memory. Still, it was a wild time.

Recently, I was leafing through a book I wrote in the midst of the 2000-02 market decline, entitled You’ve Lost It, Now What? It reminded me of all the nonsense we saw in the late 1990s: the desperate desire for 100 shares of the latest IPO, the book that predicted Dow 36,000, the mutual funds that notched 100% gains in a single year, all the talk of the New Economy and how “the internet changes everything,” the way tech companies were valued based on their “burn rate”—how long it would take these money-losing startups to burn through their corporate cash.

Today feels quite different. Yes, we’ve had the hoopla over bitcoin. Yes, in recent years, the obsession with the FANG stocks—Facebook, Amazon, Netflix and Google (now Alphabet)—is somewhat reminiscent of the one-decision “Nifty Fifty” growth-stock mania of the late 1960s and early 1970s. Yes, we’ve had some fringe weirdness, like leveraged exchange-traded index funds and funds that short volatility.

But while the anecdotal evidence isn’t especially alarming, the numbers are: The S&P 500 stocks are trading at more than 24 times earnings and yield just 1.9%—both rich by historical standards. The Shiller price-earnings ratio—which measures share prices as a multiple of average inflation-adjusted earnings for the past 10 years—has lately been at levels rivaling those of 1929 and surpassed only in the late 1990s and early 2000s.

This is puzzling: If valuations are arguably crazy, why aren’t people acting crazy? Maybe the craziness will be clear only in retrospect. Perhaps we’ll look back and be astonished that investors didn’t question the trillions that companies spent buying back their own stock. Maybe we’ll marvel at the way rising profit margins and falling corporate tax rates papered over sluggish underlying growth in company earnings. Perhaps we’ll discover that low interest rates and rising stock prices have masked all kinds of financial foolishness.

Alternatively, perhaps we’re now dealing with financial markets that are so dominated by professionals that the archetypal “dumb” small investor—whom both Wall Street and the media love to heap scorn on—simply isn’t much in evidence anymore. In recent years, the net flow of money into stock funds has been lackluster, with index funds gaining new investor dollars and actively managed funds seeing net redemptions. Indeed, today’s most important active investors aren’t individuals, but institutions—and institutions try hard not to appear giddy in public.

Another possibility: Perhaps investors are buying stocks today not out of enthusiasm, but out of disdain for everything else. I haven’t had any emails saying stocks are a great buy. But I’ve heard from plenty of readers who think bonds are a terrible investment. Maybe the craziness isn’t that folks are buying stocks, but rather that they’re shunning bonds.

But guess what? Even as stock valuations seem scary, bonds are looking less terrible. The 10-year Treasury note is now at 2.97%, up from 2.41% at year-end 2017—and more than the double the 1.37% yield we saw in July 2016. I’m not saying 2.97% is any great bargain. But with annual inflation at 2.5% and a marginal federal tax bracket of, say, 22%, you can now buy 10-year Treasurys and almost hold your own against the twin threats of inflation and taxes.

To be sure, interest rates could climb further from here. Let’s say you own Vanguard Group’s total bond market index fund, which currently yields 3.1%. Even if interest rates rose a full percentage point, the fund would dip just 6%. That would sting—but it’s nothing compared to the potential loss you could suffer with stocks.

Nervous about share prices? Got money in stocks that you’ll need to spend in the next five years? For much of the past nine years, bonds have seemed like a wretched alternative to stocks. But today, keeping part of your portfolio in bonds looks like reasonably priced insurance against the risk of a vicious stock market decline—and yes, at today’s valuations, that risk is real.

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook .

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Settling Up

I’M CHIEF EXECUTIVE of Mason Finance, a company that helps people turn their life insurance policies into cash—something known as a life settlement. HumbleDollar’s editor made me this offer: If I could write a balanced article about life settlements, clearly spelling out the pros and cons, he’d consider running it. I took him up on the challenge.

If you aren’t familiar with life settlements, you are not alone. An estimated 1.1 million seniors leave roughly $112 billion a year on the table by not selling off lapsing life insurance policies, largely because they’re unaware they can do so.

Selling your life insurance means you sign over your policy’s death benefit to a third-party investor, known as a life settlement provider. In exchange for the right to collect the benefit, the provider takes over the policy’s premium payments and pays you an immediate cash settlement.

To be sure, the payout you receive will always be less than your policy’s death benefit—usually much less—but it can be significantly more than the policy’s cash surrender value. There are several factors that go into determining the value of each individual life settlement. The most important are the policyholder’s age and health, policy size and current premium level. Industrywide, the average life settlement is roughly 20% to 25% of a policy’s benefit payout. Don’t like the life settlement you were offered? Keep in mind that payouts are often negotiable.

Most policyholders that complete a life settlement transaction are at least age 65 and have a policy size of at least $50,000. While whole life and convertible term policies are potentially sellable, 90% of policies sold today are universal life and variable universal life. For people who are terminally ill, there is often an exception to the age guidelines: These transactions are known as viatical settlements.

Should you consider a life settlement? The core issue: Does it make financial sense to continue the premium payments to maintain the policy’s ultimate death benefit—or is selling a better option? That all depends on your personal situation. If you’re in good health and comfortable financially, it’s probably smart to keep your policy. But not everybody’s so fortunate. Here are four key reasons people opt to sell:

You are about to lapse your policy. This is the most common reason. If you can no longer afford the policy and you’re about to let it lapse, you are very likely leaving money on the table if you don’t sell. You have paid thousands of dollars over the years to keep the policy in force—and you should get as much for it as you can.
Your beneficiaries no longer need protection. Most policyholders purchased the insurance as financial security for their spouse or children. But if they no longer need the protection and you could really use some additional money, selling your policy could be a good move.
You have enough for the premium payments, but they’re a burden—and the burden will likely grow as you’re squeezed by rising costs for medical care, property taxes and other expenses. If you are retired and living off a fixed income, or you haven’t saved enough for retirement, significant life insurance premiums can put a big dent in your budget.
You have large, unexpected medical expenses that you can’t afford. The morbid truth: A serious illness often increases your policy’s value.

Even if selling makes sense, keep in mind the drawbacks. First, if you sell your current policy, it could be difficult and perhaps impossible to get another policy.

Second, with most life settlement contracts, your health status is no longer a private matter: You’ll often be required to give health updates to the purchasing company.

Third, some portion of the proceeds from a standard life settlement will likely be taxable. That tax bill could have been avoided if you had passed away while owning the policy.

Finally, never forget that life settlements is a business—and you aren’t the only one getting money. Indeed, it’s important who you work with to sell your policy and understand how much they’re making. An agent or broker may charge you 30% of the total payout. But such fees are negotiable—and you may be able to pay even less by avoiding middlemen and instead working with one of the many direct-to-consumer companies.

You might also explore other avenues. Depending on how much money you need, you could borrow from the policy. Alternatively, you might talk to your children or other family members about whether they would like to help with the premium payments, knowing they’d ultimately reap the policy’s benefit payout.

Felix Steinmeyer is the founder and chief executive of Mason Finance in San Francisco. He enjoys cooking with friends and hiking California’s gorgeous national parks.

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For the Record

I REGULARLY REMIND clients to hold onto their tax records in case their returns are questioned by the Internal Revenue Service. Understandably, clients ask just how long do they need to save those old records that clutter their closets and desk drawers?

Unfortunately, there’s no flat cutoff. The IRS says the answer depends on what information the records contain and the kind of transaction involved.

It supplements this vague guideline with a cryptic warning: Keep supporting records for “as long as they are important for the federal tax law.” Translated from government argot, this means: Save credit card and other receipts; bills; invoices; mileage logs; canceled, imaged or substitute checks; and whatever else might help support income, deductions, exemptions, credits, exclusions, deferrals and other items on your return.

You should hang onto these documents at least until the expiration of the statute of limitations for an audit or for you to file a refund claim, should you find an error after filing. The statute of limitations is the limited period of time after which the tax gatherers are no longer able to come knocking and after which you can’t recover an overpayment.

In most cases, the IRS has only three years from the filing deadline to take a crack at your return. For example, the deadline is April 2019 for the government to start an examination of a return for tax year 2015 that was filed in April 2016. As soon as three years elapse, you could toss out or—if apprehensive—shred much of the paperwork that you’ve accumulated.

But wait! Predictably enough, nothing is straightforward when it comes to taxes. There are two exceptions to the three-year test, though they don’t apply to most people.

The first one authorizes the IRS to double the audit deadline from three to six years if the amount of income you fail to report is more than 25% of the amount you show on your return. To illustrate, the six-year deadline expires in April 2019 for returns for tax year 2012 that were submitted in April 2013.

The second exception specifies that there’s no time limit should you fail to file a return or you file one that’s deemed false or fraudulent. The audit, admonishes the IRS, can begin “at any time.”

Those exceptions aside, there are other situations when it’s advisable to keep tax-related documents for much longer than three years. For example, you need to retain records of home improvements, as well as payments for stocks, mutual funds, real estate and other investments. These records are vital, not only because you may need them for an IRS audit, but because you need them to figure your profits or losses on sales that may not take place until many years later.

You also should retain indefinitely copies of 1040 forms filed electronically or mailed in. Copies are always helpful as guides for future returns or amending previously filed returns, and may prove helpful if the IRS claims you failed to file them.

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 The Dreaded Letter, An Ode to Owing and Right on Schedule. 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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Looking Sharpe

WHEN ASKED WHY he robbed banks, Willie Sutton replied, “because that’s where the money is.”

Similarly, private investment funds—such as hedge funds and private equity funds—are attractive to high net worth investors, because they carry the potential for outsized returns. That, supposedly, is where the big money is. Several factors explain this potential. Among them: These funds not only use leverage to increase the size of their investment bets, but also they may buy investments that aren’t publicly traded—and hence they could receive higher returns because these investments are mispriced or as an inducement to accept their illiquidity.

But private funds also carry outsized risks. And it’s not just the Madoffs of the world that bear watching. Plain old incompetence can also bring down a private fund. The reality is, as a prospective investor, you are at a distinct disadvantage in assessing the risks involved. Not only do fund managers have much more information about their own fund than you do, but even the information they disclose is often insufficient.

Consider the Sharpe ratio, a statistic intended to summarize a fund’s risk-return profile in one easy number. Hedge funds and other private investment funds universally cite this statistic in their marketing materials, with a high Sharpe ratio suggesting the fund delivers good performance relative to its risk. Sounds great. It turns out, though, that the Sharpe ratio can be highly misleading.

Sophisticated investors understand this. David Swensen, the acclaimed manager of Yale University’s endowment, is on record saying that he doesn’t bother with Sharpe ratios because it’s apples-to-oranges to compare publicly traded stocks to private funds holding illiquid investments, such as real estate, private equity investments and nontraded loans, that aren’t priced every day. Illiquid investments have inherently lower price volatility simply because they are only reappraised sporadically.

Indeed, even the inventor of the Sharpe ratio is skeptical of how it’s used by clever marketers. In a 2005 interview, William Sharpe—a winner of the Nobel Memorial Prize in Economics—said that his ratio was being “misused” by hedge funds: “Hedge funds can manipulate the ratio to misrepresent their performance.” He added that “past average experience may be a terrible predictor of future performance” and that “no number can” help investors fully understand a fund’s potential risk.

A case in point: Integral Capital. In 2001, the venerable Art Institute of Chicago became smitten with this hedge fund’s 32-year-old founder and his impressive sales pitch. Integral funds, he claimed, had never had a losing month and had the highest Sharpe ratio in the industry. The museum ultimately invested $43 million into two Integral funds.

Its investment quickly turned to disaster. After suffering losses of more than $20 million, the Art Institute sued, accusing Integral of improprieties in how it allocated fund assets. Tellingly, the funds’ attorney responded that the manager “could have bet on the Super Bowl if he wanted” with clients’ money. In other words, Integral may have lost money, but it didn’t technically do anything wrong. Cold comfort.

Alternative measures are no better. For example, Frank Sortino, the creator of the Sortino ratio, a close cousin of the Sharpe ratio, has also expressed unease that his ratio is used by hedge funds for marketing purposes. “I think it’s used too much because it makes hedge funds look good,” he says. “It’s misleading to say the least…. I hate that they’re using my name.”

If you put money into a private investment fund, you need to recognize that it is, by definition, a black box. The insiders will always understand it better than you. Result: No matter how many years of terrific performance a fund may have under its belt, you can never know whether any given fund will succumb to the fate of an Integral. To be sure, private funds offer tremendous potential—but an extra dose of due diligence never hurts.

Adam M. Grossman’s previous blogs include Anything but Average, Protect Your Privacy and Losing It. 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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May’s Newsletter

WHAT DOES GROWN-UP money look like? As I explain in HumbleDollar’s latest newsletter, it’s less about the size of your financial accounts and more about attitude.

May’s newsletter also suggests six steps you might take to turn your adult children into financial grown-ups—and discusses how this site has grown up over the past 16 months. In addition, the newsletter includes our usual list of the seven most popular blogs from the past month.

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Where Money Grows Up

HUMBLEDOLLAR ISN’T THE FINANCIAL website for everybody. Instead, it’s the place that folks end up after they have made their fair share of youthful financial mistakes—and they’re ready to settle down and get serious about money. I even briefly toyed with adding a tagline to the site: “Where Money Grows Up.”

What does grown-up money look like? It’s less about the size of your nest egg—and more about attitude. Here are 21 signs you’re a HumbleDollar reader:

When your neighbors show off their remodeled kitchen, you stare in terror and try to imagine how much it cost.
The word “annuity” makes you twitch.
When friends tell you about the great lease terms on their new car, you immediately assume they couldn’t afford to buy.
You’d rather spend an evening with Jack Bogle than Peter Lynch (and, yes, you know who both of them are).
When your niece mentions how much credit card debt she has, you suddenly feel the need to sit down.
When friends boast that they save 10% of their income every year, you think, “Is that all?”
When you worry about money, it’s about whether you’ve become too good at delaying gratification.
If someone mentions cash-value life insurance, you instinctively reach for your wallet—to make sure it’s still there.
When your brother-in-law talks about the hot tech stock he just bought, you try not to slap him.
You suspect your heirs will be pleasantly surprised.
When you hear about your cousin’s great vacations, wonderful home and European sedan, you just know your bank balance is bigger.
CNBC makes you laugh almost as much as Comedy Central.
When you read about the lavish lifestyle of some rich dude, you wonder whether all that money really makes him happy.
You have this nagging feeling you could have got it cheaper elsewhere.
When friends say they beat the market, you assume either they’re lying—or they don’t know the truth.
The prospect of paying more than 0.2% a year for a mutual fund triggers an existential crisis.
When the family takes off on a Saturday morning for the shopping mall, you just know it isn’t going to end well.
When your neighbors mention the great guy they use at Merrill Lynch, you take deep breaths to calm yourself.
Like everybody else, you have no idea where the market is headed. But unlike everybody else, you know you don’t know.
You’re no longer capable of an impulse purchase.
When your colleague announces she signed up for the 401(k), you offer a hearty “congratulations”—and silently wonder what the hell took so long.

We’re Growing Up, Too

WHEN I LAUNCHED HumbleDollar at year-end 2016, my plan was fairly simple: I wanted to take my money guide, which I had been publishing as an annually updated book, and make it freely available on the web—and, because it was on the web, I could easily update it throughout the year. In addition, I planned to blog once a week and see if I could interest others in also writing.

I had earlier been blogging every week or so at JonathanClements.com, but I didn’t want the new site to be all about me, so I went searching for a new name. After months of racking my brain—and banging names into GoDaddy, only to discover they were already taken and were often on sale for some outrageous price—I woke up in the middle of the night and started playing with iterations on the word “humble.” I climbed out of bed, powered up my laptop and discovered HumbleDollar.com was available—for $9.99. The site went live on Dec. 31, 2016, kicking off with a blog devoted to humility.

In the 16 months since, traffic has picked up considerably—this year’s number of monthly pageviews is roughly twice last year’s level—and I’ve gone through two revamps of the homepage, one last September and one last month. Today, the site has not just the comprehensive money guide and four or five blogs every week, but also a steady stream of pithy homepage features: our daily insight, intriguing statistics, ideas to ponder and actions to take. My goal: Even if you head to the site every day, you should always find something new and interesting to read.

And How About Them Kids?

MONEY MAY NOT BE the root of all evil, but it does seem to be the source of much stress. A therapist once told me it was the No. 1 reason that couples came to see her. Today, fewer Americans express satisfaction with their financial situation than they did in the early 1970s—despite living more than twice as well. The Federal Reserve found 44% of American adults either couldn’t handle a $400 financial emergency or would cover it by going into debt or selling household possessions.

Much of this angst could be avoided with just a handful of simple financial steps. Suppose you’re the parent of young adults in their 20s. What would it cost to set them on the right financial path, so one day they, too, will be HumbleDollar readers?

It is, alas, not nearly as cheap as I had hoped—which may explain why so many Americans lead lives dogged by money worries. Consider the price tag on six key financial steps:

1. Build up an emergency fund. You might open a high-yield savings account for your kids and add $250 every month, with perhaps both you and your children chipping in. The monthly sum is arbitrary, but the idea behind it isn’t: You want your adult children to have enough set aside to muddle through at least a few months. That’ll provide a modest safety net—and, I suspect, significantly reduce your children’s day-to-day money worries.

2. Pay off credit card debt. Among older college students who carry credit cards, the average balance is some $1,100, according to a 2016 study. Got kids who accumulated card debt during their college years? You might help them pay it off.

3. Stash $250 every month in a Roth IRA. While debt can be depressing, saving money is uplifting: It gives you hope the future will be brighter.

A Roth is a great investment vehicle for those in their 20s, thanks to the decades of tax-free growth they’ll enjoy. True, they won’t get the initial tax deduction that traditional retirement accounts offer. But for those in their 20s on relatively low salaries, that tax deduction probably isn’t worth all that much.

An added bonus: Roth contributions can be withdrawn at any time, with no taxes or penalties owed, as long as you don’t touch the account’s investment gains. That means the Roth could supplement your children’s emergency fund.

4. Purchase health insurance. You may have the option of keeping your adult children on your employer’s health plan until they turn age 26. If not, consider helping them buy coverage on their own. In their 20s, this will be relatively inexpensive—perhaps $300 a month, depending on how competitive the local insurance market is, and maybe even lower if your adult children qualify for a tax credit.

Make no mistake: The potential downside of skipping coverage is huge. Indeed, as a parent, helping to pay for your adult children’s health insurance ranks as financial self-defense. If they need major medical care and don’t have coverage, you will undoubtedly ride to the rescue—and it will likely cost you dearly.

5. Buy $250,000 in term life insurance. If someone doesn’t have a spouse or children, this probably isn’t necessary. But for those in their 20s, the insurance would be cheap, perhaps $330 a year. Want to turn your adult children into buyers of term insurance—and steer them away from costly cash-value life insurance? That $330 might be a small price to pay.

6. Get a will. Your adult children may have relatively few assets, so this might also seem unnecessary. Still, wills are cheap: LegalZoom.com’s starting price is $69 and Nolo.com is $59.99. Once your adult children have a will, it will become part of their financial mindset—and there’s a decent chance they’ll update it regularly.

To be sure, there are other potential steps you might take, like subsidizing your adult children’s 401(k) contributions—assuming they have access to one—or helping them buy disability insurance. But you’ll likely find the above six steps already carry too steep a price tag. Add them all up and the first-year cost might be $11,000.

What if you cut the six steps down to three—and focus on building up your children’s emergency fund, paying off credit card debt and purchasing health insurance? Even that could potentially cost almost $8,000. If you can swing it, it would make a great graduation gift. What if you can’t? If you have sound financial advice to offer, that could be just as valuable.

April’s Greatest Hits

HERE ARE THE SEVEN most popular blogs from last month:

Cracking the Wallet
Saving Is Sexy
Exposing Yourself
Carrots and Sticks
longevity.Stanford.edu
Choosing Badly
Free Lunch

Last month’s second most-visited page, after the homepage, was April’s newsletter. Folks also flocked to our list of the most popular blogs from 2018’s first quarter and to a blog published at the end of March, Four Pillars of Investing.

The post Where Money Grows Up appeared first on HumbleDollar.