Jonathan Clements's Blog, page 416

This Week/April 8-14

TAP HOME EQUITY TO TRIM OTHER DEBTS. If you have high-interest auto loans or credit card debt, you might set up a home equity line of credit and then use it to pay off these higher-cost debts. That’ll reduce the interest you pay. You won’t, however, save on taxes. Thanks to the new tax law, such home-equity borrowing is no longer tax-deductible.

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Carrots and Sticks

FINANCIAL FREEDOM is the ability to spend our days doing what we love—and, with any luck, it will come with age. As we amass more wealth, we should become less motivated by fears of layoffs and hopes of bigger paychecks. Instead, our motivation should come from within, because we are increasingly free to focus on the things we’re passionate about. This, I believe, is one of the three pillars of a happy financial life: We have fewer money worries, we have the wherewithal to enjoy special times with friends and family—and we have the freedom to spend our days engaged in work we love.

Indeed, in the psychology literature, there’s much discussion of so-called extrinsic vs. intrinsic motivation. Being self-motivated is celebrated as crucial to mental wellbeing and fulfilling our full potential. This seems reasonable: Wouldn’t you prefer to spend your days doing what you want, rather than what others tell you to do? As I have discovered in my semi-retirement, there’s great joy in working hard at things I care deeply about.

To be sure, some folks love their job. That gives them the best of both worlds, because they can devote their time to something they’re passionate about, while also getting paid to do it. But for those who aren’t so crazy about their work, amassing wealth should allow them to focus less on the extrinsic motivation of the workplace—and eventually, with retirement, to leave behind the world of pay raises and layoffs. Instead, they can focus their energies on the things they love doing.

But here’s the surprise: While it seems older workers ought to become more intrinsically motivated—and certainly it seems desirable—it doesn’t appear to happen. Studies suggest that many older workers are just as extrinsically motivated as younger workers. Why are older workers still worrying about keeping their job and earning more money? I suspect bad financial habits, coupled with a flawed retirement savings system, have a lot to do with it.

A recent study by The New School’s Schwartz Center for Economic Policy Analysis found that, among middle-class workers and their spouses currently age 50 to 60, as many as 40% risk falling into poverty or near poverty once retired. Many folks, alas, put off saving for retirement or suffer financial misfortune during their working lives, so they desperately need to stay in the workforce and earn more money to amass a decent-size nest egg. That creates financial stress that could have been avoided if they’d started saving at a much younger age—and it means they miss out on the sense of wellbeing that comes with controlling how you spend your days.

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook .

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longevity.Stanford.edu

AS A FORMER JOURNALISM MAJOR, I’m a sucker for a good headline. I understand how difficult it is to grab a reader’s attention in ten words or less. So, when I came across a headline proclaiming that a group of Stanford researchers had determined the “best” retirement strategy, I admit I was intrigued. I clicked on a link to the study—and found not only a useful retirement planning system, but also a portal into the Stanford Center on Longevity.

The Stanford Center consists of more than 150 faculty members, students and staff who conduct research and gather data on aging-related topics. Packed with original studies, research-based statistics and historical data, the website is a tremendous resource for anyone curious about how aging in America has changed over the past few decades and where it’s likely headed in the future.

The Center focuses much of its research on the interaction between physical fitness, mental wellbeing and financial health. The Mentally Sharp section of the site features research on topics such as cognitive health and decision making. The Physically Fit portion focuses on subjects related to aging in place and increasing physical activity in older adults. In the Financially Secure section, readers can explore information about fraud prevention, retirement planning and the future of aging.

The Center also explores several multi-generational issues. In The Milestones Project, Stanford researchers investigate why members of the millennial generation tend to delay significant life events, compared to older generations. The overall economic impact of delaying marriage and homeownership has yet to be determined, though researchers have also noted a trend toward millennials faring better at retirement planning than their older counterparts.

While the website highlights several positive trends—improvements in health care and nutrition have greatly extended life expectancy over the past several decades—the forecast isn’t all rainbows and unicorns. With increasing lifespans comes the probability of having to fund a longer retirement. This, in turn, often means having to spend more years in the workforce to accumulate the necessary retirement portfolio.

Research by the Stanford Center on Longevity indicates a clear connection between financial security and wellbeing, both physical and cognitive. By exploring ways to increase the health and overall wellbeing of older adults, the Center’s researchers ultimately hope to help improve the fiscal soundness of future generations.

Headline worthy? Absolutely.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Oregon. Her previous blogs include Independence Day, Case Closed and My Younger Self.

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Getting Used

OKINAWA IS A JAPANESE ISLAND that is southeast of mainland Japan and about two hours and 40 minutes from Tokyo by plane. It is famous for fierce Second World War battles and currently houses about 26,000 U.S. military personnel. From 2006 to 2008, I was one of these military personnel, working as an emergency physician in the naval hospital.

Okinawa, my new dream come true. Going to Okinawa was not my first choice. In fact, I don’t think it was anywhere on my wish list. I completed my medical training in San Diego and that’s where I wanted to stay. The physician in charge told me I was going to Okinawa. I said I wanted to stay in San Diego. He told me that Okinawa was my new dream, and he was making it come true.

Our cars before Okinawa. It was 2006 when I was given my new dream of Okinawa. My wife and I were driving two cars we had purchased new. One was a 1999 Honda CRV and the other was a 2001 Volkswagen Jetta. There was nothing wrong with either car, but we could only store one car at government expense while we were in Japan, so we sold the CRV to our neighbor and stored the Jetta.

Johnny’s. Buying a car on Okinawa usually occurs in one of three ways. You buy a car from the person you are replacing, you buy from a used car “lemon lot” on one of the military bases or you go to Johnny’s.

Johnny’s specialized in selling 10- to 15-year-old cars to Americans. If you ever wondered where your 2004 Honda Fit is, it is probably in Okinawa being driven by someone who is defending your freedom. In fact, if you want to see it, you can go to Johnnys-cars.com. It is for sale for $4,500 right now.

Our cars in Okinawa. At Johnny’s, we purchased a black 1997 Nissan March with 111,000 kilometers on it. We also got a 1998 Nissan Cube with about 60,000 kilometers from the doctor I was replacing. Both were small hatchbacks that were “of extremely poor quality” and “in poor physical condition.” According to my dictionary app, these two phrases are the very definition of the word “crappy.”

Two crappy cars in Okinawa. We were in Okinawa for two years, and we drove both of these crappy cars the entire time. What was the impact on our happiness? Not much. There were certainly bumps in the road during our time in Okinawa, but never was it because of the cars. The crappy cars were just fine.

HumbleDollar’s weekly financial tip in early March was “buy a used car.” That’s what made me think of this story. Any time I think about buying a new car, which happens occasionally, I just remember we were happy driving two crappy cars in Okinawa. And then I buy a used vehicle.

Joel M. Schofer, MD, MBA, is a Commander with the U.S. Navy’s Medical Corps. His previous blog for HumbleDollar was The $121,500 Guestroom . 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.

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Free Lunch

PERHAPS YOU’VE HEARD the expression, “there’s no free lunch.” The idea is, you usually don’t receive something for nothing. Whether it’s with money or with time and labor, you almost always “pay” one way or another.

It’s an interesting concept—but whoever coined the phrase clearly never looked at the U.S. tax code, which is full of free lunches. Today, we’ll discuss one example, which may be of interest to the charitably inclined.

One of the most talked about changes in the new tax law is a provision that alters how deductions are treated. In the past, you were able to take a federal tax deduction for the entire amount you paid in state and local taxes (often abbreviated as SALT), including real estate taxes. But under the new rules, taxpayers can deduct just $10,000 of SALT taxes.

At the same time, the standard deduction was nearly doubled to $24,000 for a couple filing jointly. Because of these changes, many taxpayers who previously were able to itemize their deductions—and thereby receive a benefit for each and every charitable donation—no longer can. Instead, they may be limited to the standard deduction.

How can you use these changes to your advantage? Suppose you and your spouse earn a combined $250,000, and suppose you like to give away 5% of your income, or $12,500, each year. To make these contributions, you could take the traditional approach and simply write checks directly to your favorite charities. But there’s a better way—a much better way—that will result in a fairly substantial free lunch.

Here’s how I would approach it: Instead of giving $12,500 every year, give away twice as much, or $25,000, every other year. Over time, the total will be the same, but in some years you’ll double up your donations and in some years you won’t donate anything. Of course, the charities that depend on your check every year may not want you to switch to an every-other-year schedule, but I have a solution for that. It’s called a donor-advised fund or DAF. A DAF is a sort of hybrid between a charity and a checking account.

The charity part issues you a receipt right away when you make a donation. But the checking account portion holds onto your funds, in a separate account that you control. Your money doesn’t go anywhere until you ask the DAF to send a check to one of your charities, which you can at any time. In combination, these two aspects allow you to schedule your donations for tax purposes every other year, while still allowing you to send your favorite charities a check every year.

Let’s look at the tax impact, comparing the traditional approach to the approach I’m describing:

Scenario No. 1: Traditional Approach

In this scenario, you make $12,500 of charitable donations every year. You start with your $250,000 income and then subtract your deductions. The maximum deduction for state and local taxes is $10,000 and your charitable donations are $12,500. That adds up to $22,500. Because this is less than the $24,00 standard deduction for a couple filing jointly, you opt for the larger standard deduction. That means your taxable income is $226,000 and, based on 2018’s tax tables, your tax bill is $42,819.

Scenario No. 2: Donor-Advised Fund

In this alternate scenario, you make a $25,000 donation every other year. Again, you start with your income of $250,000 and subtract your deductions. Your state and local taxes are still capped at $10,000, but now your charitable contributions are $25,000, bringing your total deductions to $35,000. This is far above the standard deduction, so you can now deduct the entire $35,000. This lowers your taxable income to $215,000 and your tax bill to $40,179.

Result: In scenario No. 1, your tax bill was $42,819, but in scenario No. 2 it was quite a bit lower, at $40,179, providing a savings of $2,640. Of course, you’ll only realize this savings every other year, when you make your charitable contributions. But here’s an important point: In the years when you don’t make any donation, you still get to take the standard deduction, so your tax bill is no higher than if you were making a $12,500 contribution. That’s why it’s so important to double-up your donations in the years that you give, so you receive the full tax benefit.

Is this truly a free lunch? I believe so. Yes, it requires a little bit of administrative work, you need to be charitably inclined and donor-advised funds do charge some minimal fees. And, of course, you’ll want to verify with your tax advisor that this strategy will work with your overall tax picture. For many people, though, it’s hard to see why they wouldn’t want to do this.

One more thing: Donor-advised funds also make it easy for you to donate appreciated stock. They sell the stock for you, allowing you to donate the cash proceeds to charities. In addition to convenience, this provides an additional tax benefit, because you sidestep the capital gains taxes that would have been due if you had sold the stock yourself. Got a stock portfolio with unrealized gains? I would definitely explore this strategy.

Adam M. Grossman’s previous blogs include Face Plant, Eye on the Ball and Pouring Cold Water . 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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Top 10 Blogs: First Quarter

AS STOCKS STRUGGLED THROUGH A ROCKY first quarter, a number of HumbleDollar’s best-read blogs were devoted to the financial markets. But the others were an eclectic mix and, I like to think, found broad readership thanks to sprightly writing and the intriguing insights they offered.

The $121,500 Guestroom
The Tipping Point
Second Childhood
The Morning After
Bogleheads.org
ObliviousInvestor.com
Tales to Be Told
DaveRamsey.com
Price vs. Value
Six Figures, Tiny Taxes

Two of the most widely read blogs over the past three months were actually published late last year, Best Investment 2018 and Changing Seats. The first quarter also saw heavy traffic for HumbleDollar’s monthly newsletters, especially the March edition.

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook .

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April’s Newsletter

WALL STREET’S SECOND GREAT LOVE—after making money—is arguing over how best to do so. That brings me to April’s newsletter, which looks at four enduring questions:

What’s a retiree’s best strategy for drawing down a portfolio?
Is factor investing destined to fail?
Do U.S. stocks face a great reckoning?
How much should we invest abroad?

What do these four questions have in common? They’re debates that are almost impossible to settle, in part because they necessitate forecasting market performance. Still, that didn’t prevent me from offering my take.

April’s newsletter also includes our usual list of the seven most popular blogs from last month, plus an early look at the cover of my new book, From Here to Financial Happiness.

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This Week/April 1-7

ESTIMATE YOUR RETIREMENT INCOME NEEDS. Take your annual salary. Subtract how much you save each year and pay in Social Security payroll taxes. Also subtract your annual debt payments, including your mortgage—assuming these debts will be paid off by retirement. Result: You’ll know roughly how much you will need each year for a comfortable retirement.

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Unanswered

THERE ARE MANY FINANCIAL DEBATES that shouldn’t be debates at all. Folks strike strident poses, but often their positions don’t reflect a careful weighing of the arguments. Rather, they either have a vested interest or their ego is invested. Think of commission-hungry insurance agents who pound the table for cash-value life insurance, or retirees who took Social Security early and then insist that early is always best.

In most of these cases, if we marshal the facts and apply some reasoning, we can arrive at a sensible answer. Yes, most retirees should delay claiming Social Security. No, indexing is not distorting the market. Yes, stock-picking is a loser’s game. No, most folks shouldn’t buy cash-value life insurance. Yes, it can make sense to pay off a mortgage early. No, individual bonds aren’t always superior to bond funds.

But there are four questions where reasonable people can disagree—and where it’s all but impossible to settle the debate, in part because we find ourselves peering into an extremely cloudy crystal ball. I have my take on these four questions. But I can’t promise you I’m right.

1. What’s a retiree’s best strategy for drawing down a portfolio?

Even though I consider myself semi-retired, I must confess I’ve grown weary of this debate and rarely read new studies when they appear. Often, they start with the classic 4% withdrawal rate strategy—you spend that percentage of your nest egg’s value in the first year of retirement and thereafter step up the annual sum withdrawn with inflation—and then try to improve upon it. But the solutions seem overly engineered and overly dependent on the investment returns assumed.

In the end, what we need is a strategy that’ll work even if markets are miserable and even if we live an extraordinarily long life. My personal plan: Delay claiming Social Security until age 70, use a portion of my bond-market money to purchase an immediate fixed annuity that pays lifetime income, and each year withdraw 5% of my portfolio’s beginning-of-year value. With this last strategy, I’ll be compelled to spend less if markets perform poorly—and I’ll never run out of money, because I will always be withdrawing a percentage of whatever remains.

2. Is factor investing destined to fail?

You can view factor investing as either an intriguing rethinking of risk—or a dubious attempt to bring renewed respectability to the beat-the-market game. The basic notion: By emphasizing certain types of stocks—value shares, those with upward price momentum, small-cap stocks—investors can raise their portfolio’s risk-adjusted return, if risk is measured by share price volatility.

Academics argue this isn’t a free lunch. Rather, when we overweight these stocks, we’re taking on risk that isn’t reflected in volatility. This risk should be rewarded over the long haul, and hence those who tilt their portfolio toward, say, small-cap value stocks should earn superior long-run returns.

Many investors—professional and amateur—have rushed to take advantage, hoping to goose their portfolio’s performance. But in recent years, factor investing has generated mixed results. That raises two key questions. Did the historical outperformance of these factors really reflect extra risk? And is so much money now seeking to exploit factor investing that prices have been bid up to the point where the return advantage has disappeared?

My hunch is that small-company stocks and value stocks will indeed earn superior returns over the long haul. Small stocks are clearly less financially stable. Value stocks don’t generate the same enthusiasm among investors that growth stocks do, and hence they’re less likely to be overpriced and destined for lackluster returns. But the truth is, I don’t know this for sure—and nor does anybody else.

3. Do U.S. stocks face a great reckoning?

I’ve been wrestling with this question for more than three years—which arguably means I’ve wasted three years, because there’s been no reckoning worth mentioning.

Why all the worry? Corporate profit margins are far above historical averages. Ditto for stock market valuations. Meanwhile, economic growth has been lackluster, in part because of sluggish growth in the labor force, as new entrants barely outpace retiring baby boomers. On top of all this, interest rates and inflation remain notably low—and many wonder how stocks will fare if one or both move significantly higher.

And yet, as if to prove the Wall Street cliché true, stocks have climbed this wall of worry. Indeed, the current bull market just celebrated its ninth birthday.

I have no idea whether stocks are in for a horrific decline. Forecasting short-term returns is a fool’s errand. But I do believe all the worrying is justified—and that we’re highly likely to see modest long-run stock returns. That conviction only grows stronger as shares climb higher.

My five-part plan for investors: Make sure you’re mentally prepared for steep short-term losses, save diligently to compensate for lower expected returns, regularly rebalance back to your target stock-bond mix, consider reducing risk if you’re comfortably on track to meet your goals, and get money out of stocks that you’ll need to spend in the next five years.

But can I let you in on a secret? I’d probably offer the same five-part plan, even if I didn’t expect long-run returns to be lackluster.

4. How much should we invest abroad?

This is another topic that has consumed me in recent years—and readers have noticed that both my recommended international allocation and my own portfolio’s investment in foreign stocks have been drifting higher.

This reflects a change in how I think about portfolio construction. For years, I started with U.S. stocks and then pondered what I should add to reduce risk, without doing too much damage to my long-run returns. That led me to allocate maybe 30% of my stock portfolio to foreign shares, while also holding increasing amounts in bonds as I’ve grown older.

But these days, instead of pondering what to add to a core holding in U.S. stocks, I start with the global market portfolio—the worldwide investable universe—and then decide what to subtract. The global market portfolio consists of four major sectors, all roughly equal in size: U.S. stocks, U.S. bonds, foreign stocks and foreign bonds. In other words, if you want a portfolio that reflects what everybody else owns, you should allocate a quarter of your money to each of these four sectors.

From this mix, I subtract foreign bonds, because I don’t want the extra currency exposure, given that most of my future spending will be on U.S. goods and services. But I’m happy to hold a full helping of foreign stocks, even though it means allocating half my stock portfolio to international markets. There are three reasons.

First, I fear for my portfolio’s performance if U.S. stocks generate truly terrible long-run returns. I can’t imagine that the U.S. would suffer the fate of Japanese stocks over the past 28 years—but then again, three decades ago, nobody could imagine that fate for highflying Japanese shares.

Second, foreign stocks, and especially emerging markets, are much better value than U.S. shares. This makes my increasing foreign exposure seem suspiciously like a short-term market bet—and I’ll concede that valuations have made increasing my international allocation a far easier decision.

Third, and most important, I can’t think of a good reason not to have a market weighting in foreign stocks. The currency exposure doesn’t bother me, given that I have no foreign bonds, and the arguments in favor seem compelling.

Think of it this way: The global market portfolio is the investment mix that reflects the combined judgment of all investors, with their votes cast with every trade they make. I can imagine straying from that mix for reasons for risk. What if I have no worries about risk? In that case, I should stray only if I think I’m wiser than the collective wisdom of all investors. Long experience has taught me never to be that arrogant.

Sneak Peek

FINGERS CROSSED, my next book will hit stores later this year, probably in September. What is From Here to Financial Happiness all about? The book offers readers a 77-day plan for getting their finances in shape.

Some days, the book provides a brief financial lesson. Some days, readers learn about themselves. And some days, I suggest a few simple steps for readers to take.

The book is designed to be a conversation. Indeed, by the time readers are done, I hope they’ll have scribbled all over the book—and perhaps even revised what they earlier wrote.

March’s Greatest Hits

HERE ARE THE SEVEN most popular blogs from last month:

The Tipping Point
ObliviousInvestor.com
Six Figures, Tiny Taxes
My Younger Self
NewRetirement.com
The Unasked Question
Pascal’s Retirement

In addition, readers continued to flock to The $121,500 Guestroom, a blog that was published in early February and which ranked among that month’s most popular.

The online version of March’s newsletter also saw heavy traffic and, indeed, was the site’s most visited page, outside of the home page and the main blog page. Overall, HumbleDollar had its best month in the site’s brief 15-month history, with more page views than ever before—and double the traffic we saw in March 2017.

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook .

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Four Pillars of Investing

SUCCESSFUL INVESTING IS SIMPLE, but it’s rarely easy. Yet millions of investors, both professional and amateur, assume they know what they’re doing. “We live in this mystical state where everybody thinks they can practice finance,” notes William Bernstein, retired neurologist and author of a fistful of acclaimed finance books. “But you shouldn’t practice without understanding the science of finance.”

What science? Bernstein, whom I’ve known for more than two decades, says it has four elements: investment theory, history, psychology, and the business of investing. Those four elements form the core of one of Bernstein’s best books, The Four Pillars of Investing. “The most important of those four pillars is investment theory—and the most important concept is that risk and reward are inextricably linked.”

When are rewards likely to be greatest? When the danger also seems great. “When things look awful, expected returns are high,” Bernstein says. “When everybody is talking about a given stock, the expected return is going to be lousy. Can anybody spell Tesla? Can anybody spell Apple?”

Historically, you could have earned handsome returns simply by owning a diversified portfolio of stocks. Problem is, at this point, that’s widespread knowledge. Result: Bernstein estimates that today’s expected long-run annual return from stocks is maybe 7%, versus 10% historically.

Want to do better? That might be possible if you rebalance into stocks when share prices plunge and perhaps even increase your allocation. “You need to be able to buy when everybody is running around like decapitated poultry,” Bernstein says.

But he also notes that isn’t easy. “We tend to be overconfident not just about our investment abilities, but also about our ability to tolerate risk.”

All this is made harder by Wall Street, with its relentless focus on forecasting short-run returns and picking market-beating investments. That focus fattens Wall Street’s bottom line at the expense of investors. “Financial companies service customers in the same way Baby Face Nelson serviced banks,” Bernstein quips.

What’s the solution? Save diligently, diversify broadly, buy index funds, think long-term—and pay careful attention to risk. “If you’ve won the game, stop playing,” Bernstein argues. “And to me, stop playing is buying a TIPS ladder.”

If you have enough for retirement, you might purchase individual inflation-indexed Treasury bonds, otherwise known as TIPS or Treasury Inflation Protected Securities, with the amount and maturity of each bond geared to your likely spending needs. Why inflation-indexed Treasurys? Arguably, they are the safest investment available, because they’re backed by the federal government and they protect holders from inflation.

“If you look at financial history, the biggest threat by far is hyper-inflation,” says Bernstein. “For short-term protection, the best place is TIPS. For long-term protection, it’s stocks, because they’re a claim on real assets.”

Follow Jonathan on Twitter  @ClementsMoney  and on Facebook .

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