Jonathan Clements's Blog, page 423

Think Bigger

To be prudent managers of our own money, we need to read the small print—but we also need to keep an eye on the big picture.

To that end, whenever we make a financial decision, we should ponder three key questions: What’s the tradeoff, does the choice make sense given our broader financial life, and will we feel as good about the decision tomorrow as we do today?

Trading Off. Suppose we remodel the bathroom, buy a new car or purchase a vacation home. On their own, all are perfectly reasonable uses for our money. But we might still be making a mistake—if we don’t stop and consider whether there are better ways to spend the dollars involved.

Our financial lives are a never-ending series of tradeoffs: Every time we purchase an item, we’re effectively deciding not to purchase something else. There is, as economists like to say, “an opportunity cost”—and yet we often fail to ponder the opportunities forgone.

We may also fail to think through the full cost involved. Let’s say we trade up to a larger house. Most of us would need to take out a bigger mortgage, and that would mean either a larger monthly mortgage payment or a longer time until the loan is paid off, and possibly both.

In addition to those mortgage payments, however, there would be other costs, which we may not fully appreciate—such as heftier property taxes, homeowner’s insurance, maintenance expenses and utilities. Will all those costs make it harder to help the kids with college costs—and will we still be able to save enough each month for our own retirement?

To be sure, there’s always a risk that we’ll devote too much money to one goal and not enough to others. But I suspect we’re especially prone to do so with housing, because of the prevailing myth that homes are a great investment—and because overspending on housing involves consuming right away, whereas saving for college and retirement represent gratification delayed.

Looking Around. Novice investors often collect investments without thinking about whether they make sense as a portfolio. A classic mistake: They buy five top-performing funds—but it turns out the five funds all invest in the same market sector, which is why they ended up topping the performance charts at the same time.

Even more sophisticated investors can slip up. We might build a portfolio that makes sense when viewed in isolation, but we don’t stop to consider whether it makes sense given our broader financial life. One example: If you’re a doctor, and hence your paycheck hinges on the future of the medical profession, you should think twice before doubling down on that bet by investing in the stocks of pharmaceutical and medical device companies.

“Money may feel like our scarcest resource, especially when we’re younger. But in truth, our most finite resource is time.”

Similarly, we might plow our spare cash into bonds. But those bonds may yield less than our debts are costing us, even after figuring in any tax advantages. Result: The money would have been better used to pay off loan balances and rid ourselves of credit card debt.

On Second Thought. We typically make purchases based on how they make us feel today. But we often don’t think about how we’ll feel a year or two down the road—and perhaps sooner. For instance, the country home might initially seem like a wonderful weekend escape. But what about the weekly trek to get there and the upkeep once we arrive? At the risk of offending animal lovers, we run the same risk with pets: The family clamors for the cute dog—but the dog doesn’t seem so cute when a walk is required at 6 a.m. on a cold, wet Saturday.

Like buying a vacation home and getting a family dog, purchasing new mutual funds and stocks can make us feel good today. Often, it’s seductively easy to buy investments: The hassles are typically modest and you don’t trigger any tax bills by buying. More important, the purchase is a moment of great hope. We get to dream about all the money we might make.

But once the investment is made, there’s the potential for disappointment—and the prospect of ongoing hassles. Every new investment in a taxable account can be an added headache at tax time. Every new financial account is another one our heirs will have to close after our death. Contemplating purchasing an antique car or a timeshare? Your heirs will think of you often as they try to offload these goodies. But they may not think of you fondly.

We should also consider the downside when making career moves. Suppose we take a new job with a higher salary. Captivated by the idea of a bigger paycheck, we might fail to ask about the health and retirement benefits, and give scant thought to the longer hours we’ll be expected to work. Those longer hours would leave us with less time for friends and family—moments that are crucial to our happiness.

Indeed, as we contemplate whether we’ll later regret a decision, we should think about more than just dollars and cents. Money may feel like our scarcest resource, especially when we’re younger. But in truth, our most finite resource is time. Whether it’s a demanding new job or a bigger house that involves more maintenance and a longer commute, money decisions often have a big impact on how we spend our time.

By the Numbers

Here’s a look at how Americans feel about their financial lives, based on the 2016 General Social Survey, which was recently released:

30% of Americans said they were very happy in 2016, unchanged from the 30% who described themselves that way in 1972. Over this 44-year stretch, inflation-adjusted per capita disposable income rose 120%. More money, it seems, hasn’t bought happiness.
29% of Americans were satisfied with their financial situation, versus 32% in 1972. Meanwhile, the percentage who aren’t at all satisfied has climbed from 23% in 1972 to 27% in 2016.
31% of Americans felt their incomes were below average or far below average, compared with 24% in 1972.
58% agreed or strongly agreed that they had a good chance of improving their standard of living, versus 72% in 1987.

Stand Tall

My cousin’s daughter has a new book out, devoted to her struggle with anorexia. Hope Virgo’s book has already been published in the U.K., where it’s been well received. Now, Stand Tall Little Girl is available in the U.S., including through Amazon. I encourage you to check it out.

Greatest Hits

Here are May’s five most popular blogs:

Site Seeing (Part I)
Footing the Bill
Odds Against
Site Seeing (Part II)
Not So Dumb

In addition, two of the most popular blogs in May were articles from earlier months: Ten Commandments, which first appeared in April, and Courtside Seat, which was published in January.

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Opening My Wallet

SPENDING DIDN’T ALWAYS COME EASY to me. As a child, I had a small weekly allowance, the spending of which I carefully controlled. In boarding school, a treat for me was a Mars bar from the school “tuck shop”—a British term for a small candy store. As I entered my mid-teens and started to earn my own money, more often than not it went into my savings account. Only when I turned 16, and had my first car, did I have to start handing over some of that money, rather begrudgingly, to the car mechanic and insurance agent. Over time, I learned to loosen the grip that I had on money and to spend it on things that I really cared about and enjoyed—but it took a few decades.

There are basic necessities on which money has to be spent, such as rent or mortgage, groceries, house maintenance and utilities. In my 20s and 30s, even as I began to make a decent income, letting go of my hard-earned money on anything other than those basic necessities was difficult for me. Frugal by nature and not materialistic, it took the realization that I couldn’t take my savings with me when I left this earth. At some point, the money would indeed be spent. Why shouldn’t I do the spending?

To spend on things that I cared about and enjoyed was tricky. I had worked hard for the money—very hard. Exhausted by the end of the work week, I had little energy to develop interests and hobbies. It took close friends to help me uncover what it was that I found interesting, starting with antiques and collectibles. With their encouragement and enthusiasm, it wasn’t long before I was enjoying the hunt for collectibles that interested me and on which I was willing to spend.

As my company started to take up less time, another hobby—cycling—grabbed my interest. An impromptu visit to a bike shop started it all off. Sports had never been my forte in school and, because my work was physically demanding, I didn’t need it to maintain fitness. Still, soon enough, cycling developed into a passion on which I was happy to spend. Encouraged by my ability to do well at the sport, I found myself wanting the best equipment.

Traveling as much as I did as a child—we moved constantly between the U.S., England and Bangladesh—I didn’t have the urge to travel much during my three decades of working. I did, however, go to Mexico often, where many of my employees were from. My visits to Mexico City were primarily taken up with the management of seasonal work visas for those employees. During those trips, I relied on an employee to help me navigate the city. When we had time to spare, we would travel outside the city. A suggestion of a road trip to the south of Mexico led to a memorable vacation with him and members of his family—a family I now consider to be part of my own. The trip to areas relatively untouched by tourism cemented my love for the country and its people. Now, on an annual basis, we continue to enjoy similar vacations around Mexico, which I happily fund. Exploring Mexico and bonding with my travel companions makes every dollar spent on these vacations worthwhile.

Spending money comes a little easier to me these days, whether it’s for a memorable experience or an interest or hobby that I have a passion for. But while travel, cycling and collectibles can now prompt me to open my wallet, and I no longer begrudgingly pay the insurance agent or the IRS, there are expenses that I still balk at—that expensive cup of coffee, the overpriced glass of wine, the cost of a hotel room, the taxi from the airport. It isn’t that I can’t afford them—but I get little joy in paying unreasonable amounts for such things.

Nicholas Clements is one of Jonathan’s older brothers. An avid cyclist, Nick is retired and lives just outside Washington, DC. His previous blogs include Talkin’ ‘Bout My Generation and  Retire to What?

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Site Seeing (Part II)

WHEN I REACHED MY MID-40s and realized I was halfway through my working life, I figured it was time to get serious about retirement planning. A scientist by training, I began to dissect the details of my retirement accounts, including how my money was invested and at what age I could begin penalty-free withdrawals. I discovered retirement at age 55 might be a viable option, but only if I started saving a larger percentage of my income and made intelligent investment decisions.

I scoured the internet for information on early retirement, as well as on savings and investment strategies. I found the most frequently referenced website was MrMoneyMustache.com, a site filled with information about living frugally. The MMM forum includes numerous journal entries from people who, like Mr. Money Mustache himself, were able to retire in their 30s and 40s by saving and investing a large percentage of their income.

Next, I stumbled upon JL Collins’s book, The Simple Path to Wealth, and the accompanying website. I appreciate the simplicity of his investing advice. His manifesto on personal finance is one I try to live by.

After reading Jonathan Clements’s book How to Think About Money, I discovered Dinkytown.net, a website with a plethora of financial calculators. The Retirement Planner Calculator allows me to experiment with different retirement-related savings and investment strategies to predict how long my nest egg will last, given different investment returns and inflation values.

On AssetBuilder.com, the Knowledge Center is full of short articles on a variety of financial topics. Several of the posts were penned by Scott Burns, a financial writer who recently retired after a 40-year career. His couch potato investing strategy focuses on investing primarily in index mutual funds.

Forum.EarlyRetirementExtreme.com is another great resource for frugal living ideas, retirement planning tips and real-life stories about people who have made their early retirement dreams come true. Filled with lots of personal journals and notes, it documents what has—and hasn’t—worked for many early retirees.

This is the second in a series of articles devoted to the favorites websites of HumbleDollar’s writers. The first article appeared May 23.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Ore. Her previous blogs include Unconventional Wisdom,   My One and Only and   Say It Forward.

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This Week/May 28-June 3

CHECK YOUR PORTFOLIO PERCENTAGES. Foreign shares have topped the performance charts in 2017, U.S. growth stocks have surged, U.S. value has lagged, blue chips have outpaced small caps, bonds have puttered along and REITs have struggled. All this may have pushed your portfolio away from target asset allocation—and it could be time to rebalance.

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Nerd Gone Wild

IT’S LONG BEEN AN IDEA that’s captured my imagination: Get a child invested in the stock market at a young age and then leave compounding to work its magic. If stocks notch four percentage points a year more than inflation—which many would consider a conservative estimate—$10,000 invested at birth would be worth $230,500 at age 80. That sort of success would, I suspect, give a significant boost to parental popularity.

When my kids were born, I set out to turn this nerdy financial dream into reality. I was on a junior reporter’s salary, with a wife in graduate school, so it took a few years to get rolling. But eventually, I settled on a five-part plan to help Hannah, now age 28, and Henry, now 24.

What were the five parts? I would make sure Hannah and Henry graduated college debt-free, and give them $5,000 upon graduation, $20,000 for a house down payment, $25,000 for retirement and $5,000 toward a wedding or at age 30, whichever came first. I didn’t have this sort of money lying around, so it took many years of regular savings to hit these targets.

Earlier this year, I wrote about Hannah’s engagement—and mentioned my five financial commitments. That blog prompted a slew of emails. How, readers asked, did I go about doing all of this?

For the graduation and wedding money, I didn’t set up separate accounts. Instead, those sums sat in my money-market fund. Meanwhile, college costs were partly covered by money I had socked away first in custodial accounts and later 529 college savings plans, once those became available. Still, I probably paid three-quarters of college costs out of current income.

What about the $20,000 in house money? Hannah’s future down payment went into Vanguard Target Retirement 2010 Fund, while Henry got Vanguard Target Retirement 2015. The target funds kept things simple, offering a diversified portfolio in a single mutual fund. On top of that, I knew the funds would become less risky over time—an appealing attribute, because I wanted the money easing out of stocks as the day approached when the kids might purchase a home.

I bought both funds in custodial accounts. That wouldn’t be a smart move if you thought your children had a shot at receiving college financial aid, because custodial accounts weigh heavily against you in the aid formulas. But I was confident our family wouldn’t qualify. Hannah cashed in her target date fund in 2015, when she bought her house in Philadelphia. I provided additional help by writing a private mortgage for her.

What about the $25,000 in retirement money? That was trickier. To contribute to an individual retirement account, you need earned income. I’ve heard of parents who have funded Roth IRAs for their children, based on income that the kids earned from babysitting and mowing lawns.

Neither of my children earned much money until they were well into their teenage years, so I went hunting for a tax-deferred account that didn’t require earned income. Result: When Hannah was age nine and Henry was five, I opened a Vanguard Group variable annuity for each of them.

Variable annuities, of course, have horribly high investment expenses. But Vanguard’s offering is an exception, with an average all-in cost of 0.54% a year, versus a 2.27% industry average. The minimum investment for Vanguard’s variable annuity is $5,000. There’s a $25 annual account fee if the balance is below $25,000—which is why I settled on that as my target gift. The variable annuities were set up as custodial accounts, with me as custodian. Once Hannah and Henry turned 21, I transferred the accounts into their names.

Later, when they started earning money, I opened Roth IRAs for them. A Roth is obviously preferable—expenses should be lower and you get tax-free growth, versus the variable annuity’s tax-deferred growth. Still, for younger kids, a low-cost variable annuity strikes me as an intriguing option: They’ll enjoy tax deferral on a grand scale—and the tax penalty will discourage them from cashing in the account before age 59½. One additional feature I like: Vanguard’s variable annuity allows you to set up automatic rebalancing. That means Hannah and Henry’s accounts will likely stay on the course that I set many years ago—without any further involvement on my part.

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Too Trusting

AFTER SHARING MY BEST INVESTMENT in my previous post, it’s only fair that I follow up with my biggest blunder. I was 22 and working my first real job, as a high school English teacher in south Texas. Thanks to the job, I quickly kick-started my “adult” life: learning about health insurance, taxes and retirement savings.

A colleague introduced me to his brother, who worked as an investment advisor. We scheduled a meeting to talk about my retirement plan. He told me that I should supplement my mandatory contributions to the Teacher Retirement System of Texas with a retirement annuity. He assured me—quickly and authoritatively—that this money was guaranteed to grow over time, no matter what happened in the stock market. Furthermore, I could borrow against this money if I ever needed it. I asked a few basic questions, determined that he seemed trustworthy and had worked with other teachers, signed up and began contributing a portion of every paycheck.

A few months later, when I told my Dad about my smart move and showed him the annuity contract, he wasn’t as excited. He pointed out that the promised growth was far less than the stock market’s likely return over the next 30 years. He noted that the fees and early surrender charge on the annuity meant I had very little flexibility and would be earning even less than the promised amount. I felt ashamed by my decision and found myself arguing the advisor’s own points back to my Dad. After some debate, my Dad convinced me of his opinion and I had to admit I had made a bad investment.

I quickly pulled my money and paid the penalty. In the process, I learned three important lessons:

Don’t trust anyone who promises you that they can or will beat the market. If they can really do that, they would be rich and wouldn’t need your business.
Never immediately commit to a financial contract or decision. No one should make you feel pressured to sign right away. This is usually an indication that something is awry. Take your time and do your research. Usually, a simple Google search can help identify potential red flags and what questions to ask.
When making financial decisions, seek out people you trust, who have no conflicts of interest, to serve as your sounding board. Bounce ideas off them and listen closely, even if what they say is disappointing and doesn’t fit the narrative you’ve constructed. Your sounding board might be a financial advisor who won’t profit from your decision—or it could be a friend, colleague or parent who has some experience with the product or concept.

Zach Blattner’s previous blogs include Land Grab and Five Tips for a Better Trip. Zach is a former teacher and school leader who now teaches teachers across the Philly/Camden region as a faculty member at Relay GSE. He is a self-taught finance nerd who dispenses advice to his wife, friends, family and anyone else willing to listen.

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Site Seeing (Part I)

MAKING SMART PERSONAL FINANCE decisions involves lots of homework. Fortunately, there are plenty of great resources out there, both aspirational and practical, to help us figure out what to do. Here are my five favorite money blogs:

The Billfold is a personal finance site brought to us by The Awl, the trend-bucking culture blog favored by media industry types. On this idiosyncratic blog, you’ll find refreshingly human takes on everything from the unexpected costs of getting a divorce to receiving an inheritance.

The Simple Dollar is my blog of choice when getting up to speed on practical money issues, like picking a savings account or insurance company. If you could only have one resource to help with your overall financial planning, this would be it.

Money After Graduation is a millennial-centric personal finance blog run by Bridget Casey. The site is a perfect entry point for people in their 20s who want to start their journey toward building long-term wealth.

The Points Guy, Brian Kelly’s travel hacking blog, is my favorite resource for learning how to turn day-to-day credit card spending into tangible rewards. Thanks to advice from The Points Guy, I’ve booked eight flights this year using points and pocket money. Don’t apply for a new credit card without coming here first.

Finally, housing is probably the single most expensive spending bucket in all of our lives. I love following Curbed New York to keep up on the city’s real estate market, home design trends and new neighborhoods worth exploring. There’s a ton of motivational content, like celebrity housing listings, to keep you focused on your savings goals.

This is the first in a series of blogs devoted to the favorite websites of HumbleDollar’s writers.

Steven Aguiar’s previous blogs include Small Changes, Big Dollars and Going It Alone. Steve is the founder of  BlueWing,  a B2B digital marketing agency. He majored in Economics and Hispanic Studies at Brown, and is a big fan of compounding interest.

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This Week/May 21-27

ADD UP YOUR FIXED LIVING COSTS. Include mortgage or rent, car payments, property taxes, insurance premiums, utilities and other recurring monthly expenses. How long could you cover these costs if you lost your job? Are these expenses so high that you find it tough to save—and suffer constant financial stress? My advice: Keep fixed costs below 50% of pretax monthly income.

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Not So Dumb

IT’S ONE OF WALL STREET’S more galling rituals: its regular dismissal of everyday investors as stupid. They’re the “dumb money” you should watch so you know what not to buy—the sheep that the “smart money” regularly fleeces.

This narrative was bolstered by early behavioral finance research, which detailed our many mental mistakes: In our overconfidence, we trade too much and make large investment bets. We’re overly influenced by recent returns. We assume our investments perform better than they really do. We hang onto losing investments, because we hate selling at a loss and admitting we made a mistake. We discount the future at too high a rate. We latch onto evidence that confirms our beliefs, while ignoring information that might force us to revise our position.

The archetype of the dumb small investor was always a little suspect—and it’s become ever harder to sustain, as evidence mounts that professional investors also regularly underperform the market averages and also make their own fair share of behavioral mistakes.

Moreover, this focus on smart and dumb money ignores an alternative explanation: Even if investors aren’t rational as judged by classical economics, their behavior can make sense if we consider what they’re aiming to achieve with their money.

That’s the intriguing argument advanced by finance professor Meir Statman in his fascinating new book, Finance for Normal People. His book represents what he calls “second generation” behavioral finance. In the first generation, it was all about identifying behavioral oddities and dismissing them as mistakes. In the second generation, those mistakes are being reappraised—and viewed as more sensible when we consider investors’ wants.

As Statman explains, our purchases—including the investments we purchase—offer three benefits: utilitarian (what it does for me), expressive (what it says about me) and emotional (how it makes me feel). Hedge fund performance has been disappointing—the utilitarian benefits are often far less than promised—and yet folks are still anxious to buy, because owning a hedge fund makes them feel special and gives them bragging rights at the country club. They get mediocre returns, but maybe they’re still getting their money’s worth.

That doesn’t mean we never make errors. Investors—professional and amateur—are subject to a host of cognitive and emotional mistakes. Those mistakes can occur when we make decisions based on intuition alone, when it would have been wiser to hit the pause button and call on the reflective, slower-moving part of our brain.

For instance, rapidly trading stocks is unlikely to deliver market-beating returns, but folks find it thrilling and it gives them the occasional winner that they can boast about. So is this a sensible way to address our wants? Obviously not, if we’re betting our entire portfolio on the foolish assumption that we can predict market movements and outsmart other investors. We’re likely falling victim to a host of cognitive and emotional errors. But if we create a “fun money” account with a sliver of our savings, knowing we’ll have lots of fun but probably not much financial success, then it seems more sensible.

In its early days, classical economics would dismiss behavioral finance as just a collection of “interesting stories.” But today, behavioral finance is much more than that. Statman takes the notion of wants, coupled with potential errors, and offers up theories of how portfolios are constructed, how stocks are priced, why markets can’t be beaten and how folks think about spending and saving over their lifetime. The theories may need fine-tuning—but they seem right, because they take fuller account of the messy way humans behave.

Finance for Normal People is geared toward an academic audience, but it has much to offer everyday investors. Statman has an engaging writing style, mixing theory with real-life examples. My advice: Put the book on your bedside table and occasionally dip into one of the chapters. It’ll help you figure out what wants you have—and help you avoid costly cognitive and emotional errors.

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Shaking the Dice

WHEN THE WORLD SEEMS A LITTLE CRAZY, we strive for greater control over our lives, including our financial lives. But the greater control we feel is often an illusion and the steps we take can badly hurt our finances. Want to learn more? Check out my latest article for Creative Planning.

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