Jonathan Clements's Blog, page 426

Slip Sliding Away

WHILE TALKING RECENTLY to an estate-planning client about investments costs, she showed me a letter from her financial advisor stating that he charges her 1% of assets a year. Maureen didn’t understand that she also pays each mutual fund’s annual expenses, a portion of which is also paid to her advisor. Her fund expense ratios average 1.14%, which includes a 0.25% 12b‑1 fee that her advisor pockets. Result: Maureen’s total cost is 2.14% a year, with 1.25% going to her advisor.

Investors who need an advisor face myriad possible fee structures. Some advisors charge fixed or hourly fees. Some take sales commissions that reduce the overall amount invested or returned. Others charge a percentage of assets under management. Yet others levy some combination of these. When Maureen was younger, with a small but growing portfolio of $25,000, paying an advisor 1% of assets, equal to $250, was an efficient way to get a few hours of an advisor’s time. Now, 30 years later, she has a portfolio closer to $1.5 million. The 1% fee generates $15,000 a year for her advisor. Maureen suspects that a flat annual or hourly fee would be fair to her advisor without being unfair to her.

While Maureen may be able to negotiate a lower advisory fee, she can only influence the expense ratios on her mutual funds by changing funds or buying a different share class of her existing funds. The major components of expense ratios are management fees, 12b-1 distribution fees (if any) and other administrative costs, such as those for accounting, legal work and shareholder reporting. Management fees are the amount retained by the fund sponsor for selecting the securities that make up the fund. Marketing and distribution 12b-1 fees are annual payments of between 0.25% and 1%, and are typically paid to financial advisors and others whose clients invest in the funds. Another cost borne by investors, though not included in the expense ratio, is the transaction costs incurred by the fund when it buys and sells securities. The higher the fund’s turnover rate, the higher the cost that the fund’s investors effectively pay.

There’s wide variation in expense ratios and their component parts. Expenses tend to be higher for stock funds than bond funds, and higher for actively managed funds than index funds. Maureen’s expense ratios average 1.14%, with management fees at 0.72% and administrative costs at 0.16%. According to the Investment Company Institute, average asset-weighted stock fund expense ratios fell from 1.08% in 1996 to 0.84% in 2015, as investors flocked to lower-cost funds. But investors have plenty of room to cut expenses further—and lowering costs could dramatically increase how much their money grows over time. How low can expense ratios get? At Vanguard Group, renowned for its low-cost funds, expense ratios average 0.18%.

Matthew Sullivan is a Boston-based lawyer, consultant and entrepreneur who has been captivated by personal finance for nearly 30 years. He enjoys cycling and international travel.

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This Week/April 16-22

THINK OF YOUR ASSETS AS INCOME. If you retired today, how much income would your nest egg generate? One rule of thumb says that, in the first year of retirement, you can withdraw 4% of your portfolio’s value, equal to $4,000 for every $100,000 saved. It’s a sobering way to assess your retirement readiness—and it might prompt you to save more, postpone retirement or work part-time in retirement.

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Nothing Better

NO DOUBT YOU WOULD DRAW UP a somewhat different list. But here’s what I consider life’s greatest pleasures:

Talking to my wife over a glass of wine at the end of the day
Losing myself for a few hours in an interesting piece of work
Walking in nature
Spending time with my kids
French fries
Waking up after a great night’s sleep
Knowing I did the right thing
Wrapping up work on a Friday
Making love
A raucous dinner party
Feeling physically spent after a good workout
Finally sorting out a long-simmering problem
People watching
Taking a nap
Ending the day with a sense of accomplishment

To me, these are among the finest things life can offer—and they have a common element: You don’t need to be rich to enjoy any of them. Not sure I’m right? Draw up your own list of great pleasures. You might even post it below. How many of the items on your list necessitate great wealth?

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Upping the Ante

MY SISTER JUST HAD A BABY, our family’s first grandchild. That officially makes me a PANK: a Professional Aunt, No Kids. This often-overlooked demographic takes an active role in the lives of children they’re close to. They spend not only time, but also money: 76% of PANKs lavish more than $500 a year on each of their nieces and nephews, resulting in some $9 billion in annual purchases.

The opportunity to buy adorable items for baby Henrik is not lost on me. I’ve had the past nine months to ruminate over what being an aunt actually means, and the role I want to play in our family village. I am aware of the limited ROI—return on investment—of frivolous gifts. I would rather share values with my nephew—values that will serve him well throughout his life.

The challenge: Defy the shrewd marketing initiatives of brands that have tweaked their messages in an attempt to capture my PANK dollar, and instead focus on what truly pulls at my heart strings. Would it be possible to replace every holiday’s physical gift with an equivalent deposit into a 529 college savings plan?

Once Henrik is old enough, I will share the letter of intent drafted for his 529. This plan outlines the ideals which, I believe, will benefit him throughout the years, including the importance of discipline and education. The plan also includes monetary incentives to encourage his financial education. Henrik, of course, will initially fail to see the virtue in these virtues. I hope I survive the “why” stage.

My commitment to Henrik, and this plan, is a bit self-serving. I’m always looking for accountability partners, and now I may have the cutest one yet. It’s a good thing I will have time to try and figure out how to explain to a toddler why I don’t bring shiny gifts, and instead would love to talk to him about compound interest. Let’s just say aunt-of-the-year award isn’t on the table for a bit. When he applies for college, however, a simple view of the scoreboard—as reflected in his 529 account balance—will show complete and utter PANK dominance.

In this grand plan, there remains one unavoidable source of jealousy: While I may be a PANK, my husband gets to be a PUNK.

Anika Hedstrom is a financial planner with Vista Capital Partners in Portland, Ore. She loves to nerd-out and, when given a dollar, will save 96 cents. Her previous blog was Home Economics. Her nephew Henrik’s middle name is Olaf—named after his grandfather, who was born on April 13, the same date this blog was published.

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My One and Only

MY FAVORITE DIVORCE QUOTE, if one can have such a thing, comes from comedian Louis C.K.: “No good marriage has ever ended in divorce. If your friend got divorced, it means things were bad. And now, they’re better.”

For myself, these words certainly ring true. But “better” comes at a price: Being a divorced, middle-aged woman means looking at financial matters from a different perspective than my married friends. Since I no longer have a spouse, financial security rests squarely on my shoulders. I don’t have the luxury of knowing there’s a second income, in the event of a job loss or other financial emergency. Because of this, I made establishing an emergency fund a priority. I used the proceeds from the sale of my house to set up an account with enough money to cover at least nine months’ worth of living expenses.

My insurance needs also differ from the typical two-income household. Having both a short- and long-term disability plan is critical. I have access to long-term disability insurance through my job. It would provide 60% of my monthly income, in the event I wasn’t able to work for a period of more than 180 days. Since I typically set aside approximately 25% of my gross wages each month for retirement savings and would cut that back if I were disabled, I feel confident I could live off the proceeds from this single policy. For shorter-term illnesses, I maintain a balance of ten weeks of paid sick-leave. I could also use my accumulated vacation days to cover a medical emergency, if necessary.

Because I don’t have any dependents—my corgi Zoey doesn’t count in the eyes of the IRS—there’s no reason to carry a life insurance policy. But having no children or a spouse also means I have fewer options when it comes to long-term care. I recently learned I’m eligible to purchase a long-term-care policy through my state’s public employee retirement system. This unexpected benefit is available to me because my first job out of college was at a state educational institute. By purchasing a policy as a member of a larger pool of participants, I’d pay less than if I purchased a policy individually.

So is Louis C.K. right? Yes, for me, life after divorce is better—much better. But it took a coherent financial plan to recover my sense of financial security.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Ore. She enjoys competitive pistol shooting and hanging out with Zoey, her corgi. Her previous blogs include  Say It Forward and Wanting for Something .

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This Week/April 9-15

CAP ALTERNATIVE INVESTMENTS. How much do you have in alternative investments—everything from gold to commodities to hedge funds? As a rule, keep your allocation to 10% or less of your total portfolio’s value, and favor simpler, less expensive options, such as funds that focus on gold stocks and on real estate investment trusts.

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Next to Nothing

YOU CAN BUILD A GREAT PORTFOLIO with just three index funds: a U.S. total stock market fund, an international fund that buys both developed and emerging stock markets, and a high-quality U.S. bond fund. Thanks to the ongoing price war among major index-fund providers, all three funds are now on offer at extraordinarily low annual expenses.

Below are some of the funds available, with their expenses listed in parentheses. These figures come from fund company websites or a fund’s latest annual report:

Total U.S. stock market funds. You can buy mutual funds such as Fidelity Total Market Index Premium Class (0.045%), Schwab Total Stock Market Index Fund (0.03%) and Vanguard Total Stock Market Index Admiral Shares (0.04%). Alternatively, you might purchase exchange-traded funds (ETFs) like iShares Core S&P Total U.S. Stock Market ETF (0.03%), Schwab U.S. Broad Market ETF (0.03%) and Vanguard Total Stock Market ETF (0.04%).

Total international stock funds. The mutual funds on offer include Fidelity Global ex U.S. Index Premium Class (0.11%) and Vanguard FTSE All-World ex-U.S. Index Admiral Shares (0.11%), while ETF buyers might consider iShares Core MSCI Total International Stock ETF (0.11%) and Vanguard FTSE All-World ex-U.S. ETF (0.11%).

Total U.S. bond market funds. Mutual fund buyers can invest in Fidelity U.S. Bond Index Premium Class (0.05%), Schwab U.S. Aggregate Bond Index Fund (0.04%) and Vanguard Total Bond Market Index Admiral Shares (0.05%). ETF investors should check out iShares Core U.S. Aggregate Bond ETF (0.05%), Schwab U.S. Aggregate Bond ETF (0.04%) and Vanguard Total Bond Market ETF (0.05%).

Suppose you were aiming to build a balanced portfolio, with 40% U.S. stocks, 20% foreign shares and 40% high-quality bonds. Using the lowest-cost funds listed above, your weighted average annual expenses would be 0.05%, whether you opted for mutual funds or ETFs. That’s just $50 a year on a $100,000 portfolio.

Because ETFs are listed on the stock market, buyers also incur trading costs, including bid-ask spreads and commissions. By contrast, the mutual funds are all no-load, so there’s no commissions to be paid. Because of trading costs, those who regularly add to their accounts should probably favor mutual funds, while those with a lump sum to invest might opt for ETFs, which could prove marginally more tax-efficient. Either way, the costs are amazingly low—especially compared to actively managed funds, which often charge 1% a year or more.

Keep four caveats in mind. First, to get the low expenses on the Fidelity and Vanguard mutual funds listed above, you need to invest $10,000 per fund. For smaller accounts, annual costs are somewhat higher.

Second, today’s price war is focused largely on flagship funds, such as those listed above. Many more specialized index funds remain relatively expensive.

Third, if you already own one of the funds above, it isn’t worth swapping into another fund with marginally lower expenses: You could incur trading costs and trigger a tax bill, and you might find yourself out of the market for a few days during the switch. On top of that, it could be that the slightly more expensive fund performs better, thanks to securities lending and smarter trading, plus it might be more tax-efficient.

Finally, fund companies could reverse their price cuts. That’s unlikely at Vanguard Group, which aims to operate each fund at cost. But other companies may be barely breaking even at current expense ratios and perhaps even losing money, so there’s a risk they’ll eventually opt to raise expenses.

It’s easy to imagine that happening in a bear market, when investors are no longer in a buying mood. At that juncture, fund companies might feel they can raise expenses with impunity, knowing there aren’t many new investment dollars to attract—and knowing that existing investors would be reluctant to sell, because of the tax bills and trading costs they’d face.

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Five Tips for a Better Trip

MY WIFE AND I JUST GOT BACK from two weeks of travel through Vietnam and Cambodia. For us, traveling strengthens our relationship and reminds us what we want in life. International travel is a luxury—there’s no doubt about it—but it’s also a meaningful experience that is easier to afford if you follow some basic principles before crossing oceans or international borders:

1. Save in advance. Before booking a trip, take the time to build up the funds needed to cover your expected costs. By doing so, you will avoid paying for the trip on credit, or booking a trip that is simply out of your budget. As I mentioned in an earlier post, our approach is to regularly dedicate a portion of each paycheck to our “travel fund,” which we keep in a separate savings account.

2. Pay with a purpose. There are many travel rewards credit cards that not only give you points that can be redeemed to offset hotel and airfare, but also don’t charge any foreign transaction fees. By avoiding those 3% fees, you’ll have more money to spend on souvenirs, lunches and bus tickets.

3. Search strategically. When you’re flexible about your destination but know you want to travel, use one of the many search aggregators, like Kayak’s explore function, to find the best deals. We did this when planning our honeymoon and found cheap direct flights to the Azores. We previously weren’t considering the Azores as a destination, but I now strongly recommend them to friends for an amazing, budget-friendly week that’s off the typical tourist’s radar.

4. Borrow instead of buy. Use your local library and social media friends to get your hands on travel guides and climate-specific gear, instead of purchasing things you’re unlikely to use again. This is an easy way to save initial costs and get good recommendations.

5. Explore the outdoors. Research experiences and outings at your destination that allow you to interact with local culture and be physically active. Often, these are free or low-cost—think visiting neighborhood food markets, hiking and exploring city parks—thus ensuring that some of your time abroad doesn’t cost anything.

Got other travel tips? I’d love to hear them. Please share them in the comments section below.

Zach Blattner’s previous blogs include Zeroing In and Money Pit. 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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Retire to What?

AS I PREPARED TO RETIRE at the relatively young age of 55, it was important to me not to become isolated, not to lose touch with the world beyond my home. My husband continues to work, leaving me on my own for much of the day. I consider myself a social person. All my jobs have involved working with employees and customers, from my first job as a delicatessen cashier through to running my own landscape maintenance company with 25 employees and hundreds of accounts.

My father retired at the same age. He moved to the Florida Keys, where he became socially isolated, spending much of his time alone.  He once told me that he hadn’t spoken to anyone in days. And so, as I began a three-year transition into retirement, I wanted to ensure that I maintained touch with the outside world. Those transition years allowed me to ease into retirement and to build on my hobbies and interests.

Prior to retirement, I had thought that, after so many years in the so-called rat race, I would yearn to move to the countryside to lead a more peaceful existence. But after some thought, it occurred to me that, much like my father in the Florida Keys, I would become socially isolated. I like where I live now, able to travel easily into Washington, DC, to visit friends or wander among the monuments and museums.

For many years, I have regularly bicycled. In my home state of Maryland, there’s some of the best cycling in the country. Because of the demands of my job, there was never as much time as I wanted for riding. But on the weekends, I would seek out group rides. That enabled me not only to do a sport I enjoyed, but also to meet new people and develop friendships. Nowadays, in addition to group rides, I occasionally meet up in the early morning hours with fellow cyclists at local coffee shops. This gets me out of the house during the week and lets me stay in touch with those still in the work world.

Volunteering within my community has also allowed me to meet neighbors and remain socially active. It’s gratifying to give back to the neighborhood where I have lived for more than 30 years. During the spring, summer and fall, I coordinate beautification activities within the neighborhood. This is also time that I can spend with my husband, who often joins me in these volunteer activities. Now, as I walk around the neighborhood, I am recognized by others and inevitably a conversation ensues.

The winter months can be difficult. The cold weather makes one want to withdraw and hibernate until spring arrives. It is during these months that I travel. For the time being, much of my traveling is done solo. When I get to my destination, however, I am usually staying with family or joining friends who then travel with me.

I remain involved in the company I built with my twin brother and recently sold. I help with various tasks during the year, and occasionally join employee and manager meetings. This lets me stay in touch with workers who have been part of my life for two decades. The various tasks keep my brain active, something that research suggests can fend off dementia and Alzheimer’s.

I am now 18 months into fulltime retirement. I sense that perhaps I went too far initially—and overscheduled myself. I plan on curtailing my cycling this year, after pedaling more than 11,000 miles last year. I discovered that my aging body didn’t respond well to all those miles. In addition, last year, I helped at an immigrant advocacy organization. I spent many hours volunteering but have decided that, while I enjoyed the work, it was also too much. I can always go back if I find I have idle time that needs filling up. The last thing I want is to be sitting in the armchair every day, flipping through channels.

Nicholas Clements is one of Jonathan’s older brothers. His previous blogs were  Spending Time and Try This at Home.

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This Week/April 2-8

UPGRADE YOUR CREDIT CARDS. If you use one that doesn’t offer cash back or other rewards, swap it for one that does. Pay an annual fee? That might be worth it for the first year if it’s a travel rewards card that offers a large initial bonus. But if you can’t get a retention bonus or the fee waived for year two, you might cancel and get a new card.

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