Jonathan Clements's Blog, page 428

Zeroing In

BY THE TIME WE REACH our late 20s, we’ve made a set of fairly inflexible choices that dictate our ability to spend and save. Our career arc and earnings potential are established. Our debt from undergraduate and graduate programs has been accumulated. The number of dependents we’ll support is getting clearer. Changing any of these decisions is either impossible or mighty tough.

But there’s a second tier of financial choices that are in constant flux—and where we have the greatest flexibility to influence our spending and saving. Remember, spending and saving are a zero-sum game, so it’s all about tradeoffs: If I spend X, I can’t save Y. If I purchase Q, I won’t be able to afford R. If I prioritize M, I need to forgo N.

My wife and I discuss these tradeoffs as we make spending decisions. For us, it means that, even though we hate cleaning the house (and who doesn’t?), we aren’t ready to spend $150 a month for a cleaning service. Instead, we’d rather allocate these dollars to a larger grocery budget, knowing that we often choose to shop at Whole Foods and specialty stores. More recently, we started regularly donating to our favorite charities. This has meant reducing our monthly entertainment spending to offset the contributions.

Want to make these sorts of tradeoffs? Consider the potential value-add of any expense. Sometimes, it’s negligible or negotiable. I am happy to forgo an expensive gym membership and, instead, use a budget-priced, no-frills gym. It just doesn’t greatly impact my overall experience.

On the other hand, Sarah and I still buy paper copies of every book we read. While we’d save money with e-books and even more with a library card, we love owning books. The $50 a month we spend on books feels like it’s worth the joy it brings. In other words, budgeting doesn’t always mean choosing the most frugal option. But it does mean recognizing that, with every spending choice, we give up the opportunity to use the dollars for something else.

Zach Blattner’s previous blogs include Money Pit and Unexpected but Predictable. 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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Contain Yourself

WE’RE USED TO SEEING MONEY as one of life’s limiting factors. But if you receive a financial windfall, money may no longer be the limitation it once was. While that might sound liberating, it can also create anxiety. The reality is, constraints serve a useful purpose: They provide structure. Without that structure, you may find yourself feeling rudderless.

I experienced this when I received a windfall several years back. I remember walking into an Apple Store, with the intention of buying something just because I could. After wandering around for a few minutes, though, I walked out empty-handed, realizing that there was nothing I needed or even wanted.

If you find yourself in this situation, without the structure of normal budgetary constraints, what should you do? It took a while to find my way, but here’s an approach that seems to work well:

Don’t sign on any dotted lines. If your windfall hits the news, your phone may start ringing with pitches from brokers and other eager vendors. My advice: Ignore them. Ultimately, you might want to hire a financial advisor, but it’s best to conduct that search on your own terms. Don’t just choose the advisor who happens to be quick enough to call first. In fact, his or her speed in contacting you may indicate that the advisor puts more energy into hunting for new clients than helping existing ones.

Set priorities. Spend time by yourself—or with your spouse—creating a high-level allocation for the funds. Engage in some soul searching. Ask yourself what goals are most important. Then, assign dollars accordingly. These might include retirement savings, gifts to family, charity, a rainy day fund and major one-time purchases, such as a new home. You could also allocate a portion to serve as an “endowment” to support ongoing living expenses.

Recognize that sleeping at night is a valid goal. You may want to allocate extra “safe money” to ensure peace of mind, regardless of the market’s ups and downs. I know one windfall recipient who insists on keeping $1 million in her checking account. That might sound extreme, but these choices are entirely personal and subjective.

There is no perfect recipe for managing a windfall. Still, by introducing structure like this, you should find yourself achieving more of your goals, with less stress.

Adam M. Grossman’s previous blog was Take It Slow.  Adam is a Boston-based investment advisor. An advocate for financial literacy, he regularly teaches an adult education class titled “You Can Outsmart Wall Street.”

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This Week/March 12-18

DROP UNNECESSARY INSURANCE COVERAGE. If you no longer work or have more than enough saved for retirement, you can likely ditch your disability insurance. If the kids have left home or you have a sizable nest egg, you might drop your life insurance. If your car is old and doesn’t have much value, you might get rid of your auto policy’s comprehensive and collision coverage.

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Another Darn List

WE TRY NOT TO BE TOO JUDGMENTAL here at HumbleDollar. But if any of the items below apply to you, you might want to get yourself to the financial emergency room. Here are 33 signs you could be in trouble:

You save on eating out by attending free financial seminars.
You earn extra income by purchasing mutual funds just before they make their distributions.
All your stocks are penny stocks, but they weren’t when you bought them.
Your insurance agent is your best friend.
You’re investing in real estate—by remodeling the kitchen.
Your broker saves you money by only recommending funds with “no initial sales commission.”
You have $1 million in life insurance and no financial dependents.
Shopping is your favorite hobby.
You deduct a staggering amount of mortgage interest each year.
You’re confident you are well-diversified, because you have five different brokerage accounts.
Your friends are envious of everything you own.
You figure inflation is too low to worry about.
Your accountant whistled when he saw the size of your capital loss carryover.
You get your stock picks from your spam folder.
You’re absolutely certain the market is headed higher.
You just rented a second storage locker.
Every fund you buy has great past performance.
You had a will drawn up years ago, so that’s one less thing to worry about.
Your kitchen looks like a showroom for “as seen on TV.”
If others are selling, why would you buy? You weren’t born yesterday.
You never fail to make the minimum credit card payment.
You cosigned your son’s $80,000 college loan to study social work.
You plan to claim Social Security early and use the money to buy income annuities.
You would dearly love to invest in a hedge fund.
You know your house has been a fabulous investment, because it’s worth so much more than your down payment.
There’s an equity-indexed annuity in your IRA.
You never understood why they call options trading a less-than-zero-sum game.
Your financial advisor is a fiduciary, but only part of the time.
You don’t bother funding your 401(k) with its matching employer contribution, because you have a cash-value life insurance policy.
Your children want for nothing.
Your employer offered a lump sum instead of paying you a pension, and it was obvious the lump sum was the better deal.
You own a diversified portfolio of timeshares.
You like to have a margin of safety, so you always buy the highest-yielding bonds.

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Buckle Up

WANT TO BUY one of the fastest growing parts of the global economy—at some of the cheapest valuations currently on offer? Check out my latest client letter for Creative Planning, where I sit on the investment committee and advisory board. You might also enjoy the article Fiduciaries Matter written by my fellow advisory board member and bestselling author Jane Bryant Quinn.

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Try This at Home

OUR HOUSE IS 65 YEARS OLD. I have lived in it for almost half that time. Originally, I bought the house with my twin brother. Now my husband and I live in it. I feel like I was a pioneer of the tiny house movement. The house is 750 square feet. The bedrooms all measure 10 feet by 10 feet. The living room is all of 150 square feet. There are one-and-a-half bathrooms. The previous owner had a family of six. Two people slept in each of the three bedrooms.

When my brother and I first started to look for a house, we were told to buy as much house as we could afford. And we did. Back in 1985, $90,400 was all we could afford. We had enough money for the down payment and to have a new roof installed. There wasn’t much left over to buy new furniture. The rooms were sparse. But we both had good jobs: We felt confident that, with hard work, we could increase our income.

It wasn’t long before my brother moved out and I was alone in the house. A few years later, my partner—and future husband—moved in. We were now a two-income family. Over the years, I would look through real estate magazines and Zillow to browse new offerings in my area. I would be enticed by the homes with the open-plan concept, the spacious rooms, and the kitchens with stainless steel appliances and granite countertops. I understood that, with the more expensive house, I would have a larger mortgage and thus more to deduct from my taxes.

But why buy more house than we really needed? Perhaps it’s my frugal nature. The mortgage was affordable. I had refinanced it when rates dropped and eventually paid it off after 20 years. My utility bills are reasonable. Maintenance costs are almost nonexistent. The house is so small that most maintenance can be done by my husband and me. Even painting the exterior can be done by us. Installing a new roof can be expensive. But on a 750-square-foot abode, there isn’t much sticker shock.

Without the cost of a larger home, we have been able to stash away the maximum in our workplace retirement accounts, allowing us to retire with a comfortable nest egg. As we get older, the house hasn’t become a burden to maintain by ourselves. Even the garden is manageable. Financial savings aside, there’s a social aspect to a smaller home. You cannot hide from a family member. You learn to interact and get along. And so, when someone seeks my advice about buying a larger home, I ask them to consider just how much house they really need. For me, a tiny home will do just fine.

Nicholas Clements—one of Jonathan’s older brothers—retired at age 55. He’s passionate about bicycling and, in 2016, rode 11,311 miles. His previous blog: Spending Time.

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Unanswerable

“IF YOU DON’T MIND, I have a question for you,” wrote a former colleague. “Should folks be getting out of the stock market? This Trump bump seems like such a crazy bubble.”

Lots of folks are asking this question. How to respond? I fall back on three key points.

First, I believe U.S. stocks are expensive, while foreign stocks are cheap. But that doesn’t tell you anything about short-term performance and only a modest amount about long-run results. A Vanguard Group study found that price-earnings ratios (both the conventional and Shiller variety) were the biggest determinant of 10-year returns. But even then, P/Es explained just 40% of performance.

Second, by most measures, the U.S. stock market has been overvalued since 1990, and yet folks keep buying stocks. The market’s short-term performance is driven by news, and nosebleed valuations are not news.

Third, if we ask the wrong question, we’ll get an idiotic answer. Nobody should ever make an investment decision based on a market forecast, because nobody can predict the market’s short-term direction. Don’t ask, “Which way is the market headed?” Instead ask, “What are the consequences if stocks plummet?”

If you’re a 45-year-old who is saving for a retirement that’s two decades away, the consequences wouldn’t be particularly dire and, in fact, it could be helpful, because your monthly savings will buy shares at cheaper prices. But if you’re a parent with a stock-heavy 529 plan and college-bound teenagers, a big stock-market decline could be a disaster, which is why money you’ll need to spend within the next five years should be out of stocks and stashed in conservative investments.

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Where It Goes

WHEN I DIVORCED A FEW YEARS AGO, I found myself needing a crash course in financial management. My first task: Understanding where my money went—and figuring out where I could cut back.

Today, I create a budget each month. I don’t use any type of program or app—I prefer paper and pen. At the top of a page, I write down my take-home pay. I use take-home pay, rather than my $5,500 monthly gross income, because all taxes have already been deducted, as well as my $1,500-a-month in pretax retirement contributions.

From my take-home pay, I deduct those expenses I’ve identified as pretty much fixed. They include my rent, car insurance, utilities and groceries, plus cell phone and internet. Once those expenses have been deducted, I’m left with the money I can spend during the month on discretionary expenses—fun stuff like hobbies and eating out. So what are my fixed expenses? Here’s what my budget looks like:

Emergency Fund: This was a priority when I first got divorced. But at this point, because I’ve already set aside emergency savings equal to one year’s salary, I no longer contribute to this account. But if I had to tap my emergency fund for some reason, my monthly fixed costs would include replenishing the account.

Housing: After my divorce, I chose to rent an apartment rather than buy a house. I live in a small—800 square foot—unit in a suburb of Portland, Ore. By living just outside the city limits, my $1,050 monthly rent is less than if I lived downtown, and it’s also well below the standard recommendation, which advises limiting housing costs to 30% of gross income. For me, that would be $1,650.

Health Insurance: I have a choice of two different employer-sponsored health plans. For the less expensive choice, my employer would cover 100% of the monthly premiums. But I’ve chosen to enroll in the costlier plan, where I have to pay $130 per month. I don’t like the extra expense, but it gives me greater flexibility in choosing my health care providers.

Groceries: Food is a budget expense I include as both a necessity (groceries) and an indulgence (dining out). My monthly grocery budget is quite variable since I tend to buy staples in bulk, but fresh meat and produce on a weekly basis.

Utilities: My garbage service, water and electricity expenses average about $130 per month. My apartment was recently retrofitted with energy-saving light bulbs and surge protectors, which will likely reduce my electricity bill slightly in future.

Insurance: I have both car insurance ($78 a month) and renter’s insurance ($10 a month). I drive a 2007 Honda CRV, which I purchased used and paid cash for. I have an excellent driving record. When I got my first speeding ticket, I opted to take an online driver-safety course as part of my court settlement. By doing so, the infraction was not reported to my insurance company, thereby saving me from a potentially sharp increase in my premium.

Cell Phone and Internet Service: Last year, when my cell phone service was due for renewal, I switched to Republic Wireless. By making the change, I’ll save almost $400 over the next year in cell phone service fees.

What I’ve discovered since I began budgeting is that even with my basic “needs,” there are still financial choices to be made. By reducing the cost of certain necessities, I’m left with more money for my many “wants”—and for my eventual retirement.

Kristine Hayes is a departmental manager at a small, liberal arts college. One day, she hopes to retire and become a fulltime writer. Kristine’s previous blogs were A Less Taxing Time and From Half to Whole.

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This Week/March 5-11

IMAGINE YOU WERE THE EXECUTOR for your own estate. What would make your job easier? You might consolidate financial accounts, shed illiquid assets like collectibles and investments in private businesses, draw up a letter of last instruction that details all assets and debts, and compile a comprehensive list of usernames and passwords.

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March’s Newsletter

GREED AND FEAR play huge roles in how we manage money. But there’s also another ingredient: testosterone. I see it again and again in the messages I receive. There’s a substantial slice of the investing population who view money management as a ferocious, mano-a-mano contact sport that they have the self-confidence and skill to win—and anybody who suggests otherwise is a “loser” and “boring.” It sometimes feels like these folks live in an alternate universe—a topic I discuss in March’s newsletter. This is also a notion I also touched on in a blog back in November.

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