Jonathan Clements's Blog, page 429

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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Wall Street Story

We’re a nation divided, two camps clinging fervently to their own unshakeable beliefs and baffled at the nonsense that the other camp accepts as truth.

Yes, you guessed it: We’re talking about money management. Let’s call the two camps the Sharks and the Jets. What divides them? Here are seven fault lines:

1. Get Rich vs. Meet Goals. The Jets have one overriding goal—they want to make heaps of money—and they’ll hop any investment train that can get them there. Last year, they were buying tech stocks. This year, they’ve hitched their fortunes to a market-timing newsletter. Next year? It all depends what’s hot.

By contrast, the Sharks are focused less on getting rich, and more on amassing enough to meet various goals, such as retirement, a house down payment and college for the kids. They’re a sensible lot. Maybe even a little boring.

2. More vs. Enough. The Jets are certain that the more money they have, the better their lives will be. The Sharks are less certain, figuring more would be nice, but also sensing that money isn’t everything, and that the overarching goal is to avoid financial worries and have enough to lead the life they want.

3. Opportunists vs. Planners. The Jets are serial investors, buying one promising investment after another, without much thought to how these investments fit together in a portfolio. The Sharks take a more methodical approach: They start by figuring out what sort of investment mix makes sense, given their goals, stomach for risk and what’s happening in their broader financial life. They then buy investments to fill each slot in their target portfolio.

4. Aim for the Stars vs. Avoid the Gutter. A quick way to get rich is to bet everything on a few stocks. Unfortunately, it’s also a quick way to get poor. The Jets like their chances.

The Sharks don’t. They know investing is always risky. But they don’t want to take more risk than is absolutely necessary, so they avoid big bets on individual stocks and instead own a globally diversified portfolio.

5. I’m Smart vs. They’re Probably Smarter. The Jets are a self-confident lot, figuring that—with hard work and some street savvy—they can outpace the market averages. The Sharks have seen the statistics showing how badly active managers perform, they’ve taken a close look at their own performance—and they aren’t at all confident.

Result: The Sharks are happy to buy index funds and match the market’s performance. Instead of trying to pick winners, they get their kicks from cutting investment costs, minimizing taxes and regularly rebalancing their portfolio.

6. Investing vs. Personal Finance. The Jets focus almost exclusively on investing. That’s where the big money is to be made—and where the excitement is to be had. Other than a soft spot for rental real estate, their mental energy is devoted to hot stocks and star fund managers.

The Sharks, meanwhile, know investing is just one part of the financial game. They also spend time managing their debts, finding ways to save more, buying the right insurance and planning their estate.

7. It’ll Work Out vs. Nothing Left to Chance. The Jets know they probably ought to sock away more money. But they figure that, one way or another, they’ll get their debts paid off and have plenty for retirement.

The Sharks are more uptight. They do everything possible to stack the odds in their favor: They save diligently, minimize taxes, hold down investment costs, diversify broadly, pick their insurance policies carefully and take on debt cautiously.

Almost all of HumbleDollar’s readers will, of course, count themselves among the Sharks. We’re befuddled by the Jets’ world and they’re scornful of ours. But fear not: There’s no need for a gang war. Time will reveal who’s right—not that there’s any doubt about the outcome.

Talking Our Book

Reviewers have raved that How to Think About Money “might be the best financial book I’ve read in the last five years” and “my favorite personal finance book of 2016.” It was also recently recommended in a New York Times article and was just named 2017’s adult book of the year by the Institute for Financial Literacy. How to Think About Money is available as a $13.99 paperback, and also as a $9.99 Kindle and Nook edition. HumbleDollar has a variety of marketing partners, including Amazon and Barnes & Noble. If you click through to these and other sites from HumbleDollar, and make a purchase, we’ll earn a small fee that helps to support the website’s operation.

Greatest Hits

Here are February’s five most popular blogs:

Think Less of Me
Take It Slow
Money Pit
Fake News
Collective Wisdom

There were also many readers for Wasted Youth, which appeared at the end of January, but got a lot of traffic in February. In addition, HumbleDollar’s various lists continue to rank as one of the site’s most popular features.

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How to Keep All Your Earnings

WHERE DOES A TEEN turn for advice on money? I went to my late father. My conversations with him are burned into my memory like software on a computer.

“Do what you love and make it pay.” “Give your all enthusiastically.” “You can get whatever you want if you are willing to work for it.” “What you make is important, but what you do with what you make matters more.”

When I was 15, my dad said, “Son, there is a secret you should know. You can keep all of your life’s earnings if you leverage compound interest, by getting in the habit of saving and investing early.”

That conversation had a profound influence on my future. It is the reason I read The Richest Man in Babylon as a teenager. It is the reason I became familiar with compound interest. It is the reason I began automatic savings and investment plans immediately after graduating from college.

In just a decade, I witnessed what seemed like a miracle. Compound earnings and dividends from my investments were providing more fuel to my nest egg than I was. That was a glorious day, particularly for a kid from Frogtown, which neighbored Dogtown and which was nowhere near the nearby town of Beverly Hills.

Here’s a set of numbers every teen should be introduced to: 10, 10, and 40.  Invest 10% of everything you earn. Imagine you earn a 10% average annual return. (That’s probably optimistic, but it makes the math work.) Over 40 years, your nest egg will grow to equal the value of your entire life’s earnings.

Have your teens do the math. It helped me and it will help them. There are lots of calculators online that make it easy.

Sam X Renick‘s previous blog was Raising Money-Smart Kids. Sam is the driving force behind the “It’s a Habit” Company and its chief spokesperson, Sammy Rabbit, who is dedicated to improving children’s financial literacy. Sam has read and sung off-key with over a quarter million children around the world, encouraging them to get in the habit of saving money.

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Unenviable

JEALOUSY IS A TERRIBLE THING—and often unjustified. Our apparently self-assured coworker may be racked by self-doubt. Our rich neighbor may be far less happy than we imagine. And those institutional investors, who can buy all kinds of exotic investments that we can only lust after, may be clocking returns that are notably unimpressive.

This last thought was driven home by Ben Carlson’s short, engaging new book, Organizational Alpha: How to Add Value in Institutional Asset Management. My only criticism is the title: Individual investors might imagine that Organizational Alpha isn’t for them—and yet it’s a great, insightful read, whether you have $1,000 to invest or $100 million. Organizational Alpha illustrates how too much meddling and too many supposedly sophisticated investments can drag down performance—and how investing is often best when it is simplest.

“The majority of institutional investors are constantly looking for ways to make things more complicated,” writes Carlson, who cites four reasons: It makes life more interesting, institutional investors think it’s their job to outperform the markets, they assume complex must be better, and they believe that sophistication will impress others.

Institutional investors often devote big chunks of their portfolios to hedge funds, private equity funds, venture capital funds and other alternative investments. But this is treacherous territory where diversification isn’t necessarily the answer. Carlson notes that, while a diversified stock portfolio can generate better returns with less risk, a diversified portfolio of alternative investments is often a recipe for mediocrity.

Take hedge funds. The best of these funds can overcome their hefty expenses and deliver dazzling results. Problem is, if you pick the wrong hedge funds, you could suffer steep losses. Nervous institutional investors respond by buying a broad array of hedge funds—and almost inevitably end up with lackluster results, as the bad funds offset the good. The upshot: Unless you have the confidence and insight needed to invest with a few great managers, you’re probably better off skipping hedge funds entirely.

“As a baseline assumption, most institutional investors have to realize that it’s difficult to beat a low-cost, low-turnover, long-term oriented approach to investing,” Carlson says. If that’s true for institutional investors, it’s doubly true for individuals. Index funds may not give you bragging rights at the neighborhood barbeque. But you’re probably the only person there who isn’t lying about their investment performance.

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