Jonathan Clements's Blog, page 431

This Week/Sept. 24-30

PREPARE FOR A LONG LIFE. For a quick gauge of your life expectancy, try Social Security’s calculator. For an in-depth look, use this calculator built on academic research. What will you learn? First, the longer you live, the longer you can expect to live. Second, lifespans vary widely—with educated, health-conscious Americans living three or four years longer than average.

The post This Week/Sept. 24-30 appeared first on HumbleDollar.

Parting Thoughts

“IT HAS LONG BEEN IMPORTANT to us to help our children and 12 adult grandchildren learn some of the fundamentals of saving and investing,” wrote Henry “Bud” Hebeler in a Feb. 26 email to me. “I sent them each a booklet that I wrote, illuminating the key elements that I have talked about in the past. To test their comprehension, I sent the following message.”

Bud died in August, nine days after his 84th birthday. Trained as an engineer, he rose to become president of Boeing Aerospace Company. In retirement, he turned his considerable analytical skills to financial issues, launching the site AnalyzeNow.com and writing two books, including Getting Started in a Financially Secure Retirement. This year, he even wrote two blogs for HumbleDollar, one on tax complexity and the other on health care costs.

What was the message that Bud sent to his family? It was a quiz with “a dozen questions that I expect our grandchildren to answer correctly.” Below is a slightly edited version of the quiz.  Not sure you know the answers? Check out Bud’s 20-page booklet, which is jam-packed with financial wisdom.

What is one of the biggest threats to your savings that you can’t do anything about?
If you get a 9% return, pay your financial firm 1% and are taxed at 25%, how many years does it take to double your money using the rule of 72?
When is an employer’s savings plan that has no employer matching contribution better than a Roth IRA?
Is it better to pick particular stocks or buy low-cost, broad-based index funds for the stock allocation part of your investments? Why?
After a long period of inflation, which is likely to be worth more, a bond that pays a fixed interest amount or a broad index stock fund?
What are good investments for emergency funds?
What are some examples of “investments” that you should avoid?
Is it better to buy a car with cash or credit? Why?
Is a vacation home liquid?
What is a REIT? Is it liquid?
What does the IRS say your life expectancy will be at age 65?  (Hint: See RMD.) What is the probability that you will live longer?
Have you determined how much you need to be saving for retirement? Yes or no.

A few days after his initial message, Bud sent me a brief followup email. By then, he had reviewed the answers from his grandchildren: “All of the responses so far show that they read my material carefully and, importantly, have learned something.”

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

The post Parting Thoughts appeared first on HumbleDollar.

Right but Wrong

I’M A BIG BELIEVER in transparency, so I’d like to tell you a little about my personal investments. As you might guess, the overwhelming majority of my money is allocated to simple, low-cost index funds—the same things I recommend in my writing and for my clients. That is true almost without exception. But today, I would like to describe one of those exceptions.

Many years ago, before I entered the investment industry, I purchased shares in a small mutual fund called the Mairs & Power Growth Fund. Though it was a while ago, I still remember the reasons I chose it: First, I liked the strategy of the fund’s managers. They were based in the Midwest and focused most of their investments locally, buying well-known companies like 3M and other household names. That seemed to make a lot of sense. Second, I liked the conservative approach of the firm’s management. They had been in business since 1931 but, unlike most of their competitors, they had limited themselves to just two mutual funds, adding a third in 2011. In short, they seemed like the kind of people who would stick to their knitting. And they did.

As it turns out, Mairs & Power has been among a minority of mutual funds that has delivered good performance over the years, so this investment turned out well. Nonetheless, in hindsight, I don’t believe my purchase made a whole lot of sense and I wouldn’t do it again. Why not? There was no particular logic to the decision. I was early in my career and bought it because it seemed like a good fund run by good people. In making that judgment, I was right, but my mistake was this: I didn’t consider how it would fit with my overall financial goals.

What do I mean by that? I’ll try to relate it to something that we’ve all experienced: furnishing a house or apartment. Setting up a new home is a lot of work, but it isn’t terribly complicated: In the kitchen you’d want a table and chairs. In the family room, a couch, an easy chair and probably a TV. And so on. It’s intuitive and obvious. So obvious, in fact, that you’d never make the mistake of buying two kitchen tables or, alternatively, neglecting to buy a bed for your bedroom.

But that’s exactly what I did when I bought that randomly selected fund. It were as if I needed to furnish an entire house but ended up buying just an umbrella stand for the front hall, and nothing else.

The lesson: You should think about outfitting your investment portfolio in the same way that you think about outfitting your home. The first step is to spend time thinking through your needs. For example, are you saving for a tuition bill in three months, for a new car in three years or for retirement in three decades? The answer to this question will tell you how to “furnish” your portfolio—that is, how to choose individual investments—so that you don’t end up with the equivalent of one lonely umbrella stand and nowhere to sleep.

Adam M. Grossman’s previous blogs include Growing Up (Part V) and By the Book . 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 .

The post Right but Wrong appeared first on HumbleDollar.

Debt: 10 Questions to Ask

GOT DEBT? To get a handle on the situation and figure out whether you’re handling your debts properly, here are 10 questions to ask:

What’s your net worth? You might have a home and sizable financial accounts. But what are you worth once you subtract all your debts?
Are you taking the necessary steps to stop thieves from borrowing money using your identity? To protect yourself, regularly check your credit reports for errors and accounts you don’t recognize, and seriously consider freezing your credit or placing a fraud alert with the three major credit bureaus.
What’s your credit score? With so many websites and financial institutions offering free scores, you don’t have to pay anything these days to find out where you stand.
Do you carry a credit card balance? That ranks as one of the most foolish financial mistakes. On top of that, if your balances are large relative to your cards’ credit limits, you are likely hurting your credit score.
Are you using a rewards credit card for all daily spending? You should be getting at least 1% cash back or the equivalent in other rewards, such as travel points.
Are your children taking on a reasonable amount of student loans, given their likely career earnings? As a rule, college students should limit their total student debt so that the resulting payments don’t consume more than 10% of their eventual pretax income.
Should you make extra principal payments on your mortgage? Even if you have a home loan with a rock-bottom interest rate and even with the tax deduction, the interest you save by paying down your mortgage is likely greater than the interest you could earn by buying bonds and certificates of deposit in your taxable account.
Do you have a home equity line of credit? The fees involved are typically modest and it could come in handy if you have a financial emergency. You might also use the credit line to pay off higher-cost debt, such as credit card debt, or to finance your next car purchase.
Is your job at risk? If so, look to pay back any 401(k) loans. If you fail to get the loans paid off before you leave your employer, they’ll be considered a retirement account distribution, triggering income taxes and possibly tax penalties.
Are you on track to be debt-free by retirement? Servicing debt in retirement could force you to take larger annual retirement-account withdrawals and to sell winning investments in your taxable account. The resulting higher taxable income could, in turn, trigger taxes on your Social Security benefit and lead to higher premiums for Medicare Part B and D.

This is the ninth article in a series. Click here to find links to the eight earlier blogs.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

The post Debt: 10 Questions to Ask appeared first on HumbleDollar.

Excuses, Excuses

WE MAKE ALL KINDS of financial mistakes: spend too much, borrow too much, buy expensive investment products, try to beat the market. To be sure, there are some folks who simply don’t know better. But others give the issue serious thought—and still act foolishly, justifying their behavior with cockamamie arguments. Here are five such justifications that I’ve heard in recent months:

 1. “It’s okay to spend money if it cheers me up.” This is the crack cocaine school of budgeting. You have a rough day, splurge a little and briefly feel better. But the thrill doesn’t last long, so soon enough you’re back at the store, taking another hit.

2. “I may not beat the market, but it’s fun to try.” I wouldn’t banish you from investment paradise for buying a few individual stocks with a small portion of your portfolio. But if you start betting a large chunk of your wealth on individual stocks and actively managed funds, the potential long-term cost is huge. Let’s say the stock market returns 6% a year, with indexers earning 5.9% and your active strategy clocking 4.5%. If you invest $5,000 a year for four decades, you’ll end up with some $560,000, versus $800,000 for an investor who indexed.

3. “Mortgages are so cheap you should always have one.” Yes, mortgage rates are low—but they’re still above what you’ll likely earn on a high-quality bond portfolio. For instance, 30-year mortgages today are charging an average 3.9%, while 10-year Treasury notes are yielding just 2.2%. True, mortgage interest is tax-deductible. But if you own Treasurys in a taxable account, you’d have to pay federal income taxes on the interest you earn. The upshot: If you own conservative investments in your taxable account—or you’re tempted to buy them—you’ll almost always be better off paying down your mortgage instead.

4. “This guy from the insurance company must know what he’s talking about.” The guy from the insurance company says what he has been taught to say, and probably has very little clue whether there’s any virtue to the product he’s hawking. I don’t believe most financial salespeople are crooks. Rather, they’re just trying to make a living and that means selling whatever they have on the shelves.

5. “If they’ll lend me the money, it must be okay to borrow it.” This is the sort of mentality that leads to maxed-out credit cards and huge second mortgages. Lenders don’t want you to go bankrupt. But they are happy for you to take on so much debt that you’re both a highly profitable customer and a totally stressed-out individual.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

The post Excuses, Excuses appeared first on HumbleDollar.

Moving On

WHEN TALKING WITH HOME SELLERS, I’ve long ceased being surprised by how many routinely overlook or fail to take maximum advantage of a valuable tax break: the exclusion when unloading their principal residence.

The exclusion—meaning you pay no taxes—is capped at $500,000 for married couples filing jointly and $250,000 for singles and married couples filing separate returns. I frequently need to remind sellers that these exclusions apply to profits, not sales prices. In other words, it’s the amount over and above their home’s cost basis, which includes not only the original purchase price, but also any home improvements and many costs incurred when buying and selling.

Understandably, sellers want to know what they’re likely to shell out for taxes when their profits exceed the applicable exclusion amounts. I tell them that there’s good news and bad news.

The good news: For most sellers, the excess is taxed as a long-term capital gain and the maximum rate is usually 15%, plus applicable state taxes. The bad news: For lots of high-income sellers, the maximum rate increases to 20%. Worse yet, it goes as high as 23.8% for those who are subject to the Medicare surtax of as much as 3.8% on income from certain kinds of investments, including profits from home sales.

The surtax was introduced in 2013 by the Affordable Care Act, popularly known as Obamacare. The 3.8% tax remains on the books, at least for now, because of the collapse of efforts to repeal and replace Obamacare. State taxes, of course, will be on top of that.

The exclusion isn’t a one-time opportunity. Sellers can claim it as often as every two years. To qualify, a seller must pass two tests. First, she has to have owned and lived in the property as her principal residence for at least two years out of the five-year period that ends on the date of the sale. Second, she can’t have excluded the gain on the sale of another principal residence within the two years that precede the sale date.

Contrary to what many sellers mistakenly believe, the two years occupying the home needn’t be consecutive. They can be off and on for a total of two full years. She can count short temporary absences for vacations or other seasonal absences as periods of owner use. This holds true even if she rents out the property during those absences.

The exclusion isn’t limited to the sale of a conventional single-family home. Her principal residence could be a condo, a cooperative apartment, her portion of a multi-unit apartment building, a house trailer, a mobile home or anything else that provides all the amenities of a home, such as a houseboat or yacht that has facilities for cooking, sleeping and sanitation, or even a vacation retreat that she moves into after retirement. Moreover, the location of the principal residence doesn’t matter. It can be in a country other than the U.S.

What if she sold another home within the previous two years or fails to satisfy the ownership and use requirements? She may be able to claim a partial exclusion. To qualify, the primary reason for the sale must be health problems, a change in employment or certain unforeseen circumstances. The IRS’s broad definition of unforeseen circumstances includes divorce or legal separation, or natural or man-made disasters that cause residential damage—hurricanes Harvey and Irma, for instance.

Let’s say a seller is single and has lived in her dwelling for just 12 months before moving to a new job in another city. She can exclude a gain of as much as $125,000—12 months divided by 24 months, or 50% of her maximum allowable $250,000 exclusion.

Julian Block writes and practices law in Larchmont, N.Y., and was formerly with the IRS as a special agent (criminal investigator). His previous blogs include Late? That’ll Cost You 50% and Hitting Home. This article is excerpted from Home Seller’s Guide to Tax Savings, available at JulianBlockTaxExpert.com. Follow Julian on Twitter @BlockJulian.

The post Moving On appeared first on HumbleDollar.

This Week/Sept. 17-23

FILE FOR COLLEGE FINANCIAL AID. Hoping for grants and loans for the 2018–19 academic year? You can file the Free Application for Federal Student Aid starting Oct. 1. Income is based on your 2016 tax return. Even so, before filling out the FAFSA, you could increase aid eligibility by using taxable account money to pay down debt or fund retirement accounts.

The post This Week/Sept. 17-23 appeared first on HumbleDollar.

A Price on Your Head

WE ARE WORTH SO MUCH MORE than the value of our homes and our financial accounts. But how much more? Forget your car and household possessions. Unless you have a Chagall hanging in the living room, it’s safe to assume all this stuff will depreciate and eventually be worth little or nothing.

Instead, our three assets with potentially significant value are our regular paycheck, our Social Security retirement benefit and any traditional employer pension we’re entitled to. Admittedly, question marks hover over each. What if we lost our job, Social Security benefits were cut or our employer got into financial difficulty?

Those are reasons to discount the value of these assets, but not to ignore them entirely. Indeed, we should factor these three assets into our portfolio’s stock-bond split—and knowing their worth can be a source of solace when stocks plunge and home prices take a hit.

But how should we value them? Each is a stream of future income for which we can calculate a present value—with the help of an annuity pricing service.

For instance, a paycheck is like a “period certain” immediate annuity, paying income for a fixed number of years. Insurers sell such annuities, typically with a maximum payout period of 25 years. Over the payout period, you’ll get back your initial investment, plus a certain amount of interest. One important difference between your paycheck and a period certain annuity: Your paycheck will likely rise with inflation and probably also with merit increases.

Meanwhile, Social Security is like an inflation-indexed immediate annuity—or, if you aren’t yet retired, an inflation-indexed deferred annuity, meaning payments don’t start until some future date. A traditional pension plan is similar, except most pensions aren’t inflation-linked.

Now, imagine you’re a 45-year-old woman, live in Maryland, earn $70,000 a year and plan to retire at age 65. At that juncture, you figure you’ll receive $20,000 a year from Social Security and $12,000 a year from a traditional employer pension.

Based on numbers I pulled from ImmediateAnnuities.com, the $70,000 a year for 20 years would cost almost $1.1 million if you purchased a 20-year period certain immediate annuity. Meanwhile, the $20,000 a year starting two decades from now would cost some $250,000 today if you bought an inflation-indexed deferred income annuity, and the $12,000 a year starting two decades from now would cost some $90,000 if you purchased a deferred annuity with fixed payments.

These crude estimates tell our hypothetical 45-year-old what she is worth today: an additional $1.4 million on top of whatever her home and financial accounts are worth, minus any debts. They don’t tell our 45-year-old what she’ll be worth upon retirement. That will depend, in part, on how much of her income she manages to sock away between now and age 65, how much her investments increase in value and whether she pays down any debt.

As our 45-year approaches age 65, her stream of paychecks will come to an end and have no value. But her Social Security and pension “annuities” will be worth more—not because their expected payments have necessarily increased, but simply because they’re closer to the time when they’ll start generating income. Indeed, our now 65-year-old might count the present value of her Social Security and pension annuities as part of her bond holdings—and take that into account when she decides how to split her financial accounts between stocks and more conservative investments.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

The post A Price on Your Head appeared first on HumbleDollar.

Growing Up (Part V)

ONE OF MY FAVORITE ACTIVITIES as a child was to play with a tomahawk at my grandparents’ house. Yes, that was in the days before the Consumer Product Safety Commission. But in this case, it wouldn’t have made a difference: This particular tomahawk was no toy, but rather the real thing. It belonged to my grandfather. His name was Walking Buffalo, and he was a member of the Assiniboine, a Native American tribe who live on the Plains of Montana.

To be sure, my grandfather wasn’t born Walking Buffalo. To his friends and neighbors, his name was Sidney, and he looked like any other retiree on the quiet suburban street where he lived.

So how did Sidney become Walking Buffalo? In the years following World War II, the government dismantled the network of submarine nets that had been in place to protect our harbors. If you’re not familiar with them, submarine nets were constructed from a set of interlocking metal loops, each of which stretches several feet across.

That’s when my grandfather entered the picture, purchasing thousands of these surplus metal loops from the government. The details here are particularly hazy, but somehow, in the 1960s, my grandfather learned that some Native American tribes were struggling to contain their cattle. And somehow, he also learned that the loops from these deconstructed nets would be the perfect solution to this problem. How this all happened, no one knows. In any case, after he learned about the tribe’s needs, he donated all the loops that he had. They worked as expected, and the cattle problem was solved. In gratitude, the Assiniboine inducted my grandfather into their tribe as a blood brother.

As a child, the tomahawk, along with his headdress, were great fun to play with. As I grew older, though, I came to appreciate some larger lessons from the story of Walking Buffalo.

Primary among them: If one is in a position to do a kindness for someone, or some group, one should do it without any expectation of being repaid. Sure, we all need to put food on the table. But it’s also important to avoid feeling that we need to extract every nickel from every person we encounter. It is not inconsistent both to run a business and to help others along the way.

Another lesson: Truly outstanding investment opportunities usually lie somewhere off the beaten path, but only if you know what you’re looking for. In the case of the submarine nets, this was not a random purchase. My grandfather had prior experience with surplus materials. In fact, I recall once tagging along with him to an auction preview. Among the items on display were a decommissioned rollercoaster, in pieces, as well as one of President Kennedy’s rocking chairs. (As far as I know, my grandfather bought neither.) For most investors, I advocate simplicity. But it is also true that, if you understand what you are looking at and know how to assess value, there can be terrific opportunities among more obscure investments.

A final lesson: Our ability to succeed is driven largely by the coach or naysayer in our own heads. In his later years, my grandfather’s movement was more limited, but he never let it slow him down. In fact, even in his 80s, he was busy working to put together an unusual real estate project—one, alas, that never came to fruition. The idea was to buy an old, abandoned shipyard and turn it into a mixed-use development. And how was this to be financed? Somehow, from his home, with just a telephone and a spiral notebook, my grandfather had lined up the Bank of Tokyo. This was during the heady, late 1980s peak of Japan’s global financial ambitions, and the bank was set to foot the entire nine-figure bill. It was a reminder, if ever there was one, that many limitations exist solely in our own minds.

This is the fifth blog in a series. Click here to read the four earlier parts, as well as other articles on kids and money.

Adam M. Grossman’s previous blogs include By the Book,   Go Fish   and  Site Seeing (Part III) . 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 .

The post Growing Up (Part V) appeared first on HumbleDollar.

Help Wanted

IN THE EARLY YEARS of the landscape maintenance company that I owned with my twin brother, we would hire workers locally—both American and Latino. But each year, we struggled to find a sufficient number of willing and able workers.

It wasn’t until several years into running the company that I heard about the H-2B visa nonimmigrant program. The program allows companies to bring in foreign workers for as long as nine months. I saw this program as a way to provide our company with the workers we needed.

The process proved far from easy: Applying for H-2B visas is burdensome and costly, and there’s no guarantee that you will receive approval. The first step, and usually the most difficult, is to receive labor certification. This involves placing help wanted ads in the local newspaper, as well as on the state workforce exchange. The wage offered is the federal prevailing wage for the area. In a good year, I might receive eight to 10 applicants.  The majority of the applicants didn’t even show up for the first interview. If any of the applicants are hired, then the number of foreign workers requested is reduced accordingly. Labor certification is issued when it is shown that every attempt to hire an American worker has been made.

The second step involves receiving approval from the USCIS, the U.S. Citizenship and Immigration Services, part of the Department of Homeland Security. Following USCIS petition approval, you have to make appointments for the foreign workers to apply for the actual H-2B visa at a U.S. consulate or embassy. At this appointment, the worker is interviewed. If the worker is approved, the visa is issued. The worker then travels into the U.S. to his or her place of employment.

In the first couple of years that I used the program, I would make the 48-hour drive in a 15-passenger van from Maryland to Mexico City. It was a grueling journey, especially through the northern border region of Mexico and as you entered the outskirts of Mexico City. On my travels, I was joined by one of my Mexican workers, who shared in the driving and, more important, communicated with the Federales—the Mexican police force—who would have checkpoints along the route.

I could have done without the stressful journey, but I wanted to ensure that the workers correctly filled out the visa application form (known as the DS-160) and that they arrived at the consulate on time for their interviews.  I also wanted to ensure that the workers were successful in passing through U.S. immigration when they crossed the border into the United States. In later years, I was able to rely on some of the more seasoned workers, who had been through the process many times, to help the others fill out the required forms and to navigate the U.S. consulate.

Over the 17 years that I used the program, there were twists and turns. Each year was a little different, with one obstacle or another thrown at us by the U.S. government. But aside from two years, we were successful. During those two unsuccessful years, we had to hire local workers, reminding us once again just how critical this visa program was to the business. We faced having to find 25 to 30 workers—most of whom weren’t happy with the wages we were offering—and turnover tended to be high.

If our efforts to hire local workers are any guide, these seasonal foreign workers aren’t taking jobs that Americans want.  As with many other companies, the guest worker program provided our business with the additional labor needed to manage and grow the company. Without the program, we would not have been as successful as we were.

Nicholas Clements is one of Jonathan’s older brothers. He is retired and lives just outside Washington, DC. His previous blogs include On Our Own, Growing Up (Part III) and  Less Green . Follow him on Twitter @MDScaper .

The post Help Wanted appeared first on HumbleDollar.