Jonathan Clements's Blog, page 431

Take It Slow

ONE DAY BACK IN 2012 I received a life-changing windfall. Contrary to what you might imagine, however, that day was not very different from the day before it, or the day after. It went something like this: Woke up. Went to work. Came home. Thought about ways to splurge. Ultimately gave up and went to bed.

In other words, there was no visit to the Ferrari dealership, no trip to Las Vegas, really no dramatic change at all. It was, on the surface, a very ordinary day. And the next day was pretty much the same as well.

Don’t get me wrong: Over time, I have made a few changes. My family moved to a new house, we take nicer vacations and we give more to charity. But on that first day, and even in that first year, we did very little differently.

While I’ve certainly made my fair share of financial mistakes along the way, one thing that worked out well was to take things slow. If you see a windfall on the horizon, here is what I would recommend:

You can dream about quitting your job, but don’t do it. First, you’ll be bored. And with more time on your hands, you’ll also end up spending more. But most important, you’ll lose the valuable social interactions that work provides. Over time, you might consider a career change, but don’t walk in that first day and give your notice.

When your windfall arrives, spend time thinking through how you want to use it. Maybe it’s a new car or debt repayment. Whatever you decide, it’s critical that you have some plan. If you’re married, your spouse needs to be on board with that same plan. Otherwise, the money is likely to burn a hole in your pocket, cause marital stress and disappear faster than you had hoped.

Resist the urge to start investing right away. Instead, take time to devise a comprehensive plan and then implement it in steps. There’s no rush, and it’s perfectly okay to sit with a pile of cash while you do your homework and think things through.

If you have a windfall coming, congratulations. No doubt about it, it can be wonderful. But it can also result in headaches and disappointment if it’s mismanaged. My advice: To maximize your enjoyment, take it slow.

Adam M. Grossman is a Boston-based investment advisor. An advocate for financial literacy, Adam regularly teaches an adult education class titled “You Can Outsmart Wall Street.”

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From Half to Whole

FOUR YEARS AGO, at age 45, I got divorced. These days, divorces are equal-opportunity proceedings. Since our income streams had been roughly the same, and we didn’t have children, our assets were split 50-50. For me, that meant losing half my state pension. Along with that loss came the realization that my retirement dream was just that—a dream.

Following the divorce, my lifestyle underwent a huge upheaval. Living on my own for the first time in my adult life, I realized I needed to educate myself on personal finance issues. I started reading books on how best to manage my money. I learned how to create—and stick to—a budget. I learned how to distinguish “needs” from “wants” and I began saving more of my paycheck. I met with a representative from the investment company that manages my current retirement fund and I learned about my investing options.  I educated myself on tax strategies, the differences between Roth and traditional IRAs, and I began to pay attention to the stock market for the first time.

Studies show that women are 80% more likely than men to live in poverty during retirement, making it even more imperative they learn to manage their money after a divorce. I began my own education by reading a variety of books about personal finance, including the Jonathan Clements Money Guide (now available for free on this site) and The Simple Path to Wealth by J L Collins. I also started to follow financial websites, such as CNBC’s Personal Finance page. The investment firm that manages my retirement account created a website devoted solely to issues involving women and their finances—Woman2Woman—which contains a variety of useful information.

Although my salary is quite modest—after 19 years of working for the same employer I now make $66,000 a year—I’ve made some impressive gains towards financing my future. My retirement account recently hit the $250,000 mark, and I’ve also been able to set aside money for an emergency fund and a future vacation. Retirement, following my divorce, is no longer a dream. Instead, today, it’s a well-researched, well-funded reality.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, OR. She has an M.S. degree in biology, and hopes to one day retire and become a fulltime writer.

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This Week/Jan. 29-Feb. 4

VENTURE ABROAD. Foreign shares account for 46% of global stock market capitalization and are far cheaper than U.S. shares, yet many investors are shying away from international markets after six years of mostly lackluster performance. HumbleDollar’s advice: Make foreign shares a permanent 33% to 40% of your stock portfolio.

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Wasted Youth

EARLY IN OUR ADULT LIFE, we get involved with all kinds of dubious financial types. There are the actively managed funds that quickly lose their charm, the insurance salespeople who try to force their policies on us, the market strategists who take us to all the wrong places and the hot stocks that let us down none too gently.

By the time folks get to HumbleDollar, however, I figure they’ve finished playing the field. This isn’t the site where you date dodgy stocks and feckless market forecasters. Instead, it’s the place you settle down and commit to a sensible, long-term relationship with your money. My fondest wish: Folks get here as early in their adult life as possible.

I have heard it said (and I may even have said it myself) that, if you’re going to make financial mistakes, it’s best to do so when you’re young and there isn’t much money at stake. A foolish gamble on a single rotten stock is less costly when you have $10,000 to play with, rather than $1 million.

That’s true. Still, those reckless days of youth are more costly than they seem. Take that $10,000 mistake. If, instead, you had invested in a broad stock-market index fund that earned an inflation-adjusted 4% a year over the next 50 years, you would have more than $71,000 to enjoy in retirement or bequeath to your heirs.

And it isn’t just the wealth forgone. By messing around with our money early in our adult life, we postpone the moment when we achieve a sense of financial security and some measure of financial freedom. The initial years as a saver and investor can be discouraging, in large part because the key driver of our portfolio’s growth is the raw dollars we sock away. But if we save 10% to 15% of our income every year for 10 or 15 years, we should amass a substantial sum—and hit a financial tipping point, where the investment earnings we collect each year start to rival the dollars we sock away. Thereafter, the combination of savings and investment gains can drive spectacular portfolio growth.

By accumulating wealth early on, we can also sidestep a slew of other costs. For instance, once we have a healthy sum put away, we might be comfortable raising the deductibles on our insurance and we could avoid a host of financial account fees. The cost savings that result can allow us to sock away even more money each year—and further propel our nest egg’s growth.

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Home Economics

YOU COULD SAY I HAVE GRADUATED summa cum laude from the school of hard knocks—for first-time homebuyers.

From a financial standpoint, I did everything by the book. Over two years, my husband and I saved enough to put down 20% and cover closing costs. To ensure we didn’t buy more house than we could comfortably afford, we kept our purchase price to less than half of what some lenders pre-qualified us for. I aggressively analyzed and pursued the best financing options. We established a healthy emergency fund.

It turns out, however, that my analytical nature—I’m a Certified Financial Planner—and expensive business school training only solved half the equation. By solely focusing on the financial side, I neglected to respect, and understand, the art of the purchase: What story was the house telling me with its physical clues? Clues, I now know, can include such things as a sump pump: If there’s one, it means the previous owners experienced water in their crawl space. If a new furnace was recently installed, it’s best to ensure it has the correct capacity.

Beyond the physical clues, there were behavioral clues from the seller and his realtor. Given the hot Portland market, they knew they were in the driver’s seat. What began as an amicable but firm negotiation devolved into something quite different by the time the ink was dry. The seller and his realtor imposed a closing fine—giving us 30 days to close the deal (something that is entirely out of our control, I might add) or face a $100 per day fine. When politely questioned on items that came back from the inspection report, there were days that would pass without a response.

Under normal market conditions, this type of behavior would have sent any buyer running. We, however, were reluctant to start over, especially after six months of devoting nights and weekends to finding a house in one of the most competitive markets in the U.S., including viewing more than 65 homes. The ironic thing is, these were all sunk costs. When evaluating the decision to continue, or start fresh, they should have never entered the equation.

No surprise: Our first home came with a side of humble pie. We thought we were prepared, but experience proved once again to be a formidable teacher. My lesson: Financial planning is more than numbers. But let my loss be your gain: Learning from somebody else’s experience is a lot cheaper than learning it firsthand.

Anika Hedstrom is a financial planner with Vista Capital Partners in Portland, OR. She loves to nerd-out and, when given a dollar, loves to save 96 cents.

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Spending Time

FRUGALITY: I DON’T KNOW WHETHER it’s inherited or learned. I do know that I am frugal—and have been since I was a boy. My grandmothers were both frugal. One had to be out of necessity, while the other just was. My siblings all have the frugality trait. When asked who is the most frugal, fingers tend to point toward me. I could argue with that. But then again, being frugal is good, right?

I am not materialistic. I owned a BMW once. It was a joy to drive, but I saw it more as a status symbol, which made me uncomfortable. I sold it. We held on to our other car for a long time. It was 14 years old when we finally parted ways. My home is modest. I could afford a larger house, but I would get lost in it.

I don’t mind a little discomfort—to the dismay of my husband. It builds character and saves money. The thermostat is dialed back in the winter and I avoid using air conditioning. In the winter, I wear an extra layer of clothes and, in the summer, well, we won’t go there. I can’t say that I have always been sensible in my frugality. I’ve had a tendency to be short-sighted. But I have learned. I know now that I am better off buying one well-made bicycle than three or four cheaper versions.

Frugality helped me to become financially successful and has allowed me to retire early, a goal I set 25 years ago. All my frugality, along with a lot of hard work, helped me to stash away money. I was investing in low-cost mutual funds well before it was fashionable. I do have some actively managed funds, including a few I have held onto for 25-plus years. Their performance justified the higher expenses, though today I favor index funds.

I don’t need to be frugal at this point in my life, but it’s a part of me, something that is hard to give up. Some might ask if I regret my frugal behavior, but I’m not one to look back with regret. You don’t miss what you don’t have. Possessions don’t reflect me. Relationships with friends and family are so much more important, and you can’t put a price on that.

These days, I find myself somewhat more comfortable with spending, on myself and on others. I enjoy taking friends out to dinner. Spending time with them is priceless. Each year, I travel through Mexico with friends, who were employees at the landscaping company I used to own. We stay at primitive hotels and eat at roadside taco stands. We don’t need luxurious hotels and high-end restaurants. It’s the experience and the friendship that are most important. I give to charity, but I get the most enjoyment from helping out those I know, providing gifts of money when it’s most needed.

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

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This Week/Jan. 22-28

CHECK YOUR CREDIT REPORTS. Every 12 months, you can get a free look at your credit reports from each of the three major credit bureaus by heading to AnnualCreditReport.com. Check not only for mistakes, but also for accounts you don’t recognize. That could be a sign of identity theft. While you’re at it, you might find out your credit score.

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Did I Say That?

IF YOU’RE READING the business section, you need to read between the lines. Here are 14 things financial journalists won’t tell you:

That unbelievably telling anecdote at the top of my article? I scoured the country for three weeks to find that schmuck.
The Dow industrials fell 263 points today. Why? By the time deadline arrives, I’ll have cooked up a reason.
What qualifications do I possess? An ability to dial a telephone.
Actually, I always wanted to be a sports reporter.
Today, I had to bang out a long feature story on the mortgage market. My editor is looking to buy a new house.
What qualifications do my sources possess? A willingness to pick up the receiver.
If you saw my portfolio, you’d never ask me for financial advice.
In the story, the company’s PR guy is quoted as saying, “no comment.” But on background, the senior counsel sung like a bird.
The more the market falls, the giddier the newsroom gets.
I don’t understand collateralized mortgage obligations, but I just wrote 1,000 words about them.
My sources aren’t nearly as articulate as I make them sound.
That joking, throwaway comment that the CFO made as we hung up? It’ll be in the second paragraph.
We’ll get the online version up now, and figure out the real story for the print edition.
I want my editors and sources to think I’m smart. What about readers? Yeah, I guess they’re also important.

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Raising Money-Smart Kids

ADULT MONEY HABITS are set by age seven, according to a 2013 Cambridge University study. Want to get your kids on the right track? Three things should scare the hell out of you.

First, parents teach kids about money all the time, often without knowing it. “Turn off the lights.” “Let’s go shopping.” “We will save if we have something left over.” It’s unavoidable. The subject of money is as omnipresent as the air we breathe. But that may not be the worst part for kids: Parents teach kids about money without the requisite knowledge. A 2015 Gallup poll showed two out of three adults around the world are financially illiterate.

Second, if parents choose to delay or ignore taking charge of their kids’ financial education, someone else will, including advertisers. Third, whether it’s borrowing for education or fun, it’s never been easier for kids to drown their dreams by going into debt. Benjamin Franklin would find today’s financial world astonishing. Teenagers, along with almost everyone else, can qualify for credit without income.

So where should parents begin? How do you teach kids about money at an early age? Here are four great field-tested strategies

1. Create slogans. Language is an enormous part of life. It shapes our thinking and feelings. Take time to determine what values you want to communicate to your kids about money. Then reduce those values to short, simple slogans. Personal finance books, blogs and Google searches can help. Three of my favorite sayings are “saving is a great habit,” “earning money is fun to do” and “spend slow and smart.”

2. Use storybooks and videos. Find ones that reinforce your money values. When using storybooks, bring the books to life by acting them out. Kids will love it and you will, too. Ask your children to repeat key phrases and concepts throughout the story. It keeps kids engaged.

3. Try songs. Music is a powerful learning medium. My favorite money song for kids is Get in the Habit. I may be biased, since I produced the song. Still, I am confident you will find the tune provides an excellent combination of knowledge and joy.

4. Use activities and games, including arts and crafts. One activity I enthusiastically recommend is creating a personalized savings jar. Use a transparent jar so kids can watch their savings grow. Write a goal on the jar, perhaps in glitter. Periodically, have kids shake their savings jar. Why? It’s fun!

Finally, keep in mind the following. First, there are no silver bullets. Mastery requires time and repetition. Second, learning is typically best when active. Third, there are no replacements for enthusiasm and authenticity. Kids will largely mirror your behavior. If you are enthusiastic, they will be enthusiastic. Kids will forgive a lot when they sense your message is genuine.

Sam X Renick 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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Courtside Seat

EVERYTHING I KNOW ABOUT INVESTING I learned in court. As part of my litigation practice, I represent investors harmed by the misconduct of stockbrokers, investment advisors and financial planners. Some cases can be brought in court. Most have to be arbitrated before the Financial Industry Regulatory Authority. Many of these cases have common themes that teach important lessons about investing.

Lesson No. 1: Wall Street Doesn’t Have a Crystal Ball. We all know predicting the future is impossible. But when Wall Street breaks out its technical charts, and its highly paid analysts discuss P/E ratios, EBIDTA, relative strength, quantitative analysis, momentum plays, valuation, trading strategies, market timing and the like, it sounds as if they have discovered a window on the future.

The reality: Stock price movements are unpredictable and random, because stock prices react to news, which by definition is unpredictable and random. The resignation or indictment of a CEO, a product recall, an “earnings disappointment,” the failure of a new product to generate significant sales, or an international crisis all will affect stock prices.

These events rarely can be anticipated. Contrary to what Wall Street’s aggressive marketing would have you believe, those who beat the market in the short term do so because of luck, not skill. Academic research has shown that there is a very low probability that any one broker, money manager, or financial newsletter can pick investments that consistently outperform benchmark market averages.

Lesson learned: Avoid actively managed investments. Stock picking and market timing are losers’ games.

Lesson No. 2: One Size Doesn’t Fit All. When you shop for clothes or shoes, there are a variety of sizes and styles, because each of us is physically different and has an individual fashion sense (or lack thereof). Similarly, investing choices should be tailored to fit you as an individual. A conscientious and knowledgeable advisor will carefully evaluate you to determine which investments are appropriate and how much to invest in each.

An advisor should ask about your investing time horizon, liquidity needs, income and savings rate, net worth, tax bracket, and investment experience and knowledge. Most important, the advisor needs to understand what level of risk gives you discomfort. Can you tolerate a 20% decline in your portfolio without panicking, or do you need to construct a portfolio that, based on historical data, is likely to fluctuate up or down only 5% a year?

Lesson learned: Run, don’t walk, from any advisor who tries to sell you something without first learning about you and your risk tolerance, or who has the same solution for everyone, or who recommends putting all your assets into a single type of investment.

Lesson No. 3: Wage War on Expenses and Taxes. Over long periods—10 to 20 years—well-diversified portfolios have almost always had a positive return. But fees, expenses and commissions, imposed year after year, substantially reduce the eventual long-term net investment return. And in a taxable account, the taxes generated by trading for short-term capital gains are also a drag on returns. Because of compounding, even a small difference in expenses can make a significant difference to long-term investment results.

For example, a $100,000 portfolio earning an average 9% a year for 10 years, with 1.25% in annual expenses, will grow to $208,755.  That same portfolio, but with 2% in annual expenses, would be worth $193,431, or $15,324 less. That is money that should have been in the investor’s pocket, not Wall Street’s coffers.

Additional fees, commissions, expenses and taxes, by themselves, can make it difficult to beat the market. As I’ve noted, the vast majority of brokers cannot select investments that beat the market over the long term. The probability of market underperformance is necessarily increased when the advisor tries to do so in an account also being hit with fees, commissions, and taxes.

Lesson learned: Keep expenses as low as possible.

Lesson No. 4: Don’t Chase Winners. Mutual funds, Wall Street firms, and financial newsletters love to tout their recent successes. Investors often flock to the fund, firm, newsletter, or investment category with the highest recent returns. But what happened in the past is a poor predictor of the future. The fund, firm, or individual advisor that “beat the market” last year isn’t likely to repeat that success this year, and they’re highly unlikely to consistently outpace their peers over long periods.

Lesson learned: Don’t chase last month’s or last year’s winners.

Lesson No. 5: Be Leery of “Investment Products.” Wall Street loves to sell “investment products” like limited partnerships, real estate investments, investment trusts, annuities, and mortgage-backed securities.

Often, these products pay huge commissions to brokers and insurance agents. When I see the phrase “investment product,” I usually find an investment with a variety of fees and expenses, and one that’s too complicated for the average investor to understand.

Lesson learned: Before buying an “investment product,” make sure there is full disclosure of fees and expenses. Don’t be shy about asking how much your advisor will make if you invest. Those payments come out of your investment, either directly or buried in the overall expenses borne by the investment. If the investment is very complicated, ask yourself whether you should risk your hard-earned money on something you don’t understand.

 Lesson No. 6: Make Sure Your Money Lasts as Long as You Do. In retirement, many baby boomers suddenly have access to significant lump sums, accumulated through savings, pensions, IRAs, and 401(k)s. There is a temptation to spend those assets freely, without considering that they may have to last 20 to 30 years.

It is critical for investors to structure retirement investments, and manage withdrawals, so they don’t outlive the money they have accumulated. As a rule, holding the rate of withdrawal to 4% or less, adjusted for inflation, will help ensure there won’t be a shortfall. Of course, each investor must consider their own life expectancy, the composition of the portfolio, any other sources of funds (such as Social Security) and spending habits.

Lesson learned: The higher the withdrawal rate from your retirement assets, the greater the risk you will outlive your money.

Lesson No. 7: Tune Out All the Noise—and Invest for the Long Term in Low-Cost Index Funds. An index fund is a passively managed fund which seeks to emulate a specified benchmark, such as the S&P 500, the Wilshire 5000, or A-rated corporate bonds, by buying representative amounts of each stock or bond in the index. Other index funds (many of which trade on the stock market as exchange-traded funds) focus on one industry, such as the telecommunications or health care sector, or a single geographic area, such as the leading publicly traded companies of South America or Japan.

These funds don’t try to beat the market by actively trading. Instead, they simply capture the total market return of the fund’s benchmark index. As we have seen, only a small percentage of active money managers beat the market over the long term. That means an investment that matches the market year after year is more likely to provide superior long-term returns.

Much of the superior performance of index funds is due to their low expenses, which average 0.25%, or about one-fifth of the expenses charged by actively managed mutual funds. Additionally, most index funds necessarily provide diversification (e.g. owning the 500 companies in the S&P 500) and are tax-efficient, since there is no active manager trading for short-term capital gains.

Lesson learned: Allocate your long-term investments among a variety of passively managed stock and bond index funds, both domestically and internationally, based upon your risk tolerance, goals, and financial needs.

Robert Port is a partner with the Atlanta law firm of Gaslowitz Frankel LLC. He is fascinated with understanding how people deal with and manage money—the emerging field of behavioral finance. When not in a courtroom or before an arbitration panel, he prefers to be cycling, skiing, hiking, or swimming.

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