Jonathan Clements's Blog, page 434

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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This Week/Jan. 15-21

INVEST AUTOMATICALLY. Looking to save more in 2017? Take two steps. First, increase the sum you contribute every paycheck to your employer’s 401(k) or similar retirement savings plan. Second, sign up to invest automatically every month in your favorite mutual funds. Some funds will even waive their regular minimum if you commit to a monthly savings plan.

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Prosperity’s Pitfalls

IS IT POSSIBLE to have too much money? This falls firmly into the “nice problems to have” category. Still, imagine you’re the lucky recipient of a winning Powerball ticket or a rich aunt’s bequest. You might find yourself grappling with three threats to your happiness.

First, you could quickly get used to the finest things in life, with no prospect of ever enjoying anything better. If you’re occasionally upgraded to first class, it’s a treat, because you can easily recall the indignities of economy. But if you always fly first class, you’ll take it for granted and it won’t seem special. Gone from your life will be the pleasure of an improving standard of living.

That brings us to a second, related problem: Because you could afford pretty much anything your heart desires, each item you possess will likely have less perceived value. Let’s say you own a single piece of art. Each day, you might catch a glimpse and feel a surge of appreciation. But if you have fine art on every wall, each painting will receive only a sliver of your attention, if you notice them at all—and the abundance may downgrade the joy you receive from the entire collection. Admittedly, modest pleasure from lots of art could be worth more than great pleasure from one or two pieces, but I wouldn’t bank on it.

Third, all that money will give you endless choice. But too much choice could leave you with a gnawing sense of uncertainty. Am I squandering the financial freedom that I have? Would I be happier if I were doing something else? As you wrestle with these questions, you may discover that instead of enjoying life, you’re agonizing over how best to live it.

Related: Nine Simple Strategies for a Happier Life

Related: Jonathan’s Story: Five Takeaways from Happiness Research

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Unexpected but Predictable

WHEN THE AXLE OF MY 2006 HONDA broke in the middle of a North Philly thoroughfare in December and I needed $500 to fix it, I knew where to turn: my family’s “life reserve” fund.

Every year, there are articles about how most Americans have little or no emergency money. Whether the unexpected cost is a car bill or an unanticipated job layoff, it’s critical to save for expenses that aren’t accounted for in your normal budget. Losing your job may come as a surprise. But many of these expenses are predictable: We can assume that each year someone in our family will need dental work, a vet bill will be higher than expected or our heating system will need repairs.

So how do we prepare for these unexpected but predictable costs? As I mentioned in an earlier blog, my wife and I manage our budget through various categories—a strategy I highly recommend. One of our essential categories is a life reserve fund. Each month, we contribute a fixed amount to the reserve fund for big ticket repairs on our house and cars, as well as other random but common life events. Then, when the air-conditioning dies or a pothole wreaks havoc with our car, we don’t find ourselves making tough choices between covering these costs and maintaining our lifestyle. We know and expect to use our life reserve fund throughout the year. Although we don’t know when a precipitating event will occur, we want to be ready when it does.

If you’re considering building a similar reserve fund, I’d recommend starting with the end in mind. How much did you spend last year on the vet, home repairs and other “emergencies,” and what would that look like as a monthly contribution? Then, find a good interest-bearing online savings account and set up automatic deposits from your paycheck or checking account.

It’s helpful to distinguish a life reserve fund from a true emergency fund, which we’ve also built up over the last 10 years. Our emergency fund has nine months of household expenses and is meant for costs we hope never to face, such as mortgage payments if one of us lost our job or medical expenses if we suffered major health problems.

Both a life reserve fund and an emergency fund are important. But for those new to long-term savings, creating a life reserve fund is a first—and more attainable—step in preparing yourself to withstand the ebbs and flows of financial life.

Zach Blattner 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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Reemerging Markets

IF YOU WANT INTELLECTUAL investment stimulation, you’d be hard pressed to do better than ResearchAffiliates.com, the site for Rob Arnott’s money management firm. Rob is one of the smartest guys I’ve met during my three decades bouncing around the financial world. Over the years, he’s offered intriguing insights on topics such as tax management, share dilution and indexing.

Are you confident U.S. stocks will continue to shine? Check out Research Affiliates’ 10-year expected returns. The firm expects small U.S. stocks to lag behind inflation and larger-cap U.S. stocks to eke out the slimmest of gains, while emerging markets and developed foreign markets roar ahead.

Intrigued? Read the firm’s recent article on emerging markets. They’re arguably the world’s most attractive asset class, with modest valuations, depressed currencies and favorable demographics, plus upward price momentum from 2016 that could signal the beginning of a long-awaited rebound. Then ask yourself whether you have enough exposure in your own portfolio. Emerging markets account for 9% of global stock market valuation, based on the FTSE Global All Cap Index, and 19% of non-U.S. market capitalization, as measured by the FTSE All-World ex-U.S. Index. I’m a believer: In recent weeks, I’ve been adding to my emerging markets index fund.

How does Research Affiliates forecast stock returns? You can get a plain English explanation by heading to the site’s resources section and reading the white paper on the firm’s equities methodology.

Also check out the site’s demographic data. The chart at the bottom of the screen, which shows the shrinking number of workers per retiree, starkly illustrates why growth is so sluggish in the developed world and why we need the typical retirement age to rise. But it also explains why emerging markets remain a compelling investment—though even they will face potential demographic headwinds later this century.

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Friendly Fire

IN AUGUST, I began a PhD in history at Yale. My scholarship falls just short of $30,000 a year. While not exactly commensurate with the university’s $25 billion endowment, it’s a generous stipend compared to those at similar programs. Compare it to what most of my friends are making, however, and my financial situation looks somewhat less favorable.

I graduated two-and-a-half years ago from Washington University in St. Louis. Many of my friends are now working in New York City, with salaries approaching six figures. Even those friends accruing vast debt in law school have such high expected future income that they feel justified splurging on this and that.

This has serious ramifications for my social life—both what I do and with whom I do it. In New Haven, my fellow graduate students are similarly strapped for cash. Friday night plans generally consist of a double-size bottle of Yellow Tail and a card game. Nights out with friends in New York look rather different. The $35 roundtrip train ticket to Manhattan alone puts a sizable dent in my disposable income. Add that to subway rides, dinners out and overpriced cocktails, and I begin to realize that I simply can’t afford to hang out with certain people.

This isn’t likely to change anytime soon. My PhD will probably take seven years to finish, and Yale rarely adjusts stipends for inflation. I’ve already had to forgo vacations with friends and, if my sister’s experience is any indication, I won’t be able to attend many weddings, either. I, of course, wish all my friends the best in their financial lives. But maybe I’d see them more often if they weren’t quite so successful.

Henry Clements, Jonathan’s son, is a PhD student at Yale. Back in the U.S. after two years in Cairo, he studies modern Middle East history and is considering taking up the banjo.

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This Week/Jan. 8-14

PLAN NEXT SUMMER’S VACATION. By starting now, you’ll have a long stretch of eager anticipation—which may prove to be the best part of the vacation. Let your imagination roam, pondering lots of possible trips. In the end, you might take just one summer vacation, but in your daydreams you can visit all kinds of places—at no cost.

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The Marriage-Industrial Complex

LAST YEAR, I READ Aziz Ansari’s Modern Romance, a book where he explores millennials’ experience with finding love. Ansari writes: “In 1932 a sociologist at the University of Pennsylvania named James Bossard looked through five thousand consecutive marriage licenses on file for people who lived in the city of Philadelphia. Whoa: One-third of the couples who got married had lived within a five-block radius of each other before they got married. One out of six had lived within the same block. Most amazingly, one of every eight married couples had lived in the same building before they got married.”

Ansari finds things to be very different today: The majority of his friends “married people they’d met during their postcollege years, when they were exposed to folks from all over the country and in some cases all over the world.”

This modern reality has had serious implications for my wallet.

In the past four years, I have attended weddings in New Orleans, Nashville, Austin, Baltimore, Washington, DC, Hoboken, NJ, and Columbia, Md. Some friends’ nuptials have brought me to even more remote locations, including Sioux Falls, SD, the Pocono Mountains in Pennsylvania, Deep Creek Lake, Md, Amherst, NH, Las Cruces, NM, and Bluemont, Va. In 2017, weddings will take me to Charleston, Memphis, and Tarrytown, NY.

American Express recently reported that the average millennial wedding guest spends $893 per “big day.” On a month when I have a wedding, that is 27% of my take-home pay. Wondering how a guest could possibly spend $893? Look up the cost of a flight from my home in Philadelphia to Las Cruces, a hotel in Hoboken or pretty much anything from the Williams-Sonoma registry, and you will quickly see how. Getting to Sioux Falls was my real-life version of the movie Planes, Trains and Automobiles.

The simple solution is to respectfully decline the engagement parties, bridal showers, bachelorettes and weddings. But as someone who values family and friendship above everything else, it pains me to miss out on such significant events. And, if the situation were reversed, I would be crushed if no one came to celebrate with me. So what’s my solution to the insane millennial wedding culture? Re-wear dresses, split hotel rooms with five people and, this February, drive ten hours to Charleston to avoid the airfare.

Hannah Clements is a former teacher who now runs STEM programming for an education non-profit in North Philadelphia. She likes protein shakes, cleaning her house and, most of all, being Jonathan Clements’s daughter.

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Honey, I Shrunk the Portfolio

AN 80-YEAR-OLD WRITES, “We spend a substantial sum each year for travel, which eats up a good share of our retirement accounts’ required minimum distribution. That means our total nest egg decreases even when the portfolio shows a gain. We could stop traveling so much. But that’s no fun. So we are relegated to the facts: Our portfolio will show a decrease as long as we insist on traveling.”

My response: “You shouldn’t necessarily be concerned that your portfolio shrinks a little each year. If I were in your shoes, I would pick a target life expectancy. Let’s say it’s age 100—20 years from now. As long as your portfolio doesn’t shrink by more than 1/20th this year—or 5%—I wouldn’t be too worried. Next year, your threshold would be 1/19th, and so on.”

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