Jonathan Clements's Blog, page 435

Delusions of Immortality

We are all constrained by the income we have and the wealth we’ve either amassed or had handed to us. Result: Those on low incomes struggle to cover daily expenses. The middle class pay for today, while also socking away money for their own future. What about the rich? They often use their wealth not only for themselves, but also to help future generations.

These are, of course, gross generalizations. Some folks on low incomes manage to save surprising sums for their own retirement. The middle class may not bequeath great gobs of money to their children, but they often help with college costs. And, over the years, many spectacularly rich families have shown an alarming ability to devour wealth, leaving precious little for their children and grandchildren.

Still, I am fascinated by the possibility of helping future generations and the small sliver of immortality it offers. “I never knew my great grandparents, but I couldn’t have gone to college without their foresight,” has a nice ring to it. We may be gone, but it’s comforting to think we aren’t totally forgotten.

I have helped my children financially—a topic I have written about frequently. But what about subsequent generations? When I first pondered the issue, I had high hopes: I might not be able to commit significant sums to help later generations, but decades of investment compounding could potentially compensate.

But the more I’ve thought about it, the less promising the prospects seem—and the less surprised I am by the disappearance of great family fortunes. That doesn’t mean we shouldn’t try to help future generations. But our impact is likely to be limited and short-lived, for two reasons.

Problem No. 1: The math is against us. Efforts to pass wealth down through the generations face two obstacles: rising living standards and growing families.

As investors, we often focus on outpacing the twin threats of inflation and taxes. If we aren’t overcoming those two threats, our money isn’t growing. Seem reasonable? In truth, it’s a tad more complicated.

Our national standard of living is pegged not to inflation, but to per-capita economic growth. Over the past 50 years, U.S. per-capita economic growth has climbed at 1.8 percentage points a year faster than inflation. In other words, if our income rises with inflation, our standard of living might stay the same, but we’ll feel increasingly poor compared to our ever more affluent neighbors.

This need to keep pace with rising living standards creates big problems for family fortunes. Imagine we bequeathed $1 million, with the goal of generating income for our family in perpetuity. Our heirs invest the entire sum in stocks, an obviously risky strategy, and we’ll assume they incur no investment costs. Stocks go on to earn 6% a year, or four percentage points more than the 2% annual inflation rate. That’s a reasonable long-run forecast for stocks, I believe.

“Money doesn’t necessarily kill all ambition. But it seems to put a big dent in financial ambition.”

In the first year, the $1 million we bequeath earns $60,000. Federal and state income taxes would be owed. Let’s say that amounts to a combined rate of 18%—15% for federal taxes and 3% for state taxes—leaving our heirs with $49,200.

Our heirs would need to reinvest a chunk of that money to keep the portfolio growing. How much should they reinvest? Suppose the goal is to ensure the portfolio kicks off an income stream that rises not with the 2% inflation rate, but with per-capita economic growth. If per-capita growth continues to expand 1.8 percentage points a year faster than inflation, our heirs would need to reinvest $38,000. That would leave just $11,200 to be spent—a 1.1% withdrawal rate.

The good news: If our heirs stick to that 1.1% annual withdrawal rate, both the $1 million and the income it generates will rise every year along with per-capita economic growth, and it’ll do so in perpetuity. The bad news: Our heirs will receive pitifully little income.

To make matters worse, there’s a good chance we’ll leave behind a growing clan. Let’s assume we have two children, they each have two children, and those children each have two kids. That means we will have eight great grandchildren, all vying for their piece of the 1.1%.

You don’t need to be a genius to figure out what happens: A whole lot more than 1.1% gets spent, at which point the money we left behind won’t last in perpetuity. Instead, it will be depleted, slowly at first and then ever faster, as the demands for income outstrip the portfolio’s investment gains.

Problem No. 2: Money saps financial ambition. Potentially, our goal of helping our family in perpetuity could still come to fruition—if our heirs viewed their inheritance not as a financial mainstay, but as a nice annual supplement to the income they earn from their jobs.

On that score, however, we’re running up against human nature. Money doesn’t necessarily kill all ambition. But it seems to put a big dent in financial ambition.

I see this with my own children and stepchildren. They won’t inherit huge sums and don’t expect to. But they have grown up in comfortable upper middle-class households, and that’s had an impact.

How so? They all seem to be ambitious—but they don’t appear to be especially ambitious when it comes to making money. You can find that raw moneymaking desire among kids from affluent homes, but you’re far more likely to see it among those who grew up with too little.

I’m heartened that my children and stepchildren are, for the most part, careful spenders. That should help them avoid major financial headaches. But what about their lack of financial drive? Initially, I viewed it with some concern. But over time, I have come to see it as a luxury that comes with affluence: They worry less about money than I did, when I was their age, and that strikes me as a good thing.

Indeed, I have come to believe that, as long as they devote their days to work that benefits those around them, they are leading good lives, even if they aren’t collecting big paychecks. But there’s an obvious financial impact: To the extent that I leave them money, it’ll likely be spent and not passed along to the next generation.

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Every week, I post at least three new blogs to HumbleDollar.com—usually on Tuesday, Thursday and Saturday—plus the weekly action item that appears on Sunday. Typically, two of the three blogs are written by others. Over HumbleDollar’s first seven months, the site has attracted a stable of seven regular writers, as well as some folks who have been onetime contributors. Interested in joining them? Check out the site’s blogging guidelines.

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Finally, I’ve been surprised to learn that some readers still don’t realize that my annual money guide—which appeared in 2015 and 2016 as a paperback and e-book—is now available on HumbleDollar at no charge. Did I mention that there was no charge?

July’s Greatest Hits

Here are the five most popular blogs from last month:

Fooled You
Retirement: 10 Questions to Ask
Looking Bad
Stocking Up
Chasing Points

When a blog appears late in the month, it often gets much of its traffic in the month that follows. In July, that was true of two blogs from late June: To Buy or Not to Buy and Precautionary Measures.

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College: 10 Questions to Ask

GOT COLLEGE-BOUND KIDS? Make sure you and your children are on the right track financially—with these 10 questions:

Can you afford to help your kids with college costs? It’s important to talk to your teenagers early on about how much financial assistance you can offer—and that’s doubly true if they’ll need to shoulder much or all of the cost.
Will your family receive needs-based financial aid? Use the EFC calculator at CollegeBoard.org to figure out how much aid you might get. EFC is an abbreviation for expected family contribution.
Are you funding a 529 college savings plan? This is the best savings option for college savers, thanks to the plans’ tax-free growth and limited impact on aid eligibility.
Should you shutter custodial accounts? These used to be a popular choice for parents looking to help their kids. But you may want to close your children’s custodial accounts, even if it means paying capital gains taxes, and move the proceeds into a 529. Thereafter, you’ll enjoy tax-free growth—and you should improve your family’s chances of receiving financial aid.
Are you investing college savings too aggressively? You’ll likely empty your children’s college accounts before you start to dip into your own retirement savings, plus the college money will be spent over a brief four-year period. The implication: You should probably be taking less risk with your kids’ education funds than with your own nest egg.
How much can your children reasonably borrow? Much depends on their eventual career and likely earnings. A rule of thumb: After graduation, your children shouldn’t be devoting more than 10% of their income to servicing college loans. That cap should guide their college choices and hence how much they borrow.
Do you have a home equity line of credit? Thanks to their low rates and tax-deductible interest, a home equity line of credit can be a great backup source of college money.
Have you checked whether you qualify for any of the education tax breaks? The various credits and deductions all have income thresholds.
If your children will soon enter college, is it time to empty your checking account—and pay off consumer debt? Money sitting in regular taxable accounts will hurt you in the aid formulas, while credit card debt and auto loans don’t improve eligibility. Result: Using spare cash to pay off these debts will improve your chances of financial aid, plus it’s typically a smart financial move.
If you’ve graduated, should you consolidate your student loans—and perhaps apply for an income-based repayment program?

This is the third in a series of blogs devoted to key questions to ask. The first two blogs were devoted to retirement and housing.

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Growing Up (Part III)

I WAS LESS THAN 10 YEARS OLD when I decided that I wanted to earn some extra cash over and above my weekly allowance. I took day-old sections from the Washington Post and went door-to-door in my neighborhood, selling each section for a dime. Not many fell for it, but there was a couple who were willing to hand over a dime to a young boy looking to supplement his allowance.

I doubt that I earned much from this endeavor. Still, it marked the early beginnings of my entrepreneurial spirit. There wasn’t any financial risk taken, but certainly the initiative and the appetite for earning money was there.

It wasn’t until my family’s return to Washington, DC, from my father’s posting overseas, that I—along with my twin brother—took on the next moneymaking venture. We were 16 years old. We advertised our lawn mowing services in the community newsletter, which was sent to hundreds of households. Once again, there was very little financial risk, because we required customers to provide their own mowers. We had enough customers through the summer to keep us busy, not just with mowing, but with add-on services, too. We would do just about any household chore a customer wanted.

Additionally, we did babysitting. Word was getting around that we were reliable. If you asked us to do something, it would get done. If you wanted us to be at your home at a certain time, we would be there punctually. If you called us, we would call you back. This same attitude toward customer service would become a significant factor in the growth of our landscape company two decades later. Customers knew that they could rely on us, a reason so many customers remained with us for all the years that we owned the company. Even customers that we had as teenagers and into our 20s would become customers of the landscape company that we started in our 30s.

As if we were not busy enough, we both took on newspaper delivery routes. We would be up at 5 a.m. to each deliver the 50 newspapers that were dropped off near our home. We retrofitted our bicycles to carry newspapers in a basket, with even more copies stuffed in the canvas shoulder bag that the Washington Post provided to its carriers. The Sunday edition of the paper was substantial, so much bigger than it is today. Either we would have to do two deliveries or we would load the newspapers onto the backseat of our gas-guzzling car and drive to each of the homes.

Deliveries were made in all kinds of weather. We were committed to ensuring that each of our customers received their newspaper. I recall on one winter morning waking up to a heavy snowfall. The newspapers had already been dropped off. We dug them out and walked the newspaper route, something that we also had to do on the days that followed, until the snow had melted. This commitment to customer service was not forgotten by our customers. Many would also come to us for our mowing services.

The cash that I earned was deposited into my bank account, usually on a Friday evening, when I was at the shopping mall with my mother and siblings. For all our hard work, our treat was dinner at Roy Rogers, a fast food chain located just down the hallway from the bank. This discipline of saving diligently and spending slowly continues to this day, though now I hold the purse strings a little less tight.

This is the third in a series. The first two parts appeared July 25 and July 27.

Nicholas Clements is one of Jonathan’s older brothers. He is retired and lives just outside Washington, DC. His previous blogs include Less Green and  Not a Good Time .

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This Week/July 30-Aug. 5

COULD YOU DROP INSURANCE POLICIES? If the kids have left home or you have $1 million-plus in savings, you might no longer need life insurance. With a seven-figure portfolio, you could probably also drop disability coverage and skip long-term care. Even if you can’t cancel policies, consider raising deductibles and extending elimination periods as your wealth grows.

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Bad Old Days

“STOP PULLING MY LEG, Grandpa. You’re kidding, right? Is it really true that people:

used to believe they could beat the market?
paid 2% of assets and 20% of profits to hedge fund managers?
got their stock picks from a guy screaming on the television?
thought cash-value life insurance was a good investment?
believed that brokers would act in their best interest?
studied stock price charts to figure out what would happen next?
bought and sold exchange-traded index funds like crazy?
were given 30 investment choices in their 401(k) and left to figure it out on their own?
treated top money managers like they were rock stars?
retired and all they had to live on was Social Security?
didn’t object when companies spent billions buying back shares to disguise the dilution caused by employee stock options?
bothered to listen to the forecasts of market strategists?
paid 1% a year to financial advisors and all they got in return was a portfolio of mutual funds?
imagined they could make money with a variable annuity charging 3% a year?”

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Growing Up (Part II)

I DON’T THINK MY PARENTS ever had any sort of five-step plan to teach me about money. I was always parsimonious, so they weren’t very focused on how I spent. They did, however, teach me two powerful life lessons—which changed not just the way I thought about money, but who I am.

Everything has a cost. I attended private school from fourth to ninth grade, coasting by with B plusses and A minuses. My report cards usually included comments like “Zach could do so much better if he tried harder” or “When Zach is attentive, he is great, but at other times….”

I told my parents this is what teachers said about everybody. They told me that if the comments didn’t change, they would pull me from the school, because they weren’t paying tuition for me to be comfortable. I didn’t believe them. It turned out it wasn’t an empty threat. Despite my rage, they transferred me to public school for tenth grade.

Skin in the game. I was furious with my parents, but I also realized how serious they were. I refocused on academics and earned better grades, without any negative teacher comments. They let me reapply to my old private school, where my closest friends were and where I could actually make the basketball team, and I was accepted.

But my parents laid down a condition: I had to pay 10% of the tuition out of my own pocket. They are both doctors and didn’t need my money. But they had seen my previous lack of appreciation—and wanted to ensure I didn’t again take private school for granted.

For an entire year, I worked a retail job in the maternity and kids section of a department store in the Maine Mall in South Portland, paying back every penny to my parents. The experience made me a completely different student during my junior and senior years and, when I reached college, I valued my education—and how much it was costing—far more than some of my less grounded peers.

This is the second in a series. The first part appeared July 25.

Zach Blattner’s previous blogs include Seller’s Remorse and   Too Trusting . Zach lives in Cambridge, MA, and is a former teacher and school leader who now teaches English teachers 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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July’s Updates

EVERY MONTH, I revise a slew of pages in HumbleDollar’s online money guide. Here are some recent updates:

Home prices continue to rebound, though they remain just 3.2% above their mid-2006 peak—and houses still look affordable by historical standards.
U.S. stocks are yielding 1.9%, less than shares in almost any other developed country.
I updated the page devoted to retirement calculators, dropping some that now require site registration and adding others that don’t. My preference in online calculators: They should be simple but smart—and you shouldn’t have to create a username and password.
States continue to tweak their estate taxes, with many raising their exemptions so they’re more in line with the federal government’s $5.49 million.
The federal government boosted the student loan interest rate for the 2017-18 academic year, with Stafford loans now charging 4.45%.
I revised the page devoted to one-fund portfolio solutions, including adding Charles Schwab’s relatively new target-date index funds, which charge a slim 0.08% a year and have no investment minimum.
If you haven’t already, check out the money guide’s five new know thyself sections, which touch on overconfidence, loss aversion and our perennial dissatisfaction.

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Growing Up (Part I)

I RECENTLY RECEIVED an email from a friend asking, “What financial advice would you give to your younger self, now that you’re older?” I had to think for a while. But once I sat down to reply, I realized my attitudes about personal finance were already well-developed by the time I was in my 20s. I also realized my financial beliefs had been shaped, in part, by growing up in a family where money wasn’t exactly plentiful.

As a child, I don’t remember ever having a formal discussion about personal finance with my parents. The lessons I learned about spending and saving came from real life. My family lived in rural Oregon. The modest allowance my parents provided each week was earned doing chores around our small farm. Returning bottles to the grocery store, to redeem the nickel deposit, served as supplemental income. The back-to-school supplies I purchased in the fall were financed with the proceeds from selling an animal each summer at our local 4-H livestock auction.

We rarely ate out, but if we did, it was almost always at McDonald’s. We didn’t have cable television and we didn’t take expensive vacations to exotic locations. Instead, we went on camping trips. I spent a good portion of my summer vacations exhibiting our animals at county fairs throughout the state. The budgeting skills I have as an adult can easily be traced back to my youth, when I earned multiple awards for my 4-H record books, filled with the profit-and-loss statements for each of my projects.

When I decided to go to college, my parents were supportive of my decision, but they were unable to help me financially. Instead, I applied for, and received, several needs-based grants. I also won thousands of dollars in merit-based scholarship money. I worked part-time while taking classes and lived such a frugal lifestyle that, when I graduated with my bachelor’s degree, I was not only debt-free, but also I’d managed to amass $5,000 in a savings account to help pay for graduate school.

The financial lessons I learned growing up are still with me as an adult. I grew up not only appreciating the value of a dollar, but also learning that the memories from life experiences are far more valuable than any item that can be bought. To this day, I carefully pick and choose what I’ll spend my hard-earned money on. A day with friends at a pistol shooting competition is more highly valued than any possession I might purchase.

This is the first in a series.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Ore. Her previous blogs include To Buy or Not to Buy and Quitting Early .

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On Second Thought

IF WE’RE ABOUT TO BE HIT by a car, our instinct is to jump out of the way. As it happens, that’s also the smart thing to do. This would not be the best moment to stop and ponder whether we’re overreacting. But while our instinctive reactions are often correct, especially when faced with physical danger, they can lead us badly astray when managing money. Want to learn more? Check out my latest client letter for Creative Planning, where I sit on the advisory board and investment committee.

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This Week/July 23-29

SEE IF ESTATE TAXES ARE AN ISSUE. With 2017’s federal exemption at $5.49 million, few Americans need worry about federal estate taxes. State estate taxes are an issue in just a third of states, though state exemptions are often below the federal level. For most Americans, the biggest “death tax” will be the income taxes owed on inherited retirement accounts.

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