Jonathan Clements's Blog, page 437

Go Fish

WHEN AN INVENTOR GOES ON RECORD stating that his invention is “a monster” that he’d like to “blow up,” you know there’s a problem.

Such is the case with Ted Benna, who back in 1980 created the first 401(k) retirement plan. Since then, his invention has grown to become the dominant retirement vehicle for millions of Americans.

Why is Benna so negative on his creation? The problem, in a word: complexity. According to Benna, the first 401(k)s were a model of simplicity. They offered just two investment options, a stock fund and a bond fund, and they were offered in fixed percentages. That meant that workers needed only to choose from a total of five possible combinations (0% stock/100% bond, 25% stock/75% bond, and so on).

Today, by contrast, the typical 401(k) menu offers nearly 20 fund choices—and without the restriction of fixed percentages. As a result, the possible combinations of funds and percentages is astronomically large.

Trying to choose investments for your own 401(k)? I suggest the following three-step process to cut through that complexity:

Step 1: Opt for the easy choice. Today, many employers offer target-date funds. The key advantage of these all-in-one funds is that they adjust automatically to your age, becoming more conservative as you get older. They aren’t perfect—age, after all, isn’t the only determinant of one’s needs—but they are far better than an arbitrary selection of funds. If your company offers a target-date fund, that’s an easy choice. Just be sure to select your target date carefully, so it matches your retirement timetable. If your company doesn’t offer a target-date option, proceed to Step 2.

Step 2: Fish in the right pond. Your 401(k) menu may be long, but it’s important to know that most funds fall into just a few basic categories, such as stocks and bonds. While you want to make the best choice within each of those categories, research has shown that the category itself drives 90% or more of your results. In other words, if you fish in the right pond, that’s much more than half the battle. You might want some help with this process, but the basic idea is to allocate your portfolio to stocks when you are young and then slowly incorporate bonds as you get older.

Step 3: Cast a wide net. Once you’ve decided which types of funds you need, you have to choose specific funds. Here, the key is to go for funds that offer broad diversification at low cost. To continue the fishing analogy, once you’re in the right pond, just cast a wide net. The easiest way to accomplish that is with index funds. The data clearly show that this approach offers the best odds for success.

Anyone who has ever struggled through a 401(k) menu can sympathize with Ted Benna’s frustration. But, by following the three steps above, I believe you can significantly simplify the process.

Adam M. Grossman’s previous blogs include  Site Seeing (Part III), Footing the Bill   and Trust Issues. 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.

The post Go Fish appeared first on HumbleDollar.

Baby Steps

SHORTLY BEFORE MY FIRST CHILD was born some two decades ago, I read a newspaper column urging parents to begin saving for college early in their children’s lives. Today, my son is not far from getting his bachelor’s degree in engineering, debt-free and (fingers crossed) with a bit in the bank for his master’s degree. My daughter starts college this fall and is on track for the same outcome.

I feel like we’ve been a real life middle-class experiment, showing what happens when a family starts saving for college while little ones are still in diapers. As I’ve watched children of other families grow up around me through Legos, robotics teams and college applications, I’ve seen alternative outcomes—where families didn’t start early. Having lived this journey, here’s what I’ve learned:

Being bright doesn’t guarantee a full ride. I’ve witnessed families who didn’t save for college because their children were truly bright, often at the head of the class or even the entire grade. I met one such father in the grocery store recently. As our talk turned to our little darlings, he grimaced, put his hands to his face and said, “I don’t even ask any more about her student loans. I don’t want to know how much debt she’s in.”

His daughter, brilliant at math, was her high school’s salutatorian and he had assumed that merit scholarships would fully cover college. As it turned out, scholarships did cover her tuition. But then there’s the pesky matter of living expenses: dorm room, meal plan, transportation, laptop, cell phone and more. It adds up over six years. Yes, six years: Most bright kids today don’t dare stop at a bachelor’s degree and plow right on through to their master’s.

You’d be amazed what $25 a month can do. Soon after our first child’s birth, we started saving $25 a month in a Coverdell account at our local credit union. As soon as we could carve $50 a month from our budget, we moved up to a Vanguard 529 account. We put the money into a basic index fund covering the U.S. stock market. Later, we got fancy and added an international index fund. We never looked at the ups and downs. We just left it alone and kept adding to it with monthly automatic contributions.

If you start this early, you will be so thankful of the options that your precious child has upon graduating high school. You will also bear witness, sometimes heart wrenchingly so, to the options available to your child’s high school friends whose parents didn’t save. Starting with just $25 a month, you will be absolutely amazed at how this little bit of money adds up in the end, especially as you increase your monthly contributions over time.

Amy Charlene Reed is a science and energy writer who lives near Oak Ridge, Tenn.

The post Baby Steps appeared first on HumbleDollar.

Our Top 10 Blogs

WHAT DOES IT TAKE to attract readers? Lists are almost always popular. Humor helps. Folks are fascinated by the topic of happiness, and also deeply interested in helping their kids. And, of course, it’s always a plus if a blog gets mentioned by someone with a large following on social media.

All of which may explain the list below—HumbleDollar’s 10 most popular blogs through 2017’s first six months:

Courtside Seat
Ten Commandments
Next to Nothing
Nothing Better
The Good, the Bad and the Ugly
Did I Say That?
Site Seeing (Part I)
Take It to the Limit
Prosperity’s Pitfalls
Another Darn List

The post Our Top 10 Blogs appeared first on HumbleDollar.

This Week/July 2-8

CONSIDER A TARGET-DATE FUND. Financial advisors push the notion that every investor needs a customized portfolio—and, indeed, we all like the idea that we have an investment mix specially designed for us. Yet most of us, whether we’re investing on our own or through an advisor, would likely fare just as well, if not better, with a target-date retirement fund.

The post This Week/July 2-8 appeared first on HumbleDollar.

July’s Newsletter

RISING VALUATIONS added 62% to stock investors’ wealth over the past 50 years. But what if those gains were reversed? I explore that topic in July’s newsletter. The newsletter also offers insights into a much debated issue: Does having children help or hurt happiness?

The post July’s Newsletter appeared first on HumbleDollar.

Past Perfect, Future Tense

Over the 50 years through year-end 2016, the per-share profits of the S&P 500 companies rose a cumulative 1,604%, equal to 5.8% a year, while inflation ran at 4.1%. If share prices had climbed in lockstep with corporate earnings, $1,000 invested at year-end 1966 would have been worth some $17,000 at year-end 2016. On top of that price appreciation, investors would also have collected dividends.

But in fact, over this 50-year stretch, investors fared far better. The share prices of the S&P 500 companies rose a cumulative 2,662%, equal to 6.9% a year, enough to turn $1,000 into $27,600. Result: Investors ended up 62% richer.

Puzzled? There’s no great mystery here. Over this 50-year stretch, the S&P 500 companies went from trading at 14.7 times corporate profits to 23.8 times earnings—a 62% increase in valuations.

What if you add in dividends? The dividend yield on the S&P 500 stocks was 3.5% at the beginning of the period and 2% at the end. Those modest numbers might make dividends seem like a minor issue. But in fact, thanks to compounding, dividends added enormously to investor wealth. Over the 50 years, the S&P 500’s total return—share price appreciation plus dividends—was 12,559%, or 10.2% a year, turning our $1,000 into $126,600.

Now suppose that, at year-end 2016, the S&P 500’s price-earnings (P/E) ratio plunged back to its year-end 1966 level. Investors would have been left with $78,200—still an impressive sum. Indeed, eliminating the gain from the market’s rising P/E reduced the market’s return by a mere 1.1 percentage points a year.

Telling stories. You can view these figures as confirmation of standard Wall Street wisdom: If you’re a long-term investor, you shouldn’t fret too much about current valuations, because changes in valuations are far less important to long-run returns than earnings growth and dividends.

Seem reasonable? Before we accept this comforting investment story, let’s ponder the next 50 years for U.S. stocks. Thanks to the aging of America and the accompanying slow growth in the workforce, the current century’s real economic growth has been sluggish, averaging 1.9% a year. That’s likely to continue.

“If you follow a high-cost strategy and are careless about taxes, you could throw away your entire after-inflation gain.”

Let’s say we get 2% real economic growth in the decades ahead. Factor in 2% inflation and we’d be at 4% nominal growth. Meanwhile, dividends are currently 2%. Add that 2% dividend yield to the economy’s projected 4% annual growth, and we’re looking at 6% stock returns. This assumes corporate earnings expand at the same rate as the economy and there’s no change in valuations. At 6% a year, $1,000 would turn into $18,400 after 50 years.

But what if P/Es don’t stay the same—and instead drop from 23.8 times earnings to 14.7, reversing the gains of the past 50 years? Over the next 50 years, $1,000 would grow to just $11,400, for a return of 5% a year.

Learning lessons. On the one hand, this appears to confirm Wall Street wisdom: Our assumed collapse in valuations knocked just one percentage point a year off returns. Earnings growth and dividends were able to overcome that hit, so stock investing was still a profitable endeavor.

On the other hand, we are talking about a 5% return. That’s thin gruel. Our projected $11,400 is a far cry from the $126,600 that investors collected over the past 50 years. To be sure, the gap narrows if we factor in inflation. The next 50 years’ $11,400 would be reduced to some $4,200 if we adjust for our assumed 2% inflation rate, while the past 50 years’ $126,600 becomes $17,000 if we adjust for the actual 4.1% inflation.

Still, investors are potentially ending up with just a quarter of the wealth they would have amassed over the past 50 years. What should readers make of all this? Here are four implications:

Our 50-year projection is built on three key numbers: the starting dividend yield, economic growth and a collapse in valuations. The starting dividend yield is known—and it is, alas, modest by historical standards. The economic growth rate is a guess, but not an absurd one, given demographic trends. The collapse in P/E ratios is, of course, pure speculation. I doubt we’ll see anything that severe, though I wouldn’t be surprised to see some drop from today’s lofty level.
After backing out inflation, we’re looking at a total return that’s maybe 3% or 4% a year. If you buy low-cost index funds and pay careful attention to taxes, you should pocket most of that return. If you follow a high-cost strategy and are careless about taxes, you could throw away your entire after-inflation gain.
We have focused here on U.S. stocks. The outlook for foreign stocks—and especially emerging markets—is brighter, I believe. If you have a healthy allocation to foreign stocks, you might earn more than the 5% or 6% a year we’ve been discussing.
A potential collapse in valuations is a much bigger headache for those who have a large lump sum to invest or who are retired. For those still in the workforce and regularly adding new savings to their stock portfolio, a sharp drop in valuations would be a bonanza—provided they don’t panic and sell, but rather stay the course and continue to add to their portfolio at the lower valuations.

Children? Just Say Maybe

We know a lot about happiness. Marriage, time spent socializing, religious beliefs and a high income relative to others can all help, while commuting, divorce, unemployment and ill-health can hurt.

But a big question remains unanswered: What impact do kids have? Children may be a blessing—but it seems they’re a mixed blessing. Here are some of the research findings:

Happier people tend to have children—but having children often reduces their happiness.
In wealthier countries, the hit to happiness is greatest among those who become parents before age 30. But if you’re over age 30 and affluent, having kids can help happiness.
U.S. women report that looking after their children is slightly less enjoyable than doing housework.
The birth of a child boosts both parents’ reported satisfaction with their lives. But that boost dissipates over the child’s first few years and then turns into a drag on parental happiness.
Those living with children are more likely to report feeling anger and stress.
Young children hurt mental wellbeing, but having adult children can help. In other words, if you goal is greater happiness, children may be a bad short-term investment—but they pay dividends over the long haul.

Greatest Hits

Here are June’s five most popular blogs:

The Good, the Bad and the Ugly
Precautionary Measures
No Contest
Site Seeing (Part IV)
Site Seeing (Part III)

In late May and early June, HumbleDollar ran four blogs devoted to the favorite websites of our writers, including the two articles listed above. Also popular was Site Seeing (Part II), which was published in May but continued to receive a large number of page views in June.

Last month, there was a surge of interest in our online money guide’s lists, driven in part by a mention on Bogleheads.org, probably the best finance discussion group anywhere on the web. In particular, a bunch of folks checked out the Seasoned Investor and 11 Signs You Own the Right Portfolio. Finally, take a look at the money guide’s five new sections devoted to Know Thyself.

The post Past Perfect, Future Tense appeared first on HumbleDollar.

Deserved More

EVERYDAY AMERICANS may struggle to be honest about their finances. But that hasn’t been a problem here at HumbleDollar.

As 2017’s first half draws to a close—and HumbleDollar marks its six-month anniversary—I’ve been looking back at which blogs garnered a healthy readership and which were overlooked. Below are five blogs that, I believe, attracted far fewer readers than they deserved.

In HumbleDollar’s blogging guidelines, I specify that writers should focus on financial issues they’ve personally grappled with. The five blogs below admirably fulfilled that requirement. Indeed, in these articles—as well as in other blogs that HumbleDollar has published over the past six months—I’ve been impressed by how open and forthright folks have been about their finances.

Home Economics
From Half to Whole
Better Than a Bike
Talkin’ ‘Bout My Generation
Lessons Learned

The post Deserved More appeared first on HumbleDollar.

To Buy or Not to Buy

FOR MORE THAN 20 YEARS, I was a homeowner. Like most people, I had a love-hate relationship with the houses I owned. I loved building home equity in the two fixer-uppers I lived in. I loved knowing my mortgage payment would stay relatively constant from year to year. But I never enjoyed yardwork and I hated dealing with unexpected repairs, including replacing an aging sewer line in one house—to the tune of $10,000.

After I got divorced, I opted to rent an apartment instead of buying another home. My decision was due, in part, to Portland’s frenzied real estate market. Housing prices in Portland have been rising at a rapid rate over the past few years and I’d be hard-pressed to find a home—even another fixer-upper—within my price range.

These days, I find myself wondering whether I’ll become a homeowner again, once I retire, or if I’ll remain a renter. I can see benefits and downsides to both.

Down payment: I have about $50,000 set aside to serve as a down payment if I choose to buy another home. If I decide to continue renting, that money would provide me with an additional pool of funds to draw from in retirement.

Staying put: Most rent versus buy calculators suggest buying a home is only financially beneficial—compared to renting—if the buyer remains in the house for at least five to seven years. As a renter, I’d be able to move without having to worry about paying realtor fees and other selling-related costs.

Mortgage payments: Every year, I’m subject to rent increases. While these increases have been modest—at least by Portland standards—they still eat up the annual cost-of-living increases I receive each year in my job. Having a fixed-rate mortgage would help keep my monthly housing costs fairly stable.

Freedom of choice: If I was a homeowner, I wouldn’t have to contend with lease restrictions. As a dog lover, it can be difficult to find a rental unit that allows pets, and units that accept dogs often come with restrictions on size and breed.

Yardwork and maintenance: Living in a rental unit means I don’t have to worry about chores like lawn mowing and general home maintenance. I’m also protected from unexpected, costly repairs that inevitably come with homeownership.

There are other considerations I’ll need to think through as I get closer to retirement. It may be difficult to get approved for a mortgage once I’ve stopped working fulltime. On the other hand, I might relocate to an area where housing is substantially less expensive and be able to pay cash for a small home. Which way am I leaning? Ask me in 10 years.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Ore. Her previous blogs include Quitting Early, Social Insecurity  and  Site Seeing (Part II) .

The post To Buy or Not to Buy appeared first on HumbleDollar.

Know Thyself

WE MAKE ALL KINDS of financial errors, but three mistakes loom especially large: We use money in ways that hurt our own happiness, we derail our portfolio’s performance, and we spend too much and save too little. Why do we make these mistakes? Here are five things we need to remember about ourselves:

We’ll never be satisfied
We’re social creatures
We are too focused on today
We’re overconfident
We hate losing

In many situations, these traits can be enormously helpful. But when handling money, they can lead us badly astray. Want to learn more? Check out the five new sections I recently added to HumbleDollar’s online money guide.

I continue to update and revise other sections of HumbleDollar’s online guide. I recently updated all the numbers in the section devoted to the stock market, including data on the market’s economic underpinnings and historical valuations. I’ve also added new pages devoted to high-yield bank accounts, measuring volatility and why actively managed funds falter.

The post Know Thyself appeared first on HumbleDollar.

Not a Good Time

IT WAS APRIL 29, 2009. My 12-hour workday had already begun when, at about 4:30 a.m., I received the call from Jonathan, my younger brother. He never calls at that hour. In fact, we never phone without first texting each other to determine the best time to talk. I sensed bad news and sure enough it was. Our father had been killed 36 hours earlier while riding his bicycle. In the months that followed, it would be my responsibility, along with my twin brother, to fulfill the wishes of our father.  We were the executors of Dad’s will.

Along with the sudden loss of my father and managing Dad’s estate, there was a confluence of other events which made 2009 one of the most challenging years I have faced. At my landscaping company, we—like many others—were dealing with the fallout of what came to be known as the Great Recession. I was still going through treatment for thyroid cancer. My partner’s mother was battling an illness from which she would pass away just months after my father.

There are things you can set aside for later. But my twin brother and I could not let our company fail—it was our lifeblood. Treatment for cancer can’t wait. And I needed to provide support for my partner. Somehow, with all this, I also needed to fit in the role of being executor.

I took the task seriously. My brother and I were responsible for ensuring that Dad’s estate was settled properly and that his wishes were followed. In a matter of days, I joined my siblings and mother for the drive to my Dad’s home in Key West, Fla. Walking into my father’s house was difficult. Lying ahead for me and my family were not just the grieving process, but also what seemed the insurmountable task of sorting through Dad’s personal affairs. Dad’s will, trust and other financial papers were reasonably easy to find in his house. Balancing his check book, which had gone awry because of his Parkinson’s disease, was not so easy. On this same visit, my family met with Dad’s estate attorney. The process of getting Dad’s estate settled was about to begin in earnest.

During the next several months, I set aside time as needed to handle paperwork for Dad’s estate. I looked on it more as a business. For the most part, it wasn’t personal. Piece by piece, various aspects of Dad’s estate were settled. The estate attorney handled the probate process. While he and his staff did a lot of the legwork that was required, I am quite certain the hours involved didn’t justify the outrageous fee that was charged. The same goes for the attorney who handled claims for accidental death. Taking 33% of the insurance payout, for what I am sure entailed a few phone calls, was even more outrageous.

The decision over whether to sell Dad’s house was perhaps the most difficult. Florida was one of the states hit hardest by the mortgage crisis. Home values had plummeted 50%. The cost of maintaining Dad’s house was not inexpensive. Insurance alone ran into the thousands because of the requirement for wind and flood insurance. It quickly became clear to my siblings that selling Dad’s house was for the best. In a relatively short amount of time, a buyer came along with what seemed a reasonable offer. With the gut feeling that another buyer may not turn up soon, we accepted the offer. The settlement process was relatively painless.

One by one, I paid off Dad’s debts. After the more significant ones had been taken care of, I started to write checks to the beneficiaries named in Dad’s will and trust. As each month passed and as it became clear we were coming to the end of settling Dad’s estate, I felt a sense of relief. Closing the checking account for Dad’s estate was my final act. I had fulfilled my duty.

Death never comes at a good time.  Writing this piece for HumbleDollar required me to look back through various files that I have, because so much of 2009 and 2010 remain a blur. Thinking back on that time, I wonder how I ever coped with all that was going on. Treating Dad’s estate as a business undertaking likely helped me through. Had I taken it personally, the emotional toll would have been too much.

Nicholas Clements is one of Jonathan’s older brothers. Their father would have turned age 84 today. Nick is retired and lives just outside Washington, DC. His previous blogs include Opening My Wallet, Talkin’ ‘Bout My Generation  and  Retire to What?

The post Not a Good Time appeared first on HumbleDollar.