Jonathan Clements's Blog, page 438

This Week/June 25-July 1

CREATE A WISH LIST. Want more happiness from your dollars? Write down the major purchases you’d like to make in the next few years—perhaps a car, vacation or kitchen remodeling. Regularly revise the list, keeping only items you’re still enthusiastic about. Result: You’ll likely make wiser spending decisions—and you’ll enjoy a long period of pleasurable anticipation.

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Precautionary Measures

INVESTMENT CONTRARIANS are having a good year—but not a great one. In 2016, U.S. stocks outpaced foreign shares, smaller companies outperformed their bigger brethren and value stocks beat growth stocks. In 2017, all those roles have been reversed, with foreign shares, big-cap stocks and growth companies topping the performance charts.

For those of us who like to see the mighty fall and the downtrodden lifted up, this has been quite satisfying, except for one small issue: Even as the stock market’s leadership has changed, the market itself has continued to charge ahead. I try to avoid having any opinion about the market’s short-term direction. But after eight years of rising prices and given today’s lofty valuations, it wouldn’t be surprising to see share prices decline—and yet stocks keep barreling ahead.

Initially, I assumed the so-called Trump Bump reflected optimism that the U.S. corporate tax rate would be cut and that we would see massive infrastructure spending. Neither, however, appears close to becoming reality, but that hasn’t stopped share prices from climbing. Are stocks soaring simply because there’s an excess of capital sloshing around the global financial markets and no other asset class appears attractive?

It’s baffling—especially given all the reasons to worry. Back in March 2016, I wrote that investors faced four key questions: Is the economy slowing? Will profit margins shrink? Has capital spending been neglected? Are valuations permanently higher? All four questions are still relevant today.

The economy remains sluggish—and that isn’t good for corporate profits. After adjusting for inflation, the U.S. economy expanded 1.6% in 2016 and at a 1.2% annual rate in 2017’s first quarter. No doubt faster growth is possible, but we shouldn’t expect too much.

Why not? Historically, half of the economy’s roughly 3% average annual growth rate has come from increasing the number of workers and half from raising the productivity of all workers. But with the labor force growing at just 0.5% a year, rather than at its historical rate of 1.5%, we should probably expect 2% growth, not 3%.

Moreover, there are increasing concerns about the other component of economic growth: productivity. Increases in output per hour have averaged 0.5% a year over the past six years, versus an average 2.4% over the prior 20 years.

“Forget trying to guess the market’s short-term direction and instead focus on risk. Today, three risks loom especially large.”

Meanwhile, profit margins remain fat by historical standards. After-tax corporate profits currently stand at 9.1% of GDP, below 2012’s 10.8% peak but still well above the 50-year average of 6.5%. With unemployment at 4.3%, employers may need to increase wages to attract and retain workers, and that could put pressure on profit margins.

What about capital spending? Is it being neglected? This one is harder to assess. It seems companies are weighing two competing uses for their cash: They can invest in their business—or they can invest in their own stock.

Lately, the latter has been the clear priority. For more than a decade, companies have devoted huge sums to buying back their own shares. That suggests they see no reason to lavish their excess cash on capital spending, perhaps viewing it as unnecessary, given today’s lackluster economic growth and tepid consumer demand.

Finally, valuations grow ever richer. By almost any measure—dividend yields, price-earnings ratios, cyclically adjusted price-earnings ratios, Tobin’s Q—U.S. stocks appear expensive.

So where does that leave us? We have slow economic growth and hence slow growth in corporate profits. We have fat profit margins that could narrow. We have corporations that prefer to buy their own stock rather than invest in expanding their business. And we have valuations that look mighty rich.

This, of course, tells you absolutely nothing about the U.S. stock market’s short-term performance. I could have presented similar arguments last year and the year before that—and, indeed, did so.

What to do? Forget trying to guess the market’s short-term direction and instead focus on risk. Today, three risks loom especially large.

First, there’s the risk we could get a sharp market decline. If you have money you’ll need to spend within the next five years, it should be out of stocks and invested in nothing more adventurous than high-quality short-term bonds.

Second, there’s the risk that the market rally has left you with more of your portfolio in stocks than you intended. Consider rebalancing back to your target portfolio percentages.

Third, there’s the risk you’ll end up amassing less for retirement and other long-term goals than you had hoped, because stock returns over the next decade prove disappointing. Worried that rich valuations will mean low returns? As always, your best defense is a healthy savings rate.

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Seller’s Remorse?

AS I PREPARE TO MOVE FROM PHILLY to Boston this summer, I’ve struggled with how to handle my home. Do I sell the place and pocket the profit—or keep it as a rental property for future income and price appreciation? A quick Google search provides plenty of good reasons to choose either option. But when making a decision of this magnitude, what really matters is your personal situation—and that prompted me to sell. Here are my five reasons:

The financial benefits of renting don’t outweigh the costs. I could probably rent my house for $500 a month more than my mortgage. But all it would take is a few months with no tenant to leave me in a financial hole.
Over time, greater maintenance spending will be necessary. I’ve been lucky to avoid significant repairs on my air conditioning, water heater and major appliances in the seven years I’ve lived in the house. But all these systems will eventually require work.
I don’t have the time to do it right. I currently find it challenging to schedule maintenance work and find high-quality, trustworthy contractors. I know this will be exponentially harder when I’m living a plane flight away and still working fulltime. The same goes for finding and screening trustworthy tenants. I considered having a close friend manage the property, but that means mixing my friends with my money. That’s usually not a great move—and it would reduce my profit margin.
The market is in the right place. My neighborhood has been rapidly expanding and developing over the last seven years, as larger homes nearby dwarf mine and new retail and restaurant space sprout up close by. I might make more if I held onto the place for even longer and the surrounding area continued to improve. But my home has some limitations—small kitchen, limited closet space, overall low square footage—that will prevent it from ever commanding top dollar. Furthermore, I’m trying to remember that the ever upward feeling that exists in the market now can quickly change. It feels right to lock in my profit while low mortgage rates buoy property prices and my house is still in good condition.
I’m sick of owning. I’ve written about the challenges of owning a home before. I’m excited about getting to call a landlord when something goes wrong and locking in a two-year lease, with no worries that I’ll be hit with a big increase in property taxes or homeowner’s insurance premiums.

I’m sure I could list just as many reasons I shouldn’t sell. Part of me wishes I could keep the place, because I’m so emotionally invested in my house and what it represents. But selling now will allow us to buy another home someday—and that flexibility is priceless.

Zach Blattner’s previous blogs include Too Trusting and  Land Grab . Zach 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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Leaving Home Ain’t Easy

SHOULD YOU MOVE when you retire? The numbers can be compelling—especially if you’re like my wife and me, and you live in New York City or one of its surrounding suburbs, where living costs are absurdly high. This was hammered home by the cost-of-living calculator cited by Kristine Hayes in her blog yesterday.

I discovered that, by leaving New York, we could cut our living expenses by almost 60% if we moved to Bismarck, N.D., Dodge City, Kan., or Grand Junction, Colo. Boston, Los Angeles, San Diego, Seattle and Washington, DC, would all be cheaper by 35% or more. San Francisco was a tad less enticing, but still 22% less costly. Even notoriously expensive Honolulu looks like a relative bargain, at 17% cheaper. These figures are for someone moving from Manhattan with a $100,000 income. Those moving from outside Brooklyn or the New Jersey suburbs wouldn’t save quite so much, and in some places they’d find themselves paying more.

Much of this is driven by housing costs. For many folks in our area, retirement planning seems to consist of buying an overpriced New York home and then, upon retirement, trading down to cheaper Florida real estate. The home equity that’s freed up thereafter pays for air conditioning and early bird dinner specials.

All this might sound like great news. Lucinda and I have endless retirement possibilities that promise great financial savings. Problem is, we aren’t interested. We’re happy where we are, with our children relatively nearby, a network of friends we wouldn’t want to lose and a great apartment we’d hate to give up.

In short, we live in an area of the country where—even with a good salary—it can be a struggle to save for retirement, because living costs are so high. And the struggle is even greater if you want to stay here in retirement, because you need a supersized nest egg.

None of this is designed to elicit sympathy, let alone a flurry of charitable contributions. Lucinda and I are doing fine. Still, I now realize that we have inadvertently bought the sort of luxury good that I regularly warn readers against. Whether it’s first class air travel, European sedans or living in New York, there’s a fundamental problem with luxuries: Once you have grown accustomed to them, they’re awfully hard to give up.

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Quitting Early

I CELEBRATED MY 50TH BIRTHDAY a few weeks ago. Since then, I’ve found myself spending a lot of time thinking about numbers. Specifically, I’ve been musing about when I might be able to retire from my current fulltime job. Age 55, 58, 62? Or will it need to be later?

Several studies suggest the age at which most people leave the workforce has been steadily rising over the past several decades. This is likely due, in part, to folks living longer, having insufficient money saved for retirement and an increase in the age at which people are eligible for Social Security benefits. While the term “early retirement” is sometimes reserved for those who leave the workforce before reaching 65, the average retirement age for women is currently estimated to be 62, while for men it’s 64.

For the past few years, I’ve been planning my exit strategy. Each year, around the time of my birthday, I reevaluate and update my plan. Here are some of the key variables:

Health coverage. I’m fortunate to have qualified for a unique early-retirement health care benefit offered through my employer. If I leave my job after I turn age 55, I can maintain my current health insurance coverage until I’m eligible for Medicare at 65. My employer will continue to cover the cost of my insurance premiums until I’m 65 and, after that, it’ll make contributions towards the cost of any Medicare supplement plan I choose.

Social Security. I’ve been working fulltime since age 25 and part-time for six years before that. Because Social Security benefits are based on a worker’s highest 35 years of earnings, I’d receive a higher monthly benefit if I continued to work fulltime until age 60.

Retirement account earnings. This is the biggest question mark. The current value of my retirement portfolio is about $280,000. I will also be eligible for a small pension. Until I leave my job, I’ll continue to contribute approximately 25% of my salary to my employer’s retirement plan, in addition to the 10% contribution my employer makes. Depending on how the stock market performs—I currently use an estimated return of 6% a year—I should have a substantial nest egg to draw from within a few years.

Cost of living. Once I leave my job, I plan on moving to an area with lower housing costs than Portland. I use an online cost-of-living calculator to estimate how much less it would cost me to maintain my current lifestyle. Depending on which part of the country I move to, my cost of living could be 25% lower.

While I still don’t know exactly when I’ll leave my 9-to-5 job behind, having a plan allows me to analyze my options—and gives me something to aspire to.

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

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This Week/June 18-24

TRIM YOUR CHECKING ACCOUNT. If there were a guaranteed way to earn an extra one percentage point a year on your investments, you’d jump at the opportunity. So why would you leave excess cash in your checking account, where it likely isn’t earning interest, when that money could be in a high-yield savings account earning 1% a year or more?

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Hard Choices

FINANCIAL ASSETS can seem like mere numbers on an account statement, especially at times of stock and bond market turmoil. But hard assets feel more substantial: Your home, artwork and gold coins have a comforting physical presence.

But are they good investments? I’ve been perusing Financial Market History, a collection of essays edited by David Chambers and Elroy Dimson. The paperback costs $38.95 from Amazon, but the Kindle edition is available for free. I was particularly intrigued by the chapter from academic Christophe Spaenjers, which is devoted to the long-run return from durable assets.

According to Spaenjers, between 1900 and 2014, U.S. home prices rose an average 0.3% a year more than inflation, versus 6.5% for stocks and 2% for bonds. This isn’t as grim as it seems, because the housing number includes only capital gains—and thus excludes the rent that a landlord might receive. After costs, that rental income might be worth an additional 5% a year.

Of course, if you occupy your own home, you won’t receive that rental income, because you’re effectively renting to yourself. This imputed rent is still valuable—and likely worth more than the price appreciation that many homeowners obsess over.

Next, Spaenjers focuses on collectibles. Since 1900, art has climbed 2.2% a year more than inflation, stamps 2.9%, wine 4.1% and violins 2.7%. This data is mostly based on U.K. sources.

These figures trail stocks, but they outpace bonds—and are higher than I would have guessed, especially because they don’t reflect the “emotional yield” that collectibles deliver to their owners. Still, Spaenjers notes these figures ignore transaction costs, which can exceed 25% on a roundtrip trade. Also, there would be storage and insurance issues (though these are already reflected in the return for wine).

Finally, Spaenjers turns his attention to high value natural resources, calculating that since 1900 we’ve had a 0.7% annual real return for gold, 0.1% for silver and 0% for diamonds. Those modest returns were coupled with fairly high volatility.

Folks, of course, buy collectibles because they enjoy owning them and purchase homes to live in. But what if you’re buying durable assets to diversify a portfolio that’s invested in stocks and bonds? Almost all durable assets are illiquid, so don’t bank on selling them quickly. Moreover, most of the assets that Spaenjers analyzed were positively correlated with the stock and bond markets, meaning they tended to rise and fall in sync with the financial markets. The exceptions were gold, which is easily traded and has proven to be a great diversifier, and to a much lesser extent silver.

The implication: You might allocate a small piece of your savings to gold if you want to calm down a portfolio that’s largely invested in stocks and bonds. Want to turn that negative correlation into added investment gains? You need to set a target portfolio percentage for gold—maybe 2%—and then regularly rebalance back to that 2% target, so you’re compelled to buy low and sell high.

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Playing Your Cards

YOU’VE PROBABLY ALREADY ASKED yourself this question: Is it better for my credit score to have just one credit card—or many?

There’s no magic number, because it isn’t really about how many credit cards you have. Rather, what matters is your financial situation and how you handle your cards. For example, if you are just beginning to build a credit history, it’s best to have a single card. Try to follow three rules:

Pay your bills on time—and avoid late payments at all costs.
Keep the balance on your card as low as possible.
Don’t apply for a new credit card until you need it.

If you follow these rules, you will be on track for a good credit score. If you are also paying a student loan, car loan or mortgage on time, you’ll further prove to lenders that you’re a responsible borrower.

This good behavior will appear on your credit report and help raise your credit score. With a single credit card, it’s difficult to establish a robust credit history, so you might eventually request a second card and perhaps more.

Is it possible to have too many cards? For people with high-paying jobs, it’s common to have multiple credit cards. When those cards are used wisely, these folks can end up with a FICO score that’s well over 700 and perhaps above 800. A low score, by contrast, is usually anything below 640.

In other words, you can have many credit cards and not ruin your credit score. Instead, what matters is keeping your balances low in relation to the credit limits you have. This is called the credit utilization ratio. If you charge expenses on several cards, but have a low total balance, you’ll probably earn a high credit score.

To be sure, your score can dip when you request new credit cards. But if you have a long history of regular loan and credit card payments, asking for another card should have little or no impact. Want to see what your credit reports look like today? You can request free copies of your reports from the three major credit bureaus by heading to AnnualCreditReport.com.

George Diaz writes for finance sites MyFinancialWisdom.com and Sobredinero.com . He holds an MBA, is a digital media professional and loves writing. George can be reached at george@sobredinero.com or on Twitter @sobredinero1

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Site Seeing (Part IV)

WHEN I WAS IN GRADUATE SCHOOL, racking up my fair share of student debt at 6.8% interest, I knew I needed to get serious about financial education. I was studying finance, but had yet to encounter a personal finance class. It became my mission to filter through the endless websites and blogs to find what resonated with me. Here are my five go-to sites:

Ramit Sethi’s I Will Teach You to be Rich, both the book and blog, offered a wealth of information when I needed it most. Ramit likes to refer to himself as your surrogate Asian father, and he means business. Don’t let his blog’s name fool you. Every 20-something should visit the personal finance section of his site. Money mistakes, the importance of automation, investing and eliminating debt are topics covered.

In 2012, I read an article talking about a new financial website, NerdWallet.com. As a self-proclaimed financial nerd, I immediately became interested. The credit card tools and analysis first drew me in, but I soon realized the website offers considerably more than that. The site has some of the best financial tools anywhere to help people make financial decisions. I’ve had the pleasure of personally meeting several of the nerds behind the site. They’re bright, passionate and on a mission to streamline good advice.

Richard Thaler, a pioneer in behavioral economics, has captivated me through his work. His most recent book and associated website, MisbehavingBook.org, offer a fresh perspective, helping readers to make better decisions. I’ve developed a slight brain crush.

When you’re a nerd, you welcome opportunities to continually grow and develop. MrMoneyMustache.com does not disappoint. MMM lives an extremely optimized frugal life, retiring at age 30. His simple, unconventional lifestyle and approach to money is refreshing. You may have no plans to ditch your car for a bike, but his concepts are sure to leave you thinking.

Podcasts have yet to speak to me, unless you’re financial journalist Farnoosh Torabi of So Money. Her blog contains great advice, including the importance of asking questions and the notion that no one cares about your money as much as you do. Torabi’s content and brand have evolved throughout the years to reflect her personal journey.

This is the fourth in a series of articles devoted to the favorites websites of HumbleDollar’s writers. The earlier articles appeared May 23, May 29 and June 6.

Anika Hedstrom’s previous blogs were Upping the Ante and Home Economics. Anika is a financial planner with   Vista Capital Partners   in Portland, Ore. She loves to nerd-out and, when given a dollar, will save 96 cents.

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This Week/June 11-17

WRITE IT DOWN. Want to spend less, drink less coffee or booze, eat less or exercise more? Keep a diary devoted to one or more of these things. For instance, if you write down every dollar you spend, you won’t just have a better idea of where your money goes. You’ll also be more conscious of when you’re spending—and that by itself will prompt you to cut back.

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