Jonathan Clements's Blog, page 439

The Good, the Bad and the Ugly

EVEN BAD FINANCIAL PRODUCTS and strategies turn out okay for some investors. If that wasn’t the case, they probably wouldn’t attract enough customers to survive, no matter how aggressively they’re peddled. Still, some are so risky or so costly that the chances of a happy outcome are slim. Want to improve your odds of financial success? Here’s how I would categorize the products and strategies on offer today:

Dangerous

Buying stocks on margin
Leveraged exchange-traded index funds
Day trading
Short selling
Writing naked call options

Dubious

Cash value life insurance
Variable annuities
Equity-indexed annuities
Hedge funds
Market timing
Options trading
Structured products
Load funds
Unit investment trusts
Closed-end funds bought at the initial public offering
Brokers on commission

Proceed with Caution

Actively managed funds
Individual stocks
Bonds bought in the secondary market
Closed-end funds at a discount
Interest-only mortgages
Reverse mortgages
Long-term care insurance
Claiming Social Security early

Promising

Index mutual funds
Exchange-traded index funds
High-yield savings accounts
Certificates of deposit
Treasury bonds
401(k) plans
IRAs
Term life insurance
Rewards credit cards
Conventional mortgages
Home-equity lines of credit
Immediate fixed annuities
Deferred income annuities
Claiming Social Security late

The bottom line: With so many products in the promising category, why risk owning anything else?

The post The Good, the Bad and the Ugly appeared first on HumbleDollar.

Social Insecurity

I RECENTLY ATTENDED A RETIREMENT READINESS seminar sponsored by the financial firm that holds most of my retirement savings. The first question the presenter asked was, “How many of you think you’ll be able to retire comfortably living off just your Social Security benefits?” I was surprised to see how many people in the audience raised their hands. But maybe I shouldn’t have been surprised: It turns many of these same people couldn’t guess the average monthly Social Security benefit—and most thought it was far higher than it really is.

The Social Security Administration notes that Social Security benefits are generally designed to replace just 40% of the average wage earner’s income after retiring. Yet reports show that Social Security provides a majority of the income for 72% of retirees age 80 or older—and almost all income for 42% of those 80 and up.

Curious to find out your estimated retirement benefit? The Social Security Administration makes it easy: All you have to do is create an online account to access both your earnings history and a statement showing your estimated benefits. It might be prudent to assume the actual benefit received could be up to 25% less than the figure shown: Beginning in 2035, the Social Security Administration reports that the taxes collected will cover just 75% of scheduled Social Security benefits.

The average monthly Social Security benefit for retired workers is around $1,340. Not sure you can retire comfortably on $16,000 a year? Either you need to redefine what “comfortable” means to you—or you should start saving like crazy.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Ore. Her previous blogs include Site Seeing (Part II), Unconventional Wisdom  and My One and Only.

The post Social Insecurity appeared first on HumbleDollar.

No Contest

AS A YOUNG REPORTER in the late 1980s, trying to learn about investing, I read a slim 81-page volume with an unassuming title: Investment Policy. It remains one of the best investment books I’ve ever read.

Investment Policy was later reissued with a somewhat catchier title, Winning the Loser’s Game, and it’s now widely considered to be an investment classic. Over the years, the book has also been greatly expanded and the 2017 edition runs to 286 pages. Recently, I was in New Haven, Conn., and had lunch with the book’s author, Charles Ellis, now age 79.

Ellis recalls that, when he began working on Wall Street in 1963, outperforming the stock market was relatively easy for professional money managers. “The competition in those days was de minimis,” he says.

Much has changed in the five-plus decades since then. Financial information has become far more readily available. The number of money managers and analysts has exploded. Professional investors, who were responsible for maybe a tenth of trading volume in the 1960s, now account for almost all stock market activity.

Perhaps the biggest surprise: The cost of active management has climbed sharply since the 1960s. A 1962 study conducted for the SEC found that funds charged average annual expenses of 0.5%, and noted that this was “substantially higher” than the fees they charged their non-fund clients. Indeed, Ellis says that, at the time, bank trust departments typically charged just 0.1% of assets per year—a limit often set by state law.

Today, by contrast, many money managers levy 1%, with hedge funds often taking 2%, plus 20% of profits. Thanks to those high fees, money managers need to perform well just to keep up with the market averages—and do so in a market where their competition consists almost entirely of other professional money managers.

Put it all together, and the case for indexing is stronger than ever, as Ellis makes clear in his new book, The Index Revolution. Today, you can purchase total stock market index funds charging less than 0.05%. That would be a nice cost savings if the alternative was a 1960s bank trust department that charged 0.1% a year, or twice as much. But in today’s world, where the alternative might be an actively managed fund levying 1%, or over 20 times more, index funds look like an unbelievable bargain that only delusional, wildly overconfident stock jockeys would shun.

Still, Ellis isn’t predicting the end of active management—or worried about the day when widespread adoption of indexing threatens the functioning of the market. Even if investors move dollars from active management to index funds, driving down compensation for active managers, he believes the competition will be as fierce as ever. Active management is “fun, it’s interesting, it’s almost narcotic,” he says. “Nobody will quit voluntarily.”

I asked Ellis about passive investment strategies designed to outperform the market, commonly known as smart beta. He expressed admiration for Dimensional Fund Advisors, which has been a pioneer in this area, particularly with its focus on small-company stocks and value stocks. DFA, based in Austin, Texas, sells its funds through approved investment advisors.

But Ellis also worries about the amount of money currently being thrown at smart beta strategies. “It’s seductive,” he acknowledges. “You feel safe because you’re indexing, but you still have that chance to do better. I think there’s a large number of people who will be disappointed.”

The post No Contest appeared first on HumbleDollar.

Site Seeing (Part III)

IN TODAY’S POLITICAL ENVIRONMENT, discourse has become ever more fractious. The investment world, in my view, isn’t much better. Those who disagree generally talk past—rather than listen to—one another.

That is why, in my work as an investment advisor, I maintain a “team of rivals” approach, reading and listening to diverse opinions. Behavioral scientists often talk about confirmation bias—the tendency to seek out only information that confirms our preconceived notions. To counteract this bias, I believe investors are best served by casting a wide net. Below are five favorite sites that I would recommend to everybody, no matter what their investment bias:

Federal Reserve Economic Database. The late Daniel Patrick Moynihan once stated, “Everyone is entitled to his own opinion, but not to his own facts.” For economic and market-related facts, I have found nothing better than this free resource from the St. Louis Fed. The Federal Reserve Economic Database (FRED) includes thousands of finance-related statistics, including GDP, inflation, interest rates and more. You can chart and download any of the data, and there’s an excellent mobile app.

My favorite: FRED’s historical prices for commodities, including gold and oil. Any time I am tempted to invest in commodities, all I need is one look at those charts.

Jim Cramer’s Mad Money. If there is one person that the investment world loves to hate, it is the hedge-fund-manager-turned-CNBC-personality Jim Cramer. Yes, he is raucous and off-the-wall, but he is also brilliant and his knowledge of individual stocks is encyclopedic. He is the high priest of stock-picking, often dismissing index funds with plain logic: “I don’t want to own all the stocks. I just want to own the best ones.” While his track record is debatable, his conviction is admirable.

My favorite: Cramer’s CEO interviews. In contrast to the rest of the show, which is often cartoonish, Cramer’s conversations with big-name public company CEOs are surprisingly thoughtful.

JL Collins’s blog. If Jim Cramer is the world’s loudest advocate for stock-picking, his counterpart at the opposite end of the spectrum is the blogger JL Collins. While index fund investing enjoys broad support these days, no one says it with the same purity and take-no-prisoners orthodoxy as Collins. In fact, he summarizes his investment philosophy in just nine words: “Index funds. End of story. Vanguard. End of story.” But this site is about more than that. Collins started blogging as a vehicle to convey advice to his daughter. As a result, his advice ranges broadly across personal finance, careers and life in general.

My favorite: Collins’s Manifesto, in which his tone is equals parts finance professor and Marine Corps general.

Invest Like the Best. If Cramer and Collins represent the two extremes of the “index versus active” debate, quantitative investing is safely off to the side and outside the fray. And so it makes sense that a quant investor named Patrick O’Shaughnessy would be best positioned to have thoughtful and civil conversations with investors of all stripes. While his day job is in finance, O’Shaughnessy’s background as a philosophy major comes through in all of his interviews. He reads widely and believes in learning as an ongoing process, rather than pounding the table for some fixed set of views.

My favorite: O’Shaughnessy’s interview with Danny Moses, one of the traders who made a fortune shorting the housing market in 2008. This discussion is a good reminder that, while successful active management is very difficult and very rare, it is not impossible. Moses is one of those anomalies.

So Money with Farnoosh Torabi. For those who really love it, investing is largely a game and an end in itself. That’s why Farnoosh Torabi’s podcast is so valuable. Torabi doesn’t waste time splitting hairs on investment strategies. Instead, she helps her largely millennial audience focus on the big picture—achieving success in their careers and fulfillment in their lives. And that, after all, should be the point of all of the energy we spend building our personal finance skills.

My favorite: “Ask Farnoosh” segments, in which she addresses questions that are keeping her listeners up at night.

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

Adam M. Grossman’s previous blogs include 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 Site Seeing (Part III) appeared first on HumbleDollar.

This Week/June 4-10

GET ORGANIZED. Keep the supporting material for your past seven tax returns. The rest can be tossed. If your brokerage firm and mutual fund companies provide cost basis information for your investments, there may be no need to keep old statements. Tell your family where they can find your will, a complete list of your financial accounts, and all your usernames and passwords.

The post This Week/June 4-10 appeared first on HumbleDollar.

June’s Newsletter

IF WE THINK ABOUT OUR FINANCES too narrowly, there’s a risk we’ll make major mistakes—spending money in ways that leave us less happy, building an unbalanced portfolio, shortchanging crucial goals because we earlier committed dollars to items that weren’t our highest priorities. How can we avoid such mistakes? In June’s newsletter, which went out to email subscribers this morning, I offer three key questions to ask before making major financial decisions.

The post June’s Newsletter appeared first on HumbleDollar.

Think Bigger

To be prudent managers of our own money, we need to read the small print—but we also need to keep an eye on the big picture.

To that end, whenever we make a financial decision, we should ponder three key questions: What’s the tradeoff, does the choice make sense given our broader financial life, and will we feel as good about the decision tomorrow as we do today?

Trading Off. Suppose we remodel the bathroom, buy a new car or purchase a vacation home. On their own, all are perfectly reasonable uses for our money. But we might still be making a mistake—if we don’t stop and consider whether there are better ways to spend the dollars involved.

Our financial lives are a never-ending series of tradeoffs: Every time we purchase an item, we’re effectively deciding not to purchase something else. There is, as economists like to say, “an opportunity cost”—and yet we often fail to ponder the opportunities forgone.

We may also fail to think through the full cost involved. Let’s say we trade up to a larger house. Most of us would need to take out a bigger mortgage, and that would mean either a larger monthly mortgage payment or a longer time until the loan is paid off, and possibly both.

In addition to those mortgage payments, however, there would be other costs, which we may not fully appreciate—such as heftier property taxes, homeowner’s insurance, maintenance expenses and utilities. Will all those costs make it harder to help the kids with college costs—and will we still be able to save enough each month for our own retirement?

To be sure, there’s always a risk that we’ll devote too much money to one goal and not enough to others. But I suspect we’re especially prone to do so with housing, because of the prevailing myth that homes are a great investment—and because overspending on housing involves consuming right away, whereas saving for college and retirement represent gratification delayed.

Looking Around. Novice investors often collect investments without thinking about whether they make sense as a portfolio. A classic mistake: They buy five top-performing funds—but it turns out the five funds all invest in the same market sector, which is why they ended up topping the performance charts at the same time.

Even more sophisticated investors can slip up. We might build a portfolio that makes sense when viewed in isolation, but we don’t stop to consider whether it makes sense given our broader financial life. One example: If you’re a doctor, and hence your paycheck hinges on the future of the medical profession, you should think twice before doubling down on that bet by investing in the stocks of pharmaceutical and medical device companies.

“Money may feel like our scarcest resource, especially when we’re younger. But in truth, our most finite resource is time.”

Similarly, we might plow our spare cash into bonds. But those bonds may yield less than our debts are costing us, even after figuring in any tax advantages. Result: The money would have been better used to pay off loan balances and rid ourselves of credit card debt.

On Second Thought. We typically make purchases based on how they make us feel today. But we often don’t think about how we’ll feel a year or two down the road—and perhaps sooner. For instance, the country home might initially seem like a wonderful weekend escape. But what about the weekly trek to get there and the upkeep once we arrive? At the risk of offending animal lovers, we run the same risk with pets: The family clamors for the cute dog—but the dog doesn’t seem so cute when a walk is required at 6 a.m. on a cold, wet Saturday.

Like buying a vacation home and getting a family dog, purchasing new mutual funds and stocks can make us feel good today. Often, it’s seductively easy to buy investments: The hassles are typically modest and you don’t trigger any tax bills by buying. More important, the purchase is a moment of great hope. We get to dream about all the money we might make.

But once the investment is made, there’s the potential for disappointment—and the prospect of ongoing hassles. Every new investment in a taxable account can be an added headache at tax time. Every new financial account is another one our heirs will have to close after our death. Contemplating purchasing an antique car or a timeshare? Your heirs will think of you often as they try to offload these goodies. But they may not think of you fondly.

We should also consider the downside when making career moves. Suppose we take a new job with a higher salary. Captivated by the idea of a bigger paycheck, we might fail to ask about the health and retirement benefits, and give scant thought to the longer hours we’ll be expected to work. Those longer hours would leave us with less time for friends and family—moments that are crucial to our happiness.

Indeed, as we contemplate whether we’ll later regret a decision, we should think about more than just dollars and cents. Money may feel like our scarcest resource, especially when we’re younger. But in truth, our most finite resource is time. Whether it’s a demanding new job or a bigger house that involves more maintenance and a longer commute, money decisions often have a big impact on how we spend our time.

By the Numbers

Here’s a look at how Americans feel about their financial lives, based on the 2016 General Social Survey, which was recently released:

30% of Americans said they were very happy in 2016, unchanged from the 30% who described themselves that way in 1972. Over this 44-year stretch, inflation-adjusted per capita disposable income rose 120%. More money, it seems, hasn’t bought happiness.
29% of Americans were satisfied with their financial situation, versus 32% in 1972. Meanwhile, the percentage who aren’t at all satisfied has climbed from 23% in 1972 to 27% in 2016.
31% of Americans felt their incomes were below average or far below average, compared with 24% in 1972.
58% agreed or strongly agreed that they had a good chance of improving their standard of living, versus 72% in 1987.

Stand Tall

My cousin’s daughter has a new book out, devoted to her struggle with anorexia. Hope Virgo’s book has already been published in the U.K., where it’s been well received. Now, Stand Tall Little Girl is available in the U.S., including through Amazon. I encourage you to check it out.

Greatest Hits

Here are May’s five most popular blogs:

Site Seeing (Part I)
Footing the Bill
Odds Against
Site Seeing (Part II)
Not So Dumb

In addition, two of the most popular blogs in May were articles from earlier months: Ten Commandments, which first appeared in April, and Courtside Seat, which was published in January.

The post Think Bigger appeared first on HumbleDollar.

Opening My Wallet

SPENDING DIDN’T ALWAYS COME EASY to me. As a child, I had a small weekly allowance, the spending of which I carefully controlled. In boarding school, a treat for me was a Mars bar from the school “tuck shop”—a British term for a small candy store. As I entered my mid-teens and started to earn my own money, more often than not it went into my savings account. Only when I turned 16, and had my first car, did I have to start handing over some of that money, rather begrudgingly, to the car mechanic and insurance agent. Over time, I learned to loosen the grip that I had on money and to spend it on things that I really cared about and enjoyed—but it took a few decades.

There are basic necessities on which money has to be spent, such as rent or mortgage, groceries, house maintenance and utilities. In my 20s and 30s, even as I began to make a decent income, letting go of my hard-earned money on anything other than those basic necessities was difficult for me. Frugal by nature and not materialistic, it took the realization that I couldn’t take my savings with me when I left this earth. At some point, the money would indeed be spent. Why shouldn’t I do the spending?

To spend on things that I cared about and enjoyed was tricky. I had worked hard for the money—very hard. Exhausted by the end of the work week, I had little energy to develop interests and hobbies. It took close friends to help me uncover what it was that I found interesting, starting with antiques and collectibles. With their encouragement and enthusiasm, it wasn’t long before I was enjoying the hunt for collectibles that interested me and on which I was willing to spend.

As my company started to take up less time, another hobby—cycling—grabbed my interest. An impromptu visit to a bike shop started it all off. Sports had never been my forte in school and, because my work was physically demanding, I didn’t need it to maintain fitness. Still, soon enough, cycling developed into a passion on which I was happy to spend. Encouraged by my ability to do well at the sport, I found myself wanting the best equipment.

Traveling as much as I did as a child—we moved constantly between the U.S., England and Bangladesh—I didn’t have the urge to travel much during my three decades of working. I did, however, go to Mexico often, where many of my employees were from. My visits to Mexico City were primarily taken up with the management of seasonal work visas for those employees. During those trips, I relied on an employee to help me navigate the city. When we had time to spare, we would travel outside the city. A suggestion of a road trip to the south of Mexico led to a memorable vacation with him and members of his family—a family I now consider to be part of my own. The trip to areas relatively untouched by tourism cemented my love for the country and its people. Now, on an annual basis, we continue to enjoy similar vacations around Mexico, which I happily fund. Exploring Mexico and bonding with my travel companions makes every dollar spent on these vacations worthwhile.

Spending money comes a little easier to me these days, whether it’s for a memorable experience or an interest or hobby that I have a passion for. But while travel, cycling and collectibles can now prompt me to open my wallet, and I no longer begrudgingly pay the insurance agent or the IRS, there are expenses that I still balk at—that expensive cup of coffee, the overpriced glass of wine, the cost of a hotel room, the taxi from the airport. It isn’t that I can’t afford them—but I get little joy in paying unreasonable amounts for such things.

Nicholas Clements is one of Jonathan’s older brothers. An avid cyclist, Nick is retired and lives just outside Washington, DC. His previous blogs include Talkin’ ‘Bout My Generation and  Retire to What?

The post Opening My Wallet appeared first on HumbleDollar.

Site Seeing (Part II)

WHEN I REACHED MY MID-40s and realized I was halfway through my working life, I figured it was time to get serious about retirement planning. A scientist by training, I began to dissect the details of my retirement accounts, including how my money was invested and at what age I could begin penalty-free withdrawals. I discovered retirement at age 55 might be a viable option, but only if I started saving a larger percentage of my income and made intelligent investment decisions.

I scoured the internet for information on early retirement, as well as on savings and investment strategies. I found the most frequently referenced website was MrMoneyMustache.com, a site filled with information about living frugally. The MMM forum includes numerous journal entries from people who, like Mr. Money Mustache himself, were able to retire in their 30s and 40s by saving and investing a large percentage of their income.

Next, I stumbled upon JL Collins’s book, The Simple Path to Wealth, and the accompanying website. I appreciate the simplicity of his investing advice. His manifesto on personal finance is one I try to live by.

After reading Jonathan Clements’s book How to Think About Money, I discovered Dinkytown.net, a website with a plethora of financial calculators. The Retirement Planner Calculator allows me to experiment with different retirement-related savings and investment strategies to predict how long my nest egg will last, given different investment returns and inflation values.

On AssetBuilder.com, the Knowledge Center is full of short articles on a variety of financial topics. Several of the posts were penned by Scott Burns, a financial writer who recently retired after a 40-year career. His couch potato investing strategy focuses on investing primarily in index mutual funds.

Forum.EarlyRetirementExtreme.com is another great resource for frugal living ideas, retirement planning tips and real-life stories about people who have made their early retirement dreams come true. Filled with lots of personal journals and notes, it documents what has—and hasn’t—worked for many early retirees.

This is the second in a series of articles devoted to the favorites websites of HumbleDollar’s writers. The first article appeared May 23.

Kristine Hayes is a departmental manager at a small, liberal arts college in Portland, Ore. Her previous blogs include Unconventional Wisdom,   My One and Only and   Say It Forward.

The post Site Seeing (Part II) appeared first on HumbleDollar.

This Week/May 28-June 3

CHECK YOUR PORTFOLIO PERCENTAGES. Foreign shares have topped the performance charts in 2017, U.S. growth stocks have surged, U.S. value has lagged, blue chips have outpaced small caps, bonds have puttered along and REITs have struggled. All this may have pushed your portfolio away from target asset allocation—and it could be time to rebalance.

The post This Week/May 28-June 3 appeared first on HumbleDollar.