Jonathan Clements's Blog, page 441

Worth the Wait

THE DEBATE OVER WHEN to claim Social Security reminds me of the debate over index funds. On one side, there are those who have studied the issue—and on the other side are crackpots and those with a not-so-hidden agenda. Yes, you should index. Yes, most folks should delay claiming Social Security retirement benefits.

Last year, I blogged about the breakeven age for claiming Social Security, assuming you took your benefit and invested it. The upshot: Taking benefits at age 66 or age 70 is typically a better bet than taking benefits at 62, as long as you live until your early 80s. The life expectancy for a 65-year-old man is age 84, while for a woman it’s age 87. The upshot: Delaying benefits will usually turn out to be a smart move.

This weekend, I read “Social Security Made Simple,” the recently revised book from Mike Piper, author of the Oblivious Investor blog. He offers an alternative—and perhaps even more compelling—way to analyze the issue.

Suppose you are age 62 and currently eligible for $750 a month from Social Security. If you wait one year to claim benefits, until age 63, you will receive $800 a month. Thus, for missing out on 12 months of benefits at $750 a month, or $9,000 total, you will receive an extra $600 a year for the rest of your life starting at age 63, with that $600 rising each year with inflation. That’s a 6.67% annual payout on your $9,000 “investment.”

What if you used that $9,000 to buy an inflation-adjusted income annuity from an insurance company? Today, a 63-year-old might receive an annual payout of between 4% and 4½%, far less than 6.67% that you would get from Social Security. What if you invested the $9,000 in a mix of stocks and bonds? Today, many financial planners caution retirees to use a 4% withdrawal rate, again far less than the 6.67% you can get by delaying Social Security.

As Mike Piper notes in his book, “A similar analysis can be performed for each year up to age 70, and the conclusion is the same: Delaying Social Security benefits can be an excellent way to increase the amount of income you can safely take from your portfolio.”

A Hollow Victory?

VANGUARD GROUP founder John C. Bogle has an article in the latest Financial Analysts Journal where he reviews the growth of index funds over the 40 years since the launch of Vanguard’s first index mutual fund—and where he makes pointed remarks about their upstart cousins, exchange-traded index funds.

First, consider the phenomenal growth of index funds. They surged from 4% of stock fund assets in 1995 to 16% in 2005, and then kept barreling right along, hitting 34% in 2015. Much of the recent growth has come not from the traditional no-load index funds, but from exchange-traded index funds, or ETFs. You can buy a no-load index fund directly from the fund company involved, with your purchase price established as of the 4 pm ET market close. By contrast, to buy an ETF, you need to open a brokerage account and trade the stock market-listed shares.

Either way, the smart strategy is to buy and hold. That way, you collect the market’s performance, while incurring minimal investment costs. True, you won’t beat the market averages. But you will beat your neighbors, who are aiming for superior returns but almost always end up with far less, as their results are dragged by high trading costs and the hefty fees charged by actively managed funds. 

Problem is, ETFs aren’t used to buy and hold. In 2015’s first nine months, the 100 largest ETFs, valued at $1.5 trillion, were traded at an annualized turnover rate of 864%. As Bogle writes, ETFs seem “designed to provide a new way for institutional and individual short-term speculators to trade to their hearts’ content—and thus a new opportunity for Wall Street to make profits from index funds.” In short, index funds may have triumphed, but it’s far from clear that smart money management has prevailed.

The Importance of Importance

A HAPPY LIFE can’t be built solely on relaxing, having fun and doing exciting things. To be sure, there’s pleasure to be found in all of these. But I have come to believe that, to lead a life that’s full and satisfying, there is an ingredient that is even more crucial: We need to devote our days to activities that we think are important.

Or, to frame it slightly differently, we want our life to count for something. Arguably, this is a tad delusional: In a world brimming with 7.4 billion people, nothing that any of us do is of great significance. But even knowing that, we find it immensely satisfying to do work that we feel is important. We can become totally engrossed and the hours just whiz by. This is the state of “flow” described by psychology professor Mihaly Csikszentmihalyi.

We also experience the opposite—the irritation when we’re forced to waste time on the unimportant and unproductive, like sitting in traffic or waiting for the doctor to see us. As we tell ourselves, there are so many better things we could be doing.

But what better things? I think that changes as we age. When we’re early in our careers, what’s important is often defined by our boss. As we grow older, we care less what the boss thinks—and become more concerned with what we judge to be important. That can prompt us to make a midlife career change, perhaps swapping to a job which might be less lucrative, but which we hope will be more fulfilling. By saving diligently through our initial decades in the workforce, we can buy ourselves the financial freedom to make this sort of career change.

Our financial freedom is even greater upon retirement, when we’re now free to spend our time as we wish. But I fear many retirees squander this freedom. If we aren’t careful, we’ll focus on the conventional notion of a happy life, and try to spend our retirement relaxing and having fun—and end up with a nagging sense of dissatisfaction. Instead, we should think long and hard about what’s important to us—and then design a retirement that allows us to focus on these activities.

Almost Halfway to Heaven

THE S&P 500 IS DOWN 13% from its 2015 peak--but it would take a further 17% decline before stocks reached average valuations. I've been getting a slew of emails about the market turmoil, so today I put out a special newsletter that discusses valuations and talks about what investors should do now.  If you're reading about the newsletter here and thought you were on my distribution list, check your spam folder, mark my newsletter "not spam" if you see it--and be sure to add my email address to your list of contacts.

Blah Blah Blah

THIS PROMISES to be my least exciting blog of the year. I need to tackle four administrative matters. First, many folks who are on my newsletter’s distribution list have discovered it’s landing in their spam folder. To avoid this happening in future, please add my email address to your list of contacts and, if possible, look in your spam folder for the Jan. 1 newsletter and mark it “not spam.”

Second, the Jonathan Clements Money Guide 2016 is now available as a Nook e-book edition. Third, the various versions now available are all updated through Dec. 31. I know it says Dec. 1 at the top of the paperback’s Amazon page, but that simply represents the original publication date.

Finally, many readers have become friends of my personal Facebook page, rather than the Jonathan Clements Money Guide’s Facebook page. I have no problem with that (though you may be disappointed by how dull my life is). Still, if you want to see all of my financial updates, I would encourage you to “like” the Money Guide’s Facebook page.

Five Keys to Financial Wellness

RON LIEBER of the New York Times emailed me earlier in the week, asking for help with a special online feature. The task: Grab a 4x6 index card and, in Ron’s words, “write whatever you want on the *lined* side. A list of 10 things. Or 20 if you write small. A picture. A quote. Whatever. But it should add up to Clements's guide to financial wellness.”

This was trickier than it seemed. The temptation was to focus solely on saving and investing, rather than touching on broader financial issues. The risk was stating the obvious, like “save diligently,” “diversify” and “never carry a credit card balance.” The really tricky part: my bad handwriting. I got my wife to fill out the index card.

You can view the results on NYTimes.com. If you scroll down the article, you’ll find an interactive feature with eight index cards. Don’t just read mine. Also check out the others, all of which are filled with excellent advice. Can’t get access to the New York Times site? Here’s what I cooked up for my index card—all 116 words and numbers:

1. Keep housing, cars and other fixed living costs to less than 50% of income. That’ll mean less financial stress, more cash for fun—and the ability to save gobs of money.

2. Never take on any debt you can’t pay off by retirement.

3. In your 30s, worry what would happen if you died or couldn’t work. In your 60s, worry what would happen if you lived longer than you ever imagined.

4. You can’t control the markets, but you can control risk, taxes and investment costs. Hint: Buy index funds.

5. Want greater happiness? Design a financial life where you spend your days engaged in fulfilling work—and your evenings with friends and family.

Your Financial Plan in 18 Easy Steps

WANT A ROADMAP to guide you through 2016 and the years that follow? Check out my 18 steps for building your own financial plan, which appeared this morning on MarketWatch.com. The article, which is excerpted from the Jonathan Clements Money Guide 2016, brings together a slew of great online calculators that can help you make smarter financial decisions.

You might also want to check out this site's articles page, which I've updated with a handful of recent publications, including my latest newsletter. Are you on my distribution list but didn't receive the newsletter? Check your spam folder--and take the precaution of adding my email address to your list of contacts.

 

Lower Prices—But Not Cheaper

THE S&P 500 SLIPPED 0.7% in 2015. For those who prefer to buy their stocks at reasonable valuations, this should be cause for mild optimism. After all, even as share prices went nowhere over the past 12 months, the U.S. economy was continuing to grow, which means stocks ought to be better value.

Except they aren’t—at least as measured by the S&P 500’s price-earnings (P/E) ratio. As of Dec. 31, the S&P 500 companies were collectively trading at 22.95 times trailing 12-month reported earnings, versus 19.67 a year earlier, according to WSJmarkets.com. What gives? Even as share prices were going nowhere during 2015, corporate earnings were falling, so the market’s P/E has climbed.

Not all the news is bad. As of Dec. 31, the S&P 500 companies were kicking off a dividend yield of 2.14%, versus 1.92% a year earlier, suggesting stocks are now slightly better value. Meanwhile, the S&P 500’s cyclically adjusted price-earnings ratio, which compares current share prices to 10 years of inflation-adjusted earnings, has fallen over the past year, dipping to 25.9 from 26.8, again suggesting that stocks are slightly better value. So should we be more or less bullish? The grim reality: Whichever market yardstick you look at, it would be hard to argue that stocks are cheap.

16 Ways to Improve Your Life in 2016

WANT TO IMPROVE your life in 2016? Check out the 16 suggestions in my latest newsletter. The newsletter also includes some thoughts about bond market risk and news about today's publication of the Jonathan Clements Money Guide 2016, which is updated through yesterday's market close.

Inconsistently Irrational

OUR FINANCIAL IRRATIONALITY has been well documented by academics focused on behavioral finance. But we aren’t just irrational. We are also inconsistent in our irrationality. Here are five examples which, while somewhat amusing, can also have dire financial consequences:

Employees will work for 30 years at a job they hate to qualify for a traditional defined benefit pension, but they wouldn’t dream of delaying Social Security for a few years to get a larger monthly check. Young parents will carry auto policies with low $250 deductibles, and yet they fail to buy life insurance.Folks will load up on groceries whenever there’s a two-for-one special, but they won’t put enough in their employer’s 401(k) plan to get the dollar-for-dollar match.Couples will buy lottery tickets and take vacations in Vegas, but they steer clear of stocks because they are afraid of losing money.People will run screaming with excitement to the shopping mall whenever there’s a 50% off sale, but they’ll also run screaming with terror from the stock market whenever there’s a 50% off sale.