Jonathan Clements's Blog, page 442

So Sensitive

WALL STREET’S INHABITANTS have many unpleasant qualities: greed, arrogance, disdain for customers, inflated self-importance, a sense of entitlement. But all this is made worse by another unappealing trait: They’re so damn prickly.

The degree of prickliness is closely correlated with the outrageousness of the fees they charge. I saw this again and again during my decades as a financial journalist. I can’t recall an index-fund manager ever throwing a king-size snit, and it was rare that I got a nasty letter or email from a fee-only financial planner.

Instead, this sort of behavior seems to be the preserve of those who make a living stuffing high-cost dreck down the throats of everyday Americans. Exhibit A: sellers of variable and equity-indexed annuities. Say something nasty about these products and your inbox will likely be filled with vicious messages. Annuity salesmen appear to be emboldened—rather than embarrassed—by the huge commissions they collect, and view themselves as misunderstood victims of an unappreciative world. Sort of like teenagers.

Next on the snit list are sellers of cash-value life insurance, another group collecting commissions that would make even used car salesmen blush. Arguing with these folks is an exercise in frustration. Mention the high commissions and you’ll be told about the dividends. Pick holes in the need for lifetime insurance coverage and you’ll hear about the loan feature. Discuss the high lapse rate and you’ll be told about the tax-free death benefit. And so it goes on.

A little further down the snit list are stockbrokers who sell load mutual funds that can charge an initial sales commission of as much as 5.75%. In the late 1980s and early 1990s, I remember hearing all kinds of drivel from these folks—about how load funds outperform no-load funds (not true), how the commission creates an incentive for the fund’s manager to work harder (not true), how index funds are guaranteed mediocrity (not true).

Today, you’re less likely to hear this nonsense, in part because many stockbrokers are trying to kick the commission habit. Instead, they’re focused on getting clients to open fee-based advisory accounts that (irony alert) hold no-load mutual funds and exchange-traded index funds. 

Headscratchers

INVESTORS ARE HUMANS, TOO. In the rest of our life, we readily acknowledge that emotions play a huge role. But when handling money, we insist we’re entirely rational. Really? Here are 10 headscratchers that suggest otherwise:

Why do we concede that the car sitting out in the rain is a depreciating asset, and yet we’re convinced that the house sitting in the rain is a great investment?Why do people, who are so optimistic about everything else, rush to claim Social Security at age 62, suggesting they’re pessimistic about their own life expectancy?Why do we go out of our way to collect tax deductions, when these tax deductions might save us just 25 cents for every $1 we spend?Why will people readily admit that their family life is in turmoil, and yet they’d never admit that their finances are a disaster?Why do we buy the extended warranty in case the $300 television breaks, but we fail to buy disability, health and life insurance in case our body breaks?Why do folks, who would never dream of going into debt to buy stocks, think it’s entirely prudent to borrow 95% of the purchase price when they buy a house?Why do we build diversified portfolios—and then get surprised when all of our investments don’t go up at the same time?Why do folks flock to exchange-traded index funds for their low costs and enviable tax efficiency, and then throw away both advantages by rapidly trading their funds?Why do we spend hours researching which $100 hotel room to book, and yet we’ll invest tens of thousands of dollars based on a five-minute cold call from a broker?Why do we concede that we’d have no chance against a professional tennis player, and yet we imagine we can beat the market averages, even as most professional money managers fail?

June Newsletter

YOU CAN NOW BUY a total stock market index fund that charges just 0.03% a year. My contention: It's time to declare victory on fund expenses--and focus instead on the biggest investment cost of all, which is taxes. That's the theme of my latest newsletter, which also includes a slew of intriguing market stats and some thoughts on Brexit.

On Your Marx

WHEN I WAS AT CAMBRIDGE UNIVERSITY in the early 1980s, there was a popular joke, “What’s left of Cambridge economics? The answer: Absolutely nothing—there’s nothing to the left of Cambridge economics.” At a time when monetarism and supply side economics were on the rise in the U.S., Cambridge economics professors seemed more interested in exploring how to make Karl Marx relevant to the modern world. It was a quixotic quest—and seemed even more quixotic after the Berlin Wall’s collapse conclusively proved that Marx in practice wasn’t terribly popular.

Yet it occurs to me that Marx, if he were alive today, might try to claim some belated vindication. Think about what’s happened since the early 1980s. As business competition has gone global, we’ve seen increasing income inequality. Globalization has fostered economic growth and forced businesses to be more efficient, helping the standard of living of many. But not everybody has benefited. Those who have suffered economically seem to have found their voice with Donald Trump, Bernie Sanders, Brexit, Austria’s Freedom Party and France’s Front National.

I suspect all this will prove to be a momentary hiccup—and, a few years from now, the free movement of people and trade will once again be widely accepted as good for the global economy. But I think there’s a lesson for politicians on both the left and right: Globalization creates economic losers—and, if you want to enjoy the upside of globalization, you need also to address the downside.

Yes, We Must

MONEY ISN’T AN END in itself. Rather, it’s a means to other ends. But what ends? Some people have a good handle on what they want from their financial life. But for others, it’s a lifelong struggle. They purchase endless possessions that bring only fleeting pleasure. They pursue goals that they belatedly discover aren’t all that important to them. Result: money worries, excessive spending, mountains of debt and fierce family arguments.

How can we avoid this mess? In his new book The Feel Rich Project, financial planner Michael F. Kay advises readers to figure out what their “musts” are—as he puts it, “what must occur for you to feel secure, satisfied, and successful.” These aren’t the things that would be nice to have or nice to do, or the things we feel we should have or should do. Rather, the “musts” are things that are essential either for our sense of security or because they speak to our core values.

Everybody will have a different list of “musts.” Here’s what makes my list:

I don’t want to worry about money, and I don’t want my spouse to worry. Having enough savings obviously helps. But I also limit my purchases to things I really care about. Spending less, so I worry less, seems like a small price to pay.I don’t provide regular financial support to my adult children, and I don’t think that would be healthy. Still, I want to make their lives a little easier and I love to bring our family together for special occasions, so I’m quick to send a check when they’re hit with a surprisingly expensive car repair and I’m happy to pay for them to join us on vacation.I want to devote my days to activities I love. I have a ridiculous number of projects on my plate, but they’re all of my choosing—blogging, writing books, working on a financial startup, putting out my bimonthly newsletter, sitting on the board of a financial advisory firm. Some of these things are lucrative, some may eventually prove lucrative—and some make minimum wage look like an attractive proposition. But whatever the pay, I want to keep doing them, and I don’t want any misstep with my finances to imperil that.

51 Things You Shouldn’t Do

TODAY’S FINANCIAL ADVICE: JUST SAY NO. You can probably think of instances when an individual ought to ignore one or two of the suggestions below. Still, I’d argue that—if most folks followed these rules—they’d be far better off financially. Want a brighter financial future? Here are 51 things you shouldn’t do:

Don’t buy cash-value life insurance.Don’t envy hedge fund investors.Don’t write frequent checks against bond funds held in a taxable account.Don’t carry a credit card balance.Don’t invest in high-turnover stock funds.Don’t fund custodial accounts if your family hopes to receive college financial aid.Don’t trust brokers when their lips are moving.Don’t keep a heap of money in your checking account.Don’t assume the premium on your long-term-care insurance is fixed for life.Don’t forget that a high potential return means high risk.Don’t buy a home if you think you’ll move in the next five years.Don’t invest 100% in stocks—or 100% in bonds.Don’t die without a will.Don’t buy trip-cancellation insurance.Don’t retire with debt.Don’t buy initial public stock offerings.Don’t throw away the advantages of index funds by actively trading them.Don’t claim Social Security at age 62.Don’t buy a tax-deferred annuity in an individual retirement account.Don’t apply for credit too often.Don’t use your taxable account to buy high-yield junk bonds or real estate investment trusts.Don’t opt for low insurance deductibles.Don’t fully fund your 401(k) if you smoke, drink heavily and never exercise.Don’t buy any fund with annual expenses above 0.35%.Don’t instinctively hang on to losing stocks.Don’t be surprised if every solution offered by an insurance salesman involves insurance.Don’t assume you—or anybody else—are smarter than the market.Don’t get your stock picks from your brother-in-law, your spam folder or the television.Don’t purchase life insurance if you don’t have financial dependents.Don’t pay a 6% real estate commission.Don’t opt for the extended warranty.Don’t invest heavily in your employer’s stock.Don’t purchase a house that’s bigger than you really need.Don’t day trade.Don’t have children if you hope to retire early.Don’t read anything into short-term market movements.Don’t buy investments without first settling on your financial goals.Don’t use more than 10% of the credit limit on your credit cards.Don’t buy an individual bond without figuring out what markup you’re paying.Don’t forget about inflation.Don’t buy an investment unless you’d be happy to hold it for 10 years.Don’t assume a commission-free stock trade is cost-free.Don’t buy based on past performance and expect it to persist.Don’t leave your ex-spouse listed as your 401(k) plan’s beneficiary.Don’t take out a large mortgage just for the tax deduction.Don’t keep money in the stock market that you’ll need to spend within five years.Don’t buy variable annuities.Don’t assume a high yield means a high return.Don’t pay bills late, especially loans and credit card payments.Don’t expect stocks to earn 10% a year, even over the long run.Don’t lend money to family members if you’ll need it back.

Clueless, Cheap and in Control

PEOPLE LOVE TO TALK about themselves. Today’s subject: me. Over my three decades of investing, I have tried to cultivate three traits. In other circumstances, none would be especially endearing. But as an investor, they’re my best friends.

I’m clueless. Occasionally, I forget how ignorant I am. I might convince myself that I know where interest rates are headed or that I’ve found a stock market sector that’s truly undervalued. Fortunately, after 30 years of investing, I have been wrong often enough in my forecasts that I almost never act on them.

I’m cheap. I may not be able to predict the market’s direction or figure out which stocks are bargain priced. But there’s still plenty to keep me busy. I am constantly striving to reduce my investment costs. That means sticking with low-cost index funds and doing everything possible to hold down my portfolio’s annual tax bill.

I’m a control freak. I don’t just try to control my investment costs. I am also intensely focused on controlling risk. Taking risk, of course, is a necessity if you want to earn healthy long-run returns.

But I don’t want to take more risk than is necessary, so I’m always looking for ways to better diversify my portfolio. In recent years, that’s meant adding small stakes in foreign real-estate investment trusts and gold stocks to my portfolio, and also increasing my exposure to overseas stocks. It also means regularly rebalancing, so market movements don’t drive my investment mix too far from the target portfolio weights I’ve set for myself.

Losing Interest

“ONLY BORROW TO BUY things that’ll appreciate in value.” This was a popular piece of financial wisdom in the 1980s, when I started writing about personal finance. But I can’t recall anyone saying it in recent years. Does that mean this wisdom is no longer wise?

Financial habits have obviously changed. I might make just a single cash machine withdrawal each month, because I put almost every expenditure on my two credit cards, which I use to buy groceries, gas and restaurant meals—none of which has lasting value. Still, this is short-term borrowing that benefits me: I pay off the card balances as soon as the bills arrive, so I don’t incur any financing charges, while pocketing the credit card rewards and enjoying the convenience of using plastic.

What about longer-term borrowing? According to the Federal Reserve Bank of New York, U.S. consumers were $12.1 trillion in debt as of year-end 2015. Mortgage debt accounted for 72% of the total, student loans 10%, auto loans 9% and credit card debt 6%. With any luck, the mortgage will buy a home that appreciates in value and the student loans will increase income-earning ability. The car, by contrast, will almost certainly depreciate. But the car—or, at least, the version without leather seats—is also an economic necessity for many folks, who otherwise couldn’t get to work. Thus, it seems the vast majority of debt is indeed taken on to buy items that appreciate or have some lasting value.

But even if most money is borrowed for a good reason, it doesn’t necessarily mean borrowing is a good idea. Why not? First, the interest rate on our debts is typically higher than the interest we can earn by buying bonds, money market funds and certificates of deposit. This is true even for tax-deductible mortgage debt. The implication: To pay for our next major purchase, we should be less inclined to borrow—and instead sell conservative investments held in our taxable account.

Second, we shouldn’t borrow any money we can’t repay by retirement. Unfortunately, an increasing number of folks are quitting the workforce still burdened by debt. This isn’t smart, and not just because it boosts the cost of living for these retirees and makes their finances more precarious. With no paycheck to service their debts, retirees will need to dip into savings—and they could find themselves drawing heavily on individual retirement accounts and old 401(k) plans, with every dollar withdrawn taxed as ordinary income. Those retirement account withdrawals could, in turn, trigger taxes on up to 85% of a retiree’s Social Security benefit.

Like to Buy Your Bananas Green?

THE KINDLE EDITION of my new book, How to Think About Money, is now available for pre-order. The e-book costs just $9.99, less than a glass of vino at many Manhattan restaurants. What's the book about? Check out the description and the overly kind endorsements, as well as the cool cover created by David Glaubke, who also designed the cover for my Money Guide.

Eleven Signs You Own the Right Portfolio

1. You’re so well diversified that you always own at least one disappointing investment.

2. Your livelihood isn’t riding on both your paycheck and your employer’s stock.

3. If the stock market’s performance over the next five years was miserable, you wouldn’t be.

4. You can remember the last time you rebalanced.

5. You have no clue how your investments will perform, but a great handle on how much they’ll cost you.

6. You don’t have any hot stocks to boast about.

7. For every dollar you’ve salted away, you have an eventual use in mind—and the dollars are invested accordingly.

8. Jim Cramer? Who’s that?

9. A year from now, you plan to own the same investments.

10. You never say to yourself, “Wow, I didn’t expect that.”

11. You take tax losses when they’re available—but they aren’t available very often.