Jonathan Clements's Blog, page 444

Beating Janet to the Punch

IT'S ONE OF THOSE INDELIBLE teenage memories: visiting the Bank of Baltimore in suburban Washington, DC, in the late 1970s.  I would hand over my babysitting or lawn-mowing money to the bank clerk, who would slide my green bank book into some magic typewriter. After a joyous clatter of keys, my bank book would be returned, and there would be recorded not just my deposit, but also the latest quarterly interest payment.

My children and stepchildren—ages 10 to 27—all have bank accounts. But there’s no joyous clatter of keys and, more important, there’s little or no interest to be had. As it happens, they are better off today than I was then. In 1978, we earned around 5% in pretax interest—but inflation was 9%. Today, my kids earn nothing—but annual inflation is running at just 0.2%. It’s hardly the stuff of playground or barroom boasts, but they are losing money far more slowly.

Still, I suspect I was more motivated to save. I may have been the victim of a money illusion—imagining I was making money when I was actually losing ground—but I had the pleasure of watching my account grow both because of the money I socked away and because of the interest I earned. By contrast, my children and stepchildren’s accounts are firing on just one cylinder, the raw dollars they deposit.

How can you making saving money more exciting for your kids? You could beat Federal Reserve Chair Janet Yellen to the punch and raise interest rates for your kids. Every three months, you might pay 5% interest, adding an extra $5 to their bank accounts for every $100 they have saved at that juncture. Depending on how good your kids get at saving money, this could become an expensive proposition.  But that, of course, will be the sign that you’ve succeeded.

Is Tax-Loss Harvesting Overrated?

AFTER A TURBULENT FEW MONTHS for stock prices and with 2015 winding down, talk will soon turn to tax-loss harvesting. The notion: You sell losing stocks in your taxable account, and then use the realized capital losses to offset realized capital gains and up to $3,000 in ordinary income, thus trimming your 2015 tax bill.

Sound like a smart strategy? If you trade individual stocks actively or you’re a really bad investor, tax-loss harvesting might make sense. What about the rest of us, who sit quietly with a handful of mutual funds and exchange-traded index funds, and perhaps also own a few long-term individual stock holdings? Most of the time, there won’t be any losses to harvest.

Yes, if you’re a long-term investor, you might get the chance to realize losses in the first few years that you own a fund or an individual stock. But soon enough, your investments will likely be above your cost basis, and the chance to benefit from tax losses is probably gone forever. Instead, you’ll face an entirely different problem: How do you rebalance your holdings without getting whacked with big capital-gains tax bills?

The upshot: If you’re a sensible investor, I wouldn’t spend too much time worrying about tax losses, and instead focus your efforts on two far more important tax-minimization strategies. First, make sure you keep tax-inefficient investments in your retirement account. That list would include taxable bonds, actively managed mutual funds, stocks you plan to trade and real estate investment trusts.

Second, aim to hold tax-efficient investments in your taxable account, including stock index funds, tax-managed stock funds and individual company stocks you plan to hold for the long haul. These investments might generate dividends each year, but you shouldn’t pay much in capital-gains taxes, unless you opt to sell. You might also hold tax-free municipal bonds in your taxable account, though—as I’ve argued elsewhere—you’ll probably fare better by favoring taxable bonds in your retirement account, while reserving your taxable account for tax-efficient stock holdings.

Less Is More

"SOMETIMES, YOU HAVE TO GO BACKWARD to go forward." That's my advice to financial advisors in my latest article for Financial Planning. The advice is equally applicable to the typical investor. To get the most out of your money, occasionally you may want to take steps that trim your portfolio's value in the short-term.

Examples? It often makes sense to live entirely off savings in your early retirement years, while delaying Social Security benefits to get a larger monthly check. It might also make sense to sell certificates of deposit, money-market funds and high-quality bonds, and use the proceeds to pay off debt. Your debts are likely costing you more in interest than you're earning on these conservative investments, so you'll be ahead financially, even if your investment portfolio is a tad smaller. Got a year with relatively little taxable income? You might seize the opportunity to convert part of your traditional IRA to a Roth IRA. That may trigger a big tax bill--and hence take a slice out of your savings--but you will enjoy tax-free growth thereafter.

31 Rules of the Road

SOMETHING HAD TO GO. The final chapter of the Jonathan Clements Money Guide 2015 was devoted to 31 rules for the financial road ahead. For the Money Guide 2016, I'm replacing that chapter with a new final chapter, which details how to create your own financial plan in 18 easy steps.

But even as I axed the 31 rules from the manuscript, I figured they deserved a permanent home. Every year, we see changes in tax thresholds, financial products, market performance, economic numbers and what worries investors. But while the financial world changes constantly, sensible financial advice doesn't--and that, I like to think, is what's captured by the Money Guide 2015's 31 rules of the road.

A Distinction Without Merit

IF WE WORK LIKE DOGS for 40 years, we’ll get our reward, which is the chance to sit around and do nothing for 20 or 30 years. That’s the definition of a successful life, according to conventional financial wisdom. But it doesn’t sound like a whole lot of fun, does it?

My contention: It’s time to rethink the crazy distinction between work and retirement and, in the process, redefine what counts as a successful life. Most of us get a lot of satisfaction from doing work that we’re passionate about and that we think is important, and our goal should be to spend our days engaged in these sorts of activities, whether we’re age 30 or age 70. That brings us to two key questions: How much income will this work generate—and how much income do we need?

Early in our careers, we may not be able to do the work we love, because it doesn’t pay enough to allow us to service our student loans, buy a house and sock away money for retirement. But as we pay down debt and amass some savings, we buy ourselves more and more financial freedom. We might use this freedom to focus on work that may not be as lucrative, but which we might find more fulfilling. Think about the investment banker who becomes a math teacher or the corporate executive who quits to join a nonprofit organization. These folks traded dollar income for psychic income.

As I see it, retirement represents this tradeoff taken one step further. By our 60s, we should have a heap of savings, which means we have a heap of financial freedom—and we might use this freedom to do work we’re passionate about, but which doesn’t pay us any income. That might mean coaching a children’s sports team, volunteering, pursuing artistic endeavors, devoting ourselves to hobbies or getting more involved with our church. Don’t get me wrong: If we can get paid to do what we love, that’s all the better. Indeed, earning even a modest income in retirement can greatly ease the financial strain felt by many retirees.

The bottom line: We need to collapse the distinction between work and retirement—and instead view our financial lives as the pursuit of ever greater financial freedom. That financial freedom, in turn, can allow us to do work we find fulfilling, with less and less worry about the paycheck that comes with it.

September Newsletter

THIS MORNING, I hit send on my inaugural newsletter. What's next for the markets? How can you get your kids started as investors? How can you get a little extra yield without getting whacked by tumbling bond prices? Those are some of the  topics I cover. My next newsletter will go out in early December. If you want to be on the distribution list for that issue, shoot me an email.

Why Retirement Is Different

CHRONOLOGICALLY, RETIREMENT may be our final financial goal, but we should always put it first. Partly, that’s because retirement is so much more expensive than, say, buying a house or putting the kids through college, so it takes many decades of saving and investing to amass enough for a comfortable retirement. But among financial goals, retirement is also unique in two other ways: It isn’t optional—and we can’t pay for it out of current income.

It’s great if we can buy a home and pay our children’s college bills. But neither is something we have to do. By contrast, almost all of us will eventually have to retire. Even if we are fully committed to working until the day we die, eventually we will likely be forced into retirement by our employer, by ill-health or because we simply don’t have the energy anymore to get up and go to work.

Families are regularly exhorted to save for their children’s college education. Some savings are also required to buy a home, because we will need to pay closing costs and we will likely have to make at least a modest down payment. But in the end, whether we are paying college bills or purchasing a house, much of the cost will be paid out of current income.

We take out a mortgage and then effectively buy the house on the 30-year installment purchase plan. Moreover, our monthly mortgage cost often isn’t that much greater than the monthly cost to rent, so there isn’t a huge added out-of-pocket cost when we go from renter to homeowner. Similarly, while families might amass some savings to pay for college, they often cover much of the cost out of current income, whether it’s paying the bills as they arise or borrowing money and then repaying those loans over time. By contrast, we can’t pay for retirement with our regular paycheck—because at that point we won’t have one. Instead, on the day we quit the workforce, we need great gobs of money set aside.

Site Seeing

HOW CAN TRADITIONAL FINANCIAL ADVISORS fend off the threat from low-cost robo-advisors? I tackle that topic in my first regular monthly column for Financial Planning magazine. With the appearance of that column, and the demise of my Wall Street Journal column, I decided to revamp my articles page. That page--which previously just housed my Journal columns--now includes all articles I have written since my return to journalism in April 2014, as well as some articles by others that were devoted to my financial advice.

 

First Look

DAVID GLAUBKE, who created last year's cover for my Money Guide, just sent along the design for next year's edition. The Jonathan Clements Money Guide 2016 will be available on Jan. 1 as both a paperback and e-book, though I plan to put out an early paperback version on Dec. 1, in time for the holidays. The early version will have market and economic data through Nov. 30, while the year-end edition will use Dec. 31 data.

The 2016 edition will be roughly 25% bigger. There are new chapters on how to build your own financial plan and on the basics of investment math, as well as an appendix that describes 134 key financial concepts. I have also revised and expanded existing chapters, including adding sections devoted to some of the great financial debates and to how I handled crucial money issues in my own life.

Twice the Fun

AS THE SOUND OF SUMMER CRICKETS gives way to the din of investors wailing, I've had two relevant articles appear. I helped Bottom Line/Personal put together a piece on "7 lies investors tell themselves." The article was wrapped up weeks ago, but it seems timely in the wake of the recent market turmoil.

Meanwhile, I am now writing occasionally for Financial Planning, a publication geared to financial advisors. Check out the article posted this morning on five strategies for staying calm in the face of market mayhem.