Jonathan Clements's Blog, page 446

This Week/Feb. 26-March 4

REVISIT YOUR DEBTS. Think of borrowed money as a negative investment: Instead of making you money, it’s costing you. If you have high-cost debt, paying it off—or replacing it with lower-cost debt—should be a top priority. What about lower-cost debt? That might also be worth paying off, especially if the alternative is to buy bonds or CDs in a taxable account.

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Reaping Windfalls

MANY EMPLOYEES deliberately have too much income tax withheld from their paycheck, so they receive a fat refund each spring. Federal refunds averaged $2,850 per income-tax return in 2014, the latest year for which data is available.

This is completely irrational and entirely sensible.

It’s irrational, because we’re making an interest-free loan to Uncle Sam. Why not have the correct amount of tax withheld, and then take a sliver of each paycheck and pop it in a high-yield savings account, so we’re the ones earning interest?

We, of course, already know the answer: If the money was in our regular paycheck, we’d likely spend it. But if we get a lump sum as a tax refund, the money will seem more significant. Instead of frittering it away, we might save the money or use it to pay down debt. Homo economicus may always behave rationally, but we humans need a little trickery if we’re going to spend less today and save more for tomorrow.

In addition to tax refunds, we might receive other windfalls, such as a year-end bonus, an inheritance, and income from freelance work or a second job. There might also be smaller sums, such as reimbursement from our employer for travel expenses or the cash back we’ve accumulated by using a rewards credit card. In each case, these sums aren’t part of our regular income, so they can be a painless source of extra savings.

Over the years, my own nest egg has received a big boost from such windfalls, including advances for various books I’ve written and the year-end bonuses I received when I worked at Citigroup. Each time, I used the money for a special purpose, such as building up my mutual fund accounts, paying off a chunk of my mortgage or funding home remodeling projects. Admittedly, the latter shouldn’t be considered an investment (or, if they are, they aren’t good ones). But in each instance, I never simply spent the money, with nothing to show for it.

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Better Than a Bike

LIKE MOST PARENTS, my wife and I spent time and money building a happy and balanced childhood for our four children. That encompassed things like vacations, cub scouts, church, music, and youth soccer and baseball. But it also included trying to pass along values like hard work, thrift, generosity and education. We never hesitated to speak about our finances around the dinner table, although we only shared specific numbers when the kids got older.

About ten years ago, I was lamenting that I couldn’t contribute to a Roth IRA because my income was too high. (Yes, it’s a nice problem to have.) But it occurred to me that my children could contribute if they had earned income, plus the benefits of starting young would be enormous.

So when my oldest son turned 16, we talked about investing for his retirement. I thought this would be an awkward conversation, because retirement was so far off. He surprised me. I didn’t think he was listening much to our dinner table conversations, but he had understood enough to internalize the value of planning and saving. He asked how much he would make by retirement. We created a spreadsheet showing how a $1,000 investment would grow to perhaps $30,000 or $40,000. We went down to the garage and I pointed out that if he invested, instead of buying a bike, he would in time end up with a car. Since he was learning to drive at the time, he really liked that idea.

We tallied up his earnings. He had done some lifeguarding, as well as snow shoveling, mulching, lawn mowing and other tasks for his uncles, aunts and grandparents. They had been generous. He had just over $1,000.

He liked the idea of taking what was a large sum to him and making it into an enormous amount, but he also wanted to spend his money. I told him about how many companies are helping employees save for retirement via a matching contribution. I offered to do the same and match his savings up to $500. He took the bait: He opted to invest $500 of his money, take my $500 and keep $500 to spend.

At the time, there weren’t many investment companies that allowed you to start a Roth IRA for $1,000. We chose Vanguard STAR, a low-cost, low-minimum mutual fund that invests in other Vanguard funds. Today, Vanguard and other fund companies offer target-date funds with $1,000 minimums. If I were helping my son today, I would guide him toward one of those funds.

By the time he started college, my son had about $4,000 in his account, thanks to both additional savings and investment growth. We rolled his account balance into the Vanguard Total Stock Market Index Fund. He plans to keep his money there until retirement. It was the length of time that convinced both of us that this was a reasonable strategy. He said that he wouldn’t need the money for another 45 years. I added that he would only take out a small portion upon retirement, and withdrawals would continue for another 30 to 35 years.

During college, he had engineering internships that paid well and provided more money for his Roth. We starting calculating his “numbers.” These numbers weren’t how much he would need to retire, but rather how much the current year’s $5,000 Roth investment would be worth in retirement. Using a 7% average growth rate, we calculated that his $5,000 would grow to $120,000 by retirement, and then might provide $200,000 to $250,000 in total income through age 95.

I waited until he had a job to discuss the Roth’s tax-free growth. He called to complain about how much the government took out of his paycheck. That led to a conversation about why the Roth IRA is such a great investment vehicle. Discussions with the other kids have been much easier. They saw what their older brother was doing and they wanted to be like him—only better.

Dave Rowlands is a former Xerox executive and McKinsey consultant. With his wife, he now owns and runs two small companies. He is helping his oldest son, now an engineer, to start a personal finance blog for Millennials.

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Car Talk

I’VE LIVED IN BIG CITIES for the past six years—Cairo most recently and St. Louis before that. During that time, I’ve enjoyed inexpensive public transportation and nearby groceries. I never felt the need to buy a car, and it never made sense. But since moving to New Haven five months ago, my calculations have changed.

For the first time since high school, I’m back in the ‘burbs. I can walk or bike to class and to friends’ apartments for dinner. But getting to the grocery store or train station requires somewhat more exertion—and a decision. Should I bother my friends for a ride to Stop & Shop, or even take an Uber for a small-ish fee (around $12 roundtrip), or should I buy from the overpriced bodega just around the corner? Should I order a cab to the train station, or instead haul my bag to the Yale shuttle and profit from its free, albeit glacial, hour-long trip?

So I’m considering buying a car. I’ve thought long and hard, and still I’m unsure it makes financial sense. My mother is considering giving me her old Nissan. But even then, the ongoing costs might outweigh the benefits. I’ll save on cabs and Ubers, but there’s still the cost of gas. I could drive home to New Jersey rather than drop $40 on two trains and a subway, but surely car insurance would undo those savings. Without much cash on hand, furthermore, I’d likely have to pay off the car over time—a source of stress as mental as it is financial.

I figure today I spend about $175 a month on cabs and trains. If I owned a car, I calculate that gas, maintenance and insurance would run me around $250 a month. On top of that, there’s the cost of buying the thing. If my estimates are accurate, I’d be spending more than saving, and I’m not sure the benefit of owning a car justifies it.

Perhaps a used car makes the most sense. It would be less expensive and cheaper to insure. But the undergraduate economics major in me, wary of information asymmetry and the market for lemons, is sounding the alarm. I haven’t yet decided what to do. Until then, I suppose I’ll make the best of the (involuntary) exercise and keep cozy with my car-owning friends.

Henry Clements, Jonathan’s son, is a PhD student at Yale. Back in the U.S. after two years in Cairo, he studies modern Middle East history and is considering taking up the banjo. His previous blog: Friendly Fire.

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Unhealthy Increases

LIKE ALMOST EVERYBODY ELSE, my wife and I faced large health care cost increases this year.  It wasn’t all from changes in our health insurance. We’re getting up there in years. We go to the doctor more often. Not all hospital charges are covered by Medicare or our health insurance. And there are some costs that aren’t covered at all–namely dental, ear and eye problems.

We’re fortunate: We can afford the cost growth. Many of our acquaintances can’t. Several have changed to less expensive insurance plans, only to have trouble finding doctors and getting appointments. General practitioners and geriatric doctors are growing scarce. Many are getting away from Medicare’s low pay rates and administrative costs. In addition, fewer medical students are interested: They recognize that specialists get significantly higher incomes—and they need those incomes to pay their mounting student loans.

Political parties always promise lower medical costs. But can they really make a dent in such costs, which have been increasing for years at significantly higher rates than consumer inflation? I think not, largely because of the virtually unstoppable aging of our population. People are living longer, with increased medical problems simply from aging. That’ll require more medical care, not less. Meanwhile, the economics are getting worse: Fewer working people per retiree means not only less tax revenue to support Medicare, but also a losing battle for insurers, who will struggle to hold down insurance premiums if the covered population becomes less healthy.

It’s dismaying to consider what annual cost increases can do to health costs. Fidelity Investments projects that a 65-year-old couple will need $260,000 to cover their retirement medical costs. That’s figured in today’s dollars and excludes nursing home costs. At 3% inflation over 15 years, that $260,000 would grow to more than $400,000 in then-year dollar values. What if health care costs grow at 6% per year? In 15 years, a newly retired couple would need more than $600,000–just for medical costs.

Henry “Bud” Hebeler is the retired president of Boeing Aerospace Company and the author of Getting Started in a Financially Secure Retirement. For more on retirement issues, visit Bud’s website at AnalyzeNow.com.

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This Week/Feb. 19-25

FUND YOUR IRA—FOR 2017. This time of year, folks are exhorted to get their IRAs funded for 2016 before the April 17 tax-filing deadline. That’s a good idea. But if you want to get the most out of your IRA, you should also make your 2017 contribution. That way, your money will be invested for longer—and there’s the potential for even more tax-advantaged growth.

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Think Less of Me

IN EARLY 2005, when Hannah was age 16 and Henry was 12, I took them out to a local diner and told them exactly how much financial help I’d provide. I would make sure they graduated college debt-free. I would seed a retirement account with $25,000 and a house-down-payment fund with $20,000. On top of that, I’d give them $5,000 upon graduation, plus another $5,000 toward the cost of a wedding or at age 30, whichever came first.

Last month, Hannah got engaged.

When I made my financial commitments to my children, they reflected my values—and those values haven’t much changed. I ended up being more generous than I initially promised, putting extra money into Hannah and Henry’s retirement and house funds. Investment gains further bolstered the accounts. By the time they graduated college, they both had around $100,000. I even wrote a private mortgage for Hannah, so she could buy her first home.

But I’m still not inclined to give Hannah much more than $5,000 toward the cost of her wedding.

In a world where almost half of all Americans approaching retirement age have less than $50,000 saved, I find it unfathomable to spend $30,000, and often far more, on a single day of celebration. Every fiber in my body rebels against the notion.

Hannah hasn’t pressed me to give more. She understands that I’ve been generous over the years and that I long ago made clear what my values are. She’ll get plenty of help from my ex-wife, her grandmother and her future mother-in-law. At the wedding, I will probably feel a little awkward, because I’ll know I haven’t paid “my fair share.”

But I’m still not inclined to give much more than $5,000.

On the other hand, when the grandchildren arrive, I’ll be the first to contribute to their college accounts. Those are my values.

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Money Pit

WHEN I BOUGHT my small rowhouse in Philly, I was swept up by the idea of homeownership. Like many of those I talked with at the time, owning meant no more wasting money on rent, plus it was a great no-risk investment.

Six years later, whenever I hear that friends are considering buying, I’m more cautious and often advise holding off—or at least peeling back the onion, so they’re aware that buying a home is rife with tradeoffs and not obviously “the right thing” to do. In 2010, when I purchased my home, I’m not sure I could have even listed the drawbacks of homeownership. Today, they’re painfully clear to me:

1. Loss of flexibility. Because of the closing costs on both ends, and all of the other move-in repairs and fixes that inevitably happen, most owners don’t break even for at least five or six years. For millennials early in their careers, this can limit job opportunities at a time when many want to be nimble and exploratory. The same applies to couples starting a family, who may suddenly find they need more space or better school districts.

2. Need for cash. Not only is buying a house expensive, but once you are settled and living in the place, you need access to significant cash at all times. Most contractors won’t take credit cards or payment plans, so you need money on hand to pay for a range of emergency repairs, such as a new furnace or new dishwasher, and potentially you could face more than one cost at a time.

3. Nothing’s guaranteed. Since 1980, inflation-adjusted housing prices have gone up just 18% in the U.S. Yes, prices in markets like New York and San Francisco have gone up more than 100%. But during the same stretch, MSCI’s USA stock index increased an inflation-adjusted 1,800%. That means that renting, and then investing what you would have spent on down payments, repairs and upkeep, would likely have netted you more in the long run. And this ignores major unforeseen issues, such as structural problems, problematic neighbors and vermin, which might force you to sell your home at a loss.

4. The buck stops with you. When you own a house, there’s no landlord to deal with contractors, local government and insurance companies. Instead, it’s all on your shoulders. You have to adjust your budget when taxes rise and you have to be home to meet the repairman.

I’m not arguing that buying a house is always a bad idea. Just saw your dream home? Before you take the leap, thoughtfully consider not just the pros, but also the cons.

Zach Blattner 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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Fake News

A CLIENT WAS IN OUR OFFICES the other day, grilling one of my fellow financial advisors about some investments in his diversified retirement portfolio. He just couldn’t understand why we’d keep certain securities that hadn’t recently performed well. He kept citing “stuff I read” and “all the experts” as the basis for his concerns.

I wasn’t part of the conversation. But here are three points I would have made:

1. Those experts don’t know a thing about you or your situation. They don’t know your age, health, marital status or personality quirks. They don’t know where you live or how much your house cost. They don’t know how much you spend on groceries or hobbies, or that you were forced into early retirement by an ungrateful employer. They know none of this. Nada.

2. Virtually every expert you encounter online or on television is being paid for those opinions. If they’re discussing gold, real estate or master limited partnerships, you can be certain that their wallet or purse stands to gain from your interest in any of them. If they are recommending stocks, bonds or unit trusts, it is a sure thing that those products generate profits for them or their company. If they are discussing annuities, well, just run away as fast as you can.

3. Don’t be impressed by their purported qualifications. Not one of those so-called experts is any more expert than my colleagues and me. They’ve been in The Wall Street Journal? I’ve been in The Wall Street Journal. They’ve written articles for financial and trade industry magazines? I’ve written hundreds. They’re on television? I’ve been on television.

I may not be right all the time. But I’m just as much an expert as these talking heads—and probably more so.

Dan Danford is a Certified Financial Planner and founder of the Family Investment Center in St. Joseph, Mo. His most recent book is Stuck in the Middle.

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Pillow Talk

AS MY WIFE AND I ATTAIN a certain age, financial questions are taking an unprecedented top spot in our conversations. Gazing into one another’s eyes over Cabernet Sauvignon at our local inn, we as often coo about jobs, savings, taxes and car payments as about romance.

This New Year’s Eve, we cooed about hopes, regrets, fears—and a college bill.

We began saving for our two kids’ educations when they were very young. But with one of us working fulltime and the other only halftime, their 529 accounts have proven too small to cover all expenses at the private colleges they chose, so we’ve also had to dip into other savings. Our daughter recently graduated, while our son is a freshman. He has a merit scholarship covering 30% of his costs, and the combined total of several financial accounts—a 529, a custodial account and a regular taxable account—should cover much of the remainder.

The question we mulled over fizzed-out Korbel Brut: In what order do we spend down our accounts to cover our son’s college costs? Here’s what we’ve come up with:

1. First, we’re emptying his 529. The target-date fund it’s invested in has made some gains, which we can withdraw tax-free. But the bulk of the remainder is in bonds and cash investments that have limited upside potential, the money can’t be used tax-free for any other purpose and, with very little left in the account, the monthly fee no longer seems justified.

2. Next, we’ll turn to our son’s custodial account, which my wife’s folks generously started years back and contributed to until they died six years ago. This account mixes cash, mutual funds and laddered zero-coupon bonds that mature between now and 2018, so only some of that money is available today. We will pull out cash for tuition payments, as the zero-coupon bonds come due, and turn next to selling the funds.

3. We can also begin selling off the S&P 500 index fund in our joint taxable account. We think stock valuations are high and the large run-up over the last eight years may be nearing its end. We’ll owe capital-gains taxes, but we may be able to offset part of those taxes with charitable donations.

4. We will continue our monthly college savings, albeit not into the 529.

5. Finally, loans are always a possibility, though one we’d like to postpone as long as possible to avoid saddling our young fellow with debt.

What do you think of this approach? Let me (and your fellow readers) know your thoughts by commenting below.

David Byron—a pseudonym necessitated by the industry in which he works—is an IT project manager in financial services.

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