Jonathan Clements's Blog, page 455

Right Price, Wrong Time?

TEN YEARS AGO, the real estate market peaked. Today, prices remain 2.1% below their mid-2006 high—though they’re also 34.8% above their 2012 low, as measured by the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index.

As property prices have recovered, homes have become less affordable. The impact, however, has been softened somewhat by modestly rising incomes and slightly lower mortgage rates, according to data from the National Association of Realtors. The upshot: If you have the U.S. median family income of $68,897 and you bought the typical single-family home, which costs $249,800, the resulting monthly mortgage payment shouldn’t be any great financial strain.

But before you rush to buy that first home, consider three other factors. First, give some thought to how secure your job is. If there’s a significant risk you could be laid off, taking on the extra cost of homeownership probably isn’t smart.

Second, consider whether you might be forced to move in the near future for career, family or other reasons. Given the hefty cost of buying and selling real estate, you want to own your new home for at least five years, and preferably seven years or longer.

That brings us to a third and final consideration: Can you afford a place that you’ll be content with for the long haul? Ideally, you’ll buy a place that you will happily occupy for decades. If that’s not the case today—but could be if you spent a few more years saving for a bigger down payment and perhaps collecting a few pay raises—it might make sense to rent for a little longer.

Seven Lessons to Teach Your Children

1. That new toy you desperately want? Wait a week, and you’ll be desperate for something else.

2. Folks who appear rich often aren’t.

3. Just because you aren’t paying doesn’t mean it’s free.

4. Mom and Dad might earn lots of money. But financial obligations probably devour 90 cents out of every dollar.

5. If you were paying the electricity bill, you wouldn’t leave the lights on.

6. Those lottery tickets that get folks so excited? They’re a state tax on stupidity.

7. When you leave home and live on your own, you'll kill for leftovers like these.

Playing the Spread

HOW LONG WILL YOU LIVE? A recent study from Boston College’s Center for Retirement Research noted that, “A healthy 65-year old man in an employer pension plan has a 25% chance of dying by age 78, or of living to age 91 or beyond.”

Think about the dilemma this creates if you’re retiring at age 65. Even if you are in the middle 50% of the male population—neither among the 25% who die early in retirement nor among the 25% who live well into their 90s—your retirement could last just 13 years or it could be double that, at 26 years. For women, the middle 50% would likely range from roughly age 80 to 93.

Faced with statistics like this, it’s understandable why folks are reluctant to delay claiming Social Security benefits or to buy immediate annuities that pay lifetime income. We’ve all heard of folks who have lived to 100, or close to it. But we’ve also heard of folks who keel over soon after retiring. What if you were one of those unlucky individuals—and you had also delayed Social Security benefits and used a chunk of your nest egg to buy an income annuity? The thought just isn’t palatable.

The stats also explain why folks are puzzled by the 4% withdrawal rate. The 4% rule suggests you withdraw 4% of your portfolio’s value in the first year of retirement and thereafter increase the annual sum withdrawn with inflation. If you follow that approach, your nest egg should carry you through a 30-year retirement, no matter how rough the markets are or how bad inflation gets. But when your neighbor drops dead at age 73, withdrawing just 4% seems like an abundance of caution.

Tempted to bet on a short retirement? Keep three thoughts in mind. First, the big financial risk isn’t dying early in retirement. At that point, all your money troubles are over. Instead, the big risk is living longer than you ever imagined.

Second, average life expectancies are misleading, because there’s such a disparity among folks with different levels of wealth and education. If you count yourself among those who are affluent, healthy and well educated, there’s a good chance you’ll live three or four years longer than the general population.

Third, if you’re married or in a long-term relationship, you have two tickets to the life expectancy lottery. Even if your ticket turns out to be a dud, there’s a good chance your spouse or partner will live to a ripe old age. 

The Terrible Twenties

WHEN I WAS IN MY 20s, with two young children to provide for, I had neither an emergency fund nor nearly enough life insurance. I knew both were important—but I simply didn’t have the money to spare.

Make no mistake: Launching a financial life is daunting. Most twentysomethings have modest incomes, and yet they’re supposed to save for retirement, buy a car, build up an emergency reserve and put aside money for a house down payment, plus have all the necessary insurance coverage. And the financial stress often doesn’t stop there: Those in their 20s may also be servicing student loans and starting a family. Something has to give.

The prudent approach is to focus on risk—and that means your top priority should be amassing an emergency fund equal to as much as six months of living expenses, so you have a financial backstop in case you lose your job. But this is also the dreariest of financial goals. Who wants to worry about getting laid off?

It’s so much more fun to save for a house down payment and watch your retirement nest egg grow. Moreover, preparing for financial emergencies means stashing a heap of cash in conservative investments, where it will thereafter earn modest returns—and perhaps never be needed.

Meanwhile, you could be socking away money for retirement and reaping handsome financial benefits. For instance, if you fund your employer’s 401(k) plan, you will collect investment gains, enjoy an immediate tax deduction and possibly receive a matching contribution from your employer.

My contention: Funding your employer’s retirement plan should be the top priority—and, if necessary, it can double as your emergency fund. Financial heresy? Let’s say you are in the 15% federal income tax bracket and you put $2,000 in your employer’s 401(k) plan. Your out-of-pocket cost would be $1,700, thanks to the initial tax savings. At the same time, your employer matches your contributions at 50 cents on the dollar, with the matching contribution vested immediately. Result: Your $2,000 investment gets you a $1,000 match, bringing your account balance to $3,000.

If you are then laid off and forced to liquidate your retirement account to pay living expenses, you might lose 15% to federal income taxes, plus another 10% to the tax penalty for making a retirement account withdrawal before age 59½. That combined 25% hit would still leave you with $2,250, well above your $1,700 out-of-pocket cost. Moreover, if you are unemployed for a long period, you may have little taxable income in the year you cash in your retirement account, so your income tax bracket could be below 15%. The counterintuitive conclusion: For cash-strapped twentysomethings, funding a 401(k) could be the smartest way to build up an emergency fund.

Random

RECENTLY, I JOINED Creative Planning in Leawood, Kansas, as Director of Financial Education. This involves sitting on the firm’s investment committee, giving occasional speeches and writing a quarterly letter for clients. Want to read my first letter? Click here.

I was a guest last month on the PBS show Consuelo Mack WealthTrack. Check out the online video. On the show, I discuss my new book, How to Think About Money, which goes on sale Sept. 1. The Kindle edition is now available for pre-order.

Your 10 Most Important Financial Decisions

WHAT DOES IT TAKE to succeed financially? Here’s my list of the 10 most important choices you’ll ever make:

1. How much you borrow for college. Planning to become a journalist or a social worker? The lower your likely lifetime earnings, the less sense it makes to take on a heap of education loans.

2. What career you pursue. Obviously, the more you earn, the easier things should be financially—though this advantage is often frittered away through excessive spending.

3. How early in life you start saving—and how much you save each month.

4. How big a house you buy relative to your income. One way to waste a handsome salary: Purchase a home you can barely afford, leaving you starved of cash for other goals.

5. Whether you marry the right person. A quick way to lose half your wealth: Get divorced. The slower route: Marry someone with bad financial habits.

6. How often you replace your car. For the typical American family, cars are a huge financial drain, second only to housing. Is your sense of self-worth riding on the fanciness of your car, the size of your home and other possessions? You’re sunk.

7. Whether you make a lifetime commitment to stocks. Every year, there’s another terrifying reason to abandon the stock market. But if you look back at the market’s performance over your lifetime, you’ll likely wonder why anybody would invest in anything else.

8. Whether you have children. They’re more fun than guinea pigs, but a tad more expensive.

9. Whether you waste time and money on the foolish pursuit of market-beating gains. The reality: Your chances of beating the market over a lifetime of investing are so small as to be hardly worth considering.

10. When you claim Social Security. Remember, the big financial risk isn’t dying early in retirement. Rather, the big risk is living longer than you ever imagined—which is why most folks should delay Social Security until at least age 66 and perhaps age 70, so they receive a larger monthly check.

As you might have noticed, pure investment decisions don’t figure prominently on my list. One implication: If you’re grappling with the 10 decisions above, you will likely receive a fair amount of help from a good financial planner—but very little help from the typical stockbroker.

Moving and Shaking

THE CLEMENTS HOUSEHOLD has been in turmoil since May. After weeks of shoehorning our life’s possessions into endless cardboard boxes, we moved home and then, three days later, headed off for 10 days of vacation. My wife and I aren’t quite sure how we settled on this crazy schedule (though we’re pretty sure the other spouse is responsible). But we’re painfully aware of the result: It’s been months since we’ve had anything that felt like an ordinary day.

That might sound fun, but it has a big downside. When you’re in a routine, it’s much easier to spend thoughtfully, eat right, exercise regularly and handle the day’s tasks efficiently.

As someone once told me, “The routine is liberating.” At home, you quickly make the morning coffee, shower, dress and get on with the day. When you’re staying with friends, you hunt through their kitchen for the coffee filters, puzzle over how the shower works and crawl through your suitcase for the shirt you never packed.

On vacation, you also end up spending far more than usual—and in ways you never would at home. You eat out meal after meal. You blithely pony up huge sums for guided tours, museums and amusement parks. You buy worthless trinkets at ridiculous prices—knowing you’re overpaying, but feeling they are worth the price because of the memories that accompany them.

Moving brings the same out-of-control spending. You’ll often need to carry two residences for at least a short while. You’ll toss out stuff that seems too old or too troublesome to move, only to buy replacements for your new home. And when you’re packing and moving, who has time to cook? That’s more meals out—and, for those of us lacking in discipline, more dubious food choices.

Make no mistake: Staying put is a lot cheaper than moving around. For 20 years, I lived in the same, easily affordable house in New Jersey. Looking back, I realize that was crucial to my portfolio’s growth, because it allowed me to save gobs of money. Now that we’re settled in our new home, my hope is that the only way I’ll leave is feet first—but preferably not too soon.

Acquiring Wisdom

WHAT EXPLAINS AMERICA’S MISERABLY low savings rate? There’s no shortage of suspects. You could finger our lack of self-control, as well as our tendency to favor today’s spending and shortchange tomorrow’s goals. You can cite seven decades of post-war prosperity, which has made Americans confident they can weather financial storms, despite skimpy savings and hefty debts. You could blame rising aspirations amid increasing income inequality, which have left low-income families spending ever more as they seek to keep up with the Joneses.

To that list, here’s another potential culprit: We aren’t very good at figuring out what will make us happy. My 11-year-old stepdaughter is a regular reminder of this unfortunate fact: One day, she’s desperate to buy a particular piece of clothing or pair of shoes, confident that it’s the answer to all her fashion prayers—and the next day she’s on to something else. I can recall suffering from the same spending compulsion when I was a kid and, to a lesser degree, even in my 20s and 30s.

The good news: Our belief that happiness can be bought at the shopping mall seems to fade as we grow older. If we’re playing economist, we might argue that this is rational: The older we are, the less time we have to enjoy our new purchases, so it makes sense that possessions lose their luster.

But I’d argue it’s less to do with a rational economic thinking and more to do with wisdom acquired through repeated disappointment. By the time we reach our 40s and 50s, we’ve had many decades of eager spending and subsequent dissatisfaction—and the lesson has finally been hammered home. Instead, when we spend, we’re less focused on possessions and more on experiences—travel, concerts, dinner out with friends—which research suggests are far more likely to boost our happiness.

Committed

I PROMISE TO BEHAVE better tomorrow. What happens when tomorrow becomes today? All bets are off.

Our broken promises might involve money, such as committing to spend less, save more and pay down debt. Or they might involve some other aspect of our life, such as committing to eat healthier, exercise more and drink less.

All this highlights our irrationality. We may not be experts in nutrition, physical education and money management. But we have a pretty good idea of how we ought to behave. The challenge: getting ourselves to do it. When the moment arrives, our resolve falters and, soon enough, we’re ordering French fries.

How can we get ourselves to stick to our promises? Try four strategies:

Make it public. If you announce to friends and family that, within the next 12 months, you plan to save enough to make a house down payment, it’ll be that much harder to let the matter slide.Reveal all. Ask a friend whether you can discuss your financial situation with him or her, including sharing your account statements. Knowing that somebody else will be looking at your finances will likely spur you to clean up your act.Remove temptation. This evening, if you don’t want to have a drink or eat dessert, it’ll be a whole lot easier to show some backbone if you have neither booze nor ice cream in the house. Similarly, if you want to limit how much you spend at the mall this weekend, leave the credit cards at home—and instead bring cash equal to your shopping budget.Commit today for tomorrow. This is the reason I love 401(k) plans and automatic mutual-fund investment plans. You agree today to invest on a regular basis. Once that commitment is made, it quickly becomes a good habit that you’re unlikely to abandon, if only because of inertia.

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.