IF YOU BUY BONDS that pay a fixed rate of interest, your annual investment income will be stable—but the price of your bonds will fluctuate. With cash investments, it’s the reverse: You should never lose money with a savings account or a money-market fund, but the interest you receive will fluctuate along with short-term interest rates.
What about stocks? At first blush, there doesn’t seem to be any stability. Neither the price of your shares, nor the dividends they pay, can be counted on to stay the same. That said, the dividend income from a diversified collection of stocks should be far more stable than the price of those stocks, a topic I touch on in this week’s column.
For instance, over the past 50 years, the S&P 500 has had 12 years when it posted a price decline—but just five years when dividends decreased. Moreover, those dividend decreases were modest compared to some of the price drops suffered—and the long-run trend is impressive. Over the past 50 years, dividends have climbed 5.7% a year, comfortably ahead of the 4.1% inflation rate. That’s why I’m a fan of dividend-oriented stock funds, especially for retirees and those approaching retirement.
“TAKEN ALL TOGETHER, how would you say things were these days? Would you say that you are very happy, pretty happy or not too happy?” We now have the latest answers to this question, thanks to the release last month of results from the 2014 General Social Survey.
In 2014, 32.5% of Americans said they were very happy, versus a 42-year average of 33.3%. Meanwhile, 27% said they were satisfied with their financial situation, compared with a 42-year average of 29.6%. During this 42-year stretch, U.S. inflation-adjusted per capita disposable income grew 110%. In other words, our standard of living more than doubled—and yet both our overall level of happiness and our satisfaction with our financial situation are below their 42-year averages. Clearly, money hasn’t bought a whole of happiness.
Time, however, may help. Other studies have found that happiness through life is U-shaped, with our level of satisfaction often hitting bottom in our 40s. But this doesn’t show up in the General Social Survey. Instead, the survey found that overall happiness climbs as we grow older. The survey also found that our satisfaction with our financial situation increases with age, as does our job satisfaction.
WALL STREET LOVES WOMEN—or, at least, it loves to pitch them products through special marketing campaigns. While women’s financial needs differ somewhat from men’s—for instance, they live longer and they’re more likely to need nursing-home care—it’s always struck me that these programs are more about selling than substance.
For further proof, check out this delightful email I received last week: “I recently went to a workshop called ‘Retirement Strategies for Women’ that was put on by Valic. What did we do for most of the hour? We made a collage! They gave us a small poster and some stickers, and we each expressed what we like to do now that costs money (and what doesn't cost money) and what we hope to do in retirement that costs money (and what we would like to do that doesn't cost money). I think it was a way to visualize why we are saving money. At the end, the Valic representative offered to make appointments with us, presumably to actually discuss ‘retirement strategies,’ but I think more likely to hear about an annuity they are selling.”
My correspondent continued: “Anyway, the Valic woman was nice, and clearly she was following the Valic script, and making a collage was not terrible. But it was pretty ludicrous when you consider how much money some women have these days and the very real financial challenges we face. Also, most of the women I work with are professionals, and many of us have advanced degrees. Why would anyone at Valic think this is how they should approach us? I doubt they would do this to the men!
“I threw away my collage. But I thought the stickers they gave us to use were very telling of what they assume about women. One was of a kitten and a puppy, one was of sailboats, one showed a fancy dish from a restaurant, one showed a happy couple hiking, one had the word ‘Friends,’ etc. There were entire categories of life that were left out, but we made our collage from the life experiences Valic thinks we value.”
RISK POOLING is a great way to handle life’s financial pitfalls, and we’re happy to do it—most of the time. When we buy life insurance or we purchase a homeowner’s policy, an insurance company may be selling us the coverage. But what we’re essentially doing is tossing our dollars into a pot with other people. Those who see their homes burn down, and the families of those who die, collect big checks. Those of us who remain standing—and whose homes remain standing—don’t collect on our insurance policies. We’re out of pocket, but you won’t hear any complaints.
Unless, that is, we’re talking about a form of risk pooling known as an income annuity. Income annuities come in all kinds of flavors, as I detail in my latest column. But the idea is basically the same: We pool our money with other retirees. The insurance company that manages the pool is able to promise handsome income for life because it knows that, while some retirees will collect checks until they’re age 95, others will only collect until 75.
Why do folks—who happily buy life, health, disability, auto and other insurance—balk at this type of risk pooling? Maybe it’s the taint associated with the label “annuity.” Most of the abuses over the years, however, have involved equity-indexed annuities and tax-deferred variable annuities, not the income annuities I favor—immediate fixed annuities and deferred income annuities, otherwise known as longevity insurance.
Or maybe it’s the double bummer: If we die early in retirement, not only do we fail to get much back from our big annuity investment, but also we’re well and truly dead. Hate the idea of sinking $100,000 into an income annuity and then keeling over a few years later? There’s a silver lining: At least it isn't a decision you’ll live to regret.
I JUST FINISHED READING the Society of Actuaries’ summary of key findings from its “2011 Risks and Process of Retirement Survey Report.” From this, you might conclude two things. One, I’m way behind on my reading. Two, I don’t have a very exciting life. Both may be true. Still, I found the report fascinating. Here are three excerpts.
First, according to the report, “the two major factors in determining longevity are genetics and lifestyle choices. Studies have shown that genetics account for 20 to 30 percent of life expectancy until about age 80. However, after that age it becomes close to 100 percent.”
Second, “recent studies have shown that in the poorest part of the United States, life expectancy at birth is as low as in countries like Panama or Pakistan, a full 15 years behind the wealthiest and healthiest regions of the nation, where it rivals that of world leaders, Switzerland and Japan.”
Finally, “one actuarial research study predicts that for a healthy male age 65, 80 percent of his remaining lifetime will be spent non-disabled, 10 percent in mild to moderate disability, and another 10 percent in severe disability. For females, the corresponding disability percentages are considerably higher, with 70 percent in healthy status and approximately 15 percent in each of the two stages of disability."
MOST OF US STRUGGLE with self-control. We eat too much, exercise too little and spend excessively. One solution: Adopt rigid rules of behavior. For instance, I make it a rule to exercise every morning for at least 40 minutes, always buy whole wheat bread, avoid caffeine after 9 a.m. and eat fruit as a midmorning snack. I've followed these rules for so long that they’re no longer rules, but rather ingrained, unquestioned habits.
Not surprisingly, I've also used this approach with my finances. When I worked fulltime, I made it a point every year to max out my 401(k) and IRA. When I had a mortgage, I always added at least a little money to the monthly check as an extra-principal payment. When I bought cars, I made it a rule to pay cash.
Today, in my semi-retirement (which—go figure—means I’m working harder than ever), I follow fewer financial rules. I limit my spending to whatever I can earn from my writing and I always pay off my credit-card balance in full on the day I get the bill. There’s nothing particularly clever about these rules. But they keep me on the financial straight-and-narrow, and they do so without much thought or worry on my part.
THIS IS GRADUATION SEASON at colleges across America. That prompted me to write a column this week about human capital—which is our income-earning ability—and why it should be central to how we think about our finances.
Got a kid graduating this year? Here are three additional pieces of advice you might pass along.
First, deal with your financial goals concurrently, not consecutively. In other words, don’t save for the house down payment in your 30s, the kids’ college in your 40s and then turn your attention to retirement in your 50s. If you do that, it will be almost impossible to amass enough for a comfortable retirement. Instead, even as you put aside money for other goals, make saving for retirement a priority from the day you enter the workforce.
Second, strive to keep your fixed living costs low. In particular, look for inexpensive housing. The lower your fixed monthly costs, the more money you’ll have for discretionary “fun” spending, the less financial stress you’ll suffer and the easier you will find it to save.
Third, think carefully about which investments you buy for your taxable account. If you purchase an actively managed stock fund that proves to be a lackluster performer or you make a big, undiversified bet on individual stocks, correcting that mistake could trigger a hefty tax bill. Instead, I’d favor broadly diversified stock-index funds with low annual expenses. These funds shouldn't produce performance surprises or generate big annual tax bills, so you should be happy to hold them for many decades—and perhaps for the rest of your life.
EVERY WEEK I seem to do at least a few radio shows. But when it comes to reaching listeners, almost nothing rivals National Public Radio. Today, I had the good fortune to be on “Here & Now” talking about inflation and what it means for your finances. Check out the audio clip.
While I’m pounding my chest, I figure I’ll mention the two awards won by the “Jonathan Clements Money Guide 2015.” It collected a silver medal in the Axiom Business Book Awards and was named money-management book of the year by the Institute for Financial Literacy.
STOCKS DELIGHT IN MAKING FOOLS of short-term market forecasters. That’s why I don’t just avoid predicting the stock market’s direction. I also try to avoid even the appearance of making a prediction. But this week, I’m on thin ice.
With my latest column, I argue that stocks are unlikely to return to historical average valuations, except in a severe bear market. That might seem like good news, but it means long-run returns will probably be lackluster, because we’re starting from such rich valuations.
The danger with this sort of column: It gets published, the Dow Jones Industrial Average promptly plunges 20%, the nuances of the article are ignored and the author is held up as a complete idiot. So the story gets published this morning on WSJ.com and the Dow industrials immediately tumble 195 points. Fortunately, that’s only a 1% decline. Another 19% and you’ll find me in the fetal position.
IT’S ONE OF THE STRANGER arguments for claiming Social Security retirement benefits at age 62—but I’m hearing it with increasing frequency. The contention: We should claim benefits early because we’ll enjoy the money more in our 60s, when we’re traveling and spending more, than in our 80s, when we’ll likely be sticking closer to home. This argument has been showing up in the batch of emails I’ve been receiving in response to my latest column.
It isn’t clear to me that we should expect to spend less in our 80s, when we may have significant medical expenses. It also isn’t clear to me that money buys less happiness in our 80s. I find it hard to imagine what the octogenarian version of me will be like.
Still, let’s assume that both contentions are true—that we will spend less in our 80s and that we will get less pleasure from our money. So what? Even if we need less income at that juncture and even if we don’t enjoy the money we spend, we still need to pay the bills.
In other words, pleasure has nothing to do with it. As retirees, the challenge is to manage our money so we have enough income for every phase of our retirement, no matter how long we live. For many of us, the right strategy—as I explained in a recent post—is to delay Social Security until age 66 and perhaps age 70. That’ll give us a larger stream of guaranteed lifetime income, thus reducing the risk of poverty if we live to a ripe old age. What about all the traveling we want to do in our 60s? To pay for it, we can simply draw more heavily on our savings, knowing these withdrawals will slow once we start collecting Social Security.
EVER HEARD OF SHOPKINS? Until six weeks ago, I was blissfully ignorant. But suddenly, it was all my 10-year-old stepdaughter could talk about. Shopkins are small made-in-China plastic creatures that depict everyday household items—think coffee pots, pieces of cake and toilet plungers—with faces crafted onto them and holes so they can rest atop pencils.
Sarah’s friend Nadia had pronounced Shopkins “cool” and owned more than 100. Sarah was soon scrounging up every penny she could find to invest in Shopkins. Her collection quickly topped 50. A flourishing market sprang up during recess at PS9, as kids dumped lesser Shopkins and tried to upgrade their collection. Over dinner, Sarah would regale us with stories of the day’s feverish trading activity.
And just like that, it was over. Some contrary child suggested that maybe Shopkins weren't all that cool, and within days the fad was over. Like tulip bulbs in 1637 and Internet stocks in 2000, interest in Shopkins collapsed with shocking speed. Sarah’s plastic creatures now sit neglected in her room, not far from her collection of Eos lip balms and Disney pins—and, at dinner, Sarah talks of other matters.
I JUST PURCHASED A 2013 HONDA CRV. I told the “sales consultant” that I was paying cash. He tried to convince me to take out an auto loan, but I explained that borrowing at 3.4% didn’t make sense when I had cash in a savings account earning 0.25%.
Next, he asked whether I had ever considered leasing. I replied that leasing can make sense if you want to drive a new car every three years—but getting a new vehicle every three years was an expensive habit and I planned on keeping the car far longer. When you lease, your initial payment may be smaller than when you buy a car, but the monthly payments often aren’t that much lower, the auto-insurance premiums are typically higher and you don’t own anything at the end of the lease. That’s when the salesman told me that he always leases—and I was reminded of a phenomenon I’ve seen again and again on Wall Street.
I have spoken to plenty of securities salesmen and women who sell costly products like variable annuities, cash-value life insurance and equity-indexed annuities. The surprise: Many of these folks own these products themselves. That suggests they’re true believers, which probably makes them better salespeople. But it also suggests they don’t truly understand how expensive these products are and how unlikely they are to generate decent investment returns.
YESTERDAY, I RECEIVED AN EMAIL from a broker in Texas with the subject line: "Why do you want to put good honest advisors out of business?” The broker argued that I was being unfair in favoring advisors who charge fees over brokers who charge commissions.
My response: “You've convinced me that you do a fine job for your clients. But there's plenty of evidence that many advisors don't. Their clients—to use your phrase—need to get ‘a fair shake.’ How can we improve the odds that, when an individual ignorant of the financial world walks into a broker's office, that individual doesn't end walking out with a fistful of inappropriate, excessively expensive products? Charging fees rather than commissions isn't a panacea. But it does improve the odds of a happy outcome.”
The fact is, a commission-charging broker has an incentive to get clients to trade and to buy higher-commission products. Yes, there are also problems with charging fees. An advisor that’s levying, say, 1% of assets might push clients to save too much (hardly a terrible thing) or discourage them from taking money from the portfolio to pay down debt (more of a problem). Still, paying a percentage of assets is a fundamentally better arrangement: Both the advisor and client want the same thing, which is to see the client’s portfolio grow, so the client gets richer and the advisor’s fee increases.
WHEN WE WANT TO DESCRIBE something as wholesome, we say “it’s as American as motherhood and apple pie.” Parenting may indeed be virtuous. But does it make us happier? The research is mixed.
On average, people with kids say they’re happier. But if you dig into the data, it turns out that having children neither helps nor hurts happiness, and instead the big boost to happiness comes from being married. Indeed, folks who are single—both those raising children and those who aren’t—report being distinctly less happy than those who are married.
Clearly, raising children can involve additional daily stress. But what happens when parents sit back and evaluate their overall lives? As someone who has raised two children and is helping to raise two stepchildren, I believe having kids has made my life richer. But maybe I’m deluding myself. The research has found that, on average, parents evaluate their overall lives no better than those without children.
RISK IS PERHAPS THE MOST IMPORTANT notion in finance—and yet one that receives too little attention from most folks. Like investment costs, and unlike future investment returns, we have a fair amount of control over risk, so it’s worth spending serious time thinking about what risks we face and which ones we want to limit.
I discuss risk in my latest column, which looks at some of the major financial dangers we face. In writing the column, I was reminded of the 17th century philosopher and mathematician, Blaise Pascal, and what’s come to be known as Pascal’s wager. As Pascal saw it, it was rational to believe in God. If you believed and it turned out there was no God, the price was modest—a life with a little less immorality. But if you didn't believe and it turned out God existed, the price was somewhat higher—an eternity roasting in hell.
In other words, we should focus less on the odds that we will be right or wrong, and more on the consequences. Yes, you might get lucky and make it successfully through life with no health insurance, a badly diversified portfolio and a few heavily mortgaged rental properties. But consider the consequences if your luck isn't so good.