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.
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.
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.
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.
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.
“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.
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.
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.
TOO MUCH CHOICE can be paralyzing. This is the reason many 401(k) plans have winnowed the list of funds they offer: Thanks to the smaller selection, participants are less likely to feel overwhelmed—and more likely to make an investment decision, rather than leaving their cash to languish in the plan’s money market fund.
I think this is a good strategy for other areas of our finances. For instance, you may make smarter investment decisions if you limit your choice by, say, deciding that you’ll never purchase individual stocks. You might also decide that you’ll stick with mutual funds from a single major fund company—think Fidelity, T. Rowe Price or Vanguard—or, alternatively, that you’ll purchase only index funds.
Similarly, you could narrow your room for maneuver by developing a written asset allocation, where you specify which market sectors you’ll invest in and what percentage of your portfolio you’ll allocate to each. You might earmark perhaps 30% for high-quality corporate bonds, 5% for real estate investment trusts, 5% for emerging stock markets and so on. That’ll still leave you with the decision of which investments to buy for each slot in your portfolio, but you’ll no longer be swimming in a pool of uncertainty that’s quite so large.
You might even use this strategy in other areas of your life, with a view to reducing uncertainty, saving time and perhaps also improving your own behavior. For instance, you might opt to do all your online shopping at Amazon, limit yourself to salads at lunchtime and only allow yourself to eat out twice a week. I think such rules can be useful, but there is a downside. You may reduce uncertainty by narrowing your choice. But these self-enforced rules can also introduce a new element of uncertainty, because you could find yourself wrestling with whether to follow your own rules—or stray from the straight-and-narrow path you chose for yourself.
RESTAURANT MEALS are my biggest discretionary expense. Want me as one of your customers? Here are my seven rules for restaurants:
- If I made a reservation, don’t make me wait 10 minutes for a table.
- Dim the goddamn lights. I look better in the dark. So does your restaurant.
- Never sell a wine I can find in the liquor store. It’s one thing to suspect you’ve marked up the bottle by 300%. It’s another thing to know with absolute certainty.
- Never offer a choice of salad or French fries. That’s just cruel.
- Of course we want to see the dessert menu.
- I was looking forward to that last sip of wine in the glass you just took away.
- Thanks for not telling me that you automatically added the tip.
THIS WEEKEND, I have been clearing out old computer files that contain half-baked column ideas that never saw the light of day. One such file contained jokes that brokers tell about everyday investors.
My goal was to illustrate the disdain with which Wall Street views its clients. Indeed, I can’t think of another business that is so scornful of its customers, regularly belittling their intelligence and viewing them not as clients to be helped but as sheep to be shorn. But most of the jokes I managed to collect were, alas, pretty lame, which was probably why I never finished the column. Still, here are two jokes that just about pass muster:
- Broker pitches a stock to a client. “Put me down for 100 shares,” the client grudgingly agrees. “But for goodness sake, as soon as I get back to even, sell.”
- How many small investors does it take to change a light bulb? Two. One to unscrew it and drop it, and the other to buy it just before it crashes.
IF THERE’S MONEY you’ll need to spend in the next 12 months, you don’t want to put it at risk, so savings accounts, money market funds and similar cash investments are the only prudent choice. But as your time horizon lengthens, holding cash becomes less and less appealing. The reason: Your money’s purchasing power is pretty much guaranteed to shrink, once inflation and taxes take their toll.
Got cash in your long-term investment portfolio? You should move it into something that offers a higher return. For instance, shifting from Vanguard’s prime money market fund to its short-term corporate bond index fund would give you an extra 1.4 percentage points in annual yield. The danger: If interest rates climbed one percentage point, the short-term bond fund would suffer a 2.8% price drop—a loss you would eventually recoup through the higher yield, but it would take two years.
Of course, if you’re a truly long-term investor, you would probably want to opt for something with the prospect of even higher returns—meaning stocks. Suddenly, the potential short-term loss is a whole lot larger, as we know from the S&P 500’s 49% price drop during the 2000-02 bear market and its 57% swoon in 2007-09.
That possibility is enough to paralyze many investors. How can you unfreeze yourself? Start by deciding what percentage of your portfolio you want in stocks. How can you get from here to your target stock allocation? History tells us that you’ll clock the highest return by moving everything into stocks right away. This is no great surprise: The broad market rises over time, so buying sooner will, on average, give you a better result.
Problem is, you won’t get an average result. Instead, you get just one shot at moving all that cash into stocks, and buying all at once risks buying just before a major crash. The older you are and the bigger the sum involved, the more cautious you’ll want to be.
My suggested strategy—which regular readers have heard before: Take the money you want to move into stocks and divide it into 24 or 36 chunks. Move one chunk into stocks every month, with the goal of being fully invested within two or three years. If share prices drop 15% from current levels, double your monthly purchases. If the market falls 25%, triple your purchases.
What if you settle on a target stock allocation—and discover you currently have too much in stocks? While I favor the low-risk strategy of buying stocks slowly, I advocate selling quickly.
Many folks, of course, do just the opposite: If they discover they have too much in stocks, they will often slowly ease out of the market. This is all about aversion to regret: They hate the idea that they’ll sell a big chunk of stock and the market promptly rockets higher. But remember, while buying stocks slowly reduces risk, selling slowly increases it—because you stay over-weighted in stocks for longer and the market could go against you.
HOW DO OUR FINANCIAL HABITS STACK UP? Academics Cristian Badarinza, John Y. Campbell and Tarun Ramadorai compared U.S. households with those of 12 other developed nations. Here are some highlights:
- Almost 50% of U.S. households are invested in the stock market, versus 34% in Finland, 25% in Spain, 24% in Germany and 23% in France.
- Defined contribution retirement plans—think 401(k) plans and their ilk—are widespread in Australia, the U.K. and U.S., but are far rarer in continental Europe.
- When investing outside a retirement account, folks in Australia, Spain, France, the U.K. and U.S. are far more likely to own individual stocks than mutual funds.
- In 12 of the 13 countries, more than half of all households own their main residence. The outlier: Germany, where just 44% of households own their principal home.
- Fixed-rate mortgages are the overwhelming choice of U.S. and German home buyers, while adjustable-rate mortgages are far more common in Australia, Finland, Italy and Spain.
- Almost 75% of U.S. households are in debt—the highest of the 13 countries. Canada, Australia and the Netherlands aren’t far behind. Meanwhile, Italians are surprisingly prudent, with just 25% of households in debt.
- Homeownership is widespread in Greece and Italy—but mortgage debt isn’t. Just 10% of Italians have a mortgage on their primary residence and just 14% of Greeks, versus 47% in the U.S.
- Australian and U.K. households boast the highest median net worth, as measured by the value of their homes, financial accounts and other assets, minus all debts. What about those poor southern Europeans, with their rocky economies? Thanks to widespread homeownership and an aversion to debt, the typical household net worth in Spain, Italy and Greece is higher than in the U.S. or Germany. So where do the U.S. and Germany rank among the 13 countries studied? Citizens of these two economic powerhouses may enjoy relatively high incomes—but, if you look at the typical household, they’re at the bottom in terms of net worth.
- While the typical U.S. household—meaning the family that’s halfway down the wealth spectrum—doesn’t look so good in terms of net worth, it’s a different story if you look at average net worth. This average, which measures total household net worth divided by the number of households, is boosted by the hefty holdings of America’s wealthy. Result: Among the 13 nations, the U.S. ranks 12th on typical household net worth—but fourth on average net worth.
YOU WOULDN’T WANT to spend your entire life in the 0% tax bracket, but it’s a nice place to visit. Got stocks or stock funds in your taxable account? If you sell them in the right year, you could realize capital gains of almost $100,000 and perhaps more—and pay a 0% federal capital gains rate.
I was reminded of this loophole as I was flipping through Phil DeMuth’s latest book, The Overtaxed Investor, an amusing and easy read—not words often used to describe a tome on taxes.
Let’s say you’re out of work or you just retired and haven’t yet claimed Social Security. As things stand, you don’t expect any taxable income in the current year. To take advantage of the situation, you might convert a portion of your traditional IRA to a Roth. Part of the conversion won’t be taxed, thanks to your personal exemption and your standard or itemized deduction. But if you convert more than a modest sum, you’ll owe at least some income taxes. Nonetheless, that tax bill may be a small price to pay to get the money into a Roth, where it’ll grow tax-free thereafter.
But here’s an alternative way to exploit your low-tax year: You might sell stocks or stock funds in your taxable account that have unrealized capital gains. This isn’t worth doing if you’re happy with the holdings and plan to hang on to them until you die, at which point the embedded capital gains tax bill will disappear, thanks to the so-called step up in basis. But if you aren’t happy with the stocks or stock funds, or you know you’ll have to sell eventually, this could be the chance of a lifetime.
How so? In 2016, if you’re single and you claim the standard deduction, you could have income of as much as $48,000 and stay within the 15% federal income tax bracket. If you’re married filing jointly, the threshold would be twice as high—$96,000. Itemize your deductions? These figures may be higher still. The beauty of this tax situation: If your total income stays within these limits, any income would be taxed at 15% or less—but your long-term capital gains would be dunned at 0%. That isn’t a typo. Keep in mind that, to qualify for this 0% rate, you have to hold your stocks or stock funds for more than a year.
To be sure, there could be some tax cost involved. For instance, depending on your total income, you might have to pay taxes on your Social Security benefit, you could lose various tax credits and you might have to pay state income taxes. Still, the tax hit will likely be fairly modest—and the benefit substantial.
THE GLOBAL FINANCIAL MARKETS consist of four sectors of roughly equal size: U.S. stocks, U.S. bonds, foreign stocks and foreign bonds. Why would you bet on just one of those four sectors--specifically U.S. stocks? That's the topic I tackle in my latest free newsletter. The newsletter also discusses my enthusiasm for emerging stock markets and offers a slew of intriguing statistics. Want to view earlier newsletters? Check out the articles page. Want to be on the distribution list for future issues? Shoot me an email.