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.
ANNUITIES ARE OFTEN DISMISSED as costly, complicated contraptions that are more lucrative for Wall Street than investors. Still, I believe there are three types that can sometimes make sense for investors.
Some background: The term “annuity” covers a multitude of products. All are backed by an insurance company. But it sometimes seems like that’s the only thing they have in common.
There are variable annuities where your results vary with the investments you select and fixed annuities where your return used to be fixed, but now can vary thanks to the abomination known as equity-indexed annuities. There are tax-deferred annuities that are designed for retirement savers and immediate annuities for those already retired and looking to generate income. But tax-deferred annuities are now also used to generate retirement income, thanks to “living benefits” riders.
Confusing? You bet. Rather than tell you why so many of these are horrible products, let’s focus on the three reasonable choices.
First, if you’ve maxed out on both your employer’s retirement plan and your individual retirement account, and you’re inclined to buy tax-inefficient investments like taxable bonds and real-estate investment trusts, there’s a case for funding a low-cost variable annuity. The term “low cost” is the crucial qualifier here—and all roads lead to Vanguard.
Second, if you’ve already delayed Social Security to age 70 and you’re looking for more lifetime income, I would consider an immediate-fixed annuity. Unlike a variable annuity, an immediate-fixed annuity is a simple product with relatively low implied costs. The income you receive depends on prevailing interest rates when you buy, which means immediate-fixed annuities aren't super-attractive right now.
Third, I see a role for deferred-income annuities, also known as longevity insurance. You might buy a deferred-income annuity at, say, age 65 that will pay income starting at age 85. This can take a lot of the uncertainty out of retirement planning, because it frees you up to spend down your remaining savings, knowing you’ll have a regular stream of income waiting for you, should you live to a ripe old age.
IF THERE’S ONE NUMBER that drives your financial life, it’s your fixed living costs. We’re talking here about regular expenses that are pretty much unavoidable, such as mortgage or rent, car payments, property taxes, utilities, insurance premiums and groceries.
Why are fixed living costs so important? There are five reasons. First, the lower your fixed living costs, the easier you’ll find it to save. Many folks who struggle to save are, I suspect, boxed in by hefty home and car payments.
Second, low fixed costs mean you need less income to retire in comfort. One way to slash those fixed costs is to get your mortgage paid off before you quit the workforce, and perhaps also trade down to a smaller place.
Third, if hold down your fixed costs, you can probably get by with a smaller emergency fund. After all, if you lose your job, you’ll need less from savings every month to keep the household running.
Fourth, lower fixed monthly costs mean less financial stress. You won’t be constantly worrying about how to pay the bills.
Finally, lower fixed costs can translate into greater happiness. The spending that brings us the most pleasure tends to be discretionary spending—things like eating out and going on vacation. If you have lower fixed costs, you’ll have more money left over for the fun stuff.
IT’S THE NEVER-ENDING DEBATE: When should retirees claim Social Security? This piece, I hope, will at least serve to clarify the basic math involved.
Let’s dispense with a few preliminaries. If you have young children, it may be worth claiming at age 62, so your kids can receive family benefits. Meanwhile, if you’re married and you were the main breadwinner, it’s probably worth delaying benefits to age 70 to get the larger monthly check. This is true even if you are in poor health. The reason: Your benefit may live on as a survivor benefit for your spouse.
But today, we’re keeping it simple. Let’s assume you are single and your full Social Security retirement age is 66. You’re trying to decide between a monthly benefit of $750 starting at 62, $1,000 at 66 or $1,320 at 70. Your plan is take the money and invest it in high-quality bonds, and you want to know what the breakeven age is. In other words, if you take benefits later, at what age would the monthly checks you’ve collected be worth more than taking benefits at 62?
It’s time for a few more preliminaries. Social Security benefits rise each year with inflation, so you need to figure that into the calculation. To make things easy, I like to think in terms of real (after-inflation) returns. For instance, if 10-year Treasury notes are yielding 2% and inflation is 2%, your real return is 0%.
What if you plan to invest in stocks, not bonds? The potential return is higher—but so, too, is the risk. As I mentioned in a recent blog, it simply isn’t fair to compare a relatively sure bet (the government keeps paying Social Security) to something so uncertain (lest anyone has forgotten, stocks lost roughly half their value twice in the past 15 years). Instead, if there’s an investment alternative to Social Security, it should be high-quality bonds.
Let’s consider three scenarios in which high-quality bonds deliver after-inflation returns of 0%, 1% and 2% a year. Based on those three real returns, how long would you have to live to make delaying benefits worthwhile?
If you delay from age 62 to 66 and you’re investing in bonds that deliver a 0% real return, you’ll be ahead shortly after you turn age 78. Meanwhile, at a 1% real return, delaying benefits to 66 will put you ahead if you live to age 80, while a 2% real return will put you ahead by age 81. What if you delay benefits from age 62 to 70? You’re ahead at age 81 assuming a 0% real return, 82 assuming a 1% real return and 83 assuming a 2% real return.
So how long can retirees expect to live? According to the Social Security Administration, the median life expectancy for a 65-year-old man is age 84, while a woman can expect to live until 87.
RESEARCH ON MONEY AND HAPPINESS has had a profound impact on my thinking. It isn’t that the insights are so startling. With a little reflection, you quickly realize the validity of the research findings—that friends and family are crucial to happiness, that we quickly adapt to material improvements in our lives, that commuting is a wretched activity, that it’s better to spend money on experiences rather than things, that engaging in work we’re passionate about can be among our happiest times.
But, at least for me, the various academic studies have helped bring all of this into focus. It’s prompted me to arrange my life so I don’t have to commute, arrange my days so I spend them doing work I love, and arrange special times with my children, stepchildren and other family members. I had the latter in mind when writing my most recent column, which is devoted to getting the most out of our vacation dollars. We save now so we can spend later—and great experiences are, I would argue, among the best uses of our hard-earned dollars.
AMONG EXPERTS ON SOCIAL SECURITY, there’s a broad consensus that most folks should delay Social Security to get a larger monthly check—and yet roughly half of retirees claim benefits at 62, the earliest possible age.
Many of these retirees, I suspect, take benefits right away because they need the money or they haven’t given the issue much thought. What about those who have wrestled with the topic and still insist that claiming at 62 is the right strategy? If the emails I receive are any indication, including the ones in response to my latest column, people believe there are three reasons to take benefits right away.
First, they think the politicians will slash Social Security benefits, so they should get whatever money they can now. Second, they believe they can earn a higher return by taking benefits early and investing the money. Third, they figure their spending will be higher early in retirement, when they’re more active, so it makes sense to claim benefits right away.
My response? First, Social Security benefits may indeed be cut—but it’s hard to imagine any politician hoping to get reelected would cut benefits for existing retirees. Instead, any cuts would likely apply only to those 10 or 15 years from retirement age.
Second, you might come out ahead by claiming your Social Security benefit early and investing in stocks. But given the different level of risk involved, that’s like comparing apples and oranges. A more appropriate comparison is between Social Security and high-quality bonds. Based on that comparison, you’d be better off spending down your bonds and delaying Social Security, assuming you live to an average life expectancy.
What about the argument that you spend more early in retirement? Even if that’s true, that is hardly a reason to claim Social Security early. If you need more spending money, you could always draw more heavily on your savings.
BESTSELLING AUTHOR Thomas J. Stanley died in a car accident over the weekend at age 71. His death has received scant publicity—which is surprising, given the popularity of his books and his impact on the way we think about money.
With co-author William Danko, Stanley wrote the 1996 blockbuster, “The Millionaire Next Door.” Who are the rich? It isn’t the folks with the flashy cars and designer clothes. Those aren’t signs of wealth. Rather, they’re signs of lavish spending, and the people involved are poorer for it.
Instead, the typical American millionaire is the couple who live in a modest home, drive their cars until the bumpers drop off and buy their clothes at J.C. Penney. Thanks to their frugality, they're voracious savers--and that, more anything, has helped them to amass seven figures. This was Stanley’s powerful insight—which was not only a great rebuke to conspicuous consumption, but also a roadmap for everyday Americans who want to accumulate significant wealth.
IF THERE’S MONEY TO BE MADE, Wall Street is relentless. What if it’s time-consuming, with no extra payoff? Don’t expect a whole lot of help.
That brings me to the obvious starting point for every financial decision: What’s the goal? Many financial advisors are happy if you just tick the appropriate boxes: retirement, college, house down payment, insurance, whatever.
But to make the right financial decisions—and create the motivation to save diligently—you need to dig deeper, fleshing out exactly what you want to achieve and why. That’s the subject of my latest column. The column followed what’s become the standard publication schedule for my articles: It was carried in Saturday’s Wall Street Journal, and also posted to WSJ.com, a subscription website. But today—Monday—it was made available through MarketWatch.com, a free site.
BONDS SHOULD BE BORING—and that’s how I usually manage my portfolio. My taste typically runs to low-cost short-term corporate-bond funds, supplemented with occasional purchases of certificates of deposit.
But there’s one major exception: I have roughly 3% of my overall portfolio in a low-cost emerging-market debt fund. This is not a low-risk investment. According to Morningstar, emerging-market bond funds lost an average 18% in 2008, before bouncing back 32% in 2009. Clearly, owning emerging-market debt is more akin to investing in stocks.
So why did I buy? The fund doesn’t fit neatly into my portfolio’s design and I doubt it’ll add much diversification. Still, here’s my (self) justification: The fund has a yield of almost 5% and—unlike, say, a high-yield junk-bond fund—I’m not so fearful of defaults. Indeed, I suspect the credit rating of emerging-market debt will be upgraded over time, as emerging-market economies continue to mature. Meanwhile, over the next 10 years, the 5% yield may rival the total return from blue-chip U.S. stocks, especially given today’s lofty stock-market valuations, plus I’m getting the return in relatively assured yield, rather counting on share-price gains. My hope: The fund will give me close to stock-market returns with somewhat lower risk.
“HOW TO THINK ABOUT MONEY.” That’s the tentative title for a new book I’m working on. It probably won’t see the light of day until early next year, after I get the 2016 edition of the Money Guide out the door.
What’s the new book about? My goal is to pull together five strands that define my financial philosophy. First, the connection between money and happiness is surprisingly tenuous. That means we need to think carefully about how we spend and what goals we pursue. Second, our long life expectancy should change the way we handle money, including preparing for midlife career changes, and worrying less about dying young and more about how we’ll cope if we live an astonishingly long time.
Third, we regularly make mental mistakes and seem hardwired for financial failure. Result: Getting and staying on track financially takes great discipline, much self-awareness—and a little trickery. Fourth, we ought to take a broad view of our finances, one that encompasses our human capital, debts, investments and more, and which involves thoughtfully trading off one goal against another. Finally, the surest way to win the financial game is to focus less on scoring big gains and more on limiting losses, whether it’s the corrosive impact of investment costs and taxes or the devastation caused by panic selling during a market decline.
MOST OF US WILL ENJOY wonderfully long lives. For those born in 2000, the average life expectancy at birth was age 80 for men and 84 for women. That’s a vast improvement since 1900, when life expectancy was age 52 for men and 58 for women. The bad news: While men can now expect to live 28 years longer and women 26 years longer, the bulk of the improvement—20 years—came in the first half of the 20th century. Indeed, the Social Security Administration projects that, for men born in 2100, life expectancy will be just seven years longer than it was in 2000, while women’s life expectancy will be just six years longer. Medical advances could change that, of course, but it seems the biggest improvements in life expectancy are now behind us. Maybe our great-great-grandchildren won't be regularly living to 100.
But there’s also good news: The longer we live, the longer we can expect to live. When today’s 65-year-olds were born in 1950, the life expectancy was age 72 for men and age 78 for women. But those figures include all the unfortunate individuals who never made it to age 65. Among those still alive today at age 65, the life expectancy is 84 for men and 87 for women. Moreover, these are just medians. Half of all folks will live longer. Among today’s 65-year-olds, roughly 25 percent will live to at least age 90 and 10 percent to at least age 95. With that long life comes two key issues. First, we need to figure out what will keep us happily employed for four decades and perhaps longer. One career may not be enough. Second, we need to pay for a retirement of uncertain length, but which might last 20 or 30 years.
ESTATE PLANNING IS EASY for most folks—but many don’t bother. Surveys regularly find that half of all adults don’t have a will. Yet a will, the right beneficiaries listed on retirement accounts and life insurance, and correct titling on property (such as the house you own jointly with your spouse with right of survivorship) are all most of us need.
Sure, there are other niceties, like drawing up durable powers of attorney for financial and health-care matters, getting a revocable living trust to avoid probate, and writing a letter of last instruction. But in terms of making sure your stuff ends up with the right people, everything should be in order if you have a will, the right beneficiary designations and correct titling on jointly owned property. And getting a will is neither expensive nor difficult. You can create one online for less than the cost of dinner out. Once you’ve drawn up a will, you’ll need to get it notarized. I went to the local UPS Store. It cost a whopping $2.