WE’RE IN A WORLD of low investment returns. Bond yields are tiny—and bond investors can’t reasonably expect to earn anything more than those yields. Money market funds, savings accounts and other cash investments are even worse.
Meanwhile, economic growth is muted and stock valuations are rich, suggesting lackluster stock returns. My best guess: Over the next decade, a globally diversified stock portfolio might return 5% to 6% a year and a mix of high-quality corporate and government bonds could clock 2% to 2½%, while U.S. inflation runs at 1½% to 2%. And remember, those returns are before investment costs and taxes.
My low expectations don’t put me on the lunatic fringe: Many observers now expect modest gains from the financial markets. Vanguard Group founder John Bogle recently told The Wall Street Journal that, over the next decade, stock investors would be lucky to earn 2% a year after costs.
Problem is, a somewhat rosier view is baked into the financial calculators used by many investors. For instance, for its FuturePath and retirement income calculators, T. Rowe Price assumes stocks will return 4.9% a year more than inflation, bonds 2.23% and short-term investments 1.38%. (To T. Rowe Price’s credit, it also adjusts for potential expenses.)
The retirement planner at Dinkytown.net allows you to override its return assumptions. But if you don’t—and I suspect that would be most users—the calculator assumes your investments earn a generous 7% a year before retirement and a more reasonable 4% after retirement, while inflation runs at 2.9%. The obvious danger: Investors rely on those assumptions—and end up spending too much and saving too little.
RISING LIFE EXPECTANCIES, coupled with slower population growth, have a huge impact on how we should manage our money. Indeed, I devote an entire chapter to the topic in my new book. Here are seven key financial implications of today’s momentous demographic shift:
1. Economic growth will be slower. Over the past 50 years, half of the economy’s 2.9% annual growth has come from increasing the number of workers and half from increasing the productivity of all workers. But with the labor force projected to grow at 0.5% a year, rather than 1.5%, economic growth will almost inevitably be slower. That means slower growth in corporate profits and hence lower stock returns. To compensate, we need to save more for retirement and our other goals.
2. We can’t all retire in our early 60s, because there won’t be enough folks in the workforce to produce the goods and services that society needs. Economic pressure—which might take the form of rising taxes, cuts to Social Security and Medicare, higher inflation or lower investment returns—will keep many of us working well into our 60s and perhaps even our 70s.
3. We’ll need more than one career to get through our working years. Even if global competition and technological innovations don’t force us to change careers, we’ll likely want to. Four or five decades is an awfully long time to do the same thing.
4. Retirement is becoming more expensive. With median life expectancies heading toward age 90, folks will need larger nest eggs to pay for an increasingly lengthy retirement, including the hefty health care costs that accompany it.
5. The big financial risk isn’t an early death. At that juncture, all of our financial problems will be over. Instead, the big risk is living longer than we ever imagined—and running out of money before we run out of breath. Delaying Social Security benefits, to get a larger monthly check, is looking smarter and smarter.
6. As life expectancies grow, so too does our investment time horizon—which means stocks are more appealing. Yes, their returns will probably be modest. But stocks are still likely to outpace bonds and other more conservative investments.
7. Faced with the prospect of navigating multiple career changes and a lengthy retirement, it becomes more important than ever to start saving as soon as we enter the workforce. That way, we buy ourselves some measure of financial security early on—and that could save us from a lifetime of financial anxiety.
MONEY MAGAZINE just posted an excerpt from How to Think About Money to its website. Also check out the accompanying video, which is located halfway down the article. Meanwhile, Vanguard Group has a Q&A with me on its website.
MANY OF US ENGAGE IN MENTAL ACCOUNTING, thinking of our mortgage as separate from our savings account and our job as unrelated to our portfolio. But these are all pieces of our sprawling financial life—and, as I discuss in my new book, it’s important to understand how everything fits together. Here are 12 examples:
1. If you have plenty of cash in the bank, you can probably raise the deductibles on your auto and homeowner’s insurance.
2. If you’re inclined to buy bonds, you’re likely better off paying down debt instead. After all, the after-tax cost of your debts is typically higher than the after-tax interest you can earn on bonds.
3. If you’re married, you have less need for disability insurance. Why? If you can’t work because of illness or injury, your spouse’s income may keep the family solvent. But if you’re single, you won’t have that financial backstop—and a disability could cause your finances to quickly unravel.
4. If you work in Silicon Valley, your family’s finances are heavily exposed to the tech industry, so you should think twice before investing significant sums in tech stocks. The same logic applies to doctors and health care stocks, realtors and rental real estate, and investment bankers and financial stocks.
5. If you have children, there’s less money for everything else. One result: You’ll likely retire later.
6. The more wealth you’ve accumulated, the less need you have for long-term care insurance, because you may be able to pay nursing home costs out of pocket.
7. If you have a steady job with a decent salary, you can take the risk of investing heavily in stocks, because there’s little or no need to own income-generating investments.
8. The higher your fixed living costs—we’re talking items like car payments, property taxes and rent or mortgage—the less financial breathing room you’ll have. That means more financial stress and potentially more difficulty if you find yourself out of work. One precautionary step: Build up a larger emergency fund.
9. If you save a large percentage of your income, you need a relatively small nest egg to retire in comfort. The reason: You’re used to living on a modest portion of your salary, so you might be comfortable retiring with just 60% of your preretirement income, rather than the 80% that’s often recommended.
10. While insurance needs tend to wane as our wealth grows, umbrella liability insurance is the exception: The rich make a more tempting target for the litigious.
11. If you’re retired—or no longer have a financial need to work—there’s no need to keep much, if any, emergency money. Why not? The No. 1 reason to have an emergency fund is to cover costs during a spell of unemployment.
12. If your adult children have high incomes, you may want to spend down your traditional IRA and bequeath them other assets. The reason: If you leave them your traditional retirement accounts, they’ll have to pay taxes at a steep rate when they draw down the accounts.
HOW SHOULD YOU think about money? Check out three articles that have appeared in the wake of my new book’s publication. StableInvestor.com ran an extensive Q&A with me. NextAvenue.com reviewed How to Think About Money. The review also appeared on Forbes.com. Finally, MarketWatch.com picked up the main article from my latest newsletter.
MANY PARTS of our financial life look like bonds, with their steady stream of income. For instance, you can think of receiving a regular paycheck as similar to collecting interest from a bond portfolio. Ditto for the income you might collect from Social Security, a traditional pension plan or an immediate fixed annuity. If you receive a lot of income from these bond lookalikes, that can free you up to invest more heavily in stocks.
Our financial life, however, may include not just bond lookalikes, but also “negative bonds”—in the form of mortgages, auto loans and other debts. When we own a bond, somebody else pays us interest. But when we’re in debt, we pay interest to others. Because we are considered less creditworthy than, say, the federal government and major corporations, we typically pay a higher interest rate on our debts than we can earn by buying bonds.
This has two key implications, which I discuss in my new book, How to Think About Money. First, suppose we want to put more money in interest-generating investments, like bonds, savings accounts and certificates of deposit. Often, it makes more sense to pay down debt, because the after-tax interest cost we avoid is greater than the after-tax interest we could earn by investing.
Second, when we look at our finances, we should subtract the amount we owe on various loans from the amount we have in bonds and similar investments. Suppose we have $100,000 in stocks and $100,000 in bonds. It might seem like we have a conservative portfolio.
But if we also have a $100,000 mortgage, our effective bond position is zero—and our finances are far riskier than they appear. My advice: As you head toward retirement, lower the riskiness of your financial life—by paying off all debt. That will increase your net bond position, while also lowering your cost of living, by freeing you from a major monthly financial obligation.
LOOKING TO GET MORE HAPPINESS from your dollars? That’s a subject I tackle in my new book, How to Think About Money. Here are nine super-simple strategies that you can put into practice today:
1. Buy a gift for somebody else. Research says we get more pleasure from spending on others than spending on ourselves. Want extra credit? Give a gift when it isn’t expected. The recipient will be especially happy—which means you’ll be, too.
2. Start planning next summer’s vacation. That’ll give you a long period of pleasurable anticipation, which may prove to be the best part of the vacation.
3. Do something fun—with somebody else. Go out to dinner. Go to a concert. Go for a hike. Just as everything is better with French fries, (almost) everything is better when it’s enjoyed with a companion.
4. Whatever you do, take photos. That way, you can revisit fun moments and squeeze a little more happiness out of them.
5. Too much choice creates uncertainty and uncertainty can be the death knell of happiness. What to do? Look for ways to limit your choice. Struggling to settle on an investment strategy? You might restrict yourself to, say, the mutual funds offered by one major fund family.
6. Don’t hang around rich people by going to ritzy resorts or wandering into high-end stores. Even if you are comfortable financially, you’ll feel relatively deprived.
7. Make many small purchases, rather than one big one. Buying stuff may bring an initial thrill, but the thrill often fades quickly. By making many small purchases, you will—at least—get the initial thrill many times over.
8. Before buying an item, consider its virtues—but also consider the upkeep. The more upkeep involved, the more likely you are to regret the purchase.
9. Pause for a moment and admire your car, your latest remodeling project or your spouse—and think how lucky you are. What matters is what we focus on, so focusing on your good fortune can bring an extra shot of happiness.
Want more ideas for a happier life? Check out my latest newsletter, which includes five key insights from the research on money and happiness.
MY NEW BOOK is now on sale—and my latest newsletter was just published. The newsletter, which is free and appears bimonthly, includes nine ways to think differently about money, plus five key insights from happiness research.
Those articles are drawn from ideas in my new book, How to Think About Money. Folks who have read it say it’s the best thing I have ever written (though that may reflect their dim view of my earlier writing). I’m anxious for the book to garner a large readership and have priced it accordingly. The paperback costs just $13.99, while the Kindle and Nook editions are a mere $9.99.
WE’RE SPENDING the final two weeks before Labor Day on Cape Cod, staying with my in-laws. Everywhere we turn, there’s another delightful home with a wonderful water view. “Wouldn’t it be great to live there?” my wife and I muse, as we imagine how much happier we’d be if we lived in this place of apparently permanent vacation.
We are, of course, completely delusional.
Being in a beautiful spot can be a great joy for a week or two. Soon enough, vacationers are contemplating purchasing a second home or a time share. We’re fixated on a vision of enchanted daily life, forgetting that the humdrum of existence—mowing the lawn, buying the groceries, going to the dentist—will quickly intrude, no matter how spectacular the view.
Even when we’re at home, we devote great energy to creating special places—a remodeled kitchen, a new deck, lush landscaping with a bench where we can sit and contemplate our transformed garden.
Yet the bench almost never gets sat on, because simply being isn’t enough. Instead, what brings us great joy is doing. The real pleasure in the new garden is the planning and planting. Once it’s done, our sense of satisfaction quickly passes, and we’re on to another project.
STOCK INVESTORS this year are fretting over Brexit, tighter monetary policy and lackluster economic growth. But every year, there’s another compelling reason to bail out of the stock market. Think about the past half-century: We’ve had wars, political crises, financial crises, double-digit inflation, a double-dip recession, terrorist attacks and more. And yet, if you had stashed $10,000 in a global stock portfolio at year-end 1969 and sat tight through all the subsequent turmoil, you would have more than $450,000 today.
“That sounds wonderful,” you might respond. “But I’m not 20-years-old anymore, so I don’t have that sort of time horizon.”
Don’t be so sure—for two reasons, which I discuss in my new book, How to Think About Money. First, if you have taken reasonable care of your health, there’s a decent chance you will live to age 90—and, even if you don’t, your spouse might. The implication: Folks who are approaching retirement might have 30 more years to invest. That’s plenty of time to ride out stock-market declines and earn healthy long-run gains.
Second, your time horizon may extend beyond your own life expectancy. Suppose you are age 80 and you have money you plan to bequeath to your 20-year-old granddaughter, who will then use the inheritance to pay for her own retirement. The investment time horizon for this money might be 50 years, over which the stock market will likely clock dazzling gains.
One caveat: If you’re going to make a long-term commitment to stocks, you want to do everything possible to ensure your tenacity and patience—and that of your heirs—are rewarded. That means holding down investment expenses and diversifying broadly, thereby ensuring your strategy isn’t derailed by high costs or a few rotten stocks. My advice: Put maybe 60% in a total U.S. stock market index fund, like iShares Core S&P Total U.S. Stock Market ETF, and 40% in a total international fund, such as Vanguard FTSE All-World ex-US ETF.
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.
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.
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.
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.
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.