"C" is for "Conventional Wisdom"

"Simplicity is the ultimate form of sophistication." ~ Leonardo da Vinci

I was in a conversation the other day about eating healthier.  The person I was talking to said that he'd lost a bunch of weight because his doctor told him to cut out of his diet everything that started with a "c".

So, no more chocolate, candy, cola, cupcakes, Cocoa Puffs, etc... VegetableMedley

I got to thinking how this generalization might also cut out some healthier foods that are actually great low-calorie sources of nutrition like celery, cucumbers, carrots, and cauliflower.

While people do tend to gravitate to over-simplified ideas that may produce some moderately good results, they may be missing out on other things that are equally beneficial.

At the end of the day, whether we're talking about diet, lifestyle, or financial decisions, we must be careful not to buy into "conventional wisdom" that is so simple it is ineffective.

"Things should be made as simple as possible, but not any simpler." ~Albert Einstein

When do you plan to take Social Security?


One decision facing every future retiree is when to begin drawing Social Security.  Benefit amounts for three different ages are shown on your Social Security statement that you receive each year.  They are age 62 at the earliest, age 70 at the latest, and your full retirement age which varies based on your birth year but age 67 for anyone born after 1960.

Age 62 will provide you with the lowest monthly benefits.  Your benefits increase approximately 7% for each additional year that you delay until they max out at age 70.

So, when should you start?  There are a number of factors to consider but it is most important to view Social Security for what it is - a social insurance program.

What are we insuring against?  We are insuring against the possibility of outliving our income that can be generated from our retirement savings.

Let's run thru a quick example:

Suppose your Social Security benefits are $1,500 per month starting at age 62.  Using 7% to estimate your benefits at age 70, you would get somewhere in the neighborhood of $2,575 per month (or $1,075 per month more) if you waited.

Now let's say that you have $250,000 in an IRA account.  On one hand, you could pay yourself the $2,575 per month from age 62 thru age 70 out of your own assets (even assuming a 0% rate of return) and then opt to start receiving benefits.

On the other hand, if you opted for the $1,500 benefit at age 62 and tried to pay yourself the difference of $1,075 out of your savings, a relatively safe withdrawal rate of 4% of your $250,000 would give you about $833 per month or $242 per month less to live on.

From this perspective, it would make sense to delay as long as possible and then receive maximum benefits guaranteed for life.

A lot of people I talk with however, view it as "It's my money.  I paid into it and I'm going to start getting 'my money' back as soon as I can."

Remember I said this is a social insurance program.  If everyone took this view toward other forms of insurance, we'd all be burning our houses down just to "get what we have coming to us."

Retirement Milestones in American History

RailroadPrior to the Industrial Revolution, the two mainstays of retirement were family and personal savings.  When you were no longer able to work, you relied on your savings and/or the good will of friends and family.  If you wanted to continue to live without working, you were largely on your own.

In 1875, realizing that many loyal employees had uprooted their lives and any type of security they may have had to follow the railroad, American Express (started as a railroad company) started the first company pension plan in the United States.  This gave their employees some form of security when they were no longer able to work for a living.

The Social Security Act of 1935 sought to provide an additional layer of security for lower income retirees.  When Social Security came into being, the poverty rate among senior citizens exceeded 50%.  This was due in part to the Great Depression as well as the fact that not every company provided a pension plan and a national minimum wage was not to be established for another 3 years in 1938 when it would be set at $0.25/hour ($3.77/hour in 2009 dollars).

The Revenue Act of 1978 formally established the 401k plan.  These plans exploded in popularity with companies seeking to unburden themselves from guaranteeing lifetime retirement income to their employees.  Instead of guaranteeing you lifetime income, they could basically provide you with an account to save for retirement and they could even provide some matching dollars if they felt like it but then the responsibility is all yours.

Good luck!  Right?

The trouble is that the majority of us are 'just not prepared' to manage our own retirement funds.

Typical human behavior when faced with a challenge like this is to either do nothing (don't participate) or take wild swings in the dark and hope we know what we're doing.  We all know that men (and some women) don't like to ask for directions.

Rational. Huh?! How much for this $20 bill?

Dollar auction

I was up late last night, as usual, watching a documentary called 'Mind Over Money'.

It had my attention from the jump when it started out talking about an experiment that involves auctioning a $20 bill.

The top bidder wins the 20 bucks but, here's the catch: Bids are in dollar increments and the second highest bidder has to pay up as well but gets nothing.  So, it's really more a game of chicken than an auction.

The interesting part is that the person auctioning the $20 makes a profit when you bid $10 and your friend bids $11.  Either of you has also made a profit at this point too assuming you're the last man standing.  

It gets more interesting when you get to $21 and the question becomes  "How much can you stand to lose?"

If you can just outlast him by just a buck, you limit your losses.  Let's say, for example, the auction gets to $30.  If he drops out at $29, you only lose $1.

Don't know if this is factual or not but, it appears the record bid for the $20 in this game is $204.

Now, I have two questions:

  • "How is this type of behavior rational?" and,
  • "How much would you pay for a $20 bill?"

For more on this, check out dollar auction and war of attrition on Wikipedia.

Fair Fun: High Striker

PhotoSo, I finally got the chance to play the classic strongman High Striker game at the State Fair this year.

After about 5 swings of the hammer I realized a couple things:

First, I'm probably not cut out to play this game in the first place.

Second, after several feeble attempts, I realized that I was just a little too worried about the outcome (ringing the bell) to focus on good form and just landing a good solid hit.

I think many of us do the same thing when it comes to money.  We get too wrapped up in short-range results and worrying about all the noise to focus on and trust a good process that moves us closer to our goals.

Is college still worth saving for?

The 2012 Household Financial Planning Survey showed that Americans would rather save for vacation than their children's college.

There is a lot of sentiment out there that a college education doesn't carry as much weight as it used to carry in today's business environment.  Before you blow the kids' college fund tho, consider this graph of unemployment rates by education level. Unemployment_education

Now, part of the reason people are saving for major purchases may be that they prefer to save for a vacation or a new car rather than slap it on a credit card or take out an auto loan.  In this case, I'd say it's a positive shift in behavior.  However, don't forget to save for your long-term goals too.

The other possibility tho may be that setting long-term goals seems too daunting compared to just planning a vacation or treating yourself to a new ride.  

In this case, I urge you to talk to an adviser who can get you started.  A plan is easy to keep updated for changing needs.  Getting started is the hardest part.


What exactly is your target-date fund really targeting?

Is the focus on your goals or new investors?  

Unfortunately most people buy performance and the fund managers know it.  There's a temptation when "safe money" yields are low to ratchet up the risk seeking higher returns.  If you couldn't afford the risk when things were good, can you really afford it when they're not?

How much risk can you handle?

I've talked before about risk capacity.  How much can you afford to risk without jeopardizing your essential goals?  

Let me put this another way: Let's pretend you are meeting me for the first time and the only question I asked you was "What year would you like to retire?", you reply "2015", and I say "Cool!  Here's my recommendations."  Would you feel at ease working with me?

This is pretty much what a target-date fund does.  It bases your entire portfolio on nothing but a date and the fund manager's opinion.  And, opinions on allocations vary dramatically.

"But isn't a fund going to be cheaper than hiring an adviser?"

That depends.  The average expense ratio for target-date funds is around 0.8%.  With a handful on the low end at .18% all the way up to the most shocking one I saw (3.3%), it's important to look carefully if you're still  even considering one of these funds.

Also keep in mind that some of these funds are made up of other mutual funds with their own fees and expenses.  This may or may not be reflected in the published expense ratio.

An adviser charging around 1% and using low-cost funds that fit your goal-based financial plan may get you a lot closer to where you want to go.

"Target-date funds are an expensive tool," says one financial adviser.  "It's like taking a taxi to Vegas."

"So what are target-date funds good for?"

Here's an article that suggests that they can serve as a quick study or a starting point if you want to educate yourself on the basics of what asset allocation might look like.  Beyond that, in most cases, you're probably going to be a lot happier with a portfolio designed to fit you.


Structuring your portfolio to match your goals.

Came across this visual explaining goal-based planning.  As I've written before, the objective is to match assets with the manner in which they are to be used.

This bottom-up approach starts with the base of our pyramid in safe investments and/or reliable sources of income to fund our bare necessities - the stuff we can't live without.

As we move up the pyramid, we may be able to take on more risk to have a greater chance of funding some of the stuff on our wishlist.

Goal-based investing

While this is a concept and not an exact science, the important thing is that we don't condone taking on more risk just because you're younger.  And, we definitely don't recommend leveraging up the risk because you're nearing retirement and coming up short.

If you're falling short of any of your essential goals, the only thing that should be ratcheted up is your contribution/savings rate.

Boring!...Huh?  Well, investing for entertainment is usually gonna be a bad idea.


Moneyball: The Billy Beane Guide to Investing

Billy-Beane-007'Moneyballis a real underdog success story about the Oakland A's manager, Billy Beane, who managed to consistently put together one of the best teams in baseball despite having one of the bottom five payrolls.

He did this by changing the way he looked at baseball.  Basically, knowing he couldn't outspend teams like the Yankees or the Red Sox, he had to find a way to outsmart them.

If you watched the movie, it simplified Beane's process down to looking for undervalued players relative to their on-base percentage.  The simple theory is that, the more often a player gets on base, the more often he scores.  Pretty good logic.  Right?

Well, that's basically correct but, the book goes into a little more detail.  Beane's was most concerned with a player's plate discipline (not swinging at bad pitches, working the pitcher, getting walks, etc.)

See, in baseball, there is more than one way to get on base.  Good players ask "How do I get a hit?"  Great players ask "How do I get on base?"

"The stock market is a no-called-strike game.  You don't have to swing at everything; you can wait for your pitch.  The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!"

- Warren Buffett - 1999 Berkshire Hathaway Annual Report

There are plenty of analogies between baseball and investing.  The main point I think that this illustrates is that you can make a lot of mistakes swinging for the fences or trying to impress people.

You'll never cross home plate without touching first base.  Stay focused on the big picture, keep your investments matched to your goals, and ignore the noise.

In baseball, it's called good plate discipline.  In investing, it's called good investor behavior.

How to Tone and Sculpt Your Savings Muscles

Baby working outIf you want to get in shape, you don't turn the treadmill up as fast as it will go and run for an hour.  You don't bench press 350 pounds right out of the gate.

You're gonna want to start small and work your way up.  And, doing whatever you're able to do consistently  is going to get you results as well as keep you from burning out.

Consistency is the key to long-term results.

Many 401k plans auto-enroll you at say, 1% of your pay, and then automatically increase your contributions every year by a small amout-usually 1% per year.  Combine this with cost of living adjustments (to your income) of 2-4% and your take home pay and contributions both get bigger every year.

This is a smart idea in that it gets more people at least saving something.  You can always opt out but, most people don't  because you hardly miss the money when you start your contributions that small.

The only downside is that some people end up saving less - possibly a lot less - than they would if they chose their own comfort level.  Odd are you've probably seen a "cost of waiting" article or illustration at some point.  Maybe you remember the term "opportunity cost" from that boring high school economics class.

It's important, just like in exercise, to feel the burn without trying to do so much that you end up hurting yourself.

I encourage you to try increasing your current contributions by $25 and give that a shot for the next three months.  If you miss the money, dial it back down.  If it's still comfortable though, try bumping it up again for the next 90 days, and so on, until you find your comfort level.

Behavior finance says that if the money is in your checking account, it's earmarked to be spent and you probably will.  On the flip side, if it's invested for a future date, you'll probably learn to get by without it.

Good luck flexing those savings muscles!