All Things Financial Planning Blog


You, Your Parents, and Long-Term Care

Even after you are all grown up, your parents can still have a big impact on your life. Even though they want to be independent, and you want them to be, you may feel the need to help them in a number of ways, both formal and informal. Many children help their older parents directly – doing chores, running errands, paying bills, even providing care. Some children provide financial support, too. As with many aspects of life, your interaction with your older parents can run more smoothly with some planning and preparatory discussion.

A recent Wall Street Journal article, “‘The Talk’ with Mom and Dad” described one area that many children help their parents with – the decision about where they should live as they get older and need more help. The choices can be bewildering – stay at home and get help, move to an independent or assisted living arrangement, possibly a Continuing Care Retirement Community, and if a lot of help is needed, a nursing home.

As the article suggested, however, decisions beyond the nature of the arrangement are also important. What area will they live in – the one they know and where their friends are, or one near you, so that it’s easy for you to visit and help out? And, once they decide on a location, there are frequently several choices within a category – some larger, with more resources, some smaller and friendlier – some closer to you, others further away.

I’m going to focus on another aspect of this decision – how to pay for it, and especially how to pay for long-term care.

First, what is long-term care? It’s not medical care. Long-term care is help with the Activities of Daily Living or ADLs (eating, bathing, transferring, dressing, and using the bathroom). If your parents need help with some of these, they need long-term care. They can receive long-term care in all of the places that I mentioned earlier – at home, in assisted living, in a Continuing Care Retirement Community, or in a nursing home.

Aside from finding the right place, there are two additional issues with long-term care: it can be expensive, and it’s uncertain whether your parents will need it, and if so, for how long. While the conversation may be difficult, it can be very valuable to discuss this with your parents well in advance of when they may need long-term care. In fact, you almost can’t start soon enough.

Because the need for long-term care is uncertain and the potential cost is very large, it’s a natural opportunity for insurance. Today, the US government and the states provide insurance for all those who cannot afford care through the Medicaid program. However, to be fully eligible for Medicaid, your parents will need to have very few assets and very low incomes, and eligibility requirements have been tightening.

Alternatively, your parents can self-insure – they can simply plan to pay for whatever care they turn out to need. If they need little or no care, or if their assets are very large, this will work out just fine. However, if they need a lot of care, the cost can dramatically deplete their estate, which they (and you!) may find to be very distressing. In addition, if you end up paying the bills, and you are watching the assets drain away as you pay for their long-term care, you may end up worrying about whether there will be enough, and about what to do if the assets run out.

Finally, there is long-term care insurance. Long-term care insurance provides a sum of money that is available to fund long-term care. Most long-term care insurance policies describe their benefits in terms of the daily benefit (for example, $100 per day) and a benefit period (say, 2 years). The total benefit is the total dollar value of the daily benefits (in our example, $100 per day times 365 days per year times 2 years or $73,000).

Your parents can buy a little (a small total benefit) or a lot (a large total benefit) of long-term care insurance. Importantly, if your parents do decide to buy insurance, they don’t need to buy enough to cover the entire cost of care. For example, if they have $24,000 per year in Social Security benefits, that will cover the first $24,000 per year (or so) of long-term care costs.

How can you help your parents decide on the best approach for them? The first step is to start the discussion. You can ease into it by talking about helping them stay independent for as long as possible (at home vs an institution, assisted living vs a nursing home). Then you can talk with them about how they might pay for long-term care. Think through the three broad choices (Medicaid, self-insurance, long-term care insurance) with them.

If they do decide that long-term care insurance would make sense, you can help them sift through the alternatives. Long-term care policies can be very complex, with lots of options. Two heads can be much better than one in coming to a decision.

In addition, buying a policy sooner rather than later has two important advantages. Annual premiums are lower for people who buy a policy earlier in life. And, the longer your parents wait, the more chance there is for their health to get worse. Insurance companies strongly prefer to sell long-term care insurance policies to healthy people. If your parents wait too long, they may not be able to obtain coverage.

Finally, if your parents decide they cannot afford long-term care insurance, you and your siblings may offer to help pay the premiums. Even though only your parents are eligible for financial benefits from their long-term care insurance policies, you and your siblings can receive intangible benefits. Knowing that your parents will be able to afford some long-term care, and that you have taken steps together to protect your inheritance can provide you with considerable peace of mind.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA

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Should You Be Worried About Inflation?

A recent article in the Wall Street Journal (Why You Can’t Trust the Inflation Numbers, by Bret Arends) caught my eye. The author suggests that the most recent (low) inflation numbers published by the US government are lulling us into a false sense of security. He makes three assertions:

  • The government’s inflation numbers are not to be trusted.
  • Published inflation figures tell us what inflation was, not what inflation will be.
  • The enormous growth in the US money supply must inevitably produce inflation.

You hear the first argument a lot. As a former economist, I tend not to agree. The professional economists who work on inflation, both in the US government at the Bureau of Labor Statistics (BLS) and in academia, are a pretty careful, serious lot. They have designed (and updated) the Consumer Price Index (CPI) to measure changes in the purchasing power of the dollar.

At least two things about the CPI are useful to bear in mind:

  1. It is an index. It attempts to capture a change in average prices, not any single price. Thus, you may notice that one or several prices that are important to you may go up a lot, but the CPI doesn’t budge. That doesn’t necessarily indicate that the CPI is wrong. If other prices have gone down, average prices may not have changed. For example, if gasoline prices go up, but housing prices go down, the purchasing power of the dollar may not have changed. You can buy less gas for a dollar, but you can buy more house (and, because you don’t buy houses that frequently, you may not notice that you can buy more house).
  2. The CPI adjusts for quality. Mr. Arends points out that the cheapest Mac laptop costs the same today ($999) as it did several years ago. Yet, because the new Mac laptop offers more computing power, the CPI says that the price has fallen. Mr. Arends is scornful – just try to ask for a discount on that Mac laptop, he says. However, he misses the point that you can buy a laptop comparable to the old Mac laptop today (perhaps from Dell), and you can buy it for less. Apple has disguised falling computing power prices by incorporating more computing power in its new laptops for the same laptop price. Nevertheless, the price of computing power has fallen.

It is true that the CPI tells us what has happened. It is not a forecast. It is also true that inflation as measured by the CPI has been low for the last three years, at .1% for 2008, 2.7% for 2009 and 1.5% for 2010, for an average of about 1.4% per year.

Now, what about the money supply? The Federal Reserve purchased large quantities of bonds over the last three years, and it “printed” lots of money to do so. You may have seen a chart (the link will help you access several) showing that the Federal Reserve’s assets and liabilities have both grown dramatically (more than double) since the beginning of the financial crisis.

This is definitely a cause for concern about future inflation. As a budding economist, I learned that increases in the money supply cause inflation. However, as with almost everything, the world of monetary economics is more complex than we learn in school. The particular complexity in this case is this: the money that the Federal Reserve “printed” to buy Treasury and other bond assets on its balance sheet is largely being held by banks as deposits at the Federal Reserve. In other words, the banks sold bonds to the Federal Reserve, and kept the cash. So long as the cash doesn’t get into the economy, there isn’t more cash chasing the same amount of goods and services, and therefore, no additional inflation.

Now, to get out of this situation without a lot of inflation, the Federal Reserve has to manage the situation skillfully. In effect, just as the banks decide they want to lend some of that extra cash, the Federal Reserve has to persuade them that they should use the cash to buy bonds instead. The Federal Reserve may or may not be able to do that. But future high inflation is not guaranteed.

So, should you be worried about future inflation? I’d say “don’t worry, but do pay attention.”

  • The US government is not “cooking the books” to underestimate inflation – there’s no conspiracy to hide inflation from the citizenry.
  • The CPI did not change from April to December of 2010 – no inflation, let alone a hint of accelerating inflation. Rapid month-to-month rises in the coming months would indicate that inflation is speeding up.
  • Do watch (or ask your financial adviser to watch) for indications that the banks are lending money faster than the Federal Reserve can soak it up with asset sales.

Finally, even if you are not worried, it is wise to protect your financial assets from future inflation – TIPS (Treasury Inflation Protected Securities) are the best inflation hedge available.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA

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If I Had 10 Million Dollars

You probably remember the Barenaked Ladies song – “If I Had a Million Dollars” (I must confess – I remembered the song, but not whose it was). A recent New York Times article called it to mind: a husband and father received $10 million after tax from the sale of his family’s business and then proceeded to spend it all.

The song provides a long list of (often eccentric) ideas for what to do with a million dollars (e.g., a tree fort), and the article provides ideas for what to do with ten (million dollars): horses, a yellow Aston Martin, a house in England, a camp on a lake in the Adirondacks, a home in Vermont…

Even though $1 million is a lot of money, and $10 million is a whole lot of money, neither amount is inexhaustible. Unfortunately, while it’s easy to think of things to buy with a lot of money, it’s hard to believe that there still are limits. (“The fortune evaporated in little more than a decade.”)

You may be thinking, so what? I’ll certainly never have $10 million. I’ll never even have $1 million.

You may be wealthier than you think.

Suppose that you earn $30,000 per year. If you work for 40 years (25 to 65), your earnings will add up to $1.2 million. If you earn $50,000 per year, the total will be $2 million, if $100,000 – $4 million.

So, each of us has, or will have, access to significant wealth. What can we learn from the sad story in the New York Times article that will help us manage it? I extracted these lessons from the article (I’m sure you can find more):

  • Keep track of your important values. Fancy cars and big houses can be very attractive, but they won’t put your children through college, and they may be long gone by the time you are ready to retire.
  • Keep your day job. Your earning power is probably your most important asset. Steady annual earnings add up! If you want to quit your job to write a novel, it’s wise to have a backup plan. You may have a hard time finding remunerative work if the novel doesn’t sell.
  • Manage your spending. Your cash flow may support living large now, but the price could be reduced circumstances later. Your lifetime resources must support your lifetime expenses. A financial plan (a lifetime budget), even if it’s just an outline, can help you be sure that your luxuries are affordable.
  • Don’t risk more than you can afford to lose. When you make an investment, take care to understand how much you could lose (the potential gain will be front and center). Despite the confident assertions of many brokers and financial advisers, the future performance of the stock market is unknown. It can go down as well as up, as recent experience demonstrates. And, believe it or not, you can live a very comfortable life without ever owning a single stock.

While you may never have $10 million (or even $1 million) all in one place, you still have very substantial wealth. A bit of planning, a dose of self-discipline and cautious investing will help you make the most of it.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA


Are Bonds Blowing Bubbles?

Bonds have been getting a good deal of bad press recently. I’ve seen four articles in the Wall Street Journal in the last month or so (of which three were in the last week) warning about bond risk.

Some, perhaps most noticeably Jeremy Siegel, have declared that bonds are in a bubble, and others have pointed out that even U.S. Treasury bonds are risky, and that certain types of corporate bonds are riskier than before.

These commentators all say that bond prices are too high, that bond prices will decline and bond investors will take losses. Bond bubble advocates assert that the declines will be big and the losses large.

Bond prices may be too high, and prices may decline. However, as with all attempts at market timing, investors should take these forecasts with a (large) grain of salt. It is extremely difficult to predict changes in securities prices, including bond prices. To be of real value, predictions must include dates and amounts – and both are strikingly absent from the pundits’ pronouncements.

Investors should structure their portfolios, including their allocation to bonds, to meet their lifetime financial needs. The market is always subject to unpredictable fluctuations. Your portfolio should help you accomplish your plan, independent of what the market does in the short term.

Bonds offer stable value and predictable income, and they should play that role in your portfolio. Cash generally offers more stability and lower income, while stocks offer much less stability, less certain income, but significantly more potential for growth in value. You should base your allocation to these three asset classes on their long-term tendencies – their short-term behavior is unpredictable.

Now, let’s consider why bond prices might decline, starting with what a bond is, and which primary factors influence bond prices.

A bond is a loan. The borrower (the bond issuer) promises to pay interest to the lender (the bond buyer), and to pay back the principal (the borrowed amount) when the bond matures.

Bonds are subject to three primary risks:

  1. Interest rate risk (bond prices drop if interest rates rise)
  2. Inflation risk (interest and principal payments might decline in purchasing power)
  3. Credit risk (the borrower might not pay back some or all of the loan).

Why do bond prices drop if interest rates rise? Think about a perpetual bond – the issuer pays interest every year, but never has to repay the principal. The British government issued the first of such bonds (called “consols”) in 1751. (My example uses dollars – I never got the hang of pounds and pence.)

Imagine a 5% perpetual bond. Lend $100 today; earn $5 a year forever. Suppose the interest rate drops to 2.5%. What could you get for your 5% bond now? At 2.5%, you must lend $200 to earn $5 per year. So, your 5% bond with face amount $100 is worth $200. Alternatively, if the interest rate rises to 10%, you could get $5 per year by lending only $50. At the higher rate, your $100 face amount 5% bond would be worth only $50. When the interest rate rises, bond prices drop, and vice versa.

Prices of bonds with maturity dates vary less with interest rates than perpetual bonds. And, short-term bonds respond less to interest rates than long-term bonds do. The sooner a bond matures, the sooner the lender can reinvest the principal and get the new interest rate.

Interest rate risk

This was the primary focus of Siegel’s Wall Street Journal op-ed. He argued that interest rates are very low now – it seems that interest rates have nowhere to go but up. He also argued that dividend-paying stocks offered more attractive returns. Why would anyone hold bonds in these circumstances? There are several reasons:

  • Bonds are less susceptible to bubbles than stocks. In a true bubble, speculators buy an asset expecting its price to rise so that they can sell it later for a higher price. Assets with uncertain future returns like stocks or houses (who can say how much “people” will be willing to rent a home for in the future?) are most susceptible to bubbles. Bonds aren’t like this. They offer clearly specified future returns – the interest payments and the principal repayment.
  • Interest rates may not rise right away. Current bond interest may compensate for future price declines.
  • Stocks are even riskier than bonds. Stock prices vary much more than bond prices do.
  • Diversification. Holding bonds of differing maturities and risk levels and some stocks as well allows the investor to benefit from a variety of future scenarios.

Inflation risk

The Federal Reserve has increased the money supply significantly. The U.S. government deficit (annual shortfall of government income relative to spending) is large, and so is the national debt (cumulative deficits). Any of these factors could lead to inflation. However, with unemployment close to 10%, many economists believe that inflation will take a while to develop.

There is no agreement about:

  1. Whether inflation will begin to accelerate;
  2. If inflation does accelerate, when that will happen.

Furthermore, prices might actually start to decline (deflation). Then interest and principal payments would increase in purchasing power (future dollars would be worth more than today’s).

Therefore, it can be quite rational to buy bonds now because inflation expectations are low and mixed.

Credit risk

  • In the US, the Federal Reserve has kept interest rates low by lending to banks at very low interest rates and buying Treasury bonds.
  • Because interest rates are low, however, investors have been seeking higher returns, and companies with relatively low credit ratings have been able to issue debt (sell bonds) at very low interest rates. So-called junk bond (low quality, higher credit risk) interest rates are low relative to historic averages. Foreign government bond rates are also low, even for issuers with questionable credit-worthiness.
  • As a result, bond investors are receiving less compensation for risk than they have at most times in history.

So, should you worry about your bonds?

Bonds are always somewhat risky. Even in these risky times, you can manage your bond portfolio’s risk:

  • Emphasize high quality bonds in your portfolio such as U.S. Treasury and agency bonds, Treasury Inflation Protected Securities (TIPS), and investment grade corporate bonds. TIPS also protect against inflation.
  • Focus your exposure on bonds maturing in a relatively short time, say five years or less, so that if interest rates do rise, your losses will be limited.
  • Diversify. While some individual bonds paying “high” interest may seem to be of high quality, concentrating on just a few such bonds places your portfolio at higher risk.

Bond values may decline, and probably will at some point in the future. However, there are good reasons to hold bonds (stability and income), and the risks can be managed.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA


Clergy Need Financial Plans, Too

Last week, I had the privilege of participating in the first Clergy Financial Literacy Conference at Boston University. Bert White, a retired Methodist minister who is now a lecturer at BU, developed the conference. Zvi Bodie and Larry Kotlikoff, both BU senior faculty members with a keen interest in applying science to personal finance, provided insightful guidance.

Bodie spoke about Life Cycle Investing, the advantages of TIPS (Treasury Inflation Protected Securities), and the risks of stocks. Kotlikoff used his own ESPlanner software to illustrate the benefits of consumption smoothing. The session closed with a panel discussion that Paul Solmon (of the PBS News Hour) moderated – Bodie, Kotlikoff, Alan Silverman of MetLife and I served as the panelists.

I learned a lot in preparing for and participating in the conference. Just a few of the items:

  • Clergy have an ambivalent relationship with money. Many have an aversion to financial matters coupled with a trust in God to take care of things. This perspective can place clergy at a financial disadvantage both during their active earning years and especially once they retire. Many parishioners take the view that clergy shouldn’t need much money and therefore needn’t earn much.
  • Clergy pensions may suffer from two important weaknesses.
    1. Many clergy are the sole employees of their congregations, who are not, therefore, very sophisticated in their management of benefits. In particular, the congregations may not fully fund clergy pensions, and may then run into financial difficulties after the clergy retire. This problem is especially acute for those clergy with shrinking congregations.
    2. Many clergy have pensions from so-called “church plans,” which are exempt from federal pension rules. These plans do not need to meet minimum funding requirements. They don’t have to report to participants their degree of (under)funding. They don’t pay premiums to the Pension Benefit Guarantee Corporation (PBGC), the Federal pension insurance entity comparable to the FDIC.
      Consequently, clergy can be surprised when their pensions shrink, or simply stop. And, because
      their compensation tends to be relatively low, they are less able to save than they might otherwise be. When their pension stops, their retirement living standard can be devastated.
  • Clergy do have one countervailing advantage. Their housing allowance, if they have one, is tax-advantaged income. As best I can guess, this benefit arose because many congregations partially compensate their clergy by providing housing, thus enabling them to pay lower pre-tax cash compensation. This allowance complicates both financial planning and tax compliance for clergy. Clergy must carefully decide and track how to pay for housing to take full advantage of the benefit. Following traditional guidance about paying down a mortgage before retirement may actually reduce standard of living for clergy.
  • Clergy have lower cash compensation than other comparably educated professionals, so the appropriate retirement savings rate will be higher than for non-clergy peers.

The premise of the conference was that both clergy and their congregations would benefit if clergy knew more about money and financial planning. Participating clergy agreed with the premise – they would be better able to manage their own affairs and counsel their parishioners if they had greater financial understanding. My observations suggest that it will take a lot of work to fill the knowledge gap, and that clergy, their congregations, and the regulatory framework all need an attitude adjustment – all must realize that clergy have financial needs no less pressing than those of the population at large.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA

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Do You Know What Your Biggest Asset Is? (With Implications for Saving)

Economists refer to your earning power as “human capital.”

Your human capital is “human” because it is part of you. Unlike your other assets (your home, your car, your financial assets such as your bank account or retirement savings), you cannot sell it to someone else and only you can use it. Your employer can pay you to use your human capital on their behalf, but they can’t buy your human capital (that would be slavery).

Your human capital is “capital” because it is an asset. You can use it to generate income. If you use it more intensively, you can generate more income. And, you can increase the amount of your human capital by investing in it – more education can make it possible for you to earn more.

Well, so what? What’s the benefit of thinking about your earning power as human capital? Well, for one thing, human capital is the largest asset for most people under, say, 50. Even for people in their 60s, it is still very important.

In addition, human capital as a concept offers a powerful change in perspective. Perhaps most importantly, it helps you think more clearly about what you can afford in your life.

Consider a 31-year-old couple trying to decide how much they should save. Traditionally, they’d pick a retirement asset goal, and then save toward that goal. That’s hard! Who knows how much they’ll need to have when they retire? Many web-based calculators claim to be able to tell you, but they don’t agree.

Let’s make this concrete. The couple earns $100,000 per year, pays $25,000 per year in taxes, has accumulated $100,000 in savings, expects to pay $50,000 per year for four years for their child’s college education, will receive $20k per year in Social Security once they retire at age 71, and expect to live to age 100.

We can look at a balance sheet, but it doesn’t tell us very much about how much our couple should save:

Assets ($000) Liabilities and Net Worth ($000)
Savings: 100 Net Worth: 100

Now let’s bring in human capital.

Since they expect to work for 40 years, their Human Capital is worth $4,000,000 (if the interest rate is zero). We can calculate their other assets and liabilities in the same way, and we get:

Assets ($000) Liabilities and Net Worth ($000)
Human Capital: 4,000 Taxes: 1,000
Savings: 100 College: 200
Social Security: 600 Net Worth: 3,500
Total: 4,700 Total 4,700

So, this is a very wealthy family, with a net worth of $3.5 million. Now, what do they want to do with that wealth? Suppose they decide that, having paid for their child’s college education, they don’t need to leave a bequest. Then they can spend that net worth over the rest of their lives, which is 70 more years, or $50,000 per year (we’ll call that annual spending “consumption”). Now the balance sheet looks like this:

Assets ($000) Liabilities and Net Worth ($000)
Human Capital: 4,000 Taxes: 1,000
Savings: 100 College: 200
Social Security: 600 Consumption: 3,500
Total: 4,700 Total 4,700

And, we’ve solved the saving problem! They should save their earnings less their taxes and consumption, or $100,000 – $25 ,000 – $50,000  = $25,000 per year. They’ll work 40 more years, and save $1M. They’ll use $200k for college, leaving $900k (don’t forget the $100k they’ve already saved!). Then, they can use $30,000 per year plus their $20,000 per year of Social Security to support their $50,000 per year of consumption spending for 30 years of retirement.

If you like pictures, here’s a graph of the balance sheet. It highlights the point that you can’t spend more than you earn, and because your human capital is what you earn, you can’t spend more than your human capital!

This has major implications for how you should think about your financial situation. For one thing, it highlights the need for life insurance and disability insurance. You can really see clearly that if something happens to your ability to earn, your entire financial plan is at risk.

Financial planning is all about deciding how you want to spend your wealth (when, and on what), and how to protect the wealth you have. Knowing about your human capital is essential if you want to make good financial decisions.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA

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Financial Planning — A Contradiction in Terms?

Creating a Financial PlanThe American Heritage Dictionary defines a plan as a scheme, program, or method worked out beforehand for the accomplishment of an objective.”[1] This suggests that the objective is primary. Change your objective, and it seems very likely that you must choose a different plan.

On the other hand, many people who contact me asking for “financial planning advice” begin by saying that they need help in deciding how to invest their savings. They are often surprised when I ask them what their savings are for, and what they are trying to accomplish with their investments. They’ve skipped a step — defining their objectives.

I’ve wondered about why that is — why people don’t define their objectives, and why they think they can jump right to choosing their investment strategy. I have some ideas about why people don’t establish objectives. And, I have some thoughts about how you can overcome the difficulties, and set your objectives first.

My top three reasons that people don’t set their objectives first:

  1. Needing a financial plan (and long term financial objectives) is relatively new for our society.
  2. Deciding on your long-term financial objectives is hard.
  3. Our culture encourages investing without setting objectives.

A check listNeeding a financial plan is relatively new for our society. Your parents (and certainly your grandparents) may have done just fine without a financial plan.

  • Living much past 65 is a relatively new phenomenon. Many of our clients don’t expect to live past 80 (often, their parents didn’t), but most of them will.
  • Your parents and grandparents could count on Social Security and defined benefit pensions to cover most of their retirement expenses. Now, such pensions are rare, and Social Security will not be able to pay promised benefits to future retirees without a breathtaking tax increase. Many observers expect both higher taxes and lower benefits.

Deciding on your long-term financial objectives is hard. And, because it’s hard, nobody wants to do it. Why is it hard?

  • You are busy already. You have enough to do just doing your job, paying the bills, raising your children…having a life! Who has time for thinking much beyond this year?
  • Setting long-term objectives requires thinking (way) ahead. If you are in your twenties or thirties, retirement is thirty to forty years off. You weren’t even born thirty or forty years ago! It seems impossible to think that far ahead.
  • If you are part of a couple, setting financial objectives requires discussion and compromise. Your shared financial objectives are just one more thing to disagree about.
  • Thinking about retirement doesn’t seem to be much fun. Like death and taxes, retirement is pretty much inevitable. But, who wants to think about death and taxes?

Our culture encourages investing without setting objectives. It seems that many of the firms who want to help you invest focus on almost everything but setting objectives. Think of:

  • The E*Trade commercials about how trading with E*Trade is so easy that even a baby can do it.
  • Merrill Lynch being “bullish on America.” (I still remember those commercials – if you do, too – watch it! We’re showing our age).
  • Many mutual fund ads touting the fund’s extraordinary recent performance.

Now, how to overcome the difficulties? Let’s take them in order.

For the first, that needing a financial plan is relatively new, I’m going to encourage you to consciously adopt a new perspective. This is your life we’re talking about! Very probably, you are going to live a long time. A lot of that time will be retired time, time after you are no longer working. You want that retired time to be wonderful, just as you want married life to be wonderful, your children to be wonderful, and your home to be wonderful.

Wonderful takes work, and a wonderful retirement takes planning. Otherwise, you’ll show up in retirement without enough resources to make it as wonderful as you want it to be.

So, how can you make planning easier? Don’t feel the need to do it all at once. You can start slowly. At 30, you don’t need to know when you will retire, how much you’ll spend when you retire, where you’ll live. Start with thinking about how you want your life to develop. (For couples, this can be pretty romantic — you are thinking about a long and happy life together!). Write down your ideas — this encourages you to be concrete. Writing your ideas down doesn’t mean you can’t change them — it just helps you to remember what you’ve been thinking. You should be saving steadily, but it may be premature to have too specific a target.

As time goes on, your plans should become more specific in terms of when, what and how. And, if this is an ongoing, living discussion, more specificity will develop naturally. As the time to retire grows closer, you’ll have much clearer ideas about what the next phase of your life will look like. And, because you know what it will look like, you’ll know how much it will cost. Voilà! Specific financial objectives.

Now, what to do about the cultural environment? Filter. We all face an ever increasing flow of information. And, we all have to filter, or we’ll drown in that flow. Messages about trading and investing that have nothing to do with goals or objectives are just not relevant to you. You have goals, you have objectives. For you, any discussion of investing must begin with those goals, and end with them. Tune out the messages that don’t apply to you. Life will be simpler, and you’ll be more likely to get to where you want to go.


rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA

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Investors Have Never Had It So Good

You say, “You can’t be serious!” Investors have just been through the worst stock market decline in nearly 100 years. More investors may have lost more money faster than ever before.

I say, take the long view (investors should take the long view). Investors have never had it so good.

What’s better for investors?

  1. Investing is less expensive than ever before.
    • Led by the Vanguard family of funds, there has been a revolution in the availability of low-expense ratio mutual funds. You can now buy mutual funds that invest in almost any type of asset that you can name, all charging less than 0.2 percent. That’s 20 cents  per hundred dollars per year! And, there are many sources in addition to Vanguard. Just to name a few, Fidelity now offers many Spartan funds in that price range; Schwab also offers some very efficient index funds, just to name a few.
    • Exchange-traded funds or ETFs are another way to invest inexpensively. Some ETFs are even less expensive than low cost traditional mutual funds. Even though it came to this arena relatively late, Vanguard is also a low price leader here. The original ETF, State Street’s SPYder, charges a mere 0.09 percent, 9 cents per hundred dollars per year.
    • Competition in the brokerage business has brought trading commissions down to very low levels. You can now buy or sell a stock or ETF for under $10 at almost any brokerage company. TD Ameritrade has long had trading commissions of $9.99. Fidelity just lowered its commission to $7.95 for just about any stock and any customer. And, Fidelity will now trade Barclays iShares ETFs for no commission. Some of the bank brokerages also charge no commission for stock trades, although you must maintain a balance at the bank to enjoy this offering.
  2. Investors can invest more broadly than ever before.
    • There is easy and inexpensive access to international securities. There are many traditional mutual funds and ETFs that invest in developed economies and/or emerging markets. You can buy funds that invest in stocks from those markets, and funds that invest in international bonds. You can invest almost anywhere in the world from the comfort of your home.
    • Diversification is very inexpensive. You can buy a broad U.S. index fund, a broad international index fund, and a broad bond index fund (using ETFs, you could buy VTI, VEA, and BND). You’ll pay no more than 0.2 percent (20 cents per hundred dollars per year), and you’ll own thousands of stocks and hundreds of bonds.
  3. Investors can enjoy other advantages that I’ll go into more detail on in a later post:
    • Greater transparency – it’s easier to know what you own and to understand it better.
    • Greater tax efficiency – it’s much easier to minimize your taxes.

What hasn’t changed?

  1. Stocks are still risky. The recent market crash (I say a 50 percent decline qualifies as a crash) and recovery has to convince you of that!
  2. “News” about investments still contains an inordinate amount of “noise” – opinions and predictions that claim to provide accurate guidance. Subsequent events demonstrate that only a fraction of the predictions prove out.

So, as an investor, you can do more, more easily, and you can keep more of what your investments earn. Life is good! Just keep your wits about you, keep your costs down, diversify, keep your risk at manageable and tolerable levels, and tune out the noise.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA

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How Can You Protect Your Assets Against Inflation?

Many people are concerned that inflation will increase in the future. The forecasts of large government budget deficits and the recent rapid growth in government programs (TARP, the stimulus package and the various health care plans) both suggest that inflation is coming.

You may be worried that your savings will lose purchasing power. What can you do to protect them?

Some say gold always holds its value. Others say you should invest in stocks to keep up with inflation.

I suggest that instead of trying to figure out who’s right, we might look at some data. Let’s focus on the recent history of gold prices (the “London fixing”) and stock prices (the Standard and Poor’s 500 – an index of US stock prices).


The chart shows the price history (adjusted for inflation) of these two investments for the last 40 years or so. In times when gold’s line (the gold line) rose, the purchasing power of gold went up. When gold’s line fell, gold’s purchasing power went down. The same for stocks.

Notice that gold’s purchasing power fell from 1974 through 1976, right through the OPEC oil embargo. And, after a rapid increase from 1976 to 1980, gold’s purchasing power fell just as fast from 1980 to 1982. It fell again from 1983 or so to 1985, and then fell steadily from 1987 through 2002. Then it came back up, and recently it’s been rising.

So, gold has offered very unreliable protection against inflation, if we adopt the most charitable view.

How about stocks (the blue line)? Starting in 1968, the purchasing power of an investment in stocks declined steadily right through 1982. Then, with minor interruptions, stock purchasing power rose steadily, and sometimes dramatically, until 2000, when it crashed. Until it rose again through 2007, when it crashed again. So, the historical data suggests that stocks don’t provide very reliable inflation protection, either.

What can you do? The two most popular recommendations to protect against inflation haven’t worked consistently. Is there anything else you could try?

In fact, there is! The US government issues Treasury Inflation Protected Securities (TIPS). The face values of these bonds increase to replace purchasing power lost to inflation. How do they work?

Suppose you bought a TIPS bond today for $1,000 that would mature in 10 years, in 2019. Suppose inflation over the 10 years was 100 percent, so that you’d need $2,000 in 2019 to buy what $1,000 would buy today, in 2009. By 2019, the face amount of the TIPS bond would adjust to, wait for it… $2,000! The bond would fully preserve your purchasing power! And, over the intervening 10 years, you would receive interest, too. TIPS interest payments also keep up with inflation.

How do you buy these bonds?

  • You can buy individual TIPS, either through your broker, or directly from the US Treasury, via its Treasury Direct service.
  • You can buy TIPS through mutual funds. Two of the most efficient (lowest cost) are the Vanguard TIPS fund (ticker VIPSX, or VAIPX if you want to buy more than $100,000 worth), and the Barclays iShares TIPS fund (ticker TIP, conveniently enough). Many other mutual fund companies have TIPS funds, too (choose one with a low expense ratio).

Do TIPS offer perfect protection for your purchasing power? Unfortunately not (although, as we’ve seen, other choices seem to be even less perfect). TIPS’ imperfections include:

  • The US government might default on the bonds (not likely, but possible!).
  • TIPS adjust to the Consumer Price Index – All Urban Consumers (CPI-U) inflation measure. No inflation measure is perfectly accurate, and Consumer Price Index – Experimental (CPI-E) is probably more accurate for seniors (unfortunately, there are no TIPS linked to the CPI-E, at least not yet).
  • And, if you buy a TIPS fund, the fund’s value can fluctuate somewhat for reasons that are not directly tied to inflation.

Still, TIPS are likely to be a much more reliable protector of your purchasing power than either gold or stocks. And, TIPS are much easier to access than you might think.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA

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Did Diversification Fail?

From its peak in October 2007 to its most recent bottom in March 2009, the Dow Jones Industrial Average fell from over 14,000 to about 6,550, more than 50 percent. Most other US stock indices fell right along with it, as did European stocks, Asian stocks, emerging market stocks, and on and on. Everything seemed to fall, and no matter where you look, it’s hard to find any stock that didn’t.

Many commentators are now suggesting that diversification didn’t work (didn’t prevent losses) in the crash, and that we need new strategies that will.

Those suggestions are misleading at best, and could be downright dangerous to your portfolio.

What is Diversification, and What Is It Good For?

Diversification is a $20 word for not putting all of your eggs in one basket. Its original investment meaning was buying many stocks rather than just a few. To see why that’s a good idea, it’s  helpful to understand that each company’s stock have at least two kinds of risk – the risk of the stock market, and the risk of the company itself.

Think of Microsoft and Google. They are both technology companies, and both of their stocks tend to rise when the economy is strong. That tendency reflects the market-linked risk of the two stocks. However, if there’s an indication that the Internet (Google’s strength) is getting stronger at the expense of personal computing (Microsoft’s strength), then Google’s stock will rise, and Microsoft’s will drop. That reflects the company-linked risks of the two stocks.

When you own both stocks, when you diversify, it won’t matter to your portfolio if the Internet gets stronger at the expense of PCs – the gain in Google stock will offset the drop in Microsoft stock. That’s the benefit of diversifying, of owning both stocks. Shifts within the economy won’t matter, or won’t matter as much, to your investment portfolio.

Now suppose that there’s a recession. Google stock and Microsoft stock will both decline, because their businesses both get worse, and their profits will fall. Diversification doesn’t help in that case.

That insight applies more generally. Diversification helps smooth out the performance of your portfolio when one company or one industry does better at the expense of another. Diversification doesn’t help smooth your portfolio’s performance when the economy as a whole does worse, and the whole stock market declines. And how could it? Holding many stocks can’t help prevent losses when most or all stock prices are going down.

Why is it Dangerous to Say that Diversification Failed and We Need New Strategies?

I’ve just suggested that diversification can’t protect you from broad stock market declines. Why shouldn’t we look for new strategies that can?

I say that the search for those strategies can distract us from the very real risks, the undiversifiable risks, of investing in stocks. It’s important for every investor to understand that investing in stocks poses a very real, ever-present, risk of loss. No strategy that involves holding stocks can avoid it.

When you invest in stocks, you can lose money. The only way to be sure not to lose is not to buy stocks.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA


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