I ran into my old buddy Jake at the local outpost of a well-known, high-priced donut chain. I had just spent the better part of a sawbuck on a powdered donut hole and thimble of java when I noticed Jake seemed to be lacking his usual Christmas spirit.
His brow was furrowed, and he looked worried and perplexed. I wasted no time asking him what in the name of sugarplum fairies was wrong. Didn’t he know this was the holly-jolly time of year for chestnuts roasting on open fires, one-horse open sleighs and stoplights blinking a bright red and green?
“That’s it: It’s the holidays, man,” he sighed.
The holidays? How had the holidays depressed him? Had he gone into a store for a flat-screen TV sale, and been steam-rolled in a customer stampede?
“No, that’s not it,” he moped.
Had one of his zero percent APR credit cards been targeted in a major discounter’s massive data breach, leaving him to discover his number was being peddled around the globe by black market privateers?
“You’re not even close,” he lamented.
Had he bivouacked for days and nights outside a mall in freezing temperatures prior to Black Friday, only to be rushed by ambulance to a hospital with a case of pneumonia mere minutes before crowds stormed the opening doors?
“Don’t make me laugh,” he moaned.
Well, what is it then? What would make a normally cheerful dude look grimmer than Bob Cratchit trudging in to work Christmas morning at the corporate campus of Scrooge & Marley, Inc., LLC?
Hydra-headed holiday harangue
“It’s these conflicting messages we’re always being fed by the media,” he said. “On the one hand, they tell us that we’re not saving enough money for college and retirement and medical expenses and everything else.”
“And then they tell us that retailers are not enjoying the kind of Christmas shopping season they had anticipated, that sales are off, that customers are being too tight-fisted with their dollars and that they’re so used to sales that they don’t shop anywhere but where they can score the best deals. They’re saying some huge retailers might not make it if they don’t rack up big profits this holiday season. And you know who’s to blame? We are!”
I see what you mean. You feel kind of guilty?
“You bet I do,” he continued. “The other day I went out to the mall, and I was going to load up the car with tons of presents and holiday ornaments and boxes of candy for all my friends, relatives, co-workers and neighbors. I flipped on the radio just before I got there and heard an announcer saying that millions of people are going to have to depend almost entirely on Social Security in retirement.”
So what’d you do?
“Well, I jammed on the brakes, pulled a U-ey and went right back home. That’s going to be me if I don’t start conserving the cash, y’know. If I don’t get going, I might spend my 65th birthday feasting on Whiskas for Kittens.”
Damned if you do — and don’t
“Don’t you get it? This dismal shopping season could be a signal that the economy is weaker than expected, sending us spiraling into another recession and making it even harder for me to save. I might not even be able to afford Whiskas for Kittens on my 65th. It could turn out to be 9 Lives.”
Well, you’ll just have to head back to the mall, then.
“I did, but when I got out to the mall, I heard another radio report about Americans’ awful saving rates. So I turned around and was almost home when I got another earful about how stingy we shoppers are. I just kept on driving back and forth to the shopping center all day. Didn’t buy a thing.”
Later, I ran into Jake at the tire store, picking up a couple steel-belted radials.
“Turns out the left-side tires on my car are bald,” he explained, “from all the U-turns I made this holiday season.”
Happy holidays, Everyone!
An acquaintance of ours returned from a missionary trip to Tanzania recently. As these cross-cultural encounters go, each side had plenty to share with the other about their lives. Toward the end the trip, she asked one of the locals what stood out from everything the Americans related. It was that there are people on this earth who actually spend money to walk. (He was referring to Americans either buying treadmills or paying gym memberships to walk on them.) They (everyday folk in Tanzania) have no choice but to walk miles every day, and they simply have a hard time imagining walking as a luxury for which one would pay serious money.
That story illustrates, for me at least, that almost everyone living in America is among the top 1 percent of the world’s wealthy. This topic of the 1 percent drew a lot of headlines and attention earlier this year, highlighted by the publication of Thomas Piketty’s book, “Capital in the Twenty-First Century.” (Even before the book’s publication, I even had this to say about the topic.)
The outcome of the recent mid-term elections has been dissected and analyzed by hundreds, all striving to put a fresh spin on the events. Not surprisingly, one of the streams of comment has focused on the campaign contributions of the super-rich, questioning whether inequality is allowing a handful of people to dictate your life and mine by buying legislation, if not just buying the legislators themselves. One of the more interesting books on that subject was published a few weeks before the elections: “Billionaires, Reflections on the Upper Crust,” by Darrell West, a big shot at the Brookings Institution, who took a look at the lives and politics of the richest thousand or so Americans.
I haven’t read the book yet, but I saw an extract which lists the richest Americans and what they are doing to influence politics. I also came across two well-written reviews. One, by one of the most popular business authors of our time, Michael Lewis, was on the “Billionaire” book, and the other one was by one of the “extreme inequals,” Bill Gates, of the Piketty book.
Mr. Gates posted a long article on his personal blog, in which he reviewed “Capital in the Twenty-First Century.” In it, he agrees with a few of Mr. Piketty’s general points:
- “High levels of inequality are a problem — messing up economic incentives, tilting democracies in favor of powerful interests, and undercutting the ideal that all people are created equal.
- “Capitalism does not self-correct toward greater equality — that is, excess wealth concentration can have a snowball effect if left unchecked.
- “Governments can play a constructive role in offsetting the snowballing tendencies if and when they choose to do so.”
He also agrees with the fundamental point that taxation of labor is disproportionately high, compared to tax on capital. Not only is income by wage earners (ordinary people from the 99 percent) taxed more highly than income from capital, corporations paying out those wages are taxed on those wage expenses as well, while they pay no taxes on interest or dividend payments. He then goes on to propose a system of taxes not on wealth (as Mr. Piketty advocates) but on expenses. In his defense for the tax structure he proposes, Mr. Gates touches on three things people can do with their wealth:
- Invest it into their businesses to grow
- Give it away through philanthropy
- Spend it
That brings us to the Michael Lewis review of “Billionaires.” In it, he tells the story of a tennis coach who held a tennis camp in New Hampshire for Eastern kids of wealth. Every morning, there would be one box of cereal for every kid, some nice and some boring. The kids would rush and jostle to get the good stuff, and the losers were left with the stuff nobody wanted. By the third morning, the coach held a meeting and told the kids, “When I’m in the big city, I never understand the faces of the people, especially the people who want to be successful. They look so worried! So unsatisfied!” Here his eyes closed shut and his hands became lobster claws, pinching and grasping the air in front of him. “In the city you see people grasping, grasping, grasping. Taking, taking, taking. And it must be so hard! To be always grasping-grasping, and taking-taking. But no matter how much they have, they never have enough. They’re still worried. About what they don’t have. They’re always empty.”
Mr. Lewis then lists numerous studies which all show the same thing: People with way more money than they need are perpetually unhappy. But, worse, not realizing that having so much more than others leaves them unfulfilled and unhappy, they keep looking to more money as the answer to that emptiness. It’s like someone adrift at sea, drinking sea water when they’re thirsty, only to discover that it leaves them even thirstier. After that, they keep thinking if they only drink even more sea water their thirst will go away.
The truth, as Michael Lewis pointed out, as corroborated by numerous studies, is that the money given away brings more happiness than the money strived for. “A … study, by a coalition of nonprofits called the Independent Sector, revealed that people with incomes below twenty-five grand give away, on average, 4.2 percent of their income, while those earning more than 150 grand a year give away only 2.7 percent.”
How about you? Money-wise, what brings you the most happiness?
From the Declaration of Independence to the space program, optimism was traditionally something of a core American value; however, it is one that has taken quite a beating in recent years.
Not too long ago, an NBC-Wall Street Journal poll found that 76 percent of Americans lack confidence that their children will have a better life than they do. That is a stunning reversal from the onward-and-upward America in which baby boomers were reared. Then again, the optimism of the baby boom generation atrophied into a dangerous complacence which has been bad for the economy in general and for household finances in particular. The following are some examples of how this complacence has led to trouble, and why the new mood of pessimism might actually be constructive:
- Consumer confidence is the key to economic growth. To this day, consumer confidence figures are closely watched for signs of where the economy is heading. There are two flaws with this. The first is that there is something of a chicken-or-the-egg relationship between consumer confidence and the economy. Does confidence really help boost the economy, or do people simply feel more confident when they are experiencing stronger growth? The more damaging flaw is that the emphasis on consumer confidence presumes that the only problem with household finances is people’s attitudes. This ignores the reality that non-mortgage consumer debt is at an all-time high. People not only do not have the means to back up their confidence, but too much optimism right now might actually make the problem worse by encouraging people to borrow.
- Investing for the long term will fund retirement nest eggs. Faith in the hefty market returns of the 1980s and 1990s led professionals such as pension consultants and personal financial planners to plug overly-optimistic assumptions into their retirement funding projections. These high assumptions created the illusion that retirement plans were on track toward being fully funded, which allowed people to skimp on their contributions to those plans. All concerned were slow to revise their methods, reassuring themselves that future returns would make up for a disappointing year or two. Now, nearly 15 years into a century of unreliable stock market returns and low single-digit interest rates, reality is starting to seep into those retirement assumptions. People may not like it, but it will force them to fund their retirement plans more realistically.
- Next year will be better. The annual raise and possibility of a bonus were long staples of the American worker’s career. It was okay to overextend the credit card, sign up for a mortgage they couldn’t quite afford, or put off saving for retirement because rising salaries would soon ease those problems. Now people are considered lucky if their wages keep up with inflation; many had to take a step back in pay as a result of the last recession. This harsh reality should encourage people to make their financial commitments based on resources they know they have, not on those they hope they will have in the future.
- Housing is an asset that appreciates over time. Banks and home buyers alike thought it was perfectly fine to forego down payments and borrow heavily against home equity because rising home prices would soon build up a healthy equity cushion. When it turned out that prices could in fact go down — and stay down — banks and homeowners alike found themselves over-leveraged and under water. A more conservative approach to mortgage borrowing should lead to a more stable housing market.
- Education is the answer. Yes, education can open doors, but it cannot perform miracles. Frustrated with the recessionary job market, Americans borrowed in record amounts to go back to school. Student loan debt jumped by over 50 percent in just five years, and now tops $1.3 trillion. Too much of this money went to programs students were unsuited for, or degrees with no career value. A more consumerist approach to education would better help people get their careers on track without wasting so much money.
- Don’t let the market leave you behind. Bandwagon markets in stocks, housing, oil, and gold have led to spectacular busts. When getting rich quickly is the promise, it is amazing how many people become blind optimists. The rush into these markets is every bit as much of a panic as the scramble to get out when things go sour. People start out desperately afraid they will be left behind and end up desperately afraid they will be ruined. Perhaps by now they’ve been burned often enough to be hunting for investment bargains rather than the next bandwagon.
Pessimists are less fun at parties than optimists. They sweat the details, worry about what-ifs, build emergency savings, and never take their jobs for granted. In the wake of the banking crisis, poor financial market returns, and an extended stretch of high unemployment, that kind of pessimism might actually be healthy and lead to a sunnier future.
Have you ever wondered why your next-door neighbor must have a new car in his driveway every model year?
And not just a new car, but a new car with all the bells and whistles, like that 18-valve, turbo-charged, dyno-flex, hydroponic 4000 engine, 57-speaker audio system with Sistine Chapel acoustics and the buttery soft leathers imported from recently-discovered islands off the Madagascar coast?
It turns out he is just giving in to the inclinations that characterize too many American big spenders, who gain their greatest joy from acts of overspending.
That’s right, many humans are simply pre-programmed to overspend, an action that illuminates the pleasure centers of their brains. To these people, saving lacks sex appeal. It is spending, not saving, that is sexy.
This is among the groundbreaking and revealing factoids presented in “Thinking Money,” a new documentary released to the nation’s public television stations October 16.
Check your local listings for time and channels in your neck of the woods — or contact your local Public Television Station about “Thinking Money.”
What a concept
For generations, commercial television programs have manipulated viewers into stupid financial tricks using a variety of carefully-crafted stratagems.
Take, for instance, a sitcom portraying a group of struggling young people who live together. Rather than a hovel, they reside in a big city apartment Bill and Melinda Gates would find unjustifiably luxe. Their clothes and hair styles would require a $10,000 weekly budget, wardrobe assistant and makeup artist.
When the laughs are interrupted for commercial breaks, the air is larded with 30-second spots for luxury SUVs and lavish cruise vacations. The viewer comes away from the experience entertained — and also convinced that the only way to be happy is to remain perennially in debt indulging her consumerist instincts.
But “Thinking Money” actually takes the 180-degree opposite approach.
It shows us why we are so susceptible to hucksters peddling everything from 32-carat diamond broaches to candy-apple-red sports coupes, why we go on overspending when we know our futures depend on over-saving, why we are sitting ducks for slick-talking Madoff-esque serpents peddling risky or ultimately fraudulent investments and why we spend too little time searching for best credit cards. These, the documentary tells us, are all natural biases common to a huge swath of the human population, and they tend most to impact us when we are dealing with complex, long-term decisions.
“Thinking Money: The Psychology Behind Our Best and Worst Financial Decisions, uses a mix of humor, on-the-street interviews and provocative insights from innovative thinkers to explore why we spend, save (or don’t) and how we think about money,” a press release for the show proclaims.
“Host Dave Coyne travels from Wall Street to Main Street, and from Yale to Santa Barbara wine country, to find out how our brains — and the marketplace — maneuver to get us to spend money we shouldn’t.”
Emotional trumps rational
As any used car salesman could tell us, people are given toward making spending decisions with their emotional brains. “Thinking Money” explains how this works. Having reached decisions emotionally, we use our brains’ rational side to justify the decision. “The only long-term solution for this is to make saving more sexy … for the brain,” reports Stanford neuroeconomist Dr. Baba Shiv.
That objective better be realized pretty quickly. The documentary shows us how bad financial decision-making is wreaking havoc upon us and our society.
As Americans increasingly live paycheck to paycheck, the number of predatory credit sources has ballooned. It was once fairly difficult to find a payday loan establishment. Today, we learn, that there are more payday loan stores in America than there are McDonald’s, Starbucks and Targets — combined.
Then there is confirmation bias, a seemingly growing hindrance to effective saving. Confirmation bias is our tendency to be drawn to information that reflects what we already believe, and shun evidence that contradicts our convictions.
If, for instance, you feel the odds of saving enough to retire are stacked insurmountably against you, you are likely to seek that kind of messaging and ignore evidence of the many people who actually do bank enough bucks for retirement. The result? You give up before you even try to save.
If, in the depths of 2008, you believe the stock market is a rigged game that can only leave you busted, you will seek folks telling you never to even dream of investing in equities. And over the next six years, you’ll miss out on one of the greatest bull markets ever to stampede the financial markets.
Finally, there is the exploding information overload about college planning, retirement preparedness, and the bonds, stocks, mutual funds and ETFs that can help you line your ducks in a row.
So overwhelming is the information avalanche that some Americans wind up paralyzed when it comes to making both the small and big decisions, and head into their 65th year with $27 in retirement savings.
An oasis of insight
So if you would like to avoid the financial trap in which all too many of your neighbors find themselves, track down “Thinking Money” and consider the time you watch a shrewd investment in your own financial futures.
American television was once famously termed “the vast wasteland.” If that is true, “Thinking Money” just might be a little buried treasure tucked amid all the sagebrush and dirt.
- More than two-thirds (68.1 percent) of the elderly poor are women.
- An October 2012 study by the American Association of University Women found that over the course of a 35-year career, an American woman with a college degree will make about $1.2 million less than a man with the same education.
- More than 70 percent of nursing home residents are women, whose average age at admission was 80. In 2006, the average annual cost of a private room in a nursing home was $75,000 and a shared room almost $67,000.
- It is a well known fact that women live longer than men.
- A 2010 survey by Transamerica Center for Retirement Studies shows that just 8 percent of women feel they are already educated enough to successfully reach their retirement savings goals.
Where am I going with listing all these statistics? Women need to take their retirement planning seriously. Women will be much better off if they acknowledge this problem and take action now instead of waiting for their retirement years to address it. So what can women do to better prepare for a long retirement?
Start planning now
Whether you are a working woman, a stay-at-home mom, a mom with a son or daughter in college or just starting out in college, you have to think about your retirement now. As mentioned earlier, statistically, women live longer than men; they also tend to retire earlier than men. Put together, women have a much longer retirement than men. If you are going to be retiring early, you won’t have the entire 35 to 40 years to save. So you will probably need to put away more money than an average man to have the same income in your retirement. If you have not done so already, take stock of what you have already saved; calculate exactly how much you will need for your retirement and how much money you have to set aside every month to reach that goal.
Put your money to work even if you take a break from your career
Women tend to take the role of a caregiver more than men, which means they are more likely to take a break from their career for a few years or work part time. Just because you are taking a break doesn’t mean your retirement savings has to take a break as well. If you are stay-at-home mom, open a spousal IRA and set aside the maximum amount allowed. If you work part time, take retirement benefits into consideration when you are choosing a job. If you are interested, create a small business in an area that you like and that won’t interfere with your care-giving duties. Then set aside as much as possible in a solo 401k plan.
Don’t quit your career
You can take a break from your job; but if you had a career before you decided to quit, don’t completely quit your career. Keep in touch with your colleagues, keep your knowledge fresh by reading journals in your field; if you have any time to spare, pick up volunteering or an open-source project that can be done from home. Take a certification course to update your skills. When you do rejoin the workforce, double up your effort to save and catch up on savings. If you are over 50, don’t forget to take advantage of the higher catch-up contribution limits.
Be involved with the family finances
If you are one of those women who doesn’t take much interest in finances other than the basic home budget, please set aside some time and study your entire finances — your tax returns, bank accounts, assets, debts, insurance and your investments. (What investments do you and your spouse own? How are they doing? Do they match your goals? Do they match your risk tolerance as well as your spouse’s?) I am not saying you should not trust your spouse, but make sure you and your spouse are on the same page when it comes to goals and planning. If you are not confident about investments, take time to learn more about them or meet with a financial adviser who can guide you.
Put your retirement savings first – before your kids’ braces and college savings
It is natural to put your kids first in everything you do; but in this case, you will be doing your kids a favor by putting your retirement at the front of the queue. Otherwise, you might end up in a situation where your kids will have to support you. They can take a student loan for college education, but you can’t borrow for your retirement.
Understand how divorce and remarriage affect Social Security benefits
Divorce and remarriage is not uncommon. There are plenty of horror stories on stay-at-home moms sacrificing their career to raise the kids only to find themselves single, without any retirement savings or job prospects once the children are grown up. In a divorce, you will most likely be entitled to half of your spouse’s retirement assets. You are also entitled to Social Security payments equal to 50 percent of your ex-husband’s benefits, if you were married for at least 10 years. If you remarry, you will lose those benefits but you will be entitled to collect payments based on your new husband’s benefits. If you are a widow, you can receive full benefits at full retirement age for survivors or reduced benefits as early as age 60.
The path to retirement is a little more challenging for women than for men. But by planning early, saving diligently and investing wisely, women can overcome any obstacle and take charge of their retirement.
If you didn’t hear it on the news, you probably noticed it the last time you filled up your car: gasoline prices have been dropping lately after holding fairly steady for a year or so, following world oil prices.
After clicking your heels at the gas station when nobody was looking, you probably got in your car and started wondering: Is this for real? How long can it last? Is this just one of those blips you can clearly see on the chart, or are we seeing a fundamental shift toward lower energy prices? If lower energy prices sound like a dream, that’s because, in our lifetimes, we’ve only see them go up. However, the notion of a long-term drop in energy prices may not be so totally far-fetched.
Three mega-trends could account for the drop:
1. Natural gas
America has been the world’s largest producer of natural gas for a while now, and at record low prices. Common sense says the natural (no pun intended) thing to do is to switch to natural gas usage from liquid petroleum wherever possible. Doing that, though, is not quite as simple, because natural gas usage is limited by infrastructure: You need pipelines to bring the gas to where it is needed. The nation’s major railways are considering a wholesale switch from diesel fuel to natural gas … but they can’t until pipelines are installed to bring the gas to their refueling points.
There is one area where the switch has been happening, and that is home heating energy sources are shifting away from heating oil to natural gas.
For more than a decade, we’ve seen a myriad of initiatives, plans and efforts to reduce our use of oil in general, and imported oil in particular. This chart, produced by the White House from Energy Information Administration (EIA) data shows that we are currently importing less than 50 percent of our petroleum needs these days:
One of the biggest reasons for importing less oil is we are using less of it, regardless of where it comes from. This chart drawn from EIA data shows just how dramatic that drop is:
One of the biggest reasons we use less oil is the increasing fuel efficiency of automobiles sold in America. According to the EIA, average fuel efficiency has almost doubled from just over 15 miles per gallon (mpg) in 1977 to almost 30 mpg in 2013. What is remarkable about that is that the average horsepower per vehicle has gone up over the same period, not down — increased efficiency, indeed.
Oil is being pumped from more locations at more places around the globe. Even more important, though, is non-OPEC production sources are growing, giving OPEC less control over capricious price-setting. The USA, in particular, has seen its share of world oil production increase dramatically in the past few years, and it shows no sign of slowing down anytime soon.
However, even though America is the largest oil user in the world and its demand has been dropping, China, India and other developing nations are increasing their demand for oil, and that has kept prices from dropping.
But this year, that seems to have changed. For some reason, prices started plummeting during the summer months. What could the reason be? Could it be that demand somewhere suddenly started increasing?
In a word, no.
If you dig a little deeper, it becomes apparent that we are witnessing a power struggle of enormous proportions. America’s oil production is increasing as it’s usage is dropping, and a lot of American oil is hitting international markets because the mix of oil we produce doesn’t suit our refineries. Saudi Arabia, concerned that crude oil production in the USA and other countries could be cutting into its revenues at a time when the Arab Spring is causing it to increase its domestic spending, is putting on an old-fashioned monopoly play. It is pumping out more oil to drive prices down, ignoring distressed calls from fellow-OPEC members to back off. As prices drop, the Saudis seem to hope the nouveau-riche oil producers will start losing money and be forced to quit. Their production cost is around $27 a barrel, while the US shale oil costs over $60 a barrel.
In the long run, those oil princes in Saudi Arabia, to cope with their post-Arab-Spring world, need or want oil prices of $100 a barrel or more. From all accounts, it seems they are content to push the price down for a short while just in order to flush out some of their producing competitors; but as soon as that mission is accomplished, this dip will be nothing more than a dip in a chart.
In other words, this is a high-stakes poker game, with billions of dollars at stake … and that includes what you pay at the pump. Will the Saudis succeed? They did before, as the first chart shows, and they have always managed to secure their billion dollar income stream from competitors. Time will tell, but, in the meantime …
What does this mean to you?
The general public has demonstrated a tendency to make long-term decisions based on the assumption that immediate circumstances will continue forever. In past years, when gas prices dipped, sales of gas-guzzling SUVs soared, and sales of energy-efficient smaller cars slumped. If that history were to repeat itself, you can expect to see sales of smaller cars, hybrids, and electrics to slump yet again. Along with that, you can expect those used car prices to drop too.
Therefore, you are entering a window where, if you haven’t done so yet, you will be handed a golden opportunity to fetch a good price for that SUV that keeps growling at your wallet whenever you pull into a gas station. Conversely, you can expect to see better and better deals on the gas sippers.
However, don’t make the mistake of thinking lower gas prices are the new normal. A few oil princes in Saudi Arabia are playing a game, which will end soon.
As they say in show business: “Stay tuned.”
It’s a good thing that I am a planner by nature because, dealing with personal finance as I do involves a lot of long-term planning. So it might seem a little odd for me to take this position, but there are times when your finances might be better for not having made a plan — or at least for not being completely ruled by your plans.
Don’t take this too literally because planning has its place, but planning can also become tyrannical. It intimidates people from undertaking projects. Once a project is undertaken, too much reliance on planning can make people blind to better alternatives.
So the message here is don’t let planning become obsessive. The following are some examples of when freedom from planning can come in handy:
- An opportunist’s career. I have benefited greatly from not having a career plan. I went to college with the intention of becoming a journalist, but the job market was so tight when I graduated that I basically took the first non-fast food job I could find, which was in the operations department of an investment firm. One thing led to another: I got promoted, the firm grew, and I started to learn about the business. It turned out to be a very rewarding career, financially and psychologically. Then, when I got older and wanted to slow down a little, I decided to quit, take some time off, and see what happened. I gradually got into freelance writing, and that has snowballed into a legitimate second career. So, I am back to my first love — writing — but with more money in the bank and more marketable skills because of my investment experience. Not only didn’t I plan this, I’m certain I couldn’t have. Instead, not having a career plan made me more open to seizing the opportunities that presented themselves to me.
- The intimidation of big goals. So, let’s talk retirement savings. Suppose you are just starting your career, making about $30,000 a year, and I tell you you’re going to need to save $2 million to retire. From the point of view of someone making $30,000 a year, that may seem impossible — so intimidating a goal that it does not seem worth starting. I know someone who actually says he doesn’t save for retirement because he’ll never be able to afford to retire anyway. He’s just joking — I think. Anyway, suppose instead we look at your budget. We find a way to carve a couple hundred a month out of that $30,000 a year for retirement savings. For now, we don’t worry about how far that will get you in the long run. The important thing is that you have made a start, and when you get a little closer to the destination, starting to fill in the details will make more sense.
- Analysis paralysis. The other thing about retirement planning is that you can get caught up in the details involved. How do you figure out what you will be earning in ten years, or what inflation will be over the next 30 years? There are several similarly difficult assumptions to make in order to put together a retirement plan, and the problem is some people get so caught up in trying to formulate the perfect plan that they delay getting started. You are better off just making some big-picture guesses and then adjusting your assumptions as the answers become clearer.
- The deception of long projections. One reason not to get too caught up in your assumptions up front is that any slight inaccuracy is going to become magnified over the time frame involved in retirement planning. And inaccuracies are often more than slight. Who knew that savings account rates were going to drop to nearly zero or that we would see two major bear markets within the first decade of this century? Those developments have made a mockery of some very well-thought-out retirement plans, so understand going in that this is largely an exercise in guesswork.
- Adapt and survive. Not obsessing about planning does not mean blithely going through your career unconcerned with retirement saving. Start early, do the best you can, and take stock of where you are now and again. Just don’t go into it thinking that a good plan will see you through the next 40 years. There will be surprises and, even if those surprises shoot holes in your original plan, don’t give up and think your efforts were for naught. Keep yourself open to adapting to survive.
Ultimately, none of the above should discourage you from making plans, but they are simply reasons not to get too attached to your plans. After all, any plan is just a vehicle to get you to your destination, so don’t mistake the plan itself for that destination. You should not wait for the perfect vehicle in order to get on your way, and neither should you refuse to dump your current vehicle if a better one becomes available.
For those investing for retirement, target-date funds sound like a great idea. Say you want to retire in 2030. Simply purchase a 2030 target-date fund, the wisdom holds, and the fund will do a lot of the heavy lifting for you when it comes to your investments.
But like that time you tried to pass your literature midterm by scanning the Cliff’s Notes of “Crime and Punishment,” taking the easy way out may not be your best strategy here either. As one expert says, target-date funds are “the one-stop shop for mutual fund investing.” In selecting the holdings comprising the fund, target-date fund managers choose a higher concentration of high-risk, high-return holdings in early stages, gradually converting to lower-risk holdings as the target date nears.
The result is that the target-date mutual fund investor is investing more aggressively at younger ages, when he or she can afford to take greater risks, and more conservatively at later stages, when lower risk is the order of the day and something to be avoided.
“A target-date fund is really a mutual fund of mutual funds, because instead of owning a basket of stocks or bonds, they own a basket of other mutual funds,” says Phillip R. Christenson, chartered financial analyst with Phillip James Financial in Plymouth, Minnesota. “Each fund has a ‘glide path’ that dictates how the fund will adjust its allocation over time.”
For example, he says, a 2030 target-date fund might start with a 75 percent allocation to stocks. By the time 2030 arrives, the fund’s allocation will have been adjusted down to perhaps 35 percent in stocks, reducing the risk.
The result is that one of the most challenging aspects of investing for retirement, asset allocation, is performed for the investor. The investor gains diversification across a variety of asset classes, and enjoys the sense of not having to wade even toe deep into the varying merits of different investment choices. That makes target-date funds a favored choice among many who recognize the need to invest for retirement but are new to the market and relatively unschooled in its nuances.
Not so fast
Unfortunately, like a lot of areas of life that promise an easy approach if you put on blinders to cost and just leave things to others, target-date mutual funds have a number of drawbacks. The first, and one of the biggest, is that they tend to suffer from above-average expense ratios.
And those higher expenses can nibble away at returns over a longer period of time, like between now and, say, the year 2030.
Another negative is that in an ideal world, a number of factors making up your individual investor profile would be taken into account in determining the right investments for you. They would include your financial goals, your investment time horizon, your income, your assets outside the stock market and your ability to sleep at night should the market cliff-dive. But target-date funds consider only one of those factors, investment time horizon, in their investment allocations.
An additional downside is that target-date funds operate as if you have no other assets in your portfolio. Again, in a perfect universe, when making investment choices you would choose stock market investments you don’t already hold. Doing so adds the attractive virtue of greater diversification to your portfolio.
But when choosing target-date funds, you may be investing again in stocks you already own, resulting in less, not more diversification.
In addition, says Christenson, “a [target-date] fund won’t know if you have other stocks in your portfolio, so the fund may have you at a 50 percent allocation to stocks, but when you look at your overall portfolio, that’s actually allocated 70 percent to stocks. Is that the right allocation for you?”
Under the hood
One of the most suspect issues about target-date funds is this: If you are retiring in 2030, you’ll want to know the target-date mutual fund is selecting underlying investments just right for that 16-year window.
But how can you be sure it will achieve that goal when different 2030 target-date funds have widely differing investments underpinning them? You’ll be taking on more risk in some 2030 funds, less in others, based on which you choose.
Christenson examined a number of target-date funds for the same year, finding that not only did the allocation differ, from say 80 to 70 percent in stocks, but the quality of the investments varied as well. “One fund might invest in very high-grade bonds, whereas another might invest in riskier junk bonds,” he says.
“You have to look under the hood to see exactly what they own.”
Hmm. And how many target-date mutual fund investors will even know how to open the hood?
Ultimately, what many tout as target-date funds’ greatest attribute, simplification, ends up as their undoing as a bull’s-eye of a great investment. These funds not only simplify, they oversimplify. That turns out to be a significant handicap in a world where every investor is different, and requires different investment strategies.
The ultimate takeaway on target-date funds: Aim higher.
Quite a few parents choose to stay home because their entire salary would go to daycare if they went back to work full time after the birth of their child. If you are one of the stay-at-home parents who loves kids and wants to make money from home while taking care of your own kid, have you thought about starting your own home daycare? I have. I did some research and interviewed a mother of two who did exactly that. Unfortunately, she burned out and closed her daycare even though it was popular among the parents. I believe this is what will happen to me as well; so after giving it some serious consideration, I decided not to pursue it. Still, I thought it would be interesting to share the interview I had with the mother, in the hopes that it will be beneficial to other stay-at-home parents who are interested to earn income while they stay at home with their children.
Q. What is an at-home daycare? How does it work?
A. Although each state most likely has their own definition, at-home daycare is typically your home, opened up to a limited number of children (unrelated to you) of various ages. A home daycare program will typically offer structured learning in a safe environment. Most of my daycare children started as infants and grew to be toddlers under my care. I prepared a program for each day for that age group. I also reported (via handwritten notes) to the parents each evening on the events of the day.
Q. Why would parents use an at-home daycare when they could go to a big center?
A. Loving, affordable, safe and convenient childcare is always in demand. Many households have two-parent careers and need someone to handle the children. Some of these parents will prefer daycare in a home as opposed to a commercial setting, believing that it is a more kid-friendly solution. Others may find it is cheaper, more flexible or more suitably located than a commercial center.
Q. How much can you earn with a daycare at home?
A. Each state will have its own limits on the number of children that you can enroll in your home daycare program. To find your state’s requirements, just do an Internet search on “Child care license” plus the state abbreviation. Ours has an upper limit of eight; but with that many children, you might need an assistant!
What you should charge differs by the age of the child, the location of your home and the hours you will be open. You might have different rates for day vs. evening. You may need to charge more for infants and toddlers because your state may allow fewer children of that age to be cared for by one adult.
Some daycare homes require the parent to pay whether or not the child is in attendance (say perhaps a parent takes the child out for a week for a family vacation). The daycare home is reserving that spot and so would like to be compensated. I did not charge when children were absent.
In my small town, I charged $90 a week and enrolled six children. As my ongoing expenses were low — basically being lunch, snack, diaper wipes and an occasional piece of equipment — my profit margin was high. Based on my personal experience, depending on the cost of living in your area, I estimate you can make anywhere from $400 to $1500 a week. Of course, your mileage may vary.
Q. How do you go about starting a daycare home?
1. First, review what your area’s legal requirements are.
- You may find, for instance, that your home is not currently well suited to childcare and would require expensive maintenance or upgrades, such as, outdoor fencing or new electrical wiring. States who license want assurances that providers with a license meet certain standards regarding health, lack of criminal records, and so on. And be aware that all adults in the home may be subject to meeting those requirements, not just the provider.
- You may also find that you don’t need a license. Some states allow providers to care for a few non-related children without one. In our state, that number is four. Still, for marketing purposes, you may want the reassurance factor that being a licensed home provides prospective parents.
- You will also need verification from other members of the household that they are willing to share the home with additional children. Your parents may not meet the exact drop-off and pick-up schedule agreed upon, causing you to still be caring for their children when it is time for other household activities to begin. For my daycare license, I also had to get permission from each adjoining neighbor.
2. Look at start-up and operational costs.
- What training might you need?
- What emergency measures (including hiring others to come in and watch the children if you have to be away) will involve cost?
- How do you plan to market your services? I advertised through the church bulletin and on signs posted in the neighborhood as well as ads in the paper. So my cost of marketing was negligible, but I can easily see this expense getting out of control if you have a lot of competition and are starting new.
- What equipment and supplies will you have to buy? I did purchase added equipment — a play kitchen, additional toys and other items. Some of these came from garage sales, others had to be new.
- Is your home adequately child-proofed? What needs to be done to make it child-safe? How much will that cost?
3. Consider the risks involved.
- You should also consider the risk that you are incurring in being responsible for other people’s children. What could possibly go wrong? Children may fight with each other, fall and break a bone, run into something and get a concussion, wrongly accuse you or another adult in the house of something, and so on.
- How are you covered financially and planning-wise to handle the risks? An umbrella liability policy should be considered at a minimum. In addition, you might consider incorporating your daycare home into an LLC or S-Corp as additional personal protection if the unthinkable should happen.
Q. If you had an opportunity to re-do the whole thing, what would you do differently?
- Purchase an umbrella liability policy and incorporate my business
- Hire an assistant to help out part of each day and be on call to take over if there was an emergency. For $540 a week, my time was utterly and absolutely devoted to caring for, feeding and educating those six children, plus my own two, for a span of around 11 hours a day, five days a week. With eight children, it was nearly impossible to leave the home. So I had to use non-care time for the gathering of supplies, planning and preparation.
- Charged more! It was a feasible way for me to earn the money I needed back then — and one of the few available to me — but it was THE most exhausting job I have ever done. It was an exhausting, lucrative, emotionally satisfying way to earn money while still being home to care for my own two children; but I burned out in three years. If I have to do it again, I will most certainly charge more. I will compete based on my quality, not on the basis of price!
If you are a stay-at-home parent, what options have you considered that would allow you to work from home?
Have you ever watched the popular television show “Shark Tank”? In it, entrepreneurs pitch their young businesses to five rich tycoons (the “sharks”) in hopes of attracting an investment from one or more of them. Some entrepreneurs are youngsters with a great idea, some are savvy veterans, and others are ordinary families hoping to turn a great idea into a million-dollar business. Not all get an investment. When you do get an investment, it usually takes one of two forms:
- An equity stake in your business
- A royalty on gross sales
The sharks don’t invest in every business that gets pitched to them. They especially don’t invest in businesses where where the pitch revolves around a tear-jerking story. They don’t care that you had hardships, no opportunities, or that you’re the most upstanding citizen on Earth. They only care about two things:
- Getting their money back
- Getting a handsome return, in addition to just their money
You may also have heard of Kickstarter and other sites which offer something similar: an opportunity for entrepreneurs to raise money to fund their ventures. But as the name implies, you don’t attract investments from one or a few individuals; you attract a crowd of investors to fund your idea. The crowd usually gets a financial stake in the new business in proportion to the money invested, but not necessarily. For $5 invested, all an investor may get is a discount coupon on the new product when it gets launched.
In one form or another, crowdfunding has been around as long as the human race, it seems, whether the person giving the money has a direct stake in the venture’s financial results or not. Grandparents giving kids money to start a lemonade stand or paper route are classic examples. Don’t let the down-home examples fool you, though. The City of Green Bay, Wisconsin, is a master at this: In 2011, they raised over $60 million for the NFL team it owns, the Green Bay Packers, by selling shares which have no votes and no share in any profits. It was just a huge civic-crowdfunding exercise.
You can think of venture capital as the halfway point between crowdfunding and “Shark Tank.” Anybody has access to venture capital, just like they have access to crowdfunding; but the venture capitalists (VCs as they like to be called) are even more stringent than the sharks in their focus on the money generated by a fledgling business.
What all of these funding mechanisms have in common is: They are not loans. Loans have to be paid back — with some interest — whether the venture fails or succeeds. None of these investments carry that requirement. If the venture pays off, they make way more money than the interest on a loan. However, if it doesn’t, investors lose it all with no recourse.
The essence of crowdfunding, venture capital and the “Shark Tank” is that they put up money and take a big risk. The risk is that the venture will be a bust. Think of when England would send merchant ships to the Far East to trade for tea and spices. Fifty rich shareholders would invest a million dollars (in today’s money) to build, outfit and crew a ship, which would take two years to sail to India, Indonesia and China.
Sometimes the ship would come back and the shareholders would split five million between them. That would be wonderful. They would throw lavish parties and hire painters to paint portraits of their wives.
Frequently, though, the ships would not return, and the shareholders would lose all that money. That would be a tragedy — no parties and no paintings.
In other words, every venture had a chance for either riches or tragedy. They called that chance risk. They understood that when they pony up the money for a trip, they might lose it all. However, they take the risk because, along with the risk, there’s the promise of a rich reward.
When you invest money for your retirement, you limit your risk with something called diversification. You are not alone.
Instead of three investors putting everything they have in a single ship in the olden days, fifty investors put a tenth of their wealth in a single ship. Instead of sending just one ship, they sent four or five. If one goes down, others will survive and make it back. Lloyds of London is a famous place where ship owners shared risk and reward. There are, as you can see, many ways for investors in risky ventures to alleviate that risk through diversification.
Imagine you’re a high schooler, and you’re thinking of going to college. College these days almost costs as much as one of those shipping expeditions to the Far East. “But,” you think to yourself, “I should make a lot of money with a degree. Everyone tells me I’m smart, but I don’t have the money to pay for a college degree, and neither do my parents. Hmmm… I wonder if I could persuade all of those people who tell me I’m smart to put their money where their mouths are?”
The good news is that you can. And your friendly Congress is looking at ways to help you do it. The wellspring of three-letter acronyms is mulling yet another one for the Income Share Agreement (ISA).
ISAs allow students to raise funds to pay for their degrees by selling shares in their future earnings, kind of a cross between crowdfunding and venture capital. ISAs are financial instruments that can be administered by the government or by private financial institutions. Their defining characteristic is that an individual gains access to cash for a college degree in exchange for a promise that they will pay back a fraction of their earnings for a prescribed period of time to the entity that put up the money. And, by grouping a number of students’ funding, it spreads the risk over many students.
It is like a venture capitalist investing in You, Inc. A graduate who earns less than expected will pay back less than the full amount of the initial funding, while graduates who earn more than expected will pay back more than their share.
Does anybody do anything like that? The New York Times recently published an article about online “trade schools” like the App Academy, which charges no tuition, but will take 18 percent of the income graduates earn in their first year.
This is a classic good news/bad news situation.
Good News, Bad News
The good news is obviously that, with something like an ISA, more students will have access to increasingly expensive higher education. Furthermore, when a hundred investors invest in a pool of a hundred students, the diversification allows them to spread the risk, much like those old ship owners from days gone by.
The bad news is that outside investors, more likely than not, will, like venture capitalists and the sharks on “Shark Tank,” focus strongly on the financial outcomes of the education. If you are a student looking to get investors to fund your engineering or medical degree, you are much likely to attract ISA money than, for example, for a degree in art or history.
But, is that a bad outcome? This is not to disparage a degree in the liberal arts; but the moment outside money, whether it be student debt or something like an ISA, enters the picture, the financial return on higher education becomes much more important.
What limits the use of ISAs? Uncle Sam. At the present time, there are well-used mechanisms in place for the Federal Government to assist colleges with grants and loans, but not ISAs. Because of that, most students would only elect an ISA over a traditional loan or grant if they were tapping into private sources of funding.
We live in a time of evolving technologies and opportunities. The student debt problem is pushing the issue of higher education funding into the crucible of change.
Would you, as an investor, invest in an ISA for a student you know? For one you don’t know? Would you, as a student, accept a form of education financing that, in effect, indentures you for a specified period of time?
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