Sunday, March 27, 2016

What’s a conservative investment? It all depends on who you ask.

As a financial advisor I would frequently have clients who told me they were fed up with the volatility of the stock market and were now looking for more 'conservative investments'. As it turns out, the definition of conservative can vary widely.

Often when people think of conservative investments what comes to mind are things like CDs and investment grade bonds. These investments provide predictable and sometimes guaranteed returns, albeit at much lower rates than historical average returns from the stock market. An additional challenge for the past several years has been that when interest rates are so low, you end up losing purchasing power as inflation eats away at the value of your 'conservative' investments. How's that for conservation?

Wind creates waves, but can also be captured by a sail to propel a boat across great distances. In order to advance a boat in the absence of wind, a sailor must exert significant energy. Volatility in the stock market is like wind. The greater the wind (risk), the greater the speed at which your boat can go or the rate at which your investments can grow. If you can stomach the volatility and use it to your advantage by buying and holding, you can end up much farther ahead than if you stick to calmer waters (low volatility investments) and rely on rowing. If you insist on sticking to low risk investments, be aware that you will need to save at least double what you would need to save if you were willing to take a little more risk.

I'd like to make the argument that if you're truly looking for a conservative investment, look no further than a diversified stock mutual fund.

What? You can't say 'stocks' and 'conservative' in the same sentence!

Here's a few reasons why.

  1. Long term, stocks outperform bonds and cash.

  2. Capital gains from investing in stocks are generally taxed at a lower rate than the tax rate for interest income from bonds or cash, further widening the gap in performance.

    • But hey, DIY$, my investments are mostly in retirement accounts so I don't pay taxes until I withdraw! (See reason #1.)

  3. Preserving purchasing power is much more important than preserving your original account balance. Inflation has been relatively benign in recent years but don't let that fool you. If we were to have 2% inflation for the next 10 years (slightly lower than average) and you're invested in a 10-year Treasury bond at 1.75% because it's "safe", you end up LOSING 0.25% per year in purchasing power.

The main argument against this line of thinking is the obvious fact that the value of a stock portfolio can go down and that there are no guarantees. There are a lot of insurance companies that are more than willing to take that bet and offer you guarantees through annuities, but be VERY careful with these. What would you say if an insurance company offered a guarantee that if you invested in the stock market for 10 years, they would guarantee you not lose money? Sounds great, right? All the upside potential of the stock market but without any of the downside risk! This is how these products are sold, but the truth is usually much more confusing.

For this type of guarantee, an insurance company will charge ~2-3% per year in management fees on top of ~1% in mutual fund management fees. If you cash out early, not only can you lose the guarantee, but you will also likely have to pay an early surrender charge that could be as high as 10-15%. If you really dig into the fine print too, you may also find that the guarantee has a monthly cap. So if they cap the gains at 2% per month, and the market earns 8.3% in a month (like it did in October 2015), you would have been better off just being invested in a regular mutual fund instead of in the annuity with caps on monthly gains. If you look back over time, there have been very few times where an investment in the stock market loses money over 10 years. The 2000s were often referred to as a 'lost decade', because the market ended the decade basically where it had started. If you had been paying 2% in insurance fees per year though, your investments would be down ~20% instead of unchanged.

It's a crazy world out there, but I am confident that with the right information, you can do it. Stick with stocks, and don't let a little choppiness cause you to jump off the boat or seeker calmer waters. Understanding what you're invested in can arm you with the confidence needed to ride through the storms that may arise. Just this year, the Dow has gone down and then up again by 2,000 points. The only way you've lost anything though is if you sold. Don't do it.

Thursday, March 17, 2016

I messed up guys…

I did something dumb recently. I'm sure worse things have been done, but this one sure made me feel pretty bad. I got hit with an interest charge on my credit card!
Here's how this all went down.
We use rewards credit cards for pretty much everything we buy. I find that it's easier to manage our cash when we only have a couple of withdrawals from checking each month, and we track all of our expenses to make sure we don't overspend. Even though we make purchases using credit cards, we always treat it as if it were coming out of checking and we always have enough cash to pay our cards in full. We get mainly cash back rewards that go straight to our retirement accounts, and have earned as much as $800 in a year. It's not a ton, but it's money we wouldn't get if we were using debit cards for everything.

So, our January credit card bill was $1,063, which we paid in full. Our next month's bill came in at $1,101, which we also set up to pay in full. We had plenty of funds to cover the bill so I set up our Bill Pay to make the payment and forgot about it.

The problem though was that the two amounts were so similar to each other and on the statement the number for "Last Payment Made" is right by the number for "New Statement Balance". Somehow I ended up putting in the wrong amount for payment, and ended up paying $1,063 instead of $1,101…an underpayment of only $38.

Since we hadn't paid the balance in full, we got hit with an interest charge right away. Since we had continued using the card, though, the interest was charged on the $38 we hadn't paid AND everything else we had charged since the last statement. Thank goodness for Mint.com! As soon as we were hit with the interest charge, Mint shot me an e-mail alert. Any guesses how much the interest was? $21!. Underpaying by $38 caused a finance charge of $21….wow. More than half of what we didn't pay we were being charged as interest! I know they calculate interest differently, but from my view, that's like charging me 663% interest! ($21/38 * 12 months).

I know that if I were to tell this story to Dave Ramsey this is when he'd come back with something like "See, that's why you don't use credit cards!" or "If you don't use credit cards, you don't accidentally get into debt." Technically, he's right. I never would have to worry about this if we stuck to debit cards, and we'd never have to worry about overdraft fees since we always keep a large minimum balance in checking. In reality though, even if I made this mistake once a year, it would still be worth it to me to pay $21 in 'stupid tax' and still be able to collect $700-800 in cash back rewards.

I decided to suck up my pride and call my credit card company to plead for mercy. Apparently this sort of thing happens all the time and when I immediately paid the difference, they were able to reverse the interest charges and treat it as if it never happened. The phone call took about 5 minutes and I didn't really even have to beg. It sure was a blow to my pride though, so I'll be sure to pay more attention going forward. I've always been able to say that I have never paid interest on a credit card, and thankfully that is still true.

Thursday, March 10, 2016

Book Review – The Opposite of Spoiled


Image result for the opposite of spoiled






I recently read The Opposite of Spoiled by Ron Leiber and found it to be a thought-provoking read on ways to focus on raising kids that are 'the opposite of spoiled'. Similar to the author, I find it hard to come up with a good adjective that adequately describes this behavior, but you probably know exactly what I mean. I give the book 4/5 stars and would suggest you read it if the topic is one of interest to you.

I'm glad I came across this book, because I really didn't care for the last book I read on the topic (Piggybanking). Although the overall topic of teaching kids about money is similar, the approach and advice between the two books is very different. While Piggybanking seemed to focus more on tactics and mechanics, The Opposite of Spoiled focuses more on the general topics of teaching principles that are applicable at any level of income or wealth.

I think for me one of the big takeaways is to teach contentment. Like many others, we are blessed to the point where we are able to provide our children with most things they want. But just because we can doesn't mean that we should, so we don't. We try to live a simple life relative to our surroundings, and teaching our children contentment will continue to be more and more difficult as they begin to be invited to over-the-top birthday parties, start wanting their own electronic gadgets, or notice all the luxury cars in the high-school parking lot. I'm not going to say that people should deprive themselves of things they want to buy, especially if they've worked hard and can afford it. What I will say though is to stop and think about the messages we send to our children with our purchases. If one friend has a huge birthday party, then the next friends parents throw an even more extravagant party, you may feel pressured to splurge on your own child's next birthday. The only way to win the keeping up with the Joneses' race is to make the conscious decision to not play at all. They say 'Mo Money, Mo Problems', but in this case what we see is 'Mo Money, Different Problems'.

When kids ask for something and you can't afford it, it's easier to say no. But if you can afford something your kids ask for, the answer doesn't automatically need to be yes. It can actually be harder to say no, but I believe we miss out on a teaching opportunity if we don't have a further conversation on why we said no. Our kids are young enough that we are able to afford anything they ask for, but we have already had several conversations with our 5-year-old about why we decided not to buy something even though we have the money to do so. Don't get the wrong idea, our children are not deprived, but we do say no more than we say yes to things. I hope and believe that these lessons will be impactful and that over time our children will be able to remember these lessons and make similar decisions to practice self-control and restraint in their spending.


If we don't teach our kids about sex and drugs they will eventually learn about them on their own, and maybe not the way we would want them to learn. Money is very similar. If we don't talk about money with our children, they run the risk of learning money lessons the hard way. Just like you wouldn't want your kids to learn about sex and drugs from a loser friend at school, you wouldn't want them to learn about money from a broke friend or someone selling financial products. I believe that home is a testing ground for decision making, and that learning money lessons at home is critical so that the right decisions are made after kids leave the house when the stakes are higher.

One last point I wanted to make actually comes from the authors note preceding the actual book. In the preface, the author points out that this book is written with the assumption that readers have a household income greater than $50,000 but that the principles can be applied at lower income levels or for the extremely wealthy. The message overall is one of optimism and hope, and perhaps this is why I liked the book so much. As I read the book thinking about the intended audience, it got me thinking about who the intended audience may be for other books. I now believe that one of the reasons I didn't like the last book I read (Piggybanking) was because the author may have intended the audience to be less affluent or lower income earners. If this is true, I like that book even less. I agree with Ron Lieber that sound money principles can apply at any income level. Borrowing money for things you can't afford is a bad idea whether you make $30,000 or $300,000 per year.

Tuesday, March 1, 2016

February Net Worth – Up $19k!

February was a good month for us on the net worth front, with our net worth growing $19k to $523k. Overall, a great month, even though the market was pretty much flat.

CASH

We've been wanting to grow our cash balance over $25k, and were able to cross over that mark this month. We have some large purchases on the horizon and wanted to make sure we have a larger cash fund to not have to dip into the $20k base amount that we consider our emergency fund. We keep about $25k in our online savings account and the rest is in our checking account.

Our cash balance increased largely due to receiving an annual bonus and our tax refund. I like getting a tax refund, but don't like it to be too large. This year, our tax refund came in just under $4,000, the smallest refund we've had in years. Hopefully we can keep reducing the amount of refund as we continue to do some Roth conversions. We've had some medical issues come up this month that will reduce our cash balance once the bills start coming in, but thankfully we have enough to cover our complete deductible.

Also, on our cash front, I got another raise this month! It's actually a raise and a promotion, one that I've been working towards for a while and I'm really pleased with how it's turned out. Not only is the additional income nice, the new work is very interesting as well. On the financial side, the raise is going to be about $500/month, with an increase in annual bonus potential that won't come until this time next year. I got another raise a few months ago and we are already saving all of that increased income, so this new raise will just be additional gravy.

INVESTMENTS

Our investment balances are up $10,163 this month! That sounds great, until I tell you that including employer match, we actually added $10,574 to our investment accounts. So…we basically ended the month where we started, but added a big chunk. These deposits were split between Roth IRA's ($6,000), and a Roth 401k with nearly everything that we added to our investment account going into stocks.

HOUSE/MORTGAGE

No surprises on the house value. We've had some fairly comparable homes in the neighborhood sell for slightly higher than the Zillow estimate shown here, so it seems reasonable. We continued to pay extra on the mortgage in February, increasing the extra amount we paid compared to previous months. Now that we feel our cash balance is in a good spot and with our higher income, we'll be focusing on paying a bit more extra towards the house. When preparing our taxes this year, we were both sickened to see that we paid over $8,000 in mortgage interest last year and are determined to reduce that amount. Psychologically, it would be nice to pay under $8,000 in interest, but I'm not sure we'll quite get there this year.

I'm pleased with how the month turned out and with the trajectory we're on. We've come a long way and have a long way to go, but it's good to feel that we're on track and focused.