Sound Wisdom on Investing and Portfolio Management

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney

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Sound Wisdom on Investing and Portfolio Management
Jim Lange, CPA/Attorney
Special Guest: Jonathan Clements, Financial Columnist/Author
Episode 15

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TOPICS COVERED:

  1. Introduction of Special Guest, Jonathan Clements
  2. Portfolio of Stocks and Bonds  - Inside and Outside the IRA Account
  3. Funding Your Own Retirement Before Funding Kids’ Education 
  4. Advantages of Immediate Fixed Annuities 
  5. Asset Allocation Strategies…Through Good Times and Bad

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. Introduction of Special Guest, Jonathan Clements

Beth Bershok: We are talking smart money, we have a wonderful guest tonight, thank you so much for joining us. I’m Beth Bershok along with Jim Lange, CPA, attorney, best selling author of the book Retire Secure! Pay Taxes Later, that’s actually two different editions of the book Retire Secure! Pay Taxes Later, .and Jonathan Clements is with us today. Jonathan was with the Wall Street Journal for 18 years as the top personal finance columnist. I have to tell you, Jonathan, this is a huge compliment. Jim has been so excited about this show because he calls you his favorite financial writer.
Jonathan Clements: Well, the reason I was Jim’s favorite financial writer was because I regularly had to call him up to get his expert advice and I put his name in print.

Beth Bershok: You did I. think he was in 25 times, in the Wall Street Journal with you.

Jonathan Clements: Well, I wasn’t counting, but I guess he was.

Beth Bershok: He was counting. But honestly, Jim reads every financial piece and he says you are his favorite financial writer. And since you left the Wall Street Journal you authored something called the Little Book of Main Street Money. And Jim also says that that happens to be his favorite financial book that isn’t specifically about IRAs and retirement plans.

Jonathan Clements: I guess that’s a high compliment, Beth. Anyways it’s great to be on your show with you and Jim. I really appreciate you having me on and I’d love the opportunity to talk a little bit about my book.

Beth Bershok: Well, we’re so happy to have you. And Jim has, honestly, not only has he, I think, he’s read the book a dozen times, he has little notes all over the place little thoughts that he had while he was going through the book, so I’m just going to let Jim get right into it.


2. Portfolio of Stock and Bonds - Inside and Outside the IRA Account

Jim Lange: Well, first, I want to start usually you know they say well the good part’s coming up after the commercial, but I’m going to start with something that I thought was so good and something that was news to me and that is that the classic dilemma of, if you own stocks and you own bonds and normally long term investments are stocks and shorter term or safer investments are bonds. If you’re talking about, should you have that in the taxable account or the IRA account since the long term investment tends to be stocks, you would think that that should go in the retirement plan and the bonds that have a, let’s say, a safety in the more short term money that should go in the after tax dollars, but it’s the exact opposite in terms of income tax efficiency. That is, bonds that are fully taxable in the taxable environment will throw off the highest tax, so from a tax standpoint, you want money in the IRA that would be normally taxable like a bond. And you would want the more tax efficient investments, like a stock, outside the IRA, but that’s the exact opposite in terms of time frame. And you offer, what to me was a wonderful solution, so I thought I’d maybe ask you about that and ask you how you would handle the problem of if you have a portfolio of stocks and bonds and you want to have some money in the IRA or retirement plan and some money outside the IRA and retirement plan.

Jonathan Clements: Why am I not surprised, Jim, that you went straight for the issue involving taxes.

Beth Bershok: You knew that was coming on, Jonathan.

Jonathan Clements: But it’s a great question and I think it really is an interesting issue because it’s totally counterintuitive. If you talk to people and say where should you put your stocks and where should you put your bonds, their immediate instincts are, take your bonds and put it in your regular taxable account because their feeling is, I’ve got a financial emergency, I want to be able to sell a conservative investment to get cash because if I have my taxable account invested in stocks and I suddenly need emergency money and I go to sell the stocks, it could be a bad time in the stock market and I’d have to sell those stocks at depressed prices and boy I really don’t want to be doing that. But there’s a simple solution. Let’s say, for purposes of argument, that you need $10,000 in emergency money, maybe you need to replace the roof on your house, you got a big medical bill, maybe you’re between jobs and you need some cash to cover that period of time, and all you got sitting in your regular taxable account are stock funds. And those stock funds are way under water, we’re talking March 2009 the S&P500 is 57% its all time high, there couldn’t be a worse possible time to be selling stocks, and yet you do just that. You sell $10,000 of stocks in your regular taxable account to get the cash that you desperately need. Of course, at this juncture you have done something that is not smart, which is to sell stocks at depressed prices. To fix the damage that you’ve done what you can do is, immediately turn around in your retirement account and sell $10,000 of your bonds and move that money within the retirement account into stock funds thus recreating the stock exposure you previously had. In essence what you’re doing with all this financial finagling is, you’re getting the $10,000 that you desperately need, you’re keeping your stock exposure the same, and you’re reducing your bond exposure by $10,000, even though all you had sitting in your taxable account when you started was purely stock funds.

Jim Lange: And I love that so much. Yeah, you’re right, I went straight to let’s call it the hard stuff, but actually, what was the biggest surprise to me of your book, and because most of the columns that we worked on together were hard type things, you know, Roth IRAs and private annuities and wills and things like that, is that you have a much more philosophical orientation then I would have guessed and you know your seven key beliefs I just thought were a great foundation for the rest of the book and I guess I just didn’t think of you as that good and so philosophical in your big picture point of view. And maybe it would be appropriate to go over a few of the softer issues, something like the seven key beliefs.

Beth Bershok: Actually, I love these seven key beliefs because they apply to absolutely everyone. First of all, Jonathan, before we get to those, is this a financial philosophy, those seven key beliefs that you developed over time, over your writing career with the Wall Street Journal?

Jonathan Clements:  Yeah, absolutely. I mean, I was a financial journalist before I left the Journal for a quarter century and you know one of the intellectual progressions that I went through is the initial question you ask yourself, is, okay, what’s the smart way to invest and you know where I netted out was to think about things like you know, should you be active in mutual funds, or should you be in index funds, I’m a clear fan of index funds thinking about things like controlling costs, controlling taxes, thinking about risk exposure. You start going through all this and you know the answers you discover are really relatively straightforward and then you look up from the text books and you look around the world and you say, well, why isn’t anybody doing this, why are people messing up so regularly? And you start to realize that, while investing is simple, it isn’t easy, people regularly mess up. I mean, this is why so many people end up using financial advisors. Not because it’s hard to figure out what to do with their money. The problem is, it’s hard to get yourself to do it. And thus, you know my initial introduction into the whole sort of emotional philosophical side of this started with a lecture in behavioral finance. We had these issues of overconfidence in bull markets, why we tend to panic and sell in bad markets, why we struggle to save and hold down our spending. From there, I started to tap into other research, and in recent years, a particular area of interest for me has been, so called, happiness research. Why is it that the standard of living in the US has increased so dramatically over the last decade, and yet our reported level of happiness is no higher. That’s an issue I think about every day. Why is it that all this money doesn’t seem to buy folks a lot of happiness?

Beth Bershok: Have you discovered the answer to that?

Jonathan Clements: Well, the literature points you in the right direction. One of the things the academics talk about is this psychological phenomena known as hedonic adaptation or the hedonic treadmill. The story goes something like this, there’s something you want, maybe it’s the new car, maybe it’s the bigger house, maybe it’s the next pay raise, maybe it’s the next promotion. So you finally get what you want, you get that pay raise, you know you thought about it for months, you anxiously awaited it, finally you got that pay raise and you are thrilled, you are thrilled. And then a month later you know you’re not so thrilled and then a month after that you know it’s just another pay check and then another month after that and you’re sitting around drumming your finger on your desk thinking, when am I going to get my next pay raise? We tend to adapt to these improvements in our life. You know, we really are, you know, true descendants of our hunter gatherer ancestors. You know our hunter gatherer ancestors were able to survive and reproduce because they strove relentlessly to get ahead. They were never satisfied, they always were looking to find enough food, to find the shelter they needed, to make sure they lived until tomorrow, and in many ways that is the people that we still are, We strive relentlessly to get ahead and we are never satisfied.

Jim Lange: And one of your, I guess this is one of your key beliefs that kind of surprised me because the book is so full of just excellent, sound wisdom in terms of saving and portfolio management and rebalancing and the one that really surprised me is that you said buy experience rather than things.

Jonathan Clements: This is a really interesting phenomenon, and imagine you went out and you bought a new car, and it’s the same cycle we talked about with the pay raise. Initially you’re thrilled, you show it off to the brother-in-law, you show it off to the neighbors, you drive it around town.

Beth Bershok: That’s so truth, yes.

Jonathan Clements: Three months after that, you get the first scratch. Two years after that, you get the first fender bender, and then two years after that, the car breaks down. And suddenly, this thing that had been the source of such pride and such joy is sitting in the drive way taunting you. By contrast, imagine that you took the family to Paris. You go there for a week. The vacation is quickly over and the money is gone and yet the trip to Paris may actually give a longer run boost to your happiness than your car and the reason is this, the vacation to Paris doesn’t sit in the driveway taunting you. It’s over quickly and all that you’re left with is fond memories and those fond memories will, if anything, grow fonder over time.

3. Funding Your Own Retirement Before Funding Kid's Education

Jim Lange: Well, I just thought that that was, you know, very interesting and I actually liked some of the things obviously, is a combination of philosophy and money. So one thing that you said that I and a number of my younger clients are struggling with is, that you said something that is somewhat controversial and that people, parents, tend to not want to do, but I just think it’s so wise. You say to fund retirement before kids college, and if you could expand on that, because in my practice, I have a lot of clients who came from a home where they had their college taken care of by their parents and they just assumed that they were going to do the same things, and sometimes that’s great if you can afford it, but I have a lot of clients who, frankly, can’t, and particularly I think today there is a much higher cost per year of college and a much lower return when people get out of college. So it’s going to be a real burden for either a parent to finance, or a student to finance college and then quickly pay it off after they’re done. But I think that you seem to be more interested in long term security, so if you could expand on that thought I would appreciate it.

Jonathan Clements: Sure, yeah. There are a bunch of somewhat financial reasons to fund your own retirement over funding your child’s college education. Number one reason, the best savings and investment vehicle available to most folks is their 401(k) plan from their employer. I mean you get what I call the investors triple play. You get up front tax deduction, you get tax deferred growth, and you may get some sort of matching contribution from your employer. There’s no investment that’s going to give you those three great attributes. So if you’re not making the most of your 401(k) plan and at least putting in enough to get that full employer match, you’re making a huge financial mistake. So, that’s one reason why you should be favoring the 401(k) plan over saving for your child’s college education. Next, your time horizon with your retirement savings is likely to be longer than your time horizon with your kids college education. That means you can take more risk in pursuit of higher returns. You think about saving for a top college education, you’re looking ahead the most you’re going to have is 18 years and in terms of the financial markets that’s not a huge amount of time. You may be able to put some money into stocks initially, but within a decade, you’ll probably be thinking about throwing back your stock exposure and chipping more towards bonds so you’re going to end up getting lower returns than you would in your retirement account, where you can afford to take more risks. Finally, one of the things you think about is, there’s a lot of money available to help pay for college education. You can get grants from the college you’re going to, you can get student loans. By contrast, when it comes to retirement you’re going to have to pay cold hard cash. With the exception of reversed mortgages, it’s really difficult to borrow money to pay for retirement, which is why you probably want to put your retirement first and think about saving for college as a secondary goal.

Beth Bershok: You know the issue there, Jonathan, and I’m sure this would crop up in many, many families, is it’s almost an emotional issue, or an issue of pride, and some children, I honestly believe, fully expect to have their college paid for, it’s almost like it’s a given.

Jonathan Clements: And I think that’s why it’s really important to manage expectations. I mean, parents should sit down and consciously decide, you know, are they going to pay for the undergraduate education? If they’re going to pay for the undergraduate education, do they draw the line there, or are they willing to pay for graduate school? They should think about, are they going to put some money towards a house down payment, what sort of wedding are they willing to fund? These are all big ticket items and you know you and your spouse should sit down and think about what it is you’re willing to do, financially, for your children and then communicate that to your kids. There is no right or wrong answer here. A lot of this will come down to the values. I mean, if you really value education, or you really, really value having that big expensive wedding, then yeah, you’re going to make that a financial priority and you’re going to have to sacrifice somewhere else. But never forget, these are indeed tradeoffs. You put a dollar towards one item, it’s not available for something else. These are big tradeoffs. You need to decide how you’re going to make them and then you need to communicate that to your kids so they don’t reach age 18, have this expectation that you’re going to fund the full ride at Harvard, and discover the money just isn’t there.

Beth Bershok: How do you bring that up?

Jonathan Clements: I would say dinner.

Beth Bershok: You’re sitting around having meatloaf, oh, by the way, we’re not paying for college.

Jonathan Clements: I think sooner is better than later. As soon as you start talking about this with your kids, the more their expectations will be in tune with your pocket book and they’ll understand what the financial stakes are and they’ll make their decisions accordingly.

Jim Lange: The other thing is, I actually like the child to have a little skin in the game, and specifically my parents’ philosophy is, we will pay for undergraduate and that’s it. When I was sponsored, if you will, I was an okay student, but then, when I went to law school and it was on my own dime, all of a sudden, I did a heck of a lot better.

Beth Bershok: I think that happens, typically.

Jim Lange: Because it was my money and I cared about it a lot more. But, of course, one of the things that if we’re not going to pay for our college education is that either we, or perhaps our children, are going to have to go into debt, and one of the things that you said that I really loved is that you use the analogy of debt as a negative bond. And I thought that was such an almost paradigm shift and if you could expand on that thought, I would sure appreciate it because I thought that was just a wonderful part of the book.

Jonathan Clements: When you think about a debt, what is it? Well, a debt is something that you have to pay interest on. You have a mortgage, say, and it’s charging you 6% interest. Well you know you’re paying interest to somebody else. On contrast, when you go out and you buy a bond, somebody else is paying interest to you; it’s essentially the mirror opposite. So, if you’ve got $1,000 to spare and you’re a conservative investor and you’re thinking about how to invest that $1,000, you’ve really got a couple of choices. I mean, you could go out and you could buy a bond that’s going to pay you particular interest, but you may discover that it’s more worth while to take that $1,000 and you could pay down $1,000 of debt because that debt is costing you more than the interest you’re likely to earn than buying a bond.

Beth Bershok: And Jonathan and Jim, we are going to take a quick break. We’ll be right back with Jonathan Clements, he is the author of The Little Book of Main Street Money. It is The Lange Money Hour: Where Smart Money Talks.

Beth Bershok: Thank you for joining us tonight talking more smart money. I’m Beth Bershok, along with Jim Lange CPA, attorney, best selling author. And our guest tonight, Jonathan Clements, who is Jim’s favorite financial writer, that is absolutely the truth. Jonathan was with The Wall street Journal for 18 years as the top personal finance columnist. He’s been on Good Morning America, The Today Show, CNN. We are thrilled to have you with us tonight, Jonathan, and your book The Little Book of Main Street Money, this is brand new, this just hit bookshelves in June.

Jonathan Clements: The book came out in June, yup, and it’s available at good book stores everywhere, and a lot of bad ones.

Beth Bershok: And there are some of those. Can you also get this on your website?

Jonathan Clements: You can’t get it through my personal website at jonathanclements.com, but you can certainly go to amazon.com, barnesandnoble.com, any of those. I advise people to buy two copies because I think it gets better on the second read.

Beth Bershok: And Jim has read it many times, it’s The Little Book of Main Street Money. Honestly, he claims it’s one of his favorite financial books and there are so many points in this book that I know Jim really wants to get to tonight, so do you want to start with pensions Jim?

Jim Lange: Yeah, and actually, this is one of the issues that come up in practice, is I have a lot of people in the education field, teachers, college professors, and also engineers and people who have traditional pension plans. And a lot of times, by nature, the type of people that go into these professions tend to be a little bit conservative, particularly say, engineers or teachers who didn’t necessarily go into it for the money. And at retirement, they have some type of pension, that is, they have a certain income that will last their entire lives and maybe it’s adjusted for inflation but maybe it’s not. And then, in addition to the pension, they often have social security. And then there’s often some investments also. And I’ve always maintained that if you have pensions and social security that that’s kind of like a bond. So if you have additional investments that you would have a different asset allocation mix that is leaning more towards stocks because your bond, or your safe money, is already covered. I’ve hardly seen that anywhere. Nobody talks about that and I’ve always brought it up to people, but there’s been a certain natural reluctance of conservative people to say that you want me to put 80% of my money in stocks at this stage of my life? And I’m saying, well, look, you have a pension that’s paying you $50,000, that’s like a $2 million bond. So the other money can safely go into stocks. You write about that so I thought that was just terrific and I thought perhaps if you could expand on the whole concept of what investments are appropriate and you can have two people that have, in effect, identical investments and the same ages, but their situations and their needs can be so much different, and that should be reflected in their choice of investments.

Jonathan Clements: Yeah, I absolutely agree with you, Jim. I mean, you totally nailed the issue. Before the break, you were talking about how you could look at debt as being the equivalent of a negative bond because you’re paying interest to somebody else from them paying interest to you. Well, there are many aspects in our lives where we can think about things that are bond substitutes. For instance, you know if you have a steady pay check you can think about that paycheck as being sort of like earning interest from a bond as a consequence that frees you up to invest more heavily in stocks. I mean this is the reason why academics traditionally suggest that people who are young invest heavily in stocks, but as they approach retirement they put more in bonds. The reason being, earlier in your career you have this huge amount of bond-like income from your paycheck coming towards you and thus you would diversify that by buying stocks. Well, for most of us, when we reach retirement, we’ll have security, which gives us some bond-like income, but that’s pretty much it. So we tend to shift our portfolio more towards bonds and ratchet down the amount in stocks. Well, that might be the right strategy for many of us, it’s not going to be the right strategy for everybody. And the exception of just the people you were talking about Jim, the people who have traditional company pensions or traditional pensions from their local education authority or the government that are going to give them a lot of fixed income during retirement. If you’ve got a lot of fixed income coming from a pension as well as social security, that is very much like getting interest from a bond and thus you can afford to take more risk with your portfolio by investing more heavily in stocks. Not only can you afford to take more risk, but actually, it may be the safer thing to do to invest more heavily in stocks. Remember, if you bought a pension and it’s fixed over time, spending power of that pension is going to decline as inflation takes its toll. You know even in a modest inflation rate, say 3% a year, the spending power of a dollar is cut in half in just 23 years. That means that, even if you’ve got plenty of income from your pension at age 65, by the time you get into your 80s, your standard of living may start to feel awfully uncomfortable. If you took the precautions of investing a reasonable amount in stocks and those stocks did well over the intervening period, you would have the additional money to supplement your pension and you wouldn’t suffer that squeeze to your standard of living that might otherwise happen if you invested solely in bonds.

Jim Lange: I think that that’s a very good point. But let’s say that you don’t have one of these traditional pensions…

Beth Bershok: I think they’re becoming rarer.

4. Advantages of Immediate Fixed Annuities

Jim Lange: I think they are, and let’s also assume that yes, you understand the value of the stock market, but you’re looking at pretty low returns right now on bonds and fixed income instruments. One of the things that you both mention in your book, and that you also mentioned as a column, and it’s a little bit out of character for you because, usually, you’re not a great fan of a lot of financial products, but one that you seem to like and one that I also like that very few people do is, to purchase an immediate annuity where you, in effect, give the insurance company a chunk of money, and they give you an income for either your life, or perhaps the life of you and your spouse. And there’s, of course, variations with inflation and protected annuities, etc. I was wondering if you can talk about the concepts, so the people who don’t have a pension, whether it would be appropriate to have a portion of their income come in the form of an immediate annuity.

Jonathan Clements: Well, of course I agree with you, Jim. I mean, there really are sort of two issues that kick in here, why people are reluctant to buy that immediate fixed annuity. One is, annuities generally have a bad reputation and in many cases, that’s well deserved, but part of the problem is, the term annuity covers a variety of different investments. There are taxed deferred variable annuities, tax deferred fixed annuities, there are immediate variable annuities and there are immediate fixed annuities and we’re just talking about one of those four different types of products. And you know an immediate fixed annuity is quite unlike the other ones that we’re discussing here. Immediate fixed annuity is a very simple product. All you do is, you hand over a chunk of money to the insurer and they give you a check every month for the rest of your life. You know it doesn’t involve these sort of big sales commissions, it doesn’t involve hefty ongoing expenses, it’s really a very, very simple product. But then, we come to the second objection, and this is more of an emotional objection. People hate the idea of taking a chunk of money, turning it over to the insurance company, and knowing that, if they walk out of the office and get run over by the bus, the money they just invested is gone.

Beth Bershok: Well, that’s the issue, right?

Jonathan Clements: That is the big, emotional sticking point.

Jim Lange: Which by the way is, of course, the same if you have a pension.

Jonathan Clements: It’s true, and people are willing to work 30-40 years at one company in order to get that pension and make that sacrifice, and yet, they’re not willing to take a chunk of their own money and send it off to an insurance company in order to buy that monthly check from the insurer.

Beth Bershok: What you’re saying is, the benefit, in the long run, is you continue to get that check no matter what.

Jonathan Clements: Absolutely, I mean, what you’re getting is, essentially, longevity insurance. If you live longer than the life expectancy table suggests, if you start to out live your other savings and you have that immediate fixed annuity, you at least know you’re going to get that check every month. In order to, sort of, overcome the behavioral objections, I mean there are a couple different things you might think about doing. One, for instance, is, you might buy that immediate fixed annuity over time. You could put a chunk into an immediate fixed annuity when you first retire. You might wait a couple years and buy another fixed annuity. That way, you spread out some of that risk of dying early, retirement and seeing all of your money lost to the insurance company. The other thing you might think about doing is, thinking about what’s the sort of minimum amount of income that you need in order to be comfortable in retirement. Not your, sort of aspirational, level of income, but enough to cover the bills. The grocery bill, the utility bills, the property taxes, things like that. You could annuitize enough just to cover those bills so that you know you’ve got a base level established retirement and then you continue to invest the rest of the money more traditionally. That’s another strategy people might want to think about.

Jim Lange: So that the combination of your social security and of the immediate annuity, and maybe if you have a small pension, a combination of those, at least keeps a roof over your head, gas in the car, and food on the table.

Jonathan Clements: Exactly. I think that’s a great strategy for a lot of people and one of the things you have to realize is, that there’s a reason, a rational reason, why immediate fixed annuities make sense. When you’re dealing with a portfolio and trying to spend it down in a retirement and you don’t have anything like a pension, or social security, or immediate fixed annuity, you have to be extra, extra cautious because you don’t know how you’re going to live. And that means, inevitably you’re going to have to spend less than you would if you knew how long you were going to live because you don’t want to risk out living your savings. With the immediate fixed annuity, you pool some of that risk, outliving your savings by, you know, joining with other people. Some of those people will die early in retirement, some of them will live to ripe old age, but by pulling your risk with these other people, you can all collectively spend more than you otherwise would.

Jim Lange: I’ll tell you something that’s kind of interesting in practice. Because I, obviously, have well over 1,000 clients, and a lot of them, very few advisors out there are recommending immediate fixed annuities because if and, unfortunately, many are advising the type of indexed annuities or variable annuities or annuities that frankly pay a much higher commission to the advisor. And I’m actually licensed to sell a variety of these types of annuities, but the only one I’ve ever sold is an immediate annuity because that’s the only one that I really, in my heart, think is the right thing for the client, but, surprisingly few, because not very many people like the idea. So I wanted to pick up on it here because I know that you have written about it in The Wall Street Journal and you wrote about it in your book and in my book I’ve, actually, I analyze the math of it and talk about different break even points. That is, if you live to a certain age that you’re actually ahead of the game, compared to, say, a CD or another fixed income investment. For people who are in good health, I think it’s really a great idea. You know, people who have the longevity in their family, and people who take care of themselves. I just think that it’s a great way to, in effect, replace what the old traditional pension was.
Beth Bershok: And I’m guessing, Jim, that when you show, I’m sure you’re showing clients that analysis, and the break even point. What is the reaction that you typically get?

Jim Lange: Well, the reaction I get is, they express some interest. They always laugh when I, by the way if you do buy an annuity, or if you have a pension plan, but let’s say in the case of when you buy an immediate annuity, I would highly recommend that you follow the advice of the great French writer Voltaire.

Beth Bershok: We didn’t know he was giving financial advice.

Jim Lange: Yeah, Voltaire actually has advice for people who buy immediate annuities and have pensions and he says that I recommend that you go on living, if not only to solely, I’m botching it. I advise you to go on living solely to enrage those who are paying your annuities.

Beth Bershok: There you go. Eventually they will be enraged, if they collect long enough. And is this a strategy, Jim and Jonathan, that you would do at retirement? Is there any reason you would do this before you reach retirement?

Jim Lange: I don’t think I would, what do you think, Jonathan?

Jonathan Clements: No, I don’t think there’s any reason to do it before, but one thing you might want to think about doing. It’s sort of, you know, like along the lines of telling your kid ahead of time of what you’re willing to pay for in terms of college, the house down payment, the wedding, and so on. You may want to commit as you approach retirement to using a certain sum to buy that immediate fixed annuity. Take a certain amount of money that’s in your portfolio and say, you know, I can take $100,000 of savings at retirement and buy an immediate fixed annuity, so that you start to, sort of, eliminate that from your mental ledger and you’re more willing to commit the money when the time comes. It’s sort of tougher if you’ve never thought about the subject before reaching 65 and saying, alright, I’m going to take this $100,000 and send it off to the insurance company. It’s a lot easier if you thought about it ahead of time and made that financial commitment to yourself. One thing people may want to think about, and I mention this in my book, is to seriously think about delaying social security. If you look at the statistics, the vast majority of people claim social security at age 62, which is the earliest age which you can claim it. And as a result, you know they accept permanent reduction in their benefit. If you’re inclined to buy an immediate fixed annuity, the strategy that is equally good and arguably better, is to simply claim your social security benefit by delaying your social security benefit. You’ll get a larger monthly check, and not only will you get a larger monthly check, that check is indexed to inflation. You’ll get it for the rest of your life. It’s, at least, partially tax free, and if you are the family’s main bread winner, and you predecease your spouse, your spouse will get your benefit as a survivor benefit.

Beth Bershok: I think the reason some people don’t delay social security, because I’ve had this discussion with some of my own friends and relatives, is because they’re afraid it’s going to run out, because they think they’re just going to start taking it now anyway.

Jonathan Clements: If you can find a politician who is willing to stick his or her neck out and say that they are going to cut the security benefits of people aged 60 or older, I can tell you a politician who will not be re-elected.

Jim Lange: I would agree with that. The other thing, the natural objection to an immediate annuity, which I don’t think is founded, is well, I’m afraid that the insurance company is going to go belly up and that I’m going to give them this chunk of money for the fixed annuity, but then they’re going to go bankrupt. And I think that people sometimes, I’m not going to say that that’s mathematically a zero risk, but most states have some type of guarantee funds, and to my knowledge, even the companies that have had financial difficulty, some other companies would, in effect, buy those contracts to keep this system going. But I don’t know if you have encountered that objection also.

Jonathan Clements: No, I have indeed encountered that objection, but again, that may be one of the reasons to buy your immediate fixed annuity income on the installment program. To buy, you know, put some small chunk in upon reaching retirement, and then another small chunk a couple years later, and another small chunk after that. By doing so, you can purchase from a variety of insurance companies and you can hedge the risk that any one insurer gets into financial trouble.

Jim Lange: And, by the way, we have some software and we analyze when you should take social security. Interestingly enough, it’s sometimes a little different for men and women and for survivor options, but we find that most people are taking it earlier than they should. And the other problem with taking it too earlyr, or looked at another way, another opportunity of delaying it, and, Beth, how long has it been since we talked about Roth IRA conversions?

Beth Bershok: Well you know we’re into this show for forty minutes and we still haven’t mentioned it, so why don’t you just go ahead, Roth IRA conversions.

Jim Lange: The other thing about delaying social security is, that that will give you an opportunity to have a low income year for a Roth IRA conversion, and right now, particularly, I see 2009 and 2010 as, you know, the classic years for Roth IRA conversions. 2009, because seniors don’t have a minimum required distribution this year, their incomes are going to be way down. 2010, because there’s no income limitation on making a Roth IRA conversion, so that would be, let’s say, even another reason to delay social security. Because one of the downsides of the Roth IRA conversion is, because it might increase your taxability on social security.

Jonathan Clements: No, you’re absolutely right, Jim. In fact, I remember we worked on a story together on this very topic when I was at The Wall Street Journal.  A lot of people get into their 60s, they quit the workforce, they haven’t yet claimed social security. You know the only income that they have is the taxable interest kicked off the bonds and the regular taxable account and any, you know, mutual fund distributions they’re getting from their stock funds. There’s a great challenge that they can be paying, literally, no income taxes and you talk to them and it’s like, this is great after all these years of sending off a fat check to uncle Sam every year, I’m having these tax free years. But if you find yourself in that situation, that is a wasted opportunity, because while you may be paying no income taxes today, you may be setting yourself up for big income tax bills down the road, once you claim social security and once you start throwing down those retirement accounts. If you get into retirement, and you find yourself in one of those low income years where you’re paying little or no income taxes, this is a great opportunity to convert part of your IRA to a Roth. Pay the income taxes on that conversion, but potentially, pay income taxes at just 10-15%.

Jim Lange: I think it is a great opportunity. I know that you know when I was reading your book I was thinking, you know, this book is a combination of timely because, right now, people are very concerned about money. But it also, I think, is very classic. I think that I can pick this book up in five or ten years from now and probably, most, or all of it would be very appropriate, where that might not be quite the case with my book, for example, where I’m aggressively recommending Roth IRAs and Roth IRA conversions. But, I thought that you had a certain, let’s say, timeless feature, if you will.

Beth Bershok: And the book is called The Little Book of Main Street Money by Jonathan Clements. It just came out in June, available at amazon.com, and of course at your local bookstore. We are going to take a quick break and be back with Jonathan Clements; The Little Book of Main Street Money. It is The Lange Money Hour: Where Smart Money Talks.

Beth Bershok: Talking smart money, I’m Beth Bershok, along with Jim Lange, and our guest tonight, Jonathan Clements, who for 18 years, was with The Wall Street Journal and has recently authored The Little Book of Main Street Money. It just hit bookshelves in June. It is just honestly, Jonathan, a wonderful book because Jim mentioned this right before the break, where he said he thinks you’ll be able to pick this book up in five years and it will still make complete sense. I think it’s because you have these timeless philosophies about finances. It’s more of a financial philosophy than anything else. And, Jim has so many great points in this book, but I know that one you wanted to touch on, Jim, before we ran out of time was asset allocation.


5. Asset Allocation Strategies... Through Good Times and Bad

Jim Lange: Well, I mean everybody has discussions of asset allocation, and what is appropriate, based on age and risk tolerance, and things like that, but you actually made two points that I thought were somewhat unique and I don’t see that very often. And the first point that you mentioned was, that the percentages of the different allocations, such as stocks and bonds, and different types of bonds, and bond funds, etc., that the allocation that you choose is less important than your willingness to stick with whatever you choose. And I thought that that was just so good, and I thought, maybe, if you could expand on that thought, and tell our listeners why it is so important that they not just, you know, change their strategies every time there is a bear or bull market.

Jonathan Clements: You talk to some financial planners, they’ll sit there and, you know they will, you know, create these finely tuned portfolios with, you know, 3% in real estate investment trust, and 10% small cap value, and X% in emerging markets, and developing markets, and so on, and so on. And that is great. Those percentages are all but useless if somebody is not willing to stick with them. I mean, the fact is, that we’ve just had the object lesson in risk tolerance. The fact is, if you can’t stick with a portfolio during the rough parts of the market cycles, than that is not a good portfolio. You know when the S&P 500 is down 57%, and you make the mistake of opening up your mutual fund statement and seeing how much it lost.

Jim Lange: Better not to open it.

Jonathan Clements: And you panic and sell. It doesn’t matter how carefully constructed that portfolio is, that portfolio is not the right portfolio for you. What people need to figure out is, what portfolio can they live with through good times and bad? And this is actually a great, great moment to think about it because no matter how brave you thought you were in the late 1990s during the internet stock bubble, no matter how brave you thought you were in early 2007, when we were 5 years into the rebound from the 2000-2002 bear market, what really counts is, how brave you were in March 2009 when the S&P 500 had been more than cut in half, because that tells you how much risk you can truly tolerate. As we go forward from here, and you know my suspicion is the markets will recover, and you will get, eventually, into another bull market, and technically, we’re already there, never ever forget how you felt in March 2009 when the market had been more than cut in half and everybody thought that we were on the verge of economic apocalypse. Because that information is hugely useful because it tells you what your true tolerance for risk is.

Jim Lange: Yeah, I liked when you said, for you know the questionnaires that people have both for the financial advisors and on the internet talking about risk tolerance aren’t nearly as important as how did you behave in March.

Jonathan Clements: And one of the funny things is, back in early 2007, when I was still at The Journal, I was getting the emails that I also got in late 1999, and early 2000, which were, what’s wrong with 100% stock portfolio? Well, what’s wrong with 100% stock portfolio? Nothing, if you’ve got a 50 year timeline and you never look at those mutual fund statements, but for those of us who are human and have the tendency to collect the mail from the mail box, a 100% stock portfolio is tough to live with.

Beth Bershok: And I think that ties in, Jonathan, to one of your key beliefs that I absolutely love from this book The Little Book of Main Street Money, which is, simplicity is one of the great financial virtues. You were just talking about complicated portfolios and continuing to tweak them and adjust them, but I love that simplicity. You don’t really need to know all of that information, simplicity is really one of the great financial virtues.

Jonathan Clements: People assume that sophisticated is somehow better. That if they can understand all these fancy Wall Street terms, and if they own sophisticated investments like, you know, hedge funds, and they invest in capital and so on, that somehow they’re going to get better returns. Don’t count on it. Most people can build great portfolios for themselves with a handful of low cost mutual funds that are spread across a variety of markets. If you understand what you own, you are much less likely to be unpleasantly surprised and you are much more likely to stick with those investments in times of market turmoil because you truly understand what you own and that knowledge makes you a more tenacious investor. So stop lusting after your neighbor’s supposedly more sophisticated portfolio. Stick with the simple stuff and you’ll likely do far better.

Jim Lange: On the other hand, you certainly want to do things that you can control such as tax efficiency and tax re-growth, like Roth IRA conversions.

Beth Bershok: By the way, since he just dropped that in, and before we wrap up in the next few minutes, we do have a couple of workshops coming up that are free, and I’m going to be giving you some information about that that are all about Roth IRAs and the tax law change coming up in 2010. But I think you’re right, Jim, you want to take a look at the things you can control. And, Jonathan, if I’m not mistaken, that is one of your seven key beliefs.

Jonathan Clements: Absolutely, everybody focuses on short term performance of individual stocks, short term performance of market sectors, the short term performance of particular stock funds, but the fact is we cannot control the market’s short term performance, so instead, think about the things that you can control. How much you save and spend, how much you incur in investment costs, what the size of your investment and tax bill is, and maybe most important the amount of risk that you take. Control risk, control savings, control cost, control your tax ability. Control those things, good things will likely happen.

Beth Bershok: Jim any last minute things you want to get in from Jonathan’s book The Little Book of Main Street Money? Jim wrote so many notes, I don’t think he got to them all in this hour.

Jim Lange: No, I didn’t get to quite a few of them. The one other thought that I did have, though, this is probably closer to the softer side is, that you said commuting is terrible for happiness, which I thought was great.

Jonathan Clements: And it’s absolutely true. One of the things that people do all the time is move. You know, far out of the city to distant suburbs so they can have these huge homes and they imagine that, thanks to the bigger home, they’re going to be happier. With that bigger home comes the longer commute and the problem with commuting is that it’s one of those things that you cannot control. It brings with it great uncertainty, you never know how late the trains are going to be, you never know how bad the traffic is going to be, and we take uncertainty, and uncertainty causes great unhappiness. So, if you can avoid the long commute, do it.

Beth Bershok: And you live in New York, right Jonathan?

Jonathan Clements: Well, actually, I work in New York, and I live in New Jersey, and I have a long commute.

Beth Bershok: Yeah, because some people that work in New York have incredibly long commutes.

Jonathan Clements: Which is why 1) I commute by train, and 2) I always have masses of reading material with me.

Beth Bershok: Okay, for a second there I thought you weren’t taking your own advice. The book is called The Little Book of Main Street Money, and Jonathan, give your website, because your website, you can’t purchase the book on the website, but you have a lot of the general pieces of information from the book on the website, and I found it really, really helpful, and fascinating, so what is your personal website?

Jonathan Clements: To find out more about me, find out more about my book, go to jonathanclements.com. There, you’ll find a bio, and you’ll also find the introduction to the book, so you can learn a little bit more about it before you rush off and pay your $13.95.

Beth Bershok: Is that what it is, $13.95?

Jonathan Clements: I think that’s the discount on Amazon, but to be honest, I’m not entirely sure.

Beth Bershok: Okay, because that’s an awesome price for this book. Any quick last minute tips here, Jonathan, before we wrap up?

Jonathan Clements: I just think that this is a great moment for Americans to return to financial responsibility. We’ve started to see the savings rates picked up this year. Americans are starting to pay down their consumer debt. I think those are both wonderful trends, so those who are starting to get a better handle on their finances, I think this is a great time to be an investor. I mean, we have, even after huge rally of recent months, we still have a market that’s, you know, a third below where it was. You know this is a good time to be an investor, so if you’re sitting there saying, oh, I haven’t done enough saving for retirement, you know I wish I could get started. Well, start today. It’s a good time to be an investor.

Beth Bershok: Hey, the information has been wonderful, Jonathan, thank you so much for taking the time to join us today. The book again is The Little Book of Main Street Money and you can check it out on amazon.com. Thank you again, Jonathan.

Jonathan Clements: It’s my pleasure, Beth.

Beth Bershok: I do want to point out we have two workshops coming up this fall, and Jim was just mentioning as a strategy, Roth IRAs, Roth IRA conversions. Jim, we are getting very close to the big tax law change in 2010, it’s January 1st.

Jim Lange: The opportunities for both 2009, where you have the no minimum required distribution for seniors, and for high income earners in 2010, combined with the fact that our market is, hopefully low, and our taxes are low, relative to where they’re going to be, this truly is a historic time for Roth IRAs and Roth IRA conversions.

Beth Bershok: And we cover both in the workshop. It’s coming up, we have two of them. One is October 24th, this is a Saturday from 9:30 to 11:30 in the morning, or 1:00 to 3:00 in the afternoon. We’re going to be in Monroeville that day. It’s at the Holiday Inn on Mosside Boulevard. We are going to be doing this again on Saturday November 21st, same times, and that time we’re going to be back up in the Cranberry area at Four Points By Sheraton in Mars. To RSVP, and I would do that because we just held one a couple of weeks ago, and we were at capacity. Call 1-800-748-1571, it’s 1-800-748-1571. Again, the next one is Saturday, October 24th, it’s free, you also get a free copy of the book Retire Secure, and you can check out more information on our website, which is www.retiresecure.com. You can check out the information, the audio from the radio shows, and the upcoming workshops. And in two weeks, we’re going to be back here with Charlie Smith from Fort Pitt Capital Group. So be sure to join us then, as well. It is The Lange Money Hour: Where Smart Money Talks.

 

James Lange, CPA/Attorney

Jim is a nationally-recognized tax, retirement and estate planning attorney with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, will and trust preparation and intricate beneficiary designations for IRAs and other retirement plans.  Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.

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