The Lange Money Hour: Where Smart Money Talks
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Jonathan Clements, Former WSJ Columnist Joins
Jim Lange, CPA/Attorney
Guest: Jonathan Clements
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- Introduction of Guest – Jonathan Clements
- Realize What You Can and Cannot Control
- Expect Relatively Low Short-term Interest Rates
- Plan for Increase in Income Tax
- Economic Growth Will Be Mediocre In Years Ahead
- Don’t Panic and Stick With Your Asset Allocation Strategy
- Delay Social Security
- Using Non-Deductible IRAs and Immediate Fixed Annuities
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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 rothira-advisor.com. Now get ready to talk smart money.
Hana: Hello, and welcome to The Lange Money Hour, Where Smart Money Talks. I’m your host, Hana Haatainen Caye, and of course, I’m here with Jim Lange, CPA/Attorney and best-selling author of the first and second edition of “Retire Secure!” and now, his new book, “The Roth Revolution: Pay Taxes Once and Never Again.” Jim’s guest tonight is favorite financial writer Jonathan Clements. For eighteen years, he was the top personal finance columnist at The Wall Street Journal. Jonathan has been on “Good Morning America”, “The Today Show” and CNN, and is the author of “The Little Book of Main Street Money,” which is filled with both traditional wisdom and great new ideas. Some of the key beliefs of Jonathan’s financial philosophy may surprise you. With all the economic uncertainty present today, we will discuss what we can be fairly certain about and what we can control to improve our financial situation. Jonathan is an engaging and entertaining speaker, and we are thrilled to have him back on the show. But before I turn it over to Jim, I want to remind our listeners that the show is live, so please feel free to call in with your questions for Jonathan. The number is (412) 333-9385. Welcome to the show, Jonathan.
Jonathan Clements: Hello! Good afternoon to you.
Jim Lange: It’s great to have you. I will also take the liberty of saying a couple of things, which is Jonathan Clements is my favorite financial author. For eighteen years, he wrote wonderful columns for The Wall Street Journal and one great source of information, if you’re interested in column format, is actually getting the archives and reading through them and, particularly for the last five years which is more current, wonderful information, and then, if you want to make it a lot easier on yourself and have the information in a well-organized form, Jonathan’s book “The Little Book of Main Street Money” is my favorite financial book. It’s wonderful. It has great financial information and Jonathan does a very good job of combining some of the human elements of investing and living with the financial estimates. So, anyway, it’s a great pleasure to have you on, Jonathan. Thanks so much for agreeing to be our guest.
Jonathan Clements: Sure thing, Jim. It’s always a pleasure to talk to you.
Jim Lange: And today, I understand that there were some specific things that you wanted to talk about in terms of things that we can control and things that we can’t, so I think I’m just going, if it’s okay with you, just give you the open mike for a little bit. I’ll certainly pipe in because I’m sure I’m going to have some comment on whatever you bring up, but I thought that I would throw the mike over to you and maybe you can tell us a little bit about things that we can control, things that we can’t and some of the things that our readers and listeners can do in terms of actionable steps?
Jonathan Clements: Sure thing, Jim. One of the things that we’ve had this year has been a pretty wild financial market. At this juncture, the S&P 500 has pretty much fought itself to a draw, but we do have a 10% decline in developed foreign markets. We’ve got emerging markets off about 15%. Clearly, it’s been a pretty turbulent year. There’s been a lot of economic news to worry investors. We’ve had the downgrade of U.S. Treasury debt. We’ve had all the turmoil over in Europe. There’s been concern about the quality of municipal bonds. All in all, it’s been a wild and crazy year, and one of the things that investors tend to do when we get wild and crazy years like this is they turn into market forecasters. People who built these portfolios and said to themselves, “I’m going to hold this mix of stocks and bonds from here to retirement,” suddenly it’s become day-traded. They start buying and selling like crazy trying to figure out whether the Dow is going to rise or fall tomorrow. And clearly, this isn’t a sensible way to behave. So, what I would suggest to listeners is that what they do is they step back, look at the big picture and think about the stuff they really can control and try to ignore the stuff that they can’t control. Clearly, the stuff that they can’t control is the direction of the financial market. They’ll go whatever direction they want to go in and none of us can influence what happens there. But there are four key things that we can control: one, we can control the amount that we save every month. People I meet who have managed to amass significant wealth? Almost all of them are great savers. Being able to delay gratification and socking away a decent portion of your paycheck every month, that is the key to building wealth. Second, we can also control the amount of investment costs we incur. Clearly, if you buy a lower-cost mutual fund, or you’re a little bit more careful about how much you trade, you’re going to reduce the amount that you lose to investment expenses each year, and that should allow you to retain more of whatever investment gains you managed to earn in any particular calendar year. Third, we can control our investment tax bill. This is something, Jim, you know a lot more about than I do, by being careful about how much we trade in our taxable account, being careful about what investments we hold in our taxable account, making full use of tax-sponsored retirement accounts, we can reduce the amount that we paid Uncle Sam each year, and once again, we can thereby amass more wealth for ourselves. And then, finally, the last thing that people should really focus on, and maybe this is right up there with the amount they save on a regular basis, is they should think carefully about how much risk they take. A simple example: if you’re a technology executive, you work for some big software company, clearly, you want to think about how to diversify your capital. You’re already heavily exposed to technology business. Clearly, you don’t want to go out and buy a whole bunch of tech stocks and go down on that risk. Instead, as you build your portfolio, you probably want to build a portfolio that’s relatively light on technology and instead has exposure to other industries so that you are well diversified, and furthermore, as you build that portfolio, you probably want to have a decent amount of exposure to cash investments into bonds so that when we’ve had a rough year like we’ve had in 2011, that you don’t get so badly hit. So, those are the four things, the four tenets that I would focus on, the four things you really can control, the amount you save, the amount you pay on investment costs, the amount you pay in taxes and the amount of risk you can take. Seem reasonable to you, Jim?
Jim Lange: It does, and what’s very interesting to me is some of the things that you said were similar to what you said in your book, and one of the things, I almost thought it was almost a revelation, it was so good, in your book, when you talked about asset allocation and the risk that you were willing to take, one of the points that you made was that whatever your asset allocation is in terms of stocks and bonds and then the subcategories, that it’s usually better to start with an asset allocation model and stick with it rather than constantly shifting your asset allocation as the market shifts. Now, I’m not saying that you shouldn’t rebalance because that’s not what you were saying at all. But what you were saying was don’t be an aggressive investor, lose your shirt, and then, all of a sudden, be conservative because then you’re not going to get it on the way back up. So, I think that that’s similar to what you were talking about in terms of asset allocation and determining how comfortable you are at different levels of risk.
Jonathan Clements: It’s really an important point. I mean, one of the things that we learn as we talk to people about their finances is that risk tolerance is not stable. The portfolio that people are comfortable holding during a rip-roaring bull market is going to be far more aggressive than the portfolio they’re comfortable holding in a year like 2011. And so, what you want to think about when you put together that initial mix of stocks and bonds is how are you going to feel when the market is down twenty or thirty or forty percent? Are you still going to be happy with this mix of stocks and bonds? Because if you’re not, then you shouldn’t buy that mix because the one mistake you don’t want to be making is investing heavily in stocks, and then having second thoughts when the market is down steeply and panicking and selling at the worst possible moment. One of the standard pieces of advice that we hear out there is that you should have a more aggressive portfolio when you’re younger, and then as you approach retirement, you should cut back on risk and move more towards conservative investments, and in general, that’s right, but I would throw in one caveat into that which is this: when you’re in your twenties, you really don’t know how much risk you can tolerate. You’ve never lived through a bare market. You just don’t know how you’re going to react when the market is down thirty or forty percent. So maybe, when you start out as an investor in your twenties, you should actually be a little bit more conservative, get your feet wet, find out what your tolerance for risk is when the market is at its roughest, and then you’ll have a pretty good guide to how you should invest going forward.
Jim Lange: And the second quote of Jonathan Clements that I’m going to say, in effect, I’m quoting you, is you said something to the effect that you can fill out all the risk questionnaires that any financial advisor might give you, but one of the best ways to truly measure risk is how did you feel in 2008 when you lost your shirt? If you walked around miserable, and you just hated life because you were losing so much money, it almost doesn’t matter what you filled out on the questionnaire. You don’t have a very high risk tolerance. And I thought that that was a very good insight. I don’t know if you remember these things, but I do.
Jonathan Clements: 2008 and early 2009 were an extraordinary time, and it was a great test of an investor’s tenacity. I mean, I can’t tell you, Jim, how many seasoned investors I heard from who were absolutely scared out of their wits by what was going on. And it was understandable. I mean, we did have a true financial crisis going on. I did feel like we were on the verge of economic Armageddon, and a lot of people I know who I’d considered to be level-headed long-term investors did indeed sell, and I’m sure that they’re kicking themselves today.
Jim Lange: Yeah, and that goes back to the original point that I brought up that, again, is quoting you, which is deciding on your asset allocation and not shifting your belief or your risk tolerance radically based on what the market is doing. Now, if your life circumstances are different, that’s another thing, and also, another one of the gems…by the way, I have a whole bunch of them from your book. If you looked at my copy of your book, there’s a whole bunch of stars and underlines and everything else. You were saying, very similar to your advice that a tech stock employee should not be investing in tech stocks because if it goes bad, you’ll lose your job and you’ll lose a lot of investments, and you were also saying that you should take a look at what else is going on with your financial life in picking your portfolio. So, for example, if you are a teacher or a government worker or even an employee of a company that has a traditional pension plan where you are going to get so much money per month or per year, and if you are collecting Social Security, that that’s a little bit like a bond or a guaranteed income, which would mean that you could have a greater risk tolerance and a longer term investment horizon for some of the other investments, and I just thought that that was such a good thought.
Jonathan Clements: Yeah. No, clearly, if you have that fixed pension, it does indeed free you up to be more aggressive with the rest of your portfolio. Another insight that I think is worth considering is your bond portfolio versus the debt that you have. We all tend to engage in mental accounting and we think that we have our investment portfolio over here, and then we have our debt over somewhere else, but really, your debts and the bonds that you own are just mirror opposites of each other. The bonds are paying you interest. The debts that you have are costing you interest, and in all likelihood, the debts are costing you more interest than the bonds are earning you. So if you’re looking at your whole financial life, and you’re saying, “What should I do next?” for a lot of people, a smart thing to do is to take some of the money that they have in bonds or they have in CDs or they have in a savings account and use it to pay down higher-cost debt.
Jim Lange: And that makes particular sense today. Let’s even say that you had a 5 or 6% CD, and maybe a 4% interest on a mortgage, maybe back then, it didn’t make as much sense to pay down your mortgage, but when you go to replace that CD and you can only get 1 or 2% and you’re still paying a 4% mortgage or 5% or even higher on credit cards and things like that, paying down debts is a wonderful thing. And, again, I’ll continue with this theme of quoting Jonathan to Jonathan. In the book, you actually called a debt like a negative bond, which I thought was a great term.
Jonathan Clements: And just to sort of give this a slightly more topical flavor to this discussion, one of the things that I would like to talk about in the time that we have together here, Jim, is four things that are going on in the economy and in the financial market that we can say with a reasonable amount of certainty beyond those four things I mentioned initially, the four things that we can control: the amount you save, the amount you pay in investment costs, the amount you pay in taxes and the risk that you take. There are also, I think, four things that we probably all keep in mind as we look at the economy and the financial market, and one of them you just alluded to, Jim, which is if short-term interest rates are really extraordinarily low, and the Federal Reserve has essentially told us that they’re gonna stay that way for a considerable period of time. There is very little significant risk that we’re going see a sharp rise in short-term interest rates, which means that if you’ve got money that is sitting in a savings account, or you’ve got money sitting in a banking account waiting to buy CDs, you’re gonna wait a long time before you get any sort of attractive yield. So, you probably should be looking around and thinking about how else you might want to use that money, and that may be meaning you taking that money and using it to pay down debt. It may be taking that money and putting part of it into the bond market. But whatever you do, if you’ve got it sitting in a bank account or you’ve got it sitting in a savings account, you think you’re gonna see an increase in short-term interest rates, it’s just very unlikely that that’s gonna happen in the next couple of years.
Hana: Okay, Jonathan, we’re going to take a break right now, and when we come back, we’ll continue this conversation. I want to remind our listeners out there that we are live tonight, so if you have any questions, you can give us a call at (412) 333-9385. We’ll be right back with Jonathan Clements and Jim Lange on The Lange Money Hour.
Hana: Welcome back to The Lange Money Hour. This is Hana Haatainen Caye, and I’m here at a special time tonight for a special airing of The Lange Money Hour, Where Smart Money Talks. You can listen to us at our normal time on the first and third Wednesday of each month from 7:00 to 8:00 pm, or during the rebroadcast every Sunday morning at 9:00 am. Archives of the past shows covering retirement, taxes and estate planning issues with notable guests like Jane Bryant Quinn, Ed Slott and Robert Ibbetson can be found at www.paytaxeslater.com, and again, we’re back with Jim Lange and Jonathan Clements, noted Wall Street Journal columnist.
Jim Lange: And by the way, Hana, when you gave that list of impressive guests, you left out Jonathan Clements, who has been on before, and I think it would be very worthwhile for people who are enjoying Jonathan’s comments to go to either www.paytaxeslater.com or www.retiresecure.com and you can listen to a full hour of Jonathan. But anyway, Jonathan, you were starting to say that there were four factors, and one of the factors is that we can expect relatively low interest rates for the foreseeable future.
Jonathan Clements: Right. We can expect relatively low short-term interest rates.
Jim Lange: Short-term, right.
Jonathan Clements: Which brings us to the second point, which is clearly, people do wake up to the fact that short-term interest rates aren’t going to rise in the near future, and they decide to take more risks by stepping into the bond market. They should realize that they’re getting into the bond market at a point when interest rates are at historic lows, and you can see this most if you look at the benchmark ten-year treasury note. If you go back to 1981, the yield on the benchmark ten-year treasury note was almost 16%. Recently, it’s been kicking around 2%. Over the last three decades, we’ve gone from 16% to 2%. Interest rates cannot go much lower. They can’t go any lower than zero, right, Jim?
Jim Lange: I don’t think so.
Jonathan Clements: And in fact, we’re in a situation now that we haven’t seen since the 1950s, which is you can get higher yields by buying the stocks in the S&P 500 than you can by buying the ten-year treasury note. We haven’t seen that situation since the 1950s. That gives you an indication of how low treasury yields have come, and I think, if you’re an investor, that should make you nervous if you’re buying treasury bonds. It seems to me that there’s a huge fear factor built into the pricing of treasury bonds, and that if fears subside for any reason, treasury yields can bounce back up and as we all know, when interest rates rise, bond prices fall and that can be rough on people who own treasury bonds. My sense, and it’s simply my sense with no guarantees here, the risk if you step out into the core bond market or into the municipal bond market is not as great. The likelihood of getting really whacked by rising interest rates isn’t quite as great in those sectors, but even then, you do need to be aware of the risk. You probably want to stay to the shorter end of the curb just in case interest rates do bounce back up because, again, we do know that long-term interest rates can’t fall much further, and there is a serious risk that they could rise.
Jim Lange: Well, the other thing is, you bring up a good point that for income investors, and a lot of people say, “Well, I want income,” but actually, many of the stocks and the dividend of the stocks are paying a higher dividend rate than the interest rates of bonds, whether it be treasury or corporate-type bonds, and the other thing that maybe some listeners should keep in mind is that the taxation on the dividends is usually quite favorable, usually as a qualified dividend taxed at 15% or even lower for 15% taxpayers. So, that’s actually kind of an argument for people who are otherwise conservative who are looking for income that they might actually get a higher income from many stocks that are paying higher dividends than a bond.
Jonathan Clements: You know, I think that’s a very good point. I mean, clearly, you know, if you step into the stock market in search of yield, there is a risk that prices will fall further. I mean, you have to be aware that the downside of stocks is a lot greater than the downside on bonds. Nonetheless, if you have a reasonably long time horizon and you’re looking for income, buying stocks for dividends doesn’t seem like a bad proposition, and if the market turns around, it could be a two-fer. You could get the yield and you could see a nice rise in the price of the stocks that you purchased. But you actually beat me on the punch on the third point I wanted to make, which is talking about tax rates. At this juncture, even in the heat of the presidential nomination battle, the one thing that we are not hearing to any significant extent is people talking about cutting taxes. If the debate is about anything, it’s about whether they need to rise, and I think that that is an important piece of information for investors. We already know that higher tax rates are baked into the legislation unless Congress acts. We know that the Bush tax cuts are going to disappear in 2013 unless Congress acts. We also know that as part of the healthcare bill, we had an increase in the Medicare tax that it would be applied to upper income earners starting in 2013. So, nobody’s talking about tax rates going down, and we are already set to see taxes increase unless Congress acts. And so, the people who think about how they manage their portfolios through the rest of 2011 and into 2012 may want to figure that into their plans, and that means, you know, maybe this is the time when you want to do that Roth conversion. Maybe this is the time to get out of that stock where you have big unrealized capital gains and possibly diversify into other investments. This may be the option if you do it while we’re still at historically low tax rates.
Jim Lange: Well, it sounds like you’re a tax pessimist, because I have heard the other side. “Hey, if one of the Republicans wins, we might have an even further favorable treatment of capital gains or dividends, and the estate tax is going to be eliminated, etc.” But maybe the more balanced view, and I think that you probably have a pretty good handle on it, is that in reality, tax rates are going to go up and that you should plan accordingly.
Jonathan Clements: The caveat there, I think, is that there’s any real risk that we’re going to see tax cuts. I mean, at this juncture, the only question is where are we going to find more revenue in the future. Are we going to find it by raising tax rates, or are we going to go in the opposite direction and really slash spending? Nobody who’s a serious contender for the nomination is out there talking about cutting tax rates. It’s really about whether they can hold the line at the current level. The caveat, I believe, is whether the tax burden somehow gets shifted. Not that it gets lowered, I don’t think anybody can reasonably expect that, but maybe we could see the introduction of a national sales tax, and that is used to pay for a reduction in income taxes, or it could be that we get a reform of the tax code that eliminates a lot of deductions and as part of that, we might see a slight decrease in tax rates. But after that, I don’t think there’s any serious chance that we’re going to see lower tax rates from here.
Jim Lange: And then, even if there is a sales tax that is implemented, and some people have said that that’s a good reason not to do a Roth IRA conversion because if, for example, you do a Roth IRA conversion and you pay a bunch of taxes upfront and they eliminate the income tax and they institute a sales tax instead, you’d have paid tax for nothing. But my inclination would be that if they do implement a national sales tax that it would be on top of, not in replacement for, the income tax. I don’t know if you have any feelings or a crystal ball on that one, but I guess what I’m saying is I would not plan on the elimination of the income tax for your tax planning, and that’s particularly important in a working town like Pittsburgh because, certainly, most of my clients, and I would even imagine most of the people in the city of Pittsburgh, the greatest source of their wealth is actually not their savings account, but it’s actually their 401(k)s and their IRAs and their retirement plans, and I think anybody who is hoping for a change in the taxes that would be eliminated and go to a sales tax, or even a 999 type thing, where there would be some income tax but not much, I think are going in the wrong direction. I think I would be more inclined to go in the direction that you’re saying, which is it’s more likely that there’s going to be an increase in the income tax and to plan accordingly.
Jonathan Clements: I think you’re absolutely right, Jim. I mean, suddenly, my expectation is just really a question of, you know, how much the tax burden will increase in the years ahead, and what sort of tradeoff the American voters are willing to accept in terms of higher taxes versus reduced spending. We face a really tough dilemma in the years ahead, and a lot of it centers on paying for retiree healthcare. I know there’s a lot of discussion about Social Security and whether we need to cut Social Security, but the fact is that between now and 2050, the percentage of GDP that is going get allocated to Social Security payments is only forecasted to rise from 5 to 5.5%. Meanwhile, the amount of GDP, if we continue on the current course, would have to be devoted to Medicare and Medicaid. We’d go from around 5% today to around 12% in 2050.
Jim Lange: More than double.
Jonathan Clements: Clearly, that is unsustainable, and clearly, some really tough choices have to be made. I certainly think we’re going to see cutbacks in entitlements, but I think that the extent of the cuts needed to make the numbers work is so great that people will balk, and at least part of the balancing the books is going to come through higher taxes.
Jim Lange: Alright. Well, I’ll give you a choice if you want to keep going with the, I think there’s two more issues, or something that you brought up, which is Social Security because you have some very interesting points in your book about Social Security and I’d be happy to talk about that, or…I don’t want to leave it hanging if there were one or two other points that you wanted to make.
Jonathan Clements: Sure. There were four points that I wanted to make that I felt that people could sort of accept with a reasonable amount of certainty. One, short-term rates aren’t going to go up in the near future. Two, long-term rates don’t have much more room to go down. Three, tax rates probably aren’t going to go down and there’s a serious risk that they’re going to go up, and the fourth thing that I think we can say with a reasonable amount of certainty is that growth over, say, the next five years is not going to be great. And it’s for a very simple reason. There is a huge portion of the U.S. population and also a huge portion of the population abroad that simply cannot afford to spend, and to give you a sense of what the scope of the dilemma is, consider some numbers. Back at the end of 1999, total consumer debt of all Americans, excluding student loans, student loans are not included here, the total consumer debt of all Americans was $4.8 trillion at year-end 1999. At the end of the third quarter of 2008, that number was up $12 trillion. It went from $4.8 trillion to $12 trillion by the end of the third quarter of 2008, which, of course, was the height of the financial crisis. Today, that number is back down to $10.8 trillion partly because of people defaulting, and partly because of efforts that Americans have made to pay down debt. Nonetheless, Americans, on average, are carrying more than twice as much debt that they were eleven years ago. The families that are struggling with that debt load, they simply cannot afford to spend the way they used to, and that’s going to slow economic growth in the years ahead. We’re just going have a number of years where because consumer demand is going be weaker than we would like, the U.S. economy is not going to grow that quickly, and a similar problem exists in a lot of other developed nations. You know, this is bad news if you’re out there looking for a job, or if you’re in a job that you’re unhappy about and you’d like to move somewhere else, it’s not gonna be great for job growth. What it means to the stock market is less clear. It could be the stock market has already discounted this and the current valuations are…the realization that growth is going be slow. That I can’t answer, but in terms of raw economic growth, I think it’s pretty fair to say that growth is going be mediocre in the years ahead.
Jim Lange: Well, boy, you really cheered us up. You’re saying that bonds are no good, stocks aren’t going to go up and taxes are going to go up. So, do you have any good news for us?
Jonathan Clements: Well, actually, Jim, now I didn’t say that stocks weren’t going to go up.
Jim Lange: Well, alright. That’s fair. You said that we’re going to experience a limited growth in the next five years.
Jonathan Clements: Yeah, and it could be that stocks already reflect that realization. I mean, the S&P 500 today is trading at about twelve-and-a-half times next year’s expected operating earnings, which is a pretty modest valuation. It could easily get much more modest, and it could be that the forecasters are wrong when it comes to operating earnings, but based on current forecasts, the stock market does not look overvalued. So, it could be that the share prices will rise from here, but I have no crystal ball on that one. And as for bonds, all I’m saying is, you know, long-term interest rates are unlikely to drop significantly from here and there is a risk that they would go up, and people should factor that in as they consider how much risk they’re willing to take if they step into the bond market.
Jim Lange: Yeah. By the way, you mentioned something that’s important and you glossed over it, which is fine, but I just wanted to reinforce what you said for a little bit because a lot of listeners might not have caught it. When you were talking about a 12.5, what you were talking about was basically a price-to-earnings ratio, in other words, what is the price of the stock or the shares compared to the earnings, and historically, the price-to-earnings ratio has actually been higher, meaning that people thought that, you know, let’s say that a stock was worth maybe twenty times when it had the likely potential to earn, and from that standpoint, stocks are not overvalued. If anything, maybe undervalued using historical data, so I just thought that I would bring that up because that’s an important point for some people who are maybe a little spooked by the stock market, and it might be consistent with what you had said, which is the stock market may have taken some of these factors into account in terms of what their price is for the stock right now.
Jonathan Clements: Yeah, I mean, there are two important points for people to remember about the stock market: one is, with stocks, as with any other investment, you should generally become more enthusiastic the lower the price gets. This is the fundamental truth of investing that is ignored on a regular basis. When department stores hold their sales on December 26th, people rush out to buy. Whenever the stock market holds a sale, people panic and sell. It makes no sense. But the second thing that people need to remember about the stock market is, it doesn’t reflect current economic conditions. It reflects the economic conditions that people expect a year or two down the road. So even if things look grim today, if people expect matters to be better a year or two down the road, stocks could rally sharply.
Jim Lange: Well, I think it’s a very good point to realize that people are not necessarily acting rationally, for example, when the stock is on sale. In fact, I’ve actually had a couple financial behaviorists on the show, and they pointed out something that I found very interesting, which was that a Vanguard investor, or an investor of pick any mutual fund or any sets of mutual funds, that a Vanguard investor does worse than Vanguard. Well, how can a Vanguard investor do worse than Vanguard? Let’s just say it’s a balance fund or a certain allocation of different funds, and the Vanguard investors in reality do get spooked when the market goes down and they sell, and they do get exuberant when the market goes up and they buy, where the straightforward price of the Vanguard investments almost always do better than the performance of somebody who is doing it on their own because they let their emotions interfere and they don’t do what Jonathan Clements says, which is to pick a asset allocation strategy and stick with it. Don’t be shifting as the market goes up and down.
Jonathan Clements: I mean, almost by definition, the crowd, when it comes to investing, is going to be wrong. If everybody is hugely enthusiastic about an investment, it means the price has been bid up. It means all the people who had planned on buying have done their buying, and there’s really nowhere for the price to go but down. You know, we saw that with real estate in 2005 and early 2006. We saw it with tech stocks in 1999 and early 2000. The crowd is almost always wrong. To be sure, these periods of exuberance often go on far longer than rational observers believe is possible. And that’s why people tend to capitulate and join in the buying frenzy, but eventually, when the crowd gets big enough and gets enthusiastic enough, there is nowhere for the price to go but down.
Jim Lange: Well, one of the potential solutions that you’ve always been a fan of ever since doing all those columns, and I will also tell the listeners that I always considered you to be one of the great champions of the consumer, and I remember some of your personal indignations, and I don’t want to mention the name of the company, but there was a cruise line that had a relatively low base, but then, everything was very expensive like oh, you wanted a glass of water with dinner, or oh, you wanted a door that closed to the bathroom, and everything was an extra, and I always considered you to be one of the great, let’s say, defenders of the consumer, and your book, which, by the way, I will repeat for the benefit of our listeners, Jonathan’s book, which really is my favorite financial book. It has just so many gems in it. It’s called “The Little Book of Main Street Money: 21 Simple Truths That Help Real People Make Real Money,” and is the best place to get that Amazon.com?
Jonathan Clements: Yeah, Amazon seems to be selling it at a steeply discounted rate, I regret.
Jim Lange: Well, I’m sorry to hear, but what’s so interesting is even though the book is maybe two years old, to me, it’s really classic thinking, and there are very few things in here that I think would not apply today, and some of the things, and I don’t really want to get off on that because there are two things that I really want to talk about before we end tonight, which is Social Security and immediate annuities, but some of the things that I thought were so, I don’t know, human, things like don’t buy things, buy experiences. And you know, that’s kind of classic advice that frankly people should be reading and following whether it’s now, two years from now or a hundred years from now.
Jonathan Clements: To me, “The Little Book of Main Street Money” was really a chance to take a lot of things that I had thought about and argued for during my eighteen years at The Wall Street Journal, and to put it between two covers and put it into some sort of coherent form, and to some extent, you know, present it to the readers who used to follow me and say you clipped all those columns, well, don’t worry. You can throw them all away because here it all is in one neat little 200-page book. A quick segue here onto another topic that related to what Jim just mentioned. Probably, a lot of listeners do not know that one thing about Jim is he’s an avid cyclist.
Jim Lange: As are you.
Jonathan Clements: And Jim, I just want to tell you that piece of advice about buying experiences rather than things, when I went out riding today and I had my second flat in two days, the experience just didn’t seem so good!
Jim Lange: Well, I’m sorry to hear that, and by the way, for our listeners, Jonathan is an even more avid cyclist and puts up some pretty impressive times because he was telling me how long it takes him to do some pretty significant riding. I’d love to ride with him but, frankly, I don’t think I could keep up.
Hana: Jonathan, I just wanted to tell you that after Jim’s endorsement of your book, I just put that on my Christmas list for several people, so I’m looking forward to reading it, as well, and I want to take a quick break right now, and I want to remind everyone of two things: one is that we are live, so you have about twenty minutes to call in and talk to Jonathan and ask him your questions. You can call us at (412) 333-9385. The other thing I want to remind our listeners is that we are airing at a special time tonight, and this is live. It will rebroadcast on Sunday morning at 9:00 am, and we will be returning on the 21st at another special airing time at 6:00 pm. So you are listening to us live even though it’s not our normal time, which is from 7:00 to 8:00 pm on the first and third Wednesday of each month. We will be right back with Jonathan Clements and Jim Lange on The Lange Money Hour.
Hana: Welcome back to The Lange Money Hour. This is Hana Haatainen Caye, and I’m here with Jim Lange and Jonathan Clements, noted Wall Street Journal columnist and author of “The Little Book of Main Street Money,” which is filled with both traditional wisdom, as Jim has been pointing out, and some great new ideas.
Jim Lange: Jonathan, two of the topics that you covered in your book, and actually you have covered in your columns, and I should tell the listeners, I’m slightly biased here because I in at least some way participated in 26 of those columns, and it was really one of the highlights of my professional life working with you on those columns. But one of the things that you have said in both columns and in your book that people aren’t going to like to hear, but something that I agree with strongly, is to delay Social Security, and you know, not all that many people are willing to say it, and when I do have somebody who really knows what they’re talking about and has gone through some of the numbers, I do like to bring that point up. So, if you could tell our listeners a little bit about some of your thinking on when they should be collecting Social Security? So, let’s assume, for discussion’s sake, that they are eligible for early Social Security now. They’re thinking about either taking it now, or maybe waiting until they’re 66, or even possibly waiting until they are 70. I was hoping that you could illuminate what some of these listeners should be thinking about.
Jonathan Clements: I’ll be happy to do that, Jim, but you must promise me this: before we wrap up today, I want to ask you one question about non-deductible IRAs. So, you have to give me a minute to ask you that question towards the end of the show, but before we do that, sure, I’ll be happy to talk to you about Social Security.
Jim Lange: Okay.
Jonathan Clements: Why is it that you should delay Social Security? Social Security is one of the most valuable assets that a retiree has. I mean, think about the stream of income that you’re going get. It is at least partially tax-free, it’s guaranteed by the government, it rises every year with inflation and you’re guaranteed to get it for the rest of your life. Given how great Social Security is, why wouldn’t you want to get as much of that income as you possibly can? And the way you get that income is by delaying Social Security from the earliest possible age that you can get it at, which is 62, as Jim mentioned, all the way up to 66, or even to age 70. If you delay Social Security from age 62 to age 70, your payments, ignoring adjustments for inflation, will increase by 70% or more. That monthly check will be 70% larger or more. And I would even advocate spending down other assets in order to be able to delay Social Security. Now, clearly, there is a risk that you will delay Social Security, and then you will go under a bus, and you will miss your chance to get any money back from Uncle Sam. The good news is, as I always joke to people, this is not a decision that you will live to regret. Still, it is a risk, but if you are in moderately good health and you think that you will live into your eighties, the math suggests that it is worth delaying Social Security. Even if you’re in lousy health, if you’re married and you are the family’s main breadwinner, it may still make sense to delay Social Security because your spouse will likely receive your benefits as a survivor benefit. So even if you don’t make it past, say, age 70, if your spouse lives to a ripe old age, your Social Security benefits will live on after your death. I think delaying Social Security is one of the smartest things that most retirees can do, and indeed, I would argue that if the only way that you can retire early is by taking Social Security at age 62 or age 63, you probably should not be retiring.
Jim Lange: Well, I would agree with that, and by the way, there’s a little trick that we don’t have the time to go into in detail, but one of the interesting twists that I’ve learned about Social Security is, let’s say, for example, you have a husband and a wife who are both 66. You can have the husband apply for Social Security but suspend collection. I shouldn’t say husband. I should say the person who has the most money in, which maybe at least traditionally has been the husband, and then the wife can start collecting on the husband’s Social Security, and interestingly enough, it doesn’t hurt the husband when he eventually collects on his own record at 70, and then let’s say the wife also collects on her level at her own record at 70. So, that’s a little trick that not a lot of people know about Social Security. But I did promise you that before we ended, we would talk about non-deductible IRAs, so why don’t we do that, and you can post it as a question to me. So, why don’t you go ahead and we’ll talk about non-deductible IRAs for a minute?
Jonathan Clements: So, in your Lange Money Minute, you mention the order in which people should fund different retirement accounts. You mention that if your income was too high such that you weren’t eligible to make regular Roth IRA contributions, and you weren’t eligible to make a tax-deductible IRA contribution, you should go ahead and make a non-deductible IRA contribution. But isn’t the case now, Jim, that I, on January 3rd of 2012, can throw my $5,000 into a non-deductible IRA, and then turn around on January 4th and convert it into a Roth IRA and just get my money into the Roth IRA that way through the back door?
Jim Lange: That is accurate if you don’t have any other IRAs. Let’s say, for discussion’s sake, that you don’t have any other traditional IRAs at all, then yes, you can do that. You can make an IRA contribution, and the next day, you can convert that into a Roth. If you make a non-deductible IRA contribution, you don’t get a tax deduction for it, but then when you convert to a Roth, then there is no tax. So, in effect, you have achieved a Roth IRA, so you got around those rules.
Jonathan Clements: Yeah, the caveat is, like I said, is…or, the downside or the problem is that you cannot specify which IRA you’re converting. You have to look at all your IRAs combined, so if you have, say, a rollover from your 401(k) that’s sitting in a rollover IRA, you have to assume that the conversion to the Roth is coming pro-rata from your entire IRA combined rather than just from that specific account where you put the non-deductible IRA.
Jim Lange: That’s correct. So, that’s the problem. If you have other IRAs, you have what are known as the aggregation rules that say you have to aggregate all your IRAs, and then if you make a Roth conversion, you have to prorate the amount. So, let’s say for discussion’s sake, you put $6,000 into a non-deductible IRA and you have $100,000 in a traditional IRA. Yes, you can do a Roth IRA conversion of $6,000 after you make the non-deductible contribution, but you’re still going to have to pay tax on the lion’s share of that because when you prorate, the $6,000 doesn’t go very far with the $100,000. Now, there’s a little trick that we do with some of the Westinghouse 401…and not just Westinghouse, but other people who have non-deductible IRAs and after-tax dollars inside their IRAs, but I’m afraid we’re not going to have time for that one. But I am still a fan of non-deductible IRAs for people who are earning too much to put in with Roths. If you do have the opportunity to convert them to a Roth the next day, that’s a great thing and why not, but sometimes in, at least in my world, in the financial world, it’s not necessarily one huge killer idea that’s gonna transform somebody from poverty to immediate, unlimited wealth, but it’s just going to be a series of good ideas and good strategies. So, for example, even just the Roth IRA, if you’re 50 or older, and even just one spouse works and makes $6,000 or more, they can put in $6,000 for themselves, and then if there’s sufficient income, $6,000 for the spouse. So you’re getting $12,000 that you’re transferring from what used to be, let’s say, some type of investment account where you’re paying taxes every year, into an account that’s going to grow income tax-free for your life, your children’s lives and your grandchildren’s lives. So, I’m still a big fan of non-deductible IRAs, and if sometime in the future, you can efficiently convert them to Roth IRAs, that’s a wonderful thing. Alright, is that good with non-deductible IRAs, or should we talk a little bit more about them?
Jonathan Clements: I think you certainly covered my question, Jim.
Jim Lange: Okay.
Jonathan Clements: I appreciate that.
Jim Lange: Alright. The one other thing that I remember about your column that was probably at the time not received as well as it might be now, is you were talking about with a lack of guaranteed pensions, which, you know, some teachers have it, some government workers have it, and I guess there are still some people in some industries that still have it, but probably the traditional guaranteed pension is certainly becoming more and more rare, and more and more people have money in 401(k)s and IRAs and they have wealth, and then, you know, we see this enormous flexibility, and at least a lot of, particularly working class people in certainly the Pittsburgh area and probably all over the country are probably more interested in not necessarily being fabulously wealthy when they retire, but they want a certain guarantee so that no matter what happens, there’s food on the table, there’s gas in the car, there’s shelter over your head and a couple of bucks for entertainment, and one of the issues that you brought up was immediate annuities, and I wonder if you could tell some of our listeners actually two things: why you are a fan of immediate annuities, and by the way, I’m gonna distinguish between what you’re going to talk about and commercial annuities, which tend to be very high-commissioned type financial products, where the immediate annuity is a much simpler product and typically a very low-commission product. So a) a little bit about them, and I remember your percentage of 25%, and b) if you think that now is a good time, or if people are better off waiting, and then should they include a cost of living adjustment. And by the way, you have about three minutes. But don’t feel any pressure!
Jonathan Clements: Alright, well, thank you for the challenge. So here’s the deal on immediate fixed annuities. For the immediate fixed annuity, what you essentially do is you turn over a chunk of money to an insurance company, in return for which, they’re going to cut you a check every month for the rest of your life. It’s essentially taking a portion of your retirement savings and turning it into a regular stream of income. People hate this idea. They loathe the idea that they’re going to turn over the money to the insurance company, they’re going to walk out into traffic and they’re gonna get hit by that proverbial bus, and people just cannot bring themselves to do it. In recent years, immediate fixed annuities have generated about $6,000,000,000 in annual sales, which, to give you a comparison, that’s a bad week in the mutual fund business. People do not like immediate fixed annuities. I love them. I think that people should indeed seriously consider annuitizing a portion of their nest egg so they have that stream of income which, together with the income they get from Social Security, will provide a base level of income that covers their core expenses, takes a lot of anxiety out of their retirement and allows them to get on with enjoying the rest of their lives.
Jim Lange: And I’m afraid that’s it. I was off by about a minute in my estimate.
Hana: Thank you, Jonathan, for joining us, and thank you to our listeners for joining us for another Lange Money Hour, Where Smart Money Talks. We hope you enjoyed our discussion and found it educational. One final reminder before we sign off is that this is a special airing of the Lange Money Hour. Starting in January, you can listen to the show at its normal time every first and third Wednesday from 7:00 to 8:00 pm. Please note that our next show will air on December 21st from 6:00 to 7:00 pm.
Jim Lange: And a special thank you to Jonathan Clements for being our guest tonight, and “The Little Book of Main Street Money,” by Jonathan Clements.END
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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