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Source: pennypinchinmom.com
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Hey Afforders —
Three stories today:
One about Charlie Munger, one about Taylor Swift, and one about a NASA astronaut who also starred (no pun intended) on the Big Bang Theory.
Charlie Munger’s Deathbed Regret
A few weeks before he died, Charlie Munger was asked if he had any regrets in life.
Only one, he replied.
“I would have paid any amount to catch a 200 pound tuna when I was younger. I never caught one,” he said in an interview with CNBC’s Becky Quick.
But at age 99, he didn’t have the youthful strength and vitality of a 96-year-old, he said.
“I am so old and weak compared to when I was 96 that I no longer want to catch a 200 pound tuna. It’s just too goddamn much work to get it in. Takes too much physical strength … Now if you give me the opportunity, I would just decline going after [the fish]. There are things you give up with time.”
Lessons:
- At the end of your life, you don’t think about your net worth. (Charlie’s is estimated at $2.6 billion.) You think about experiences. Don’t trade the opportunity to enjoy experiences for the sake of clutching onto your cash.
- If you’re under 96, stop complaining that you’re too old. The future version of yourself will regard your current age as young.
- There’s no alternative but to act now. Opportunities are fleeting.
Munger also described fishing as a metaphor for investing:
“I have a friend who says the first rule of fishing is to fish where the fish are,” Munger said when he was 93. “The second rule of fishing is to never forget the first rule. We’ve gotten good at fishing where the fish are.”
Taylor Swift’s Windfall at Age 18
From TIME’s Person of the Year profile on Taylor Swift:
But some months later, at Swift’s 18th birthday party, she saw [Kenny] Chesney’s promoter. He handed her a card from Chesney that read, as Swift recalls, “I’m sorry that you couldn’t come on the tour, so I wanted to make it up to you.”
With the note was a check. “It was for more money than I’d ever seen in my life,” Swift says. “I was able to pay my band bonuses. I was able to pay for my tour buses. I was able to fuel my dreams.”
Most people, at 18, would spend that cash on a more comfortable lifestyle, or pay for college, or make market investments (stocks, crypto).
Instead, she invested in her fledgling music career. Tour buses.
Lesson:
The best investment is the one that you make in yourself.
In expanding your business or side hustle. In building your skills and smarts. In honing your craft. In strengthening your relationships. And even — dare I say — in your appearance.
No, the ROI can’t always be measured. I doubt anyone has plugged the cost of those tour buses into a spreadsheet and amortized those across her 15-year career.
But *YOU* are the investment with the strongest upside potential.
The Astronaut Who Almost Didn’t Make It
In this special Afford Anything podcast episode, former NASA astronaut Mike Massimino explains how YOU can take your own moonshot.
We met at a video studio in Brooklyn and spoke for hours about tenacity, drive, determination — and about sending the first tweet from space.
He described getting mocked by Seth Meyers on Saturday Night Live, joining the cast of the Big Bang Theory 💥, and how astronauts fart in space.
And he shared lessons that anyone can apply to their own life, as they chase dreams that society says aren’t “realistic.”
Watch our interview on YouTube
Source: affordanything.com
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Let’s discuss the proper way to account for inflation in retirement and FIRE planning.
I lurk in some online personal finance forums, and what I see scares me. I see “the blind leading the blind” discussing how to account for inflation as part of your retirement or financial independence plan.
These mistakes can be gut-wrenching. If you double-count inflation, you’ll assume a worse-than-real future and mistakenly believe retirement is impossible. But if you improperly discount inflation, you’ll assume a better-than-real future and torpedo your retirement with false hopes.
We’re going to fix that today.
What’s the Problem in the First Place?
The problem is that it’s challenging to understand if/when/how to apply inflation. It’s entirely understandable. Inflation is a weird phenomenon and the math isn’t intuitive.
Should you inflate your current salary into the future? What about your current spending? What about investment returns? You’ve probably heard of the 4% Rule; but how does inflation affect its usage?
All great questions. We’ll answer them all today.
The True World vs. The Convenient World
I’ve heard intelligent people tackle this concept before. It’s tough. Lots of numbers are involved. There are mysterious rules about when to apply those numbers and when not to. My friends Cody Garrett and Brad Barrett expertly tackled this topic on a recent episode of ChooseFI. :
As I listened to Cody and Brad, I thought: a few visual aids and analogies might help here.
My preferred analogy is what I call “The True World” vs. “The Convenient World.”
“The True World” involves numbers as they actually exist in our society and economy.
“The Convenient World” involves shortcuts that financial experts frequently use.
I’ll explain both worlds below.
Good news: you can do math in either world and get correct answers for your life. Hooray! This is wonderful. It shows the power of smart mathematics.
Bad news: you cannot flip-flop between worlds. You must do all your math in “The True World” or do all your math in “The Convenient World.”
The problems I see every week arise when DIYers flip-flop between worlds. So I say again: you cannot flip-flop between worlds!
Let’s describe these worlds.
The True World
Let’s talk about The True World a.k.a. our actual society and economy.
- Inflation: inflation exists in the True World, typically varying between 2% and 4% per year. We don’t know what future inflation will look like. But it’s reasonable to use a benchmark like 3% per year.
- Stock returns: stock returns vary in the True World and can do so by significant amounts. Still, a pattern emerges when we zoom out to large time scales (20+ years). On average, a diversified stock portfolio has returned ~10% per year over long periods. It’s reasonable to use that 10% benchmark for the future. $100 this year turns into $110 next year.
- Bond returns: bond returns also vary in the True World, though typically by smaller amounts than stocks. Over the past 100 years, intermediate-term, high-grade bonds have returned ~5% per year. It’s reasonable to use that 5% benchmark for the future. $100 this year turns into $105 next year.
In the three bullets above, I made an interesting assumption: that the future will closely resemble the past. You’re allowed to disagree with me and say, for example, that you want to assume inflation will be 4% ongoing and stock returns will be 8% ongoing. That’s fine.
The critical point is that all your numbers occur here in the True World. Inflation is above zero. Stocks and bond returns are measured using the actual amount of dollars. When we combine these factors, we conclude:
- Your future income will be higher than your current one, increasing with inflation.
- Your future raises will be greater than current, increasing with inflation
- Your future spending will be higher than current, increasing with inflation.
- Your future annual savings will be higher than current, increasing with inflation.
- Your future nest egg will grow by some mix of true-world return percentages (assuming you build a diversified portfolio).
Keep those four components in mind: income, raises, savings & spending, and investment growth.
If you do all of your future planning using “True World” numbers, your analysis results will show reality as it is. That’s the goal.
The Convenient World
In the True World, as we’ve seen, it seems everything gets adjusted up by inflation. Lame! And also a bit tedious. Can’t we just do a mathematical trick to remove inflation from the equation entirely?
Yes. That’s exactly right. Some intelligent people wanted to make The True World more convenient for us. We’re here today (discussing a confusing financial planning topic) because of that desire for convenience.
…which, in my opinion, is a great idea! Unfortunately, those good intentions paved the road to our present confusing situation. Those intelligent people said,
“Three of our four main components (income, raises, spending & saving) are adjusted by annual inflation. To make the math easier, let’s remove inflation. No more adjustments! But to even out all facets of the equation, we must also decrease the investment growth by the inflation rate.”
The Convenient World contains no inflation! Here in the Convenient World, our four components are:
- Your future income will equal your current income (assuming no merit-based raises).
- There are no raises (at least, no “cost of living” or “COLA” raises)
- Your future annual spending & saving will equal your current values.
- Your investments will grow by a mix of true-world return percentages minus the annual inflation rate.
There’s no inflation in any of the four factors. While we’ve decreased our future spending needs, we also decrease the amount we save in the future and the rate at which our investments grow. Everything is a bit muted in The Convenient World.
But because we’ve discounted inflation in both positive ways (less future spending) and negative ways (less investment growth), you can do future planning using these “Convenient World” numbers and your results will show reality as it is.
Don’t Believe Me?
“But Jesse! How can the math work if we remove inflation in retirement and FIRE planning?! We’re ignoring a very real phenomenon!”
Trust me. Trust the math. Take a look at this simple spreadsheet.
The True World tab uses true world data. The Convenient World tab removes inflation entirely as I’ve described above.
Both tabs yield the same exact retirement savings results (Column I).
What About “The 4% Rule?”
The famous 4% rule throws an important question at us.
As my 4% rule explainer article details, the 4% rule builds inflation into its math. The creators of the 4% rule told us, “Hey future retiree – don’t you worry about inflation in retirement, we’ve already built it into our mathematical construct. All you need to worry about is hitting your 4% or 25x nest egg goal at your retirement date.”
What’s that sound like? What world washes inflation away? The Convenient World!
Now, the 4% Rule applies starting Day 1 of Retirement and extends until the day you meet Charlie Munger (RIP). That stretch of time is covered by the 4% rule (or whatever retirement rule/simulation you choose to utilize).
How should you get from today to Day 1 of Retirement? I recommend continuing to do all of your math in The Convenient World. Remove inflation from your numbers altogether.
Can you mix and match? While dangerous, the answer is technically yes!
To get from Today to Your Retirement Date, you can either:
- Do all your math in The Convenient World, where both your future annual spending AND your future nest egg need will be muted values, but the ratio of those two will be 4% or 25x.
- Do all your math in The True World, where both your future annual spending AND your future nest egg will reflect reality, and the ratio of those two will be 4% or 25x.
You can technically use True World math to get from Today to Your Retirement Date, and then let the 4% Rule (which is Convenient World math) take over from there.
But you CANNOT mix-and-match True World and Convenient World math when determining how to get from Today to Your Retirement Date.
In this example, both True and Convenient math get us to a place we can start using the 4% Rule.
But – Those Future Nest Egg Amounts Are Different?!
We’re sitting here in 2024. The True World tells us we’ll need $3.75M to retire in 2040. The Convenient World tells us we’ll need $1.875M. Those two numbers are vastly different…so which one is right?
The way to think about that is:
- We’ll need $1.875M to retire as measured in 2024 dollars
- We’ll need $3.75M to retire as measured in 2040 dollars
Either way, the most important takeaway from these types of planning analyses is to understand what we need to do right now in 2024 to hit these future goals. Then we can revisit in 2025, 2026, etc.
Thankfully, both True and Convenient math will inform us precisely what we need to do here in 2024. Both methods would tell us, for example, “You need to save $30,000 in 2024 to stay on track for your retirement goal.”
What About “Real” vs. “Nominal” Returns
You might have heard of “real returns” and “nominal returns” before. I use those terms regularly here on The Best Interest, but I’ve intentionally excluded them so far in our discussion of inflation in retirement and FIRE planning.
The reason is that “real returns” confuses my analogy of “The True World.” Ugh.
Investment professionals use the term “nominal returns” to describe the actual dollar amounts that investments are increasing/decreasing by. If $100 turns into $110, the nominal return is 10%. In other words, nominal returns exist in The True World.
Investment pros use “real returns” to describe whether investments increase your purchasing power. In other words, have the investments outperformed inflation? If $100 turns into $110 but there was also 4% inflation, the real return is ~5.77%. “Real returns” exist in The Convenient World.
Yes, it’s confusing. You’ve been warned. Good luck.
Lessons and Takeaways
What have we learned?
- Inflation in retirement and FIRE planning is a touchy topic. It’s not intuitive or easy. In fact, it requires great attention to detail.
- You can use True World numbers and get all the answers you need.
- You can use Convenient World math that excludes inflation, and you’ll also get the answers you need.
- I recommend against mixing and matching. That said, if you’re very comfortable with the math, you can mix-and-match and end up fine.
- You don’t want to mess this up. Misapplying inflation (a ~3% annual mistake) compounded over decades will lead you to a dark place.
Talk to an expert if you need to. CFP financial planners know how to handle this. Modern financial planning software takes care of the math for you.
Go get ’em!
PS: Here’s a straightforward financial independence and 4% rule calculator where you can input your own data.
PPS – you’ll notice my calculator does all its math in The Convenient World!
Thank you for reading! If you enjoyed this article, join 7500+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
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Source: bestinterest.blog
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Key takeaways:
- Investing is a way to increase your wealth based on your risk tolerance and time horizon
- The best investments for low-risk investors looking for moderate returns are index funds, government bonds, and high-yield savings accounts
- The best investments for high-risk investors that want high returns are individual stocks, real estate, and cryptocurrencies
Investing is one of the best ways to grow your wealth and improve your financial future. One of the keys to finding the best investments is to recognize the power of compound interest. The credit bureau Experian® describes compound interest as “when interest gets added to the principal amount invested or borrowed, and then the interest rate applies to the new (larger) principal.”
There are many ways you can invest, and some investments earn more than others, and some investments are riskier than others. Today, you’re going to learn about the nine best investments in 2023 based on average returns as well as your personal risk tolerance.
The investing information provided is for educational purposes only. We recommend consulting a financial professional before investing.
The best investments
The best investments right now to grow your wealth include:
- High-yield Savings Accounts
- Short-term Certificates of Deposit (CDs)
- Government Bonds
- Corporate Bonds
- Real Estate and REITs
- Individual Stocks
- Index Funds
- Exchange-traded Funds (ETFs)
- Cryptocurrency
1. High-yield Savings Accounts
High-yield savings accounts are similar to a regular savings account, but you’ll often earn more interest by keeping your money in one of these accounts. You can sign up for a high-yield savings account through many banks and credit unions, and some accounts can earn you anywhere from three to four percent annually.
If you have or plan on making an emergency fund, Javier Simon from SmartAsset recommends using one of these accounts. “Anyone looking to open a rainy day or emergency fund that provides a higher-than-average interest rate and high liquidity should consider a high-yield savings account,” writes Simon. You’re saving anyway, so why not make money from storing your funds?
Best investment for: People with lower risk tolerance and who are good at saving. This is one of the safest investments with high returns because many banks are FDIC insured, so even if the economy has a downturn, your money is backed by the government.
Risk level: Very low
How to invest: Banks, credit unions, and online banks
Potential returns: Moderate
2. Short-term Certificates of Deposit (CDs)
When looking for where to invest money, many people turn to certificates of deposit, which are also known as CDs. Like high-yield savings accounts, CDs are another type of account. CDs work by allowing you to deposit your money with the caveat that you don’t withdraw the money for a certain amount of time. Once that time frame expires, you’ll receive your money back as well as the interest.
Best investment for: People willing to store their money for one, three, or five years, which are the average predetermined time frames. Just remember, unlike a savings account, there’s a fee for withdrawing your money early.
Risk level: Very low
How to invest: Banks and credit unions
Potential returns: Moderate returns that sometimes exceed those of high-yield savings accounts
3. Government Bonds
Sometimes, the government needs to borrow money, so they offer people the option to loan them money via government bonds. Like CDs, these bonds are for a specified period, but they provide regular payments. Peoples sometimes use bonds as one of the best passive income investments due to these payments.
One caveat to note is the return on government bonds varies depending on how the economy is doing.
Best investment for: People with a low risk tolerance often buy government bonds. Unless the government fails, there’s not much that will prevent getting your return from this investment. Unlike other investments, government bonds can last for up to 30 years.
Risk level: Very low
How to invest: The United States Treasury or through a stock broker
Potential returns: Low
4. Corporate Bonds
Like government bonds, corporate bonds are loans, but you’re providing that loan to a company. This investment helps companies that need money to invest in new products and expand their business. Since these aren’t backed by the government, they can be riskier because the company may go out of business. Although these have a higher risk, they also have a higher return than government bonds.
Best investment for: Individuals with a higher risk tolerance and are looking for higher returns may want to invest in corporate bonds. These bonds pay out regularly, and they’re a safer investment when buying bonds from large, stable companies that have been around for a while.
Risk level: Moderate to high
How to invest: Stock brokerages
Potential returns: High
5. Real Estate and REITs
One of the investment ideas many people turn to is real estate because it can provide extremely high returns when the housing market is good. The downside is that when the housing market has a downturn, as we saw in 2008, people experience big losses.
Rather than investing in real estate, you can invest in real estate stocks, which are called real estate investment trusts (REITs). These stocks are for companies that own properties like malls, office buildings, and other forms of real estate that generate revenue. These can be slightly less risky but still have some risk due to the nature of real estate.
Best investment for: Those who are looking for high returns or have a diversified portfolio already and can weather some higher-risk investments.
Risk level: High
How to invest: Mortgage broker for real estate and stock brokerages for REITs
Potential returns: High
6. Individual Stocks
Individual stocks are available to everyone, and when the average person buys these types of stocks, they’re known as “retail investors.” You may have heard of retail investors investing in individual stocks during the GameStop stock hype of 2021, which also showed how risky individual stocks can be.
Individual stocks come with a high risk and high reward. Basically, you’re buying a portion of a single company, also known as a share of the company. Numerous factors dictate the price of a stock including the profits or losses of the company as well as speculation of the future of the company.
Best investment for: People who are looking for higher returns and don’t mind the risk may want to invest in individual stocks. These stocks can involve doing a lot of research into a company in order to make a quality decision. It’s possible for single stocks have the potential for large returns and losses. For example, investing in Amazon (AMZN) in 2018 and selling in 2021 would have over a 100 percent return, but buying in 2021 and selling in 2022 would have a 50 percent loss.
Risk level: High
How to invest: Stock brokerage
Potential returns: Low to high
7. Index Funds
Index funds are a type of stock, but rather than owning one stock, you’ll own multiple stocks. These stocks track a specific market, like the S&P 500 or the Dow Jones. When purchasing an index fund, there are often low fees and steady returns. The famous investor and founder of The Vanguard Group, John C. Bogel, popularized investing in index funds. This type of investing is popular because indexes like S&P 500 index funds track the 500 largest companies in the United States.
Best investment for: People who are new to investing as you don’t need to regularly check in and research different companies because index funds track the top companies in the U.S.
Risk level: Low
How to invest: Stock brokerage companies
Potential returns: Moderate
8. Exchange-traded Funds (ETFs)
Exchange-traded funds (ETFs) are similar to index funds because your single stock has shares of multiple companies, but ETFs are usually for specific industries or categories. For example, ARK Invest is a well-known ETF that often invests in technology companies, and there are other ETFs that have an assortment of bonds, like Vanguard’s Bond Market Index Fund (BND).
Best investment for: People with a moderate level of risk tolerance. ETFs can be thought of as a mix between index funds and individual stocks since they’re riskier than index funds, but they’re less risky than individual stocks because you’re more diversified.
Risk level: Moderate
How to invest: Stock brokerage
Potential returns: Low to high
9. Alternative Investments
Cryptocurrency trading is a hot topic, but many people don’t fully understand how it works. Cryptocurrencies are a digital form of currency that’s traded on a network known as the blockchain. The first cryptocurrency was Bitcoin, and now, there’s an endless number of cryptocurrencies. Many people have become millionaires or billionaires from investing in crypto, but it’s an extremely volatile market, and many more have also lost their life savings.
Currently, there is very little to no regulation around cryptocurrency, and much of the investing involves speculation. Notable investors like Warren Buffett and his business partner Charlie Munger have been highly critical of crypto investing, calling it, “worthless, artificial gold.”
Best investment for: People with a high risk tolerance and can tolerate losing their investment may find high returns with crypto investing.
Risk level: Very high
How to invest: Crypto exchanges
Potential returns: Very high
How to Choose the Best Investments
There’s no single right way to choose the best investments because it’s dependent on your unique situation. To make the best choice for yourself, you’ll need to assess your personal risk tolerance and when you’re hoping to cash out on your investments.
1. Assess Your Risk Tolerance
When it comes to investing, the higher the risk, the higher the reward, but it can also mean bigger losses due to unforeseen circumstances. While looking at the top nine best investments, consider how risky they are and whether or not they’re right for you. If you’re concerned about losing money and simply want steady, average returns from your investments, you may want to choose investments that are lower risk.
2. Gauge Your Time Horizon
An important aspect of investing is when you plan on needing the returns from your investment. Many people invest as a way to save for retirement, but some people invest in order to make money to pursue another goal, like purchasing a new home or going on a big trip. For those with a longer time frame of 10 or more years, you can tolerate making low-risk investments with steady returns. If you need the returns sooner, you may want to look into taking more risks.
A simple way to invest based on your time horizon is to use target date funds. The United States Securities and Exchange Commission describes target date funds as being “designed to be long-term investments for individuals with particular retirement dates in mind.” With this type of fund, you set the date you plan on retiring or selling your investments, and it will automatically adjust for risk.
3. Recognize Your Personal Investment Knowledge
Investing does come along with some risks, and these risks vary depending on which type of investing you do. For example, investing in a high-yield savings account is much less of a risk than investing in individual stocks. As a way to minimize your risk and be fully aware of the risks you’re taking, it’s helpful to educate yourself further on each investment and gauge your personal knowledge.
There’s always room to grow your investing and personal finance knowledge. Even the greatest investors in the world continue to learn as much as they can about investment strategies.
4. Assess How Much You Can Budget for Investing
When getting started on your investment journey, it’s often a good idea to minimize your debts as much as possible before creating a budget. For example, if you have a high amount of credit card debt, the interest you’re paying will counteract the money you’re putting into different investment opportunities.
Once you have minimal debt, you can create a budget to see how much you can invest each month. With many of the investments covered here, you can set up automatic investments to make the process a little easier as well.
Best Investments: FAQ
Now, you know about various investments as well as the risk associated with each one. The following are some additional frequently asked questions to help you get started with investing.
What Is Compound Interest?
Compound interest is when the money you make from interest starts making you additional money as well. For example, with a 10 percent interest rate, $1,000 would make you $100. The following year, you’d earn 10 percent interest on $1,100 because that extra $100 you earned will earn interest as well.
Without investing anything else, your original $1,000 investment will be more than double your original investment in 10 years.
Which Investment Gives the Highest Returns?
Investments that have the highest return opportunities include real estate, individual stocks, and alternative investments like cryptocurrencies. Just be sure to keep in mind that these investments also come with the most risk.
Is It OK to Invest During Times of Uncertainty?
Investing during uncertain times can bring better-than-average returns later on. Marcus by Goldman Sachs recommends taking the long view when making your investments. Even during a bad economy, historical data shows that it eventually recovers. You’ll just need to assess your risk and decide if you can weather the storm until it rebounds.
Should You Invest with Bad Credit?
Investing is a way to save for your retirement or future purchases, and it can increase your overall net worth. If you have bad credit or a lot of debt, it may be best to wait on investing because that money could go to paying off debt, improving your credit, and increasing your financial security.
If you need help improving or repairing your credit score, allow Credit.com to help. We have services like ExtraCredit, and we can also provide you with a free credit report card. We’ll be there to help you learn how to improve your credit as well as other ways to increase your wealth, so sign up today!
Source: credit.com
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As I mentioned in my missive from two weeks ago about the power of dividend reinvestment, I attended the Morningstar Investment Conference earlier this summer and heard from all kinds of mutual fund managers and investment professionals. However, the presentation that had the biggest impact on me — which is to say, it depressed the bejeezers out of me — came from Harvard professor David Laibson. His main point: From age 53 or so on, our cognitive skills begin to decline to the point where approximately half of people in their 80s suffer from some kind of impairment that could lead to significant financial mistakes. Recently, I grabbed a box of tissues and interviewed Dr. Laibson.
Robert Brokamp
We all expect to slow down as we get older. However, your research indicates that the slowdown starts sooner than most people expect.
David Laibson
There are two types of intelligence that are particularly important.
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- One is crystallized intelligence, which is accumulated through experience — think of wisdom, intuition, your familiarity with a set of problems that you have encountered many times. Crystallized intelligence rises over the entire life course; we keep getting better and better, but the rate of progress diminishes. We get better quickly as a young person, and then as we get older, the progress gets slower. Eventually we plateau, and maybe very late in life it declines. But mostly, it’s progress.
- The other category is fluid intelligence, which is the capacity to confront a new problem and handle it very well. Fluid intelligence appears to peak around age 20 and then declines. When you put those two together, it looks as if we make the best decisions in mid-life — in our analysis, around age 53. Along with Sumit Agarwel, John Driscoll, and Xavier Gabaix, we find that the accumulation of wisdom and experience swamps the decline in fluid intelligence early in life. We are just getting better, even though our ability to solve novel problems is going down.
But around age 53, there is not a lot of additional crystallized intelligence year to year, while there is ongoing decline in fluid intelligence — so the decline in fluid intelligence ends up dominating. We peak around 53 and then start declining. That doesn’t mean that we fall off a cliff at 53. But as you get out to the 70s and then particularly the 80s and 90s, the decline becomes sharper and stronger. Decision-making in the 80s and 90s is significantly impaired for many older adults.
Robert Brokamp
Is there anything people can do about it — exercise, a good diet, anything like that?
David Laibson
Well, no, there is not a lot. Exercise and diet will reduce the odds of cognitive impairment a little bit, but those effects are modest. And so I think we shouldn’t be focused on avoiding the possibility of cognitive impairment. We have to recognize that no matter what we do, the risks are significant and hence we have to prepare for that possibility rather than naively thinking we can somehow avoid that outcome.
Robert Brokamp
At what age should people start factoring this into their financial and estate plans?
David Laibson
The second you form a family — even if you have modest assets — you should begin to prepare for this possibility. I say that because it is not just dementia that can be a problem. You can have a stroke in your 40s and not be in a position to make great decisions; you can get into a car accident and have a head injury. So the earlier, the better.
On the other hand, risks don’t really pile up until the 70s, so if someone told me, “Look, I am just not too worried about these issues; I am 45 years old,” I would say, “I think you are making a mistake,” but I wouldn’t get too agitated. For someone in their mid-60s, that is really when further delay is becoming irresponsible. By the time someone is in their mid-60s, there is no excuse for delaying the acquisition of the key legal documents that enable you to prepare for these transitions.
Those documents should include durable power of attorney, and would include — if you have significant assets — a living revocable trust as a way of protecting your assets, and would include, of course, a will. Then there are two health-care documents that are very important. There is a health-care proxy, which is the assignment of some person or set of people to make health-care decisions for you if you are incapacitated, and there is also a living will, which is a set of instructions to those individuals that expresses your preferences about the nature of medical care. If you are in an ICU, for example, what extreme measures should or should not be taken to prolong your life? Those are the five documents I strongly recommend that anyone who is part of a family have. By age 65, it is critical.
Robert Brokamp
One of the solutions you propose is for older investors to buy income annuities, which provide income for as long as you live.
David Laibson
An annuity is such a wonderful way of addressing a lot of the risks that older adults face. Let me go through the benefits of an annuity, and then I want to acknowledge that most people don’t want annuities, despite these benefits, so we can talk about that psychological resistance.
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- The first big benefit is that it addresses longevity risk — in other words, the risk that you might outlive your assets. Here we are at age 70; we could live five years or 30 years or even 40 years, so that is a big risk. If you live a very long time, and you are spending down your wealth, you face the possibility that you will run out. An annuity eliminates that risk, because the annuity pays out as long as you survive. If it is a joint annuity — owned by you and your spouse — the annuity pays out until the second member of the unit dies. So it is a great way of insuring against the possibility of living too long. That is one benefit.
- Another benefit of an annuity is that it is very, very simple. The check comes every month in the mail. There is no need to worry about asset allocation. There is no need to worry about how much to spend, how much to save. The check comes, and that is your budget for the month. The chance of having some nasty person rip you off by getting you to invest in their harebrained scheme is reduced, because you don’t have your personal wealth sitting in a checking account. Instead, the annuity company, in essence, is holding your personal wealth for you. So in all these ways, the annuity is protective. It protects you against longevity risk, it simplifies your decision making, and it protects you from bad actors and from mischief. Terrific.
So why don’t people have annuities? Well, annuities, of course, have a bad name for many reasons. First of all, people perceive them as being complicated, and in some ways they are complicated legal documents, complicated financial contracts — particularly, a lot of the modern annuities have a lot of special clauses. People worry about fees with annuities, and it is true that the majority of annuity products are excessively expensive and not a good deal. And people like to have a sense of control; annuities mean passing control over to somebody else — in this case, the insurance company.
Now, I don’t want to dictate to people and say, “You have to have an annuity.” I hope that people can weigh the pros and cons, particularly while they are still highly cognitively functioning in their 60s, and figure out what is right for them. I do think people should think seriously about annuities and look hard for an insurance company that offers highly competitive rates if they are going to proceed with an annuity. But if at the end of the day, you insist on controlling your assets, and you want full liquidity, then an annuity is not for you.
The one thing I would consider is a partial annuity. You still have some significant fraction of your wealth in your own hands. You can decide what to do with it, and it is there as a bequest in the event of your death. You can spend a lot or a little each year, you have flexibility. Then take some other fraction of your wealth and annuitize that. Now, we have the best of both worlds: You have got some control, but you also have a nice amount of longevity insurance in the form of a significant fraction of your wealth annuitized.
Robert Brokamp
It also seems that you don’t only have to worry and plan for your own possible cognitive decline but also for that of your spouse and maybe older relatives. Any advice on how to make protecting against age-induced financial mistakes a family affair? How do you broach that topic with older parents or other relatives who are getting up there in age?
David Laibson
I think the key thing is that people recognize that when we recommend these things, we are not recommending it because a particular parent is showing some kind of cognitive impairment; it is a recommendation that is universal. All people — regardless of their vitality, regardless of their cognitive function — should execute the five documents that I described a moment ago. It is just how responsible people behave, and so I think the messaging has to be, “It is not about you, Mom, or you, Dad. It is not any judgment that anyone is making about your mind or your thinking, it is just the normal course of affairs for everyone who has a family, and anyone who has an estate.”
Robert Brokamp
How do you respond to someone who says, “Well, Berkshire Hathaway Chairman Warren Buffett is 80, and Vice Chairman Charlie Munger is 87, and they are still beating the market”?
David Laibson
It is not that everyone’s fate is to have dementia at age 85; no one is saying that. What is being said is that the frequency of dementia increases with age to the point where one in five individuals in their 80s has dementia, and one in three individuals in their 80s has cognitive impairments that fall short of dementia. Put all that together, about half of people in their 80s have significant cognitive impairment. So half the population is going to be in a good position to make decisions and half is not. The problem is that you don’t know which half you’re going to fall into.
Source: getrichslowly.org
Apache is functioning normally
If you want people to read your investing-related post or book, you’ll increase your chances by mentioning Warren Buffett in your title. After all, I just did it — and it might be why you chose to read this. Every financial media company does it, including us at The Motley Fool.
His investing skills while the chairman and CEO of Berkshire Hathaway have made him the fourth-richest man in the world. Most of the articles and books about him attempt to dissect his investing strategies and explain how you can use them to identify your own winning stocks. So it was a bit surprising when Larry Swedroe wrote Think, Act, and Invest Like Warren Buffett. He’s the director of research for the BAM Alliance of independent financial advisers, the author of several books, and a blogger on CBS Marketwatch. He also thinks that picking individual stocks — as opposed to investing in index funds — is a really bad idea.
I’ve chatted several times with Larry over the years, because he’s as smart as they come on the topics of asset allocation and financial planning. Recently, we had a conversation about why he would write a book singing the praises of the world’s most famous stock picker. Of course, that whole “increase sales by including Buffett in your headline” thing probably had something to do with it. But it’s not just a gimmick; Larry has three main arguments for why the index investor should still listen to the Oracle of Omaha, and he uses actual quotes from Buffett to back them up. And it starts with…
1. Warren Buffett recommends index funds
It may not be widely known, but Buffett is actually a fan of index funds. Here’s what he wrote in his 1996 annual letter:
“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expense) delivered by the great majority of investment professionals. Seriously, costs matter.”
Buffett’s a smart fellow, and he knows his history and his statistics; both establish that it’s pretty darn hard (though not impossible) to outperform an index fund over the long term. Obviously, he doesn’t think this applies to him — he still keeps picking individual stocks (or buying companies outright). But he recognizes the great value of the index fund. The same goes for us at The Motley Fool. My colleagues devote a great deal of time and energy to finding great stocks. But we also have a room named after John Bogle, the founder of the Vanguard family of mutual funds and one of the primary progenitors of the index fund. (Next to the entrance to our Bogle room, we have a picture of Mr. Bogle wearing a Motley Fool cap during one of his visits to our office. It’s pretty cool.)
2. Warren Buffett ignores market forecasts
Wade into the waters of the ever-flowing financial media, and you’ll see an endless flotilla of gurus offering their assessments of where the market is headed. Buffett thinks you should pay them no heed:
“We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie [Munger, vice chairman of Berkshire Hathaway] and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”
In case you need some stats to back that up, CXO Advisory Group analyzed the predictions of 68 “experts” from 2005 to 2012. As a group, they were right less than half the time. You would have been better off flipping a coin than listening to these people.
During our most recent discussion, I asked Larry Swedroe why these people still have jobs. He had a few reasons, but one in particular stood out: “I have come to the conclusion, after my long years of experience both as an adviser to some of the largest corporations in the world on managing financial risk and as adviser to individuals and endowments, that there’s an all-too-human need for us to believe that there’s somebody out there who can protect us from bad things.” I think he’s on to something. Unfortunately, market predictions just create — rather than offer protection from — bad things.
3. Warren Buffett doesn’t try to time the market
You won’t see Berkshire Hathaway buying and selling its stocks or businesses too often. Once a company joins the Berkshire family, it’ll likely be in there for quite a while — decades probably. Here’s what Buffett said about it:
“Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.”
My very first post on Get Rich Slowly was about attending the 2009 Berkshire Hathaway annual meeting. It happened in May, just two months after the stock market hit bottom after dropping more than 50 percent. It was a dang scary time.
During that annual meeting — and at just about every annual meeting over the past several years — the topic of Buffett’s and Munger’s successors came up. After all, Buffett is 82 and Munger is 89. They didn’t name names, but they have some people in mind. However, it won’t be someone who tries to move in and out of the stock market. Here’s what they said:
Munger: I don’t think we’d want an investment manager who would want to go to cash based on macro factors. We think it’s impossible.
Buffett: In fact, we’d leave out someone who thought he could do that.
The important three questions
The main argument that Larry makes in his latest books is this: If you agree that Buffett is one of the greatest investors of all time, then take his advice. And the next time you’re inclined to act according to some expert’s forecast market forecast, Larry has three questions you should ask yourself:
- Is Warren Buffett acting on this expert’s opinion?
- If he isn’t, should I be doing so?
- What do I know about the value of this forecast that Buffett and the market in general doesn’t?
As Larry told me, “If someone has already told you that they think Buffett’s the greatest investor, it’s hard for them to say that they should do the opposite of what he’s advising them.”
Source: getrichslowly.org
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