Archives for January 2015

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Investing Blog Roundup: Missing Out on Subsidized Insurance

This week, the Kaiser Family Foundation released the results of a survey showing that, of the approximately 30 million adults in the U.S. who remain without health insurance, 48% would qualify for assistance purchasing such insurance (either tax credits or Medicaid). If you (or somebody you care about) doesn’t have health insurance, it’s worth taking the time to learn how such subsidies work, so that you don’t miss out.

You can read more about the survey and its other findings here:

Investing Articles

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Moving Beyond Sound-Bite Investing Wisdom

The following questions — and others of a similar nature — are some of the most common in my email inbox:

  • Does buying an S&P 500 fund count as stock picking, given that there’s a committee of people choosing which stocks are included in the index?
  • Does overweighting U.S. stocks (or value stocks, or REITs, or whatever) count as active investing?
  • Does rebalancing count as market timing?
  • Does basing my spending rate in retirement on market valuations (and/or interest rates) count as market timing?
  • Does Social Security count as a bond?

Typically, the person is asking the question because they’ve latched on to a sound bite-style piece of investing wisdom (e.g., stock picking is bad, market timing is bad, passive investing is better than active investing, your bond allocation should be equal to your age, etc.) and they’re trying to figure out how to apply it.

Sound bites are helpful when you’re first getting started investing, because they allow you to put a decent plan into place without being completely overwhelmed with information. But as you might imagine, they tend to be oversimplifications. And, eventually, rather than trying to base every decision on such simplified advice, you’re better off taking the time to understand the reasoning behind the sound bite, so you can make critical decisions on your own.

For example, why do we often say that stock picking is bad? The answer:

  • It results in less-diversified portfolios,
  • It often results in higher costs (i.e., brokerage commissions and sometimes taxes) as the investor rapidly buys and sells various stocks, and
  • There’s quite a bit of research showing that it’s unlikely that you’ll consistently pick above-average stocks anyway.

Once you understand that, you don’t have to ask whether something counts as stock picking. You can simply determine for yourself whether the activity in question has the same drawbacks — because, ultimately, that’s what you really care about.

So for example, if you’re considering using an S&P 500 index fund in your 401(k), rather than wondering whether or not that would count as stock picking, you can instead try to directly address the important questions:

  • Would using that fund allow you to be sufficiently diversified? (And, is there a way to be better diversified?)
  • Would using that fund result in high costs? (And, is there a way to achieve lower costs?)
  • Is there any reason to think that the stocks included in the index (and therefore the fund) are in some way systematically chosen to be poor performers?

In summary, when it comes to investing, when you find yourself asking, “Does _____ count as _____?” there’s a good chance you’re asking the wrong question.

Investing Blog Roundup: Taking Winnings Off the Table

There’s no reliable way to know when the next market downturn is coming. For those of us who are still many years from retirement, that shouldn’t be a scary thought, given that a market downturn simply allows us to buy shares at lower prices. But, as Bill Bernstein reminds us this week, a market downturn can be a big problem if you’ve just retired, if your portfolio isn’t prepared for such an event.

Investing Articles

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3 Common Social Security Misunderstandings

The following three statements about Social Security are common, but incorrect. (Or rather, each is partially correct, but the part that’s incorrect is super important.) Can you spot the errors?

  1. If you are married, it’s a good idea to delay taking Social Security.
  2. If you have a shorter than average life expectancy, you should claim early. (Or conversely, if you have a longer than average life expectancy, you should wait to claim.)
  3. Social Security is actuarially neutral (meaning that claiming at one age is as good as another, given that you’re likely to get the same overall amount).

In each case, the error is the same: It addresses the when-to-claim question by looking at the wrong life expectancy in some cases.

Myth: “If you’re married, it’s a good idea to delay taking Social Security.”

When the spouse with the higher “primary insurance amount” delays taking retirement benefits, it increases the amount the couple will receive per month as long as either spouse is still alive (because if the high-PIA spouse dies first, the low-PIA spouse can claim a widow/widower benefit, which will be increased as a result of the high-PIA spouse having waited).

As a result, it’s true that it’s typically advantageous for the high-PIA spouse to delay taking benefits.

However, for this very same reason (that is, the availability of widow/widower benefits) it is typically less advantageous for the low-PIA spouse in a married couple to delay than for an unmarried person to delay. When the low-PIA spouse delays, it only increases the amount the couple will receive per month as long as both spouses are still alive.

Myth: “If you have a short life expectancy, you should claim early.”

While the above statement is typically true for unmarried people, it’s often wrong for married people.

For married people, each person must consider both life expectancies.

If one spouse has a very short life expectancy, that is a reason for the low-PIA spouse to claim early (because the couple’s first-to-die life expectancy isn’t for very long). But it is not necessarily a reason for the spouse with the short life expectancy to claim early.

And conversely, if one spouse has a very long life expectancy, that is a reason for the high-PIA spouse to wait to claim (because the couple’s second-to-die life expectancy is quite long). But it is not necessarily a reason for the spouse with the long life expectancy to wait.

Myth: “On average, it doesn’t matter when you claim, because Social Security is actuarially neutral.”

Social Security is designed to be approximately actuarially neutral for unmarried people.* That is, if they claim early, the lower monthly benefit they receive should be, on average, approximately offset by the fact that they’ll receive benefits for a greater number of months.

However, if delaying retirement benefits is actuarially neutral for an unmarried person (i.e., on average, it will neither help nor hurt them), then, for the reasons discussed above, delaying must be better than neutral for the high-PIA spouse in most married couples and worse than neutral for the low-PIA spouse in most married couples.

How to Make Better Social Security Decisions

In summary, to make proper Social Security decisions:

  • If you are unmarried, the decision should of course be based on only your own life expectancy,
  • For the high-PIA spouse in a married couple, the decision should be based on the couple’s second-to-die life expectancy, and
  • For the low-PIA spouse in a married couple, the decision should be based on the couple’s first-to-die life expectancy.

*But even for a specific unmarried person, Social Security still tends not to be actuarially neutral. That is, most single people have a reason to expect that claiming early or late will be advantageous. For example, you may have a longer (or shorter) than average life expectancy, or inflation-adjusted interest rates may be higher or lower than those baked into the Social Security benefit calculations.

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Investing Blog Roundup: Automatic IRA Contributions for Many in Illinois

The state of Illinois recently passed a law that is intended to increase the rate at which people are saving for retirement. When the law eventually goes into effect, businesses that have 25 or more employees and that do not offer an employer-sponsored retirement plan will be required to set up a program in which employees will have 3% of their pay automatically contributed to a Roth IRA. (Employees will have the ability to opt out or change the contribution percentage.) It will be interesting to see what happens.

Jim Blankenship and Dan Kadlec discuss the new law:

Investing Articles

Other Money-Related Articles

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Why Is Currency Risk Bad?

A reader writes in, asking:

“I don’t see why currency risk is necessarily bad. Sure, sometimes the dollar will increase in value, making your foreign investments worth less. But sometimes the opposite will happen. It seems like, on net, this should neither help nor hurt over an extended period.”

As a bit of background information: “Currency risk” refers to the volatility that foreign investments (such as international stock funds) experience as a result of fluctuating exchange rates. For example, your international holdings will decline in value if the dollar increases in value relative to the currencies in which your foreign holdings are denominated. Currency risk is often cited as a reason for underweighting international stocks and bonds relative to the part of the overall world market that they make up.

This reader is correct that currency risk should, on average, neither increase nor decrease your returns. And that’s precisely why it’s an undesirable risk. After all, there are an assortment of risks that do increase the expected return of your portfolio: increasing your equity allocation, increasing the duration of your bond holdings, reducing the average credit rating of your bond holdings, etc.

So, if there’s a certain level of overall risk that you can tolerate, you might as well get as much expected return for that level of risk as you can. In other words, why take on any risks for which you would not expect to be compensated? (This is also, by the way, the reason that holding a concentrated portfolio of individual stocks does not typically make sense. It increases the risk relative to a diversified stock portfolio, yet it does not increase expected return.)

To be clear, the point here isn’t that including an international allocation is a bad idea. It isn’t. Most experts agree that including international stocks in your portfolio is still desirable, because it increases the total number of stocks that you hold, which improves diversification, and because it adds a component that has less-than-perfect correlation to U.S. stocks while still having similar expected returns. The point is simply that it likely makes sense to hold a smaller allocation to international stocks (and bonds) than you would if currency risk did not exist.

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