Archives for June 2019

“Don’t Sell Stocks During a Downturn”

A reader writes in, asking:

“I’ve read everywhere that, if retired, one should have money to live on, invested in other than equities to protect against a market downturn (to reduce sequence of return risk, and to try to avoid locking in big losses, especially in the first 10 years of retirement).

My first question is: what would you consider enough of a downturn (amount and/or duration?) that you would recommend not selling equities if possible? I’ve yet to see anyone clarify this. A market drop of 15%? More?

My second questions is this: my taxable account has an all stock allocation because that is what Vanguard says is optimal. If there is a big market downturn/crash/recession, I will be selling stocks as that’s all I have in my taxable account. This is contrary to much of what I’ve read as recommended. When I asked my Vanguard CFP about this, his response was that yes I’d be selling stocks in the taxable account but my portfolio will be rebalanced so the portfolio as a whole will be selling bonds to buy more stock. That does seem to make sense to me. Is there some flaw to this explanation?”

Firstly the one easy part: the Vanguard CFP is correct. It’s the overall allocation of the portfolio that matters, rather than the allocation of any individual account. And from an overall asset allocation standpoint, selling stocks (or anything else) in your taxable account doesn’t (usually) matter, because you can simultaneously make transactions in retirement accounts to adjust the overall allocation back to whatever you want it to be.

And he is correct that if your portfolio is rebalanced during a stock market downturn, you will not only not be selling stocks but will in fact be buying them.

For anybody attempting to use “don’t sell stocks during a downturn” as a stand-alone rule though, it’s a challenge. It’s one of those vague statements that sounds like it makes great sense — hard to argue with, even. But once you try to turn that into an actual plan of action, you start to realize that you need something more specific/concrete than that.

There’s the question you noted: how bad does a downturn have to be, before I should avoid selling stocks?

There’s also the question of how many years worth of spending you want to keep in bonds, in order to avoid selling anything other than bonds when the stock market is doing poorly. That is, exactly how long of a downturn should you plan for? (Though if you prefer a conservative allocation anyway, this generally wouldn’t be an issue in early retirement, as you already prefer to have many years of spending in bonds.)

This doesn’t mean that “not selling stocks during a downturn” is a bad strategy, but you will have to choose some answers to the above questions. And — just like any other asset allocation question — there is not one answer that everybody agrees upon. There’s no consensus as to the specifics.

About as close as you can get to a consensus for managing asset allocation in retirement is something along these lines:

Diversify, in the sense of “not having a large percentage invested in any one company.”
Diversify, in the sense of “own stocks and bonds, and own some international too.”
Keep costs low.
Make sure that your asset allocation does not make you uncomfortable — and will not make you uncomfortable even when the market is doing poorly.
Have a specific plan for how you will change (or not change) your allocation as you age and in various market circumstances. For example, will you rebalance into stocks when the market falls, or not? And will you rebalance out of stocks as the market rises, or not? Having a specific plan is better than making it up as you go along. (If nothing else, it helps you keep your sanity: “I’m sticking to the plan” — whatever the exact plan happens to be.)
Keep your spending rate low-ish if at all possible (below 4% in early retirement — ideally even below 3.5%; a higher rate is OK later in retirement).
If your spending rate is low-ish, then any diversified allocation should be OK. A higher stock allocation is likely to result in a larger bequest (and/or higher spending late in retirement) and a bumpier ride along the way.

June 24, 2019

The Problem with Socially Responsible Mutual Funds

I’m often asked what I think about socially responsible mutual funds (or socially responsible investing in general).

To explain, let me introduce you to Jim.

Jim is an accountant. He has never had a super high income, but he has been consistently employed since finishing college 30-something years ago.
Jim has saved diligently throughout his career, and his index-fund portfolio is now sufficiently large that he expects to be able to retire within the next few years, despite having no pension.
In other words, Jim has accumulated a significant sum of money.
Every so often, Jim experiences some misgivings about having that much money. He recently read that his seven-figure net worth means he has more wealth than 99% of other people in the world.
Jim also has some misgivings about several of the companies that are owned by his index funds.
Jim’s annual budget does include a non-trivial amount of charitable giving each year, but the reality is that in order to meet his goals, he has to keep most of his money.
Jim wants to feel better about having a lot of money. That is, he wants to continue to have a lot of money. But he doesn’t want to feel bad about it.

Jim has a need.

There are a lot of Jims.

What does the financial services industry do when it sees a lot of people with a given need/desire? It creates a product.

Socially responsible mutual funds are that product. Socially responsible mutual funds exist to let you feel better about having money (i.e., not giving it away). The fund industry usually doesn’t want you to give your money away. If you do, they don’t get to collect a percentage (in most cases).

This isn’t to say that socially responsible funds are a bad thing. From a “doing good in the world” standpoint, a socially responsible fund might have a beneficial effect in that it might exercise its voting rights more frequently — or more frequently in line with your views — than typical index funds.

Conversely, if the fund’s way of being socially responsible is simply to exclude certain stocks/industries from the fund, it is giving up its power to vote to change the behaviors of those companies/industries. That is, as a shareholder, a fund has influence. If it chooses not to own those companies, it gives up any potential influence it might have. You may see where I’m going with this. As a socially responsible investor, I would like a fund that owns all firms (i.e., an index fund) and which votes to make the changes I want to see. I do not want a fund that goes out of its way to give up its influence over the companies I would most like to influence.

Unfortunately, whether or not socially responsible funds actually have a positive societal effect is not generally super important from the perspective of the fund company (or, in most cases, from the perspective of an advisor recommending the fund). As long as you feel better about owning this fund as opposed to another one, mission-accomplished.

It is normal to have some misgivings about having far more wealth than almost everybody else in the world.

And it is clear that the most effective way to alleviate those misgivings is to give away more money — either directly to people who need it more than we do, or to charitable organizations that fight against the thing(s) we find unethical.

But, unfortunately, there’s a limit to how much we can give while still reaching our goals. With our current retirement system (in which few people have pensions and Social Security doesn’t cover everything), if you want to retire someday with a middle class level of spending or higher, you must accumulate a pile of money — and keep it for yourself.

It is also normal to have misgivings about owning shares of companies that do things you find unethical.

Yet owning those shares and using your vote as a shareholder is precisely how you can attempt to influence those companies. Unfortunately, as mutual fund investors, it is the fund managers that must vote on our behalf, and we have limited information as to how fund managers vote their shares. And the “socially responsible” funds (i.e., the funds with a stated mission of working for positive change) go out of their way to give up their right to vote on such issues, because doing so allows people to feel better about owning the funds (i.e., it makes them more marketable).

June 10, 2019

How Important is Social Security Planning?

A reader writes in, asking:

“Just how important is it to learn about all the ins and outs of social security? When I look at the benefit estimates on my statement, they aren’t exactly small amounts, but this doesn’t look like it’s going to be the most important financial decision I’ve made in my life. And yet people go back and forth forever (eg on bogleheads) about whether filing at 62, 66, 70, or whatever is best.”

In terms of expected spending (in today’s dollars) over the course of a retirement, the difference between the ideal Social Security filing strategy and a very bad strategy is often in the $20,000-$40,000 range for a single person. For a married couple, the difference between the ideal strategy and a very bad strategy would often be in the $50,000-$100,000 range.*

The difference between the ideal strategy and a fairly similar strategy is much smaller. For instance if filing at 70 is ideal for you, filing at 69 and 6 months is likely to have a very similar result — a few thousand dollar difference over the course of your retirement.

So even if we’re comparing a good strategy to a very bad strategy, no, it’s not even close to the most important financial decision you’ll ever make. The career you pick, the city/cities you choose to live in, the home(s) you buy or don’t buy, the job(s) you take, whether you get married/divorced/have kids — all of those things will have a larger impact on your finances over your lifetime than your Social Security claiming decision(s).

But, for most people, you can learn most of what you need to know about Social Security from just a handful of hours of reading (in addition to my book Social Security Made Simple, I can also enthusiastically recommend Andy Landis’s Social Security: The Inside Story or Jim Blankenship’s Social Security Owner’s Manual). And if a few hours of self-education can provide a mid-five-figure expected return, those are some well-spent hours.

A key point here is that if you are not a financial planner (i.e., you are not trying to become an expert in all of the situations your clients might face), you only need to learn about the parts that apply to you. You can (probably) ignore most of the complexity. For example:

If you don’t have minor children or adult disabled children, you can ignore everything about child benefits and the family maximum.
If you don’t have a pension from non-covered employment, you can ignore everything about the windfall elimination provision and government pension offset.
If you have never married (or if you were married less than 10 years prior to a divorce), you can ignore everything about spousal/survivor benefits.
If you are married and you and your spouse were both born after 1/1/1954, you can ignore everything about restricted applications.

Most unmarried people and married couples have either one or zero complicating factors. A basic cookie-cutter-type plan works reasonably well for most people.

Social Security planning is primarily about avoiding a particularly bad strategy, and that mostly means:

Don’t miss a restricted application if you have the chance.
Get within a year or so of your ideal filing age. (For example if age 70 is the mathematically ideal age for your circumstances, don’t file at 62 or 63. But don’t worry too much about the difference between 69 and 70.)

*The differences are often greater when we also account for tax planning. Also, delaying has a risk-reduction effect that isn’t reflected in these numerical differences.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less

See it on Amazon.

Topics Covered in the Book:

How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
How to decide the best age to claim your benefit,
How Social Security benefits are taxed and how that affects tax planning,
Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Read other reviews on Amazon

June 3, 2019

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