Episode 135 – Jonathan Clements: A Good Friend Writes Again

Episode: 135
Originally Aired: July 23, 2015
Topic: Jonathan Clements: A Good Friend Writes Again

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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Jonathan Clements: A Good Friend Writes Again
James Lange, CPA/Attorney
Guest: Jonathan Clements, Columnist, The Wall Street Journal & Author
Episode 135


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  1. Guest Introduction:  Jonathan Clements
  2. The Jonathan Clements Money Guide
  3. Returning to The Wall Street Journal
  4. Family Mortgages
  5. Responding to Increased Market Volatility
  6. Indexes
  7. Immediate Annuities
  8. Reverse Mortgages
  9. Fears about Inflation:  What is Justified and What isn’t
  10. Acting Upon Things You Can Control

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1. Guest Introduction: Jonathan Clements, Columnist,
The Wall Street Journal

David Bear:  Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks.  I’m David Bear, here in the KQV studio with James Lange, CPA/Attorney, and author of three best-selling books: Retire Secure!, The Roth Revolution: Pay Taxes Once and Never Again, and most recently, Retire Secure! For Same-Sex Couples.  Today, we welcome an old friend back to the show.  For eighteen years, Jonathan Clements was the top personal finance writer for The Wall Street Journal before joining Citi Personal Wealth Management as Director of Financial Education.  Earlier this year, Jonathan returned to journalism and now writes a weekly column for The Wall Street Journal Sunday, a special section that runs in seventy U.S. newspapers.  The author of four personal finance books, including the best-seller The Little Book of Main Street Money, he’s just finishing a new book, The Jonathan Clements Money Guide, which is due out in January.  Over the years, Jim and Jonathan have collaborated on some thirty Wall Street Journal columns, the most recent this past May 25th.  It’s always interesting when the two of them get together, so stay tuned for an informative hour.  And with that, I’ll say hello, Jim and welcome, Jonathan.

Jim Lange:  Welcome, Jonathan.

Jonathan Clements:  It’s great to be with you, Jim.

Jim Lange:  It’s great to have you on.  First, let me make it clear to the audience that Jonathan is my favorite personal finance writer, and I, obviously, work with a lot of personal finance writers.  I just think he has so many insights, and he really does his due diligence.  I do have an idea of how much time and research goes into just one column, and I think that he is providing an enormous service to the investing public by sharing such great information.  I don’t know if it’s really a compilation of his best thoughts, but I love his book The Little Book of Main Street Money.  It’s relatively short, and it has really some profound insights.  But Jonathan, when we were visiting in New York, you mentioned that you had a new idea for a book, and it’s not just like one more Jonathan Clements book, but it’s a little bit of a different idea that, at least right now, is being called The Jonathan Clements Money Guide.  Can you tell us a little bit about it and when it will be available?

2. The Jonathan Clements Money Guide

Jonathan Clements:  Happy to do so, Jim.  A couple years ago, I self-published a novel, and I want to talk about the novel, but I want to talk a little bit about the process.  I’d never self-published before.  It’s something that’s become super easy for ordinary folks to do, thanks in large part to the platform that Amazon has established.  And one of the things that I was struck by when I self-published my novel was I submitted to Amazon one day and it was available for sale the next.  And I sat there and I thought about it and thought, “Wow!  Suddenly, you can get incredibly timely information in front of book readers.  What could I do with that concept when it comes to personal finance?”  And that’s when it occurred to me: what I should do is put out an annually updated personal finance guide, and that’s what I’m in the midst of doing.  Come December 31st, when everybody else is out on the town drinking champagne and partying, I will be stuck at home doing the final updates on The Jonathan Clements Money Guide.  I’m going to be inputting the closing numbers for the financial markets as of December 31st, calculating year-to-day performance, and also in the guide will be the latest information on the economy, on tax rates and so on.  I’ll submit it to Amazon that evening, and as long as they don’t mess up, it should be available for sale January 1st with all the latest financial information.  I thought about doing this through a traditional publisher, and they’re just not geared up to have that sort of turnaround.  And it won’t be just as an eBook.  You can also do print on-demand editions through Amazon, which means you could have incredibly timely information available to ordinary investors about what they should be doing with their money.  So, that’s my big project right now, and it’s one of the reasons that I left Citigroup earlier this year, in order to pursue that project.

Jim Lange:  Let me ask you a quick question about that: that brings up the possibility that, let’s say that there’s a major tax law change or something that you want to communicate to your listeners, let’s say, sometime in the middle of the year before the second annual update.  Do you picture making any changes before January, 2016?

Jonathan Clements:  It’s a good thing you mentioned that, Jim.  I was actually thinking about that notion this morning.  We’ve been hearing some grumblings out of Washington.  Who knows whether anything will come to pass, but there have been some murmurings that maybe next year, we’ll finally get a re-write of the tax code.  It’s long overdue.  I mean, the tax code has become so junked up with all these special credits and deductions, and it’s time that we slimmed down the tax code and tried to clean things up.  If that came to pass in 2015, it would be a great opportunity to go back, update the book, turn it around and have an updated version available with all the latest tax information.  That’s one of the things that you can do with eBook publishing, with the platform that Amazon has created.   I mean, you saw this yourself, Jim, with the book you put out earlier this year.  I mean, you literally were playing around with it right up until the last minute.  You finished it one day and it was available the next, right?

Jim Lange:  Well, that’s right, and I’m actually now…by the way, Jonathan is referring to Retire Secure! With Same-Sex Couples: Live Gay, Retire Rich, and since I have written it, and it came out in May, eight more states have allowed same-sex couples to marry, and I’m actually thinking of updating the book so people will have the latest and greatest.  And by the way though, before we go any further, if I’m one of the listeners, and you know I usually have authors and I usually do promote their books and I genuinely believe in it, but if there was going to be one financial book that you were going to read, I think Jonathan is just such a great writer.  I would literally put your calendar out and make a note to yourself on January 1st, go to Amazon and buy Jonathan’s book.  Probably most of the listeners on this station are maybe a little bit more comfortable with the old fashioned hard copy book, but whether it’s a hard copy book or whether it’s the eBook, I would highly recommend that people do that, and I will make a personal guarantee here.  If you buy Jonathan’s book and you don’t like it, you come to me and I’ll refund double your money.  How’s that?  And I mean that.  I can’t imagine anybody not getting a lot out of it.  I’m very much looking forward to it myself.  So, anyway, you had mentioned that one of the reasons that you came back was this potential for providing more great information to more people, and I always love seeing you in The Wall Street Journal.  I actually thought that it gave you a terrific forum to write about more or less whatever you wanted to, I guess within certain constraints.  What made you really want to come back?

3. Returning to The Wall Street Journal

Jonathan Clements:  It was really a bunch of different issues, Jim.  One was the opportunity to do the book, and I knew that I wouldn’t be able to do it while still working at Citi, which brings up one of the issues of working for a large financial organization.  I’m all in favor of investor protection.  I mean, I think there are too many financial advisors out there who are unscrupulous and don’t put the interest in investors first, but we have this incredibly overregulated financial environment where if you work for a company like Citigroup, you have to deal with multiple compliance people, multiple lawyers, all of whom are worried about running afoul of the regulators.  That’s all well and good, but what I was doing at Citigroup was in no way a threat to the ordinary investor.  There were plenty of other shenanigans that were potentially going on that weren’t looked at closely at all, and yet those folks weren’t spending their days dealing with lawyers and compliance people, and I just got tired of it.  I got tired with dealing with the compliance people and with the lawyers, and that sort of brings me to a related issue, which is one of the great things about being a journalist is you get instant gratification.  You write something one day and it’s in print the next.  When you work for a large bureaucracy, you don’t get that instant gratification.  I may write a piece and it could take six weeks, two months, to see the light of day after I’ve dealt with all those lawyers and all those compliance people.  And that’s just not a fulfilling way to live. So, I had the opportunity to come back to journalism and also to work on this book, and I jumped to that opportunity, and frankly, I was able to do it financially.  My youngest just graduated from college…

Jim Lange:  Congratulations!

Jonathan Clements:  …so I could afford to live on a substantially reduced income.

Jim Lange:  Unless, of course, you buy her a house.  That’s an inside joke, by the way!

4. Family Mortgages

Jonathan Clements:  Yeah, well, Jim’s referring to a topic we were recently discussing outside of this radio show on writing private mortgages or family mortgages.  My oldest is twenty-six years old.  She lives in Philadelphia and she’s talking about buying an apartment, and so I’ve been discussing with her the possibility of rather than her going to the bank and getting a mortgage, maybe I would write the mortgage for her, so that rather than paying 4% a year to the bank, she might pay 4% a year to me, which is going to be substantially more than I can get by going out and buying CDs or high quality government bonds.

Jim Lange:  And, of course, my concern is because I’ve been doing this for close to thirty-five years now and I’ve seen a lot of these deals go down, and the problem is, what happens when daughter doesn’t pay dad, is dad going to evict daughter from her house or his house in the middle of winter because she’s late on her mortgage payments?  Well, probably not.  And maybe, if dad can afford it anyway, that is, if she doesn’t pay, dad has enough money that, well, it’s okay, it’s not going to break him, but I have seen situations where dad really can’t afford daughter to miss mortgage payments but daughter does.  So, I always take this with a great hesitation, and I had mentioned that to Jonathan.  Not, of course, that your daughter wouldn’t be absolutely punctual.

Jonathan Clements:  I mean, Jim, clearly, if you do a private mortgage, or what’s called a family mortgage, that is indeed the big risk.  The big risk is that you lend the money to your kid and your kid doesn’t pay it back, you do have the advantage of working on inside information.  You know your kids better than anybody else.  You certainly shouldn’t go into this with rose-colored spectacles.  You’ve got to be frank with yourself about how financially responsible your kids are, but when it works out, it can work out really well.  I mean, let’s face it, Jim.  It did work out well for the Lange family.

Jim Lange:  Well, it did, it did, and I mean, very frankly, my wife and I were in a $500 a month apartment and we were looking for a home, and my mother could no longer handle the steps, and the family home, I actually bought it from her, and she basically wrote the mortgage, and I paid that mortgage for fourteen years and seven months, and then she died and then I paid off my siblings for the rest, and I never missed a payment, not one day late, and it worked out very well for her because she got a higher rate than she could’ve at the bank, and I was able to, in effect, have the available credit to use for my business instead of just having it for my home.  So, you’re right.  It did work out beautifully for me, and in those situations where it can work out, I think it’s great, but in the situations where it can’t, or it might not, then you have to be really careful.

David Bear:  And I’d also like to say that it worked well for the Bear family too.  We got a loan from my father-in-law to buy our house, and that worked out well.

Jim Lange:  All right.  And you actually paid it off?

David Bear:  We paid it off, yeah.

5. Responding to Increased Market Volatility

Jim Lange:  All righty.  So, Jonathan, could I ask you something a little bit more about the market?  So, we now have some increased volatility, and people are all of a sudden getting a little bit nervous when maybe they were a little bit complacent.  What do you think is going on, and, perhaps more importantly, how would you tell our listeners how they should be responding to the increased volatility in the market?

Jonathan Clements:  Well, first of all, let’s talk about what’s NOT going on.  Every day (and I blame the media for this), whether the market goes up or down, financial reporters out there cook up some excuse for why the market has risen or fallen.  And it’s all over the map.  It’s political uncertainty.  It’s Ebola.  It’s something else.  Frankly, there is very rarely a single reason why millions of people choose to buy or sell in the financial markets on any particular day.  So, you should take these explanations for what’s happening in the market with a grain of salt.

That said, there do seem to be two key issue here: one, there does seem to be some indications that growth outside of the U.S. is slowing, notably in China.  Problems in Europe don’t seem to be going away, and that’s clearly an issue.  If the economy grows more slowly on a global basis, that’s not good for corporate earnings, and people need to be aware of that.  And the second thing is, we are dealing with expensive financial market.  We have a 10-year treasury note that’s using barely more than the inflation rate.  Meanwhile, we have the S&P 500, which has tripled from the March, 2009 low.  It’s trading something like eighteen times earnings, which seems on the high side, but not outrageous.  But you have to remember, that’s eighteen times earnings based on a relatively robust economy here in the U.S., wide corporate profit margins, low corporate tax rates, all of which makes companies’ profits unusually high.  So, in fact, if you normalize those earnings, the stock market here in the U.S. really does actually look pretty expensive.  As a consequence, people are right to be nervous, and I think there are many people out there who’ve enjoyed the long run that we’ve had since March, 2009, and they’re now thinking, “If the market dips, I want to get out, but I’m not really sure where to go because the bond market offers such low yields.”  I think those low yields are one of the reasons why people are flocking to stocks, but they don’t seem to be particularly enthusiastic, and that’s what’s really driving the volatility here.  People are nervous.  They do realize we’re dealing with expensive markets, and I think a lot of people will sell if the dark clouds get any darker.

Jim Lange:  Well, what would you tell somebody who is…let’s say that they are conservative.  Let’s say that they are nervous, and let’s say that maybe in a different era, they would’ve had maybe 50% of their portfolio in some type of CD or bond that might have been paying 5% or 6%, and now the best they can get is maybe 1% or 2%, unless they’re looking for either a very long holding period or some increased volatility and risk.  What would you tell somebody who is by nature conservative and doesn’t like the yields on the bonds?

Jonathan Clements:  I guess there are three things that I would focus on, Jim: first of all, realize that nobody knows where the financial markets are going over the short-term.  You go back to the beginning of this year and what people were forecasting, and there was a fairly strong consensus at the beginning of this year that this was going to be a terrible year for bonds, and that this was going to be a pretty good year for stocks.  The typical prediction for the stock market was that we would see 10% gains this year.  Meanwhile, the typical prediction for the bond market was that interest rates were headed higher.  So, here we are, almost with the year done.  What happened?  Well, instead of interest rates going up, we’ve seen the 10-year Treasury note go from 3% to pretty close to 2%.  So, clearly, people were totally wrong on the direction of interest rates.  Meanwhile, stocks are up somewhat here in the U.S., but they’re down in emerging markets, and they’re down in Europe and Japan.  So, the forecast of the stock market also turned out to be wrong.  Nobody knows where the financial markets are headed in the short-term.  So, you shouldn’t be basing what you do on some short-term forecast.  At this stage, you need to think about risk more than anything else.  And the question is: what are you going to do about these risks?

That brings us, sort of, to the second issue: everybody, and I mean everybody, should have target portfolio percentages for what percent of their money should be in stocks, what percentage in bonds, what percent in cash investments and what percentage in alternative investments like gold stocks and real estate investment trusts and similar investments.  Every so often, you should look at your portfolio, see whether it’s in line with those targets, and if it’s not, you probably want to do a little bit of rebalancing.  After the year that we’ve had so far, you might find yourself trimming back on U.S. stocks a little bit, adding a little bit to foreign stocks given their weak performance, and maybe you’re leaving your bond portfolio pretty much the same.

And that really brings me to the third point and the second part of the question you raised, Jim, about what should income-oriented investors do?  I don’t want to sound too much like an economist with the “on the one hand, on the other hand,” but on the one hand, yields are not that bad when you think about yields relative to inflation.  Sure, we don’t have the double digit yields that we had in the early 1980s, but we also don’t have double digit inflation.  Yields in, say, the 10-year Treasury note, are still above the inflation rate.  Once you subtract out taxes, they’re a little bit below, but that would also have been the case in the early 1980s.  So, in a post-tax, post-inflation point of view, we’re not in a terrible situation.  On the other hand, there’s clearly a lot more room for interest rates to rise than fall, and that’s an issue that a lot of people are worried about and it worries me.  The 2.5% on the ten-year treasury note, you know, there just isn’t a lot of room for interest rates to fall further, and there’s plenty of room for rates to rise, and if rates rise, people are going to take a short-term hit to their portfolio.  That’s why short-term bonds, certificates, deposit and so on, do look like a more attractive option given the risk and return on offer in the bond market.  If you’re looking at that part of the bond market, one thing you might want to look at is longer term CDs.  If you buy a five-year CD and you shop around these days, you can get 2%, which is not a bad yield, and if you decide you need the money earlier, it may be worth buying that 2% five-year CD and just cashing it out and paying the early withdrawal penalty.  Even after paying that early withdrawal penalty, you may find that you’re better off than buying short-term CDs and rolling them over on a regular basis.

David Bear:  Let’s take a quick break at this time, and when we return, Jonathan and Jim will continue this conversation.


David Bear:  And welcome back to The Lange Money Hour.  I’m David Bear, here with Jim Lange and Wall Street Journal financial columnist Jonathan Clements.  Jim?

Jim Lange:  And Jonathan Clements, by the way (and I’ve already mentioned this before, but he is my favorite financial writer), has a terrific book that’s actually available now, called The Little Book of Main Street Money, which I would highly recommend, and his new book, which I think is going to be just fabulous because he’s really put the time (and I know how much time and work he’s put in it, and I love reading his stuff anyway), is The Jonathan Clements Money Guide,”and what I’m going to recommend our listeners do is put it on their calendar for January 1st (because that’s when it’s going to be out).  It will literally be fresh off the press, or, I guess, the eBook for a lot of people.  Again, The Jonathan Clements Money Guide, available January 1st.  Jonathan, one of the pieces of information that always stuck in my head about the advice that you gave is that you said you’re not even all that concerned with what asset allocation model somebody has, and you had alluded to that earlier, a certain percentage in stocks, bonds, cash and probably, if we were to go further, even sub-divisions like large cap growth and large cap value and small cap growth and small cap value, etc.  But one of the things you always said was, “Pick your allocation, and then stay with it, and it was the people who didn’t stick with their allocation that got hurt in the long run.”  Do you still believe that even in today’s volatile times?

Jonathan Clements:  Absolutely, Jim.  I think the biggest mistake you can make is settle on an asset allocation, and then we get some big decline in the financial markets, and you panic and you sell.  That’s the point at which you start to lose major amounts of capital.  That is a financial disaster.  And one of the things that people should take away from the recent volatility is if you’ve gone through the recent volatility AND you were unnerved AND you were thinking about selling, maybe you should do a little selling now because it’s much better to sell now while the financial markets are close to their all-time highs rather than waiting until the markets are down to 25% or 30%, then panicking and selling.  Much better to panic when we’re at an all-time high.

6. Indexes

Jim Lange:  All right.  The other thing that you always talk about (and I think you had alluded to it again earlier), that there are a lot of unscrupulous financial advisors, people that don’t have their client’s best interests at heart, and I haven’t talked to you about this issue, but I suspect that you would prefer that all financial advisors have literally a legal fiduciary duty (like I do) to do what is in their client’s best interests, not their own.  But you have always been a low-cost-type investor and advocate, and are you still a low-cost advocate, and do you still like index funds for the underlying investments that clients have and listeners have?

Jonathan Clements:  I am a huge, huge fan of indexing.  While my philosophy has evolved somewhat over the years, that basic notion is that what you want to do is put aside attempts to try to outperform the market by trying to pick one stock over another or one active managed mutual fund over another.  Put aside that task, which has proved to be all but impossible over the long run, and instead, simply accept the market’s return at the lowest possible cost.  I think that is a great strategy.  One of the things that Standard & Poor’s does on a regular basis is they analyze all actively managed mutual funds to see how they perform against appropriate benchmark indexes.  This is a scorecard they put out every six months or so, and the results are utterly consistent.  Over a five-year period, typically between 60% and 80% of actively managed funds lag behind their benchmark index.  When you buy an actively managed fund, the odds are against you.  In all likelihood, you will trail the market averages, and when I see odds like that, I don’t want to accept them.  It’s the same reason I don’t go to casinos, because you know you’re going to come out a loser.  Much better to buy an index fund and accept the market’s return.  Having said that, my approach to indexing has evolved over the years.  If you went back to the 1990s, I was very much of the view that you should have a portfolio that looks like the broad U.S. stock market, and for the foreign component, have a portfolio that looks like the broad international market.  Now, I’ve become more willing to introduce more specialized index funds into my portfolio so that I might tilt a little more heavily towards small stocks and tilt a little bit more heavily towards beaten down value stocks.

Jim Lange:  Well, speaking of smaller in value, now I know the, kind of like the baby elephant in the room when you talk about indexes is Vanguard.  I think that John Bogle has done a fabulous job and Vanguard is a great company, and particularly for the do-it-yourselfer, Vanguard offers some of the best index funds in a variety of asset allocation models.  But there are others, and one of them that actually skews exactly the way you had mentioned (that is, they skew small, and not only will they recommend a higher percentage of small company stocks, but the small company stocks they choose are smaller than, say, the Vanguard small cap fund) is Dimensional Fund Advisors.  Do you have any opinions about them, or are you still mainly a Vanguard person, or do you like both depending on the situation?

Jonathan Clements:  Well, as you know, Jim, the thing about Dimensional Fund Advisors that people should be aware of is that they sell their funds through financial advisors that have sort of been registered and approved by DFA.  So, if you want to buy DFA funds, you do need to work with a financial advisor who is connected to that firm, and in many cases, if you are working with a financial advisor and they do use DFA funds, that’s a good sign because, in my experience, only the most thoughtful and more ethical advisors tend to be using DFA funds.  So, in some ways, it’s a housekeeping seal of approval when you find out that they use DFA funds, but what I like about what DFA does is they’ve taken the latest academic research and they try to put it into action, and to understand what’s going on, you need to sort of cast your mind back forty years through the evolution of financial theory.

Historically, the key notion was that to earn higher returns in the financial markets, you had to take more risk, and initially, that risk was measured by something called volatility, how much a stock bounces up and down in price.  But over the decades, we’ve seen a number of academic studies come out that indicate that volatility alone does not explain why some groups of stocks do better than others, and two of the biggest anomalies that have been detected are one: that small stocks generate higher returns than can be explained by their greater volatility alone, and similarly, value stocks tend to generate higher returns than would be explained by their volatility alone.

So, what does explain their greater performance?  And there’s a lot of debate about this.  Some say that in some sense, these stocks are riskier.  Others say that really what we’re seeing is a behavioral phenomenon that investors are reluctant to buy value stocks because they’re not as attractive, because maybe they’re slowly growing, or there’s something a little sketchy about the companies, and similarly, small stocks may be overlooked because they’re seen as being financially weak.  Whatever the reason, there is a lot of debate about why small stocks and why value stocks outperform.  To date, the phenomenon has persisted, and I’m willing to at least tilt my portfolio towards small stocks and value stocks to try and take advantage of this outperformance.

Jim Lange:  Well, thank you.  And by the way, in fairness and in the spirit of full disclosure, I am one of those DFA providers, and you are right.  There’s roughly a million financial advisors in the United States and there’s only about 1,200 who are approved for DFA, and I went through that process, and it’s not easy to become a DFA provider, and I think that a lot of what you’re saying is right.  Even if we don’t have a great explanation of why some of these things perform better, like smaller smalls and lower price earnings ratios for value, they have, and the arrangement that I have, as you might know, is that our office does things like the Roth IRA conversion analysis, the Social Security analysis, the retirement planning, the estate planning, and we have another DFA provider who actually does the investments, and then together we charge one percent or less, depending on how much money is invested.  But anyway, one of the things that you have been a fan of in the past, and have some, frankly, outspoken opinions on, is the issue of immediate annuities.  So, maybe if you could tell our listeners what an immediate annuity is, if you are still a fan of them, and maybe distinguish between those and commercial annuities, I think that would be maybe one of the alternatives for some conservative investors.

7. Immediate Annuities

Jonathan Clements:  So, the term ‘annuities’ is used for a whole bunch of different products, many of which I wouldn’t touch with a ten-foot pole.  For instance, there’s a big sales effort out there to sell equity index annuities.  There’s a big sales effort out there to sell tax deferred variable annuities.  There’s also a lot of sales effort behind tax deferred fixed annuities, and in general, with a few exceptions, I would not touch those products.

So, what we’re talking about here, Jim, are immediate fixed annuities, and with immediate fixed annuities, it’s a very simple product.  You hand over a chunk of money to an insurance company.  If you buy the lifetime version of the immediate fixed annuity, in return, they’re going to cut you a check every month for the rest of your life.  This is like having your own personal pension.  The irony, people will work for thirty years at a company they hate in order to get a traditional company pension.  But you take somebody who’s saved money on their own for thirty years, and you put them at the start of their retirement, and yet they are loath to hand over their money to an insurance company in return for an immediate fixed annuity.  And yet, they’re getting exactly the same thing.  They’re getting their own personal pension plan.  I’m not saying people should put all their money into immediate fixed annuities.

I know the objection that you’re going to raise immediately, which is right now, with interest rates so low, the payouts on immediate fixed annuities are not super attractive.  Nonetheless, I think this is a product that a lot of people are going to turn to in the years ahead, for one very simple reason: if you want to squeeze a lot of income out of your retirement savings, and let’s face it, there are a lot of people out there who don’t have enough retirement savings, if you’re looking to squeeze maximum income out of your retirement savings, an immediate fixed annuity is one way to do that.  So, how should you go about approaching immediate fixed annuities?

Well, my first advice is if you want an immediate fixed annuity, the number one immediate fixed annuity out there is delayed Social Security payments.  If you’re inclined to buy an immediate fixed annuity, the first thing you should do is delay Social Security, potentially as late as age seventy.  That’s the best annuity you can get.  If you want more lifetime income, that’s when immediate fixed annuities come into play.  Given that interest rates are so low right now, you may want to consider a couple strategies: one, you don’t want to put all your money into immediate fixed annuities right away.  You may want to buy them over time, given the possibility that interest rates are going to head up from here.  Second, you may want to buy from multiple insurers just in case we have a bankruptcy by one insurance company, and that way, you’ll have spread your risk.  And third, if you buy over time, you’re going to buy one year later, and one of the reasons why immediate fixed annuities pay more income than other investment products is because you’re essentially betting your life.  You’re betting that you’re going to live long enough to get a decent amount of income back from the annuity.  There are a number of people who make that bet, and then they’re going to be wrong.  They’re going to die relatively early in retirement.  You’re the beneficiary of that mortality pool, we hope, and the later you buy, the closer you are to your life expectancy, and hence, the more income they’re going to pay you.  So, buying an immediate fixed annuity in your early seventies, say, rather than at age sixty-five, may be attractive because you’re going to get more income as a consequence of your shorter life expectancy.

David Bear:  Well, let’s take one more break at this point.


David Bear:  And welcome back to The Lange Money Hour with Jim Lange and Wall Street Journal personal financial columnist Jonathan Clements.

Jim Lange:  And also author of The Little Book of Main Street Money, which is a book that I love.  I think Jonathan’s classic.  And a book that is coming out, and I’m going to say that this is going to be so good that I will recommend that you put on your calendars for January 1st to be looking for The Jonathan Clements Money Guide from my favorite personal financial writer anywhere.

So, before, we were talking about immediate annuities for a minute, and I just wanted to add my own two cents because, basically, with an immediate annuity, you are giving up a chunk of money in return for an income source for the rest of your life.  If you are married, unless there is a significant difference in the health or life expectancy of the couple, I’m usually going to recommend what’s called a two life annuity, meaning that you would get less money per month, but you would get it for both your and your spouse’s life.  So, I will throw that in.  On the marriage issue, Jonathan mentioned the possibility of waiting until seventy before collecting Social Security, and, in general, I am a big fan of that, but I do just have to mention again, if you are married, there is a technique called apply and suspend, and then there’s another technique called claim now, claim more later, that are both very powerful techniques.  In fact, I actually just wrote an article that’s in Trust and Estate magazine, which actually, I think, we might even be allowed to give away to our radio station listeners.

The other thing that I wanted to mention…so yes, with an immediate annuity, you are taking a risk.  So, let’s say, theoretically, that you invested that money that you would’ve paid for an immediate annuity.  Depending on how long you live, there is a certain break-even point, and depending on what assumptions you might use, that break-even point might be around age 84.  But one of the points that Larry Kotlikoff made on this show was if you die early, that is, before the break-even point, you’re dead!  You don’t have any more financial problems.  What you should fear is living a long time, and what the immediate annuity does (which is the same idea as delaying Social Security) is it provides you a higher income for the rest of your life.  So, I just wanted to throw those little two cents in.  I don’t know if you have anything to add to that before we go on.

Jonathan Clements:  Yeah.  Well, two things: first is, I totally agree with your final point.  The big financial risk in retirement isn’t dying young having collected very little money from Social Security and having collected very little money from your immediate fixed annuity.  The real financial risk is living longer than you ever planned for and outliving your other savings.  At which point, if you’ve delayed Social Security to get the larger monthly check, and if you bought that immediate fixed annuity, you’re going to be a much happier camper.  But coming back to that issue of regret, I just want to put in a plug here for a different type of immediate annuity.

If you really are averse to handing over a big chunk of money to an insurance company because you fear you’re going to die early in retirement, an alternative is to buy a charitable gift annuity.  If you buy a charitable gift annuity, what you do is, you go to your favorite charity (a lot of them offer this) and they will write you an immediate annuity.  It’s not going to pay you as much as an immediate annuity from an insurance company, but one, you can fund that charitable gift annuity with appreciated stocks, or you can get a tax break.  But two, if you die early in retirement, the beneficiary of your early demise isn’t the insurance company, it’s the charity itself.  They will be the ones who win because of your early death.  So, that should take some of the sting out of the possibility that you don’t have as long a retirement as you would like.

8. Reverse Mortgages

Jim Lange:  I like that.  What do you think of…let’s say, a third source of income in the form of a reverse mortgage?

Jonathan Clements:  I’m not crazy about reverse mortgages, but I think it’s one of those things that everybody should keep in their back pocket.  In other words, if you do get into your eighties and you discover that you’re starting to run through your savings and you need more income, yeah, I think a reverse mortgage is something that you should consider.  The fact is, you only get one shot at retirement.  You amassed this money.  If you need it to live out the rest of your days in comfort, then yeah, you should do it despite the costs, despite all the drawbacks, despite the fact that the whole house isn’t going to be available to give to your kids.  Nonetheless, if you need it to be comfortable in retirement, I would do it, but I wouldn’t use a reverse mortgage as your first choice.  It should really be your financial backstop if you lived far longer than you expected.

Jim Lange:  Yeah.  Most clients and listeners are probably not thrilled with the idea.  On the other hand, very frankly, I think it is a viable way of increasing income.  I might be a little bit more aggressive than you.  I might consider it earlier than eighties, particularly for somebody who has a lot of equity in their home.  And the other thing is, reverse mortgages today do have lower fees and lower commissions, etc. than in the old days.  But I think we’re somewhat on the same tune with that.  One of the things that you talk about a lot is that you worry about inflation, and even you had alluded to it earlier when you were talking about the possibility of people suffering short-term losses on their bonds.  Can you tell our listeners some of the fears that you think are justified about inflation, and then perhaps some that are not?

9. Fears about Inflation:  What is Justified and What isn’t

Jonathan Clements:  I’m not concerned that we’re going to get a big surge in inflation.  I know there has been a lot of talk about that, particularly with regards to the Federal Reserve’s policy.  People are concerned that we have a lot of liquidity in the system and that eventually is going to lead to hyperinflation.  At this point, with so much slack in the economy, I mean, yes, we have the unemployment rate down to 6%, but still, there are a lot of people, I believe, who would like to work more, or who have become discouraged (we’re not even sure or not in those unemployment statistics).  There’s a lot of slack in the economy, and if growth really did pick up, we are unlikely to be confronted by a lot of inflation.  That said, clearly, when you have inflation that’s running at less than 2%, there’s a lot more room for inflation to rise than to fall from current rates, and you should be prepared.  And what does that mean?

Well, I would think about two things: one is it’s a reason to have some stocks in your portfolio if you’re a retiree.  If we do get a pickup in inflation, it’s going to hurt the fixed income side of your portfolio, but with any luck, that higher inflation will translate to higher and nominal corporate profits, and that will help to buoy the stock market, and so you may be able to offset the losses on the bond side of your portfolio with the gains that you make in the stock market.  And second (and this is a bit more specific than I would normally make in terms of an investment recommendation), I think that there is an opportunity to put at least a small sliver of your portfolio into gold stocks.  We’ve seen gold stocks fall by 50%.  That part of the market really has been roughed up to somebody who’s an investor who has a fair amount of investment courage and they’re not going to be panicked by further volatility.  Taking maybe 3% of your portfolio and putting it into a gold stock fund that’s getting ready to rebalance back to that target percentage, if gold falls from here, that may provide you with a nice piece of portfolio protection, particularly if we do see a big stock market decline.

Jim Lange:  Well, that is a surprise.  I don’t think of you as a gold-type guy.  And you did say a small sliver, but that still is surprising and probably interesting food for thought, something that I usually have not recommended.

Jonathan Clements:  Well actually, Jim, I had actually, up until this year, never owned a gold stock fund, but we’ve had three rough years in a row for gold stocks, and this is turning out to be the fourth year.  To me, it looks like an interesting opportunity, but again, only for a tiny percentage of your portfolio, only if you’re willing to stick with it if things get worse from here, and thinking about it less as an investment that’s going to provide you with great long-run returns and more as an insurance policy in case things do get rough for financial assets.

10. Acting Upon Things You Can Control

Jim Lange:  Maybe, perhaps, as our final question, you have always stressed to think about and act upon things that you can control and not things that you can’t control.  First, could you maybe explain that a little bit, and do you still believe that today?

Jonathan Clements:  Well, going back to earlier in the show, Jim, I was talking about what people were forecasting for 2014.  They were forecasting that stocks were going to go up and bonds were going to go down.  And they were wrong.  The stock market has not gone up as much as people were forecasting, and this is turning out to be a great year for bonds.  So clearly, we cannot control the markets over the short-term.  We are no good at predicting short run market performance.  So, instead of worrying about some short-term forecast of financial markets, what should you focus on?

Well, there are three things that I would emphasize: one, you should try to control your annual investment tax bill.  There are all kinds of things that you can do to keep your investment tax bill low by, for instance, favoring tax efficient investments in your taxable account by making full use of the retirement accounts available to you.  Second (and again, it’s a topic we touched on during the course of the hour), you should keep your investment costs low.  When you buy an investment, you never know whether it’s going to turn out to be a winner, but if you keep your investment costs low, you will at least keep more of whatever you do make.  And third (it may be most important), you should focus on risk.  You cannot be sure when you buy an investment whether it’s going to have the sort of performance that you hope, but if you manage risk, you can at least insure that you won’t be badly hurt if you get it wrong.  And managing risk means owning a portfolio that has the right balance between stocks and bonds, and within those two parts of your portfolio, making sure that you’re well diversified so that you can’t be hurt if any one security turns bad.  And when you think about risk, you should think not only about the risk of your portfolio, but also think about the risk that you personally bring to that portfolio, by potentially panicking and selling at the worst possible time.  You should take each of the mutual funds that you own and see how the bonds did in 2013, and see how the stock funds did in 2008.  Look at those losses that the funds suffered and imagine how you’d react if we had those losses again.

Jim Lange:  Well, this has been a wonderful hour, Jonathan.  Thank you so much.  And again, one last time for our listeners, The Little Book of Main Street Money, which is available right now at Amazon, and I’m going to recommend that everyone go to their calendars, mark January 1st, and on January 1st, purchase The Jonathan Clements Money Guide.  Thank you again, Jonathan.




jim_photo_smJames Lange, CPA

Jim is a nationally-recognized tax, retirement and estate planning CPA 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, 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.