Many good quotes about common sense have been uttered over the centuries…
“Common sense in an uncommon degree is what the world calls wisdom.” – Samuel Taylor Coleridge
“Common sense is not so common.” – Voltaire
“Common sense is the most widely shared commodity in the world, for every man is convinced that he is well supplied with it.” – Descartes
“Common sense is genius dressed in its working clothes.” – Ralph Waldo Emerson
The financial world is riddled with opportunities for people to violate some basic common sense principles. Let’s explore a couple of them.
Buy Low and Sell High
Pretty obvious, right? I’ve never encountered a single person who disagrees with the wisdom of this common sense investing principle.
And yet, when I examine investing behavior, I constantly see people in violation of it.
Here’s the perfect example. I met with a fellow last month who walked in with about $750,000. Before the 2008 financial crisis, he had close to $1.3 million. But after the crash his account balance dropped by about 40%, he panicked, pulled his money out of the market, and stuck it in a money market account where he’s been making 1% ever since.
Obviously, he sold low. (You might recall that you’re supposed to sell high).
But that’s not the end of it. He walks in my office saying that he’s tired of having his money sitting in cash earning 1% interest and he’d like to get back in the market.
This is the same market where we’ve hit new all-time highs on multiple days in the last two months.
So, he sold low, camped out in cash for 8 years, and now wants to buy high. The exact opposite of what you’re supposed to be doing, on both fronts!
And while it’s easy to scoff at his extreme violation of the “buy low, sell high” principle, it’s not like he’s the only one guilty of this. I see it all the time—maybe not to that extreme, but I see some version of that story at least once a month.
Common sense. Not so common.
Don’t Pay More in Taxes Than You Have To
There are varying levels with which people revile taxes.
At one end of the spectrum, you have people who say things like, “Well, I don’t like paying taxes, but I try to be conscious of the government services that I benefit from and that usually makes me feel better.”
At the other end, you have the people who are ready to secede from the union at the mere mention of the IRS.
But there’s nobody who’s voluntarily signing up to send more money to the government than they’re required to send because they feel that the folks in Washington DC are a beacon of efficiency and virtue and they want to help them fund a few more studies about the effects of cow flatulence on the environment.
Well, I shouldn’t say nobody. There’s probably a dude in Carrboro who can’t get enough of the federal government constantly expanding and wants to contribute every penny he can to that enterprise. But other than that one guy, then “nobody” is probably a safe word to use here.
And yet I frequently see people paying more in taxes than they have to.
Sometimes it’s just laziness when it comes to tax preparation—like taking the standard deduction when you could itemize your deductions and be much better off.
But more often, it’s a problem of tax planning. Most of your tax mistakes aren’t going to be when you’re doing your taxes every spring. It’s the opportunities that you miss now to save yourself some money five years down the road.
So do some planning and don’t pay more than you have to. Unless you’re really into cow flatulence.
4 Things That Don't Work (in retirement planning and in life)
There’s lots of stuff in this world that just doesn’t work, and that’s not limited to the financial realm. Here’s four of those things…
Thing That Doesn’t Work #1: Arguing with people about political issues on Facebook
Tell me how many times you’ve had this conversation with someone.
“Hey, so I heard that you switched party affiliations. What caused that change of heart?”
“Well, I’ve been engaged in a debate on Facebook with a girl I went to high school with. Haven’t even seen her in probably 15 years, but she really made me think with her nine-paragraph response to something that I posted the other day. And then when she shared a 2013 article from Politico with me, I decided that now was the time to change my lifelong political ideology.”
Remember all those times you’ve heard somebody say that? Me neither.
Thing That Doesn’t Work #2: The “Close Door” button on elevators
They almost never work. It’s usually a dummy button.
So what’s going on here? Are the elevator manufacturers going out of their way to install an extra button that gives us the illusion of control?
Not exactly. In fact, the buttons used to work. Then along came the Americans with Disabilities Act and most places decided to disable the buttons to be in compliance with the law. Sure, they could give us some kind of signage to let us know that we’re wasting our time pressing the button, but that seems like a lot of trouble.
Thing That Doesn’t Work #3: Timing the Market
About once a month, somebody will walk into my office, seemingly for no other reason than to tell me their story of how brilliantly they timed the market in 2000 or 2008 and how they got out at just the right time and avoided the crash.
This is a lot like somebody telling you about their recent trip to Vegas and how much money they made with their new blackjack strategy. Of course, they’re forgetting to tell you about the previous four trips to Vegas where they lost all of their money but just couldn’t stop playing and eventually found themselves pleading “GIVE ME MORE CREDIT” as they were whisked away to a dark room.
Is it possible that you can guess when the crash is coming and get out at just the right time? Sure, it’s possible. Not highly likely, but within the realm of possibility. Then all you have to do is wait for the market to bottom out, then you come galloping back in on your steed and buy everything while it’s deeply discounted and then ride it back to the top.
But that’s the problem with successfully timing the market. You have to be right twice.
You have to not only get out at the right time, you also have to get back in at exactly the right time. And if you miss just a few days of a strong recovery and you get back in too late, you’ll wipe out most of the money that you saved by avoiding the initial downturn.
To illustrate what I mean, here are some fun numbers, that I’ve borrowed (stolen?) from J.P. Morgan.
They did a study on the returns on $10,000 invested in the S&P 500 for 20 years—from January of 1995 through the end of 2014.
If you let the money ride untouched for the full 20 years, your $10,000 would have grown to $65,453. That’s a 9.85% average annual return.
If you remove the gains from only the 10 best trading days during that 20 year period, you now have only $32,665. Half of your gains came during just 10 trading days.
Miss the 40 best days over a 20-year period and you actually have a negative return with your $10,000 now being worth $9,140.
So you can see what happens to a lot of people who successfully time the market and get out before the crash. While they’re on a victory tour around the country club locker room celebrating their investing prowess, the market bounces back before they have a chance to go buy all of their stocks at bargain prices. By the time they re-invest, the market is pretty close to where it was when they got out.
Thing That Doesn’t Work #4: Pick-up lines
“Hey Mom, how did you meet Dad?”
“Well, I was at this dumpy, crowded bar when this guy accidentally brushes up against me and then says ‘Hey, are you an overdue library book?’ And I look at him with a puzzled look on my face and I say, ‘No, I’m not, in fact, an overdue library book…why do you ask?’ And he says, ‘Because you have FINE written all over you!’ And I blushed and giggled and he grabbed my hand and led me to the dance floor and I knew immediately that I wanted to bear his children.”
Yep, that’s usually how those pick-up lines work out. And they lived happily ever after.
Three Tax Tips
To quote Margaret Mitchell: “Death, taxes, and childbirth…there’s never a convenient time for any of them.”
And because taxes are so inconvenient, it seems like people go out of their way to spend as little time thinking about them as possible. Unfortunately, that means ignoring some elements of their portfolio that could be costing them money. These are three of my biggest pet peeves when it comes to taxes and investments:
1) Mutual fund inefficiency
Most people understand capital gains and the tax bill that you can create for yourself when you sell stock in an after-tax account. If you bought a share of stock for $20, then sell it 10 years later after it’s grown to $50, you’re going to be taxed on that $30 gain.
But most people seem to forget about the tax implications of mutual funds. If you own shares of a mutual fund, and you hold those shares for that same 10-year period without selling, you’re still going to incur a tax bill every year.
Why?
Because within that mutual fund, there are stocks or bonds constantly being bought and sold by the fund managers. And every time they sell something, you’re going to have to pay your share of the taxes on those gains that were created.
The thing I hate about this is the lack of control that you, the individual investor, have over the situation. If you own stocks, you can take the tax implications into account whenever you choose to buy or sell. If you’re going to create a gain that’s bigger than you want, you either don’t make the sale, or you sell something else at a loss to offset the gain. You’re in control.
But you don’t have that same control with the mutual fund. You can hold onto those fund shares indefinitely, but still be taxed every year.
Does that mean that you should never, ever own mutual funds in an after-tax account? No. But it does mean that you need to be aware of the tax inefficiencies and lack of control that you’ll experience. Most of the time, there’s a better way to invest those dollars.
2) Conservatively-invested Roth IRAs
With the majority of my clients, I like to have Roth IRAs invested aggressively. In most cases, their Roth is the most aggressive piece of their entire portfolio.
Let’s think about the whole point of a Roth IRA. The point is for you to contribute after-tax dollars, then let those dollars grow tax-free.
So if you invest $50,000 in your Roth (let’s say $5000/yr for 10 years) and then it grows to $150,000 before you get around to needing it, that’s $100,000 of growth that you don’t have to pay any taxes on. That’s a sweet deal.
But way too often, I’ll see people with a Roth that they opened years ago at the bank or credit union. They’ve faithfully contributed to it every year. Let’s assume that they contributed that same $5,000/yr that we just referenced earlier. But because it’s sitting in a bank product earning 1%, it hasn’t really grown. So instead of turning $50,000 into a tax-free $150,000, we’ve turned it into a tax-free $57,000.
Not too impressive.
And not the best use of this fantastic vehicle that allows us to grow our money on a tax-free basis. Generally speaking, Roth IRAs should be invested with a long timeline, which is going to mean higher risk, but higher growth potential in the long run.
3) Municipal bonds in an IRA
Municipal bonds often go by a different name. They’re often called “tax-free bonds.” That’s because the interest income is immune from federal taxes.
So why would anyone invest in those stinky old corporate bonds where you have to pay taxes on the interest income? Well, the municipalities issuing bonds know that you’re not being taxed on their interest, so they know that they can get away with paying a lower interest rate.
So if you were comparing a corporate bond (let’s say Coca-Cola) and a municipal bond (let’s say Des Moines, Iowa), you’d have to take the tax-implications into consideration.
Let’s say the Coca-Cola bond pays 4%. If that’s the case, then there’s a good chance that the Des Moines bond pays 3%.
If you’re in a 25% tax bracket, these two bonds are essentially equivalent for you.
The Coke bond pays 4%, but you’re going to lose 25% of that to taxes. So, that’s a net income of 3%.
The Des Moines bond pays 3%, but it’s tax-free. Net income of 3%.
So, it’s a wash.
But the problem is that I sometimes see people with municipal bonds inside of an IRA. That doesn’t make much sense. You’re accepting a lower interest rate in order to get something with a tax-free status, but then you parked the investment in an IRA where all of the interest is tax-deferred anyway. So you just cost yourself an extra 1% return for no reason.
So take a look at your account statements. If you have mutual funds in an after-tax account, money market funds in a Roth IRA, or municipal bonds in a traditional IRA, you should probably ask yourself why. If there’s not a good reason, it’s probably something worth fixing.
The Trump Market: The Danger of Consensus
It’s a rare occasion when nearly everyone in the financial industry agrees about something. Take any question you can think of…
When will the next big bear market be upon us?
How big will the next downturn be?
When will the Fed finally raise interest rates?
Which sectors are currently overvalued and which are still a good buy?
You’ll never get a consensus on any questions like that. But leading up to the election, we had a consensus: If Trump somehow pulls out a victory, the market isn’t going to like it. Stocks will crash, bonds will rally, people will be moving to cash. It will be a classic panic reaction.
Whoops.
Around midnight on election night, when a Trump victory was starting to seem like the most likely scenario, the Dow Jones and S&P futures were a bloodbath. It looked like the night of the Brexit vote, but this time on steroids.
In case you’ve forgotten, the Brexit fallout went something like this. It becomes pretty clear between 9-10pm ET on a Thursday evening that the UK is going to vote to leave the European Union. The markets don’t like the economic uncertainty that this could portend, so all of the futures start tanking. When the market opens on Friday morning, everything is down. Way down.
But then cooler heads start to prevail. People realize it’s not the end of the world. The market starts to rally. By closing time on Friday, it’s as if nothing ever happened. We’re right back where we were at closing time on Thursday afternoon, before they started counting votes in the UK. The only people who got hurt were the people who panicked on Friday morning and sold everything before the recovery. And the people who were buyers on Friday morning (while the rest of the world was panicking), well…they had a good day.
It’s like Warren Buffett says, “Be fearful when others are greedy and greedy when others are fearful.”
So on election night, it seemed like we were setting up for a nearly identical pattern. Futures are down overnight, so the market will be way down at open, then bounce back. Unlikely that this recovery happens in a single day like it did after Brexit, but it shouldn’t be a prolonged downturn.
But then the markets open on Wednesday morning after the election and stocks are….up? And they kept going up. A day later, on Thursday, we hit a new all-time high in the market. So what exactly happened?
A lot of it probably stems from Trump’s victory speech. He talked about focusing on rebuilding our infrastructure—things like highways, bridges, tunnels, and airports. While it’s debatable as to whether or not this is much of a boon to the economy overall, it definitely would help the profits of several major companies. So the market liked that.
At the same time, his speech avoided all of the topics that the market wouldn’t like so much. He didn’t mention starting a trade war with China (which would hurt our auto industry and high-profile technology companies like Apple), and he didn’t mention mass deportation (which would hurt the agricultural industry and service industries that rely on immigrant labor).
If that’s true—if an election night victory speech can cause the market to completely forget about the last 18 months of campaign rhetoric—that shows us just how fickle and unpredictable the market can be.
Which means that my message is the same as it’s always been.
If you’re retired or getting close to retirement, you simply can’t afford to have all of your money exposed to the whims of such a fickle mistress. If your stomach is in knots every time we have an event that creates volatility, that’s a good sign that you probably need to make some adjustments.
At the same time, if you’re not retiring for another couple of decades, you just don’t need to panic every time the market hiccups.
But perhaps the most important lesson from the market’s response to Trump’s victory is this—when the financial world reaches a consensus on something…be wary.