With Jonathan Clements, Founder and Editor of Humble Dollar and prolific author
This week, Steve spoke with Jonathan Clements, the founder and editor of Humble Dollar, as well as author of a fistful of personal finance books. Jonathan helped to answer some of the most pertinent financial questions you may be asking yourself.
How To Handle Life Insurance
Both stockbrokers and life insurance agents work off of commissions. They have a vested interest (financially) to get you to not only buy the products with the highest commissions, but also to get you to act frequently to generate even more commissions. It’s your responsibility to figure out how to get the best deal.
Term life insurance is probably the best bet for most investors because there’s a low annual premium. However, the majority – about 60% – of life insurance policies are whole life, cash value policies. The commissions on these is ridiculously high. If you already have a cash value policy, should you hang on to it or not? The answer is difficult because it’s an emotional one. You’ve been paying premiums for years, so you may be emotionally, as well as financially, invested in the policy. But if you bought the policy seven years ago, the cash value of it is probably only 80% of what you’ve paid in.
Moving on to social security, is it wise to take it out early, assuming you’ll be able to make double digit gains by investing the money? If you can invest in the stock market and make some good plays, this might be an option. However, the stock market is fickle. That’s one of the issues to keep in mind.
The other issue is the fact that when you compare investment in the stock market to social security, you’re really comparing apples to oranges. Social security is more like a bond, guaranteed by the government, meaning you get the same amount every year. In contrast, investing in the stock market isn’t so predictable.
Steve raised an important issue: are you actually going to use all of the money you’d take out, investing it back into the stock market? If you’re mentally and emotionally strong enough to handle it, to put up with the volatility and uncertainty, then it might be a good idea. Otherwise, probably not.
Investing In A Home
Investing in the purchase of a home is another thing to consider. Yes, you’re putting up a lot of money for a home. But when it comes time for you to retire and move to a retirement community, you’ll have the option of selling it. So, is investing in a home a good way to spend your money, or not? The answer is: both.
Houses eat money; anyone who’s ever owned a home can tell you that. Because you own it, you’re responsible for repairs and maintenance. This is on top of the upfront cost of the home, plus the interest you’ll be paying on the mortgage.
On the other hand, homes can be a great long-term investment. The main advantage of home buying is the fact that you are building up equity, as opposed to renting where you never have anything to show for all those monthly payments you make. Then, when you retire, you have the option of trading down to a much less expensive place.
Be A Wise Investor
With investing in the stock market, one question that comes to mind is: are investors as stupid as Wall Street is now claiming, or just greedy? The truth is that investors may be a little foolish, but in the end, they’re protected by market efficiency. The markets tend to be highly efficient, meaning that stocks and bonds are – most of the time – priced pretty close to their actual value. So, even if you don’t know anything about the assets you’re buying, you’re most likely getting a pretty fair price.
There are statistics which suggest that the average investor – after making incorrect or unwise investments – ends up trading too much. They believe that they are going to beat the market, that the rate of return is somehow going to be better than what the market is averaging. In fact, that’s rarely the case.
Ignorant investors run two primary risks. First, if they trade too much, they’ll incur high investment costs. Second, if they don’t diversify their portfolios, they run the chance of blowing up their portfolio entirely if the assets they invest in don’t do as well as they believed they would. The biggest dangers that unwise investors really face are high costs and excessive risk taking. If you can avoid those two mistakes, the odds are that your investment portfolio will fare better in the long run.
To get more financial tips from Jonathan, check out his website, humbledollar.com.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: Jonathan Clements is the founder and editor of Humble Dollar. He’s also the author of a fistful of personal finance books, including From Here to Financial Happiness and How to Think About Money. Now, Jonathan also spent almost 20 years at The Wall Street Journal where he was the newspaper’s personal finance columnist. I always enjoy talking with him and sharing our knowledge and experiences together and here he is with me on the line. Jonathan, welcome once again.
Jonathan Clements: Steve, thanks so much for having me on.
Steve Pomeranz: My pleasure. I was reading through your articles trying to figure out what to talk about this time. I saw some little throwaway that you put out there on Labor Day and it was the great, what you call, the 11 great unanswered financial questions. I thought we’d have some fun with that in a nerdy kind of way. This is questions about finance, kind of nerdy, but I don’t know that we’ll have the answers to these, but I thought we would give it a shot. What do you think?
Jonathan Clements: Let’s go for it.
Steve Pomeranz: Okay, good. All right, here we go. Number one, who does more financial damage, stockbrokers or life insurance agents? Oh my God, what a question.
Jonathan Clements: Of course, what we’re getting at here is both stockbrokers and life insurance agents, the thing they have in common is they both work on commission.
Steve Pomeranz: That’s exactly what I wrote in my notes. That’s it, okay.
Jonathan Clements: They have an incentive not only to sell you the investment products that have the highest commissions, but also they have an incentive to get you to act frequently so that you generate even more commissions.
Steve Pomeranz: All right, let’s be fair and say that there are, I’m sure, many people who have these conditions of earning commissions who do the right thing as much as they can. I think what we’re trying to say here is that there is human nature, being what it is, some possibility of abuse and part of the problem is the investor or the client doesn’t always know what they’re paying.
Jonathan Clements: Let’s just give an example of how this financial incentive tilts the odds. If you look at the statistics on life insurance and you talk to most unbiased financial observers, they’ll say that for the vast majority of Americans, the best bet is term life insurance, which is you have a low annual premium. You have it for the time it takes to raise the kids and get them through college and then you drop the policy. As it turns out, 60% of the life insurance policies that are sold every year are cash value life insurance. Why do you think that is, Steve?
Steve Pomeranz: Because the commissions for those policies are really horrendously high.
Jonathan Clements: Faced with the possibility of a high commission, guess what life insurance agents sell?
Steve Pomeranz: Yeah. Yeah.
Jonathan Clements: Cash value life insurance.
Steve Pomeranz: Cash value life insurance, which brings me to another question. Question number four, should you dump that wretched cash value life insurance policy you were persuaded to buy seven years ago or hang on and hope you’ll die young so you turn a profit?
Jonathan Clements: This is a tough one because, more than anything else, it’s an emotional question. If you’ve been paying those huge premiums for cash value life insurance for seven years, you have what economists call a sunk cost. You really don’t want to walk away from all those premiums that you’ve paid even though after that seven years of premium payments, the amount of cash value that you’ve accumulated is probably not a huge amount.
Steve Pomeranz: I don’t think you’d necessarily get, even with your premiums that you’ve put in, I think it normally takes about 10 years before you’ve made up the commissions. Of course, there is the cost of insurance in there too, but until the premiums that you’ve put in… The cash value equals the premiums that you’ve put in, 10 years.
Jonathan Clements: Maybe I should have changed the question to 10 years rather than seven. Would that have made it easier on you, Steve?
Steve Pomeranz: No,, seven is right. No, no, no. I think seven is [inaudible 00:04:28] you get the seven year itch. I’ve been paying this thing for seven years. The cash value is only 80% of the amount that I’ve actually put in, if it’s that much, and should I dump this thing? It is cynical to say, “Do I have to die young in order to make a return on this investment?” I’m not going to let you off the hook too much. That was a little cynical, Jonathan.
Jonathan Clements: Really? Just a little?
Steve Pomeranz: All right. All right. All right. Okay, so let’s go to the next question here, is taking social security early and then assuming you’ll make double digit gains by investing the money a brilliant strategy or utterly delusional? Go, what do you think?
Jonathan Clements: There are two parts to this, right? One is whether you can indeed earn double digit gains and history tells us that you can do that by investing in the stock market, at least that’s been the case in the past. Whether it’s going to be true in the future, we don’t know but that isn’t a crazy assumption. We then have this issue that when you compare investing in the stock market to social security, you’re really comparing apples to oranges because social security is more like a bond. It’s Government guaranteed, you get the same amount every year. In fact, it increases along with inflation. It’s a very reliable, predictable stream of income. Investing in the stock market, strange to relate, it’s not quite so predictable.
Steve Pomeranz: Is that true? I never heard that before.
Jonathan Clements: Really?
Steve Pomeranz: Yeah, yeah.
Jonathan Clements: Yeah, no. It’s a rumor out there.
Steve Pomeranz: Yeah, yeah, yeah.
Jonathan Clements: These things go up and down.
Steve Pomeranz: Here’s another thing too. When you’re at the age to take social security, are you really going to take all that money, 100% of that money and throw it into stocks, number one? Number two, do you have the kind of emotional behavioral makeup to put up with the uncertainty and the volatility and to actually do the right thing when things are at their greatest point of stress?
Jonathan Clements: The answer to that is there is 0.1% of the population that maybe able to do that. For the other 99.9, unless they’re one of your clients, Steve, I don’t think they’re going to be able to do it.
Steve Pomeranz: I think the idea about the… There are reasons to take social security early but taking the money and investing it in the stock market looking for double digit returns, I don’t think is one of them.
Jonathan Clements: I would agree.
Steve Pomeranz: Okay. All right. Number three is, or four or five, whatever we’re at, is a home the best investment you’ll ever make or a money sucking pile of bricks?
Jonathan Clements: I would answer it is both. Anybody who’s ever owned a home knows that houses eat money, they have a voracious appetite. It is indeed a hole in the ground into which you pour your excess cash. On the other hand, homes can be a great long run investment, but not for the reason that people think. It’s not that you’re going to make a whole lot of money from the price appreciation. The value in owning a home is the fact that you get to live there and you get to enjoy the house’s, what’s called, imputed rent. The fact that you get to live there without having to send a check off to the landlord every month, that is the value in owning a home. It’s not the price appreciation.
Steve Pomeranz: All right, let me add my two cents. When you talk about the cost of maintaining your home, that’s coming out of current income mostly. The house itself, as you’re paying this rent or this mortgage, you’re slowly paying down the principal. In a sense, your income is handling the maintenance, but your principal is building up over time. Then, you’ve got this nest egg that has been created because of all the savings, the appreciation of the home, which is not that great, but, nevertheless, maybe inflation, you’re appreciating by the rate of inflation, but you’ve paid down the mortgage. In a sense, it’s that forced savings idea. Again, the maintenance is coming out of current income. A lot of people… Matter of fact, I just interviewed somebody who is 95 years old. He said he sold his house, and it was the sale of that house that allowed him to move into an assisted living facility.
Jonathan Clements: Here in the New York area, which is where I live, we have one word to describe our retirement strategy and that strategy is called Florida. You spend your entire working career struggling to buy a New York area piece of real estate. When you finally pay off that mortgage, what you do is you trade down to some much less expensive place in Florida, free up a bunch of capital and live off it for the rest of your life.
Steve Pomeranz: Okay. That’s arbitrage, that’s what the term means. You’re arbitraging cost of living, right?
Jonathan Clements: I think Florida is a much better term for it.
Steve Pomeranz: Okay, all right. All right, so let’s move on here. Are index funds… No, let’s not do that one here. Hold on a second. Are everyday investors as stupid as Wall Street claims or are folks on Wall Street just rude and cravenly self-serving?
Jonathan Clements: I would argue that investors maybe foolish, they maybe, but they actually are protected by something called market efficiency. We know that the markets are highly efficient, meaning that stocks and bonds most of the time are priced at about the level they should be. That means that even if you don’t know anything and you go out and you buy a stock mutual fund or you buy a bond mutual fund, you’re probably getting a fair price. There is indeed a serious chance that many investors are foolish, but it doesn’t mean they end up acting foolishly.
Steve Pomeranz: Okay, that’s quite interesting. There are those statistics which show that the average investor, because they invest incorrectly, they trade too much, they invest in things that they believe are going to somehow beat the market, that the rate of return that they earn is significantly less than the what the markets offer if you just kind of leave it alone. Do you think that fits into this question?
Jonathan Clements: No, absolutely. Even if investors do not buy investments that are overpriced on a regular basis, even if we say that’s the case and I believe that is indeed true, ignorant investors run two risks. One, they trade too much, which means they incur excessive investment costs. Two, they don’t diversify, which means they make big bets on just a couple of different stocks or on just a few bonds. Because of that, they run the risk of blowing themselves up if any of those stocks or bonds turn out to be bad investments. It’s the costs and the excess risk taking that’s the problem. It’s not that they are buying these investments at the wrong price.
Steve Pomeranz: Yeah, we are out of time Jonathan. My guest Jonathan Clements, founder and editor of Humble Dollar, people get to your website how Jonathan?
Jonathan Clements: There’s this thing called the internet, Steve, and you put in …
Steve Pomeranz: Yeah, well.
Jonathan Clements: You put in humbledollar.com and then you hit the return button and you should end up there.
Steve Pomeranz: I’m going to make a 12th question, is Jonathan Clements a wise guy or what? Okay, that’s the next question, but you don’t have to answer that because we’re out of time. I do want to say, what is it, humbledollar.com and you’ve got a lot of personal finance books, they’re all great, all this experience at The Wall Street Journal, which is where I read you for many, many years. Thank you for coming on once again and sharing this time with me.
Jonathan Clements: It was a lot of fun, Steve, thanks for having me.
Steve Pomeranz: My pleasure. To hear this and any interview again, if you have a question about what we’ve just discussed, don’t forget to go to our website. That’s that thing on the internet that Jonathan was talking about, stevepomeranz.com, P-O-M-E-R-A-N-Z. Skip the T, go right to the Z. You can also sign up for our weekly update where we’ll have everything that we’re doing on the show sent to you at a nice, sweet little package once a week of pictures and audio and transcripts. If you’d like to read it, that’s stevepomeranz.com.