Thinking Different

Jonathan Clements

FOR MORE THAN THREE decades, I have written and thought about money—and I like to believe I’ve been fairly consistent in my financial philosophy. Today, I still live by the same principles I championed starting in 1994, when I became The Wall Street Journal’s personal-finance columnist. I remain almost entirely invested in index funds, my portfolio is heavily tilted toward stocks, I’m a big believer in global diversification and I continue to argue that great savings habits are the key to financial success.

Yet, today, certain ideas loom much larger in my thinking, in part because of upheaval in the financial markets and changes in the economy. In particular, here are nine financial notions that strike me as especially important for today’s investor:

1. Demographics Are Destiny

Over the past 50 years, the U.S. economy has grown roughly three percentage points a year faster than inflation, with half that growth coming from an expanding workforce and half from rising productivity. But with the workforce projected to grow at just 0.5% a year, well below the 1.5% historical average, economic growth is likely to be slower—and that’ll also mean more modest corporate earnings growth. Result: Stocks probably won’t match their strong historical performance, though they will likely still outpace the returns from bonds and cash investments.

2. Start With Everything

When thinking about my portfolio, I used to begin with U.S. stocks and then consider which investments I should add to diversify that core holding. Today, my thinking begins with the so-called global market portfolio—the investable universe of stocks, bonds and other investments owned collectively by all investors—and then I decide what I want to subtract. I end up in roughly the same place, though this second approach has made me even more willing to invest abroad.

3. Ponder Your Paycheck

For most folks in the workforce, their most valuable asset is their so-called human capital—their income-earning ability. I have come to believe that we should design our financial lives around that paycheck, or the lack thereof.

For instance, those who are employed may need disability and life insurance, in case they can’t provide for themselves or their family. But they also have the freedom to invest heavily in stocks, because they don’t need income from their portfolio. By contrast, those who are retired don’t need to protect their human capital with disability and life insurance, but they probably ought to hold more bonds now that they no longer have a paycheck.

4. Stay Grounded

In late 2008 and early 2009, many investors inflicted huge financial damage on themselves, by bailing out of stocks at deeply depressed prices. How can we avoid that mistake in future? We need a sense of the stock market’s value that’s distinct from current prices.

To that end, consider this approach: Imagine a line climbing steadily at 6% every year. That’s my forecast for long-run U.S. stock returns, based on current dividend yields and likely growth in corporate earnings per share.

In the short run, however, stock performance will be all over the map. If returns are above the 6%-a-year growth path, we should smile at our good fortune, but realize we’ll likely pay a price later, in the form of lower returns. When performance is below 6% a year, we may not smile as much, but we should take comfort in the notion that—at some point—stock performance will likely play catch-up.

5. Consider the Consequences

We should think less about the odds of some risk becoming reality and more about the consequences. For instance, it’s highly improbable that U.S. stocks will suffer the same fate as Japanese shares, which today languish at less than half their year-end 1989 price. But if the improbable came to pass, it would be devastating for anyone invested exclusively in U.S. shares—which is why we should probably keep 30% or more of our stock portfolios invested abroad.

6. Fix Your Future

Over the past three decades, we’ve seen a collapse in the U.S. savings rate. I think many Americans would like to save more, but simply can’t—because they have boxed themselves in with high fixed living costs. At issue here are items like mortgage or rent, car payments, phone plans, student loan payments, cable bills and more.

My advice: We should aim to keep fixed living costs to 50% or less of our pretax income. That way, we’ll suffer less financial stress, have a greater ability to save and have more money for discretionary “fun” spending. An added bonus: These low fixed costs will give us extra financial breathing room should we lose our job or we’re retired and our portfolio takes a battering from rough financial markets.

7. Don’t Ever Retire

As the developed world’s population ages, the typical retirement age needs to rise, or we won’t have enough folks producing the goods and services that society needs. This should not be a cause for despair. I’d like to see the distinction between work and retirement disappear, not just for the good of the economy—but for the good of our collective happiness.

The fact is, many folks get a lot of satisfaction from work. I have come to believe that retirement should be seen as a chance to take on new challenges—both paid and unpaid—rather than deliberately avoiding them.

8. Dying Isn’t the Problem

Americans are an optimistic people—except, it seems, when it comes to their own life expectancy. For proof, look not only at the pitifully low sales of immediate fixed annuities that pay lifetime income, but also at the many retirees who claim Social Security at age 62, the earliest possible age. Both strategies make sense if you think you’ll die relatively young.

Yet, for retirees, their biggest financial concern shouldn’t be dying early in retirement. Rather, the big risk is living longer than they ever imagined—and running out of money before they run out of breath. If that’s the big risk, we should delay Social Security until age 66 and perhaps age 70, and also consider using part of our bond-market money to buy lifetime income annuities.

9. Aim for Enough

The goal of managing money isn’t to outperform our neighbors, prove how clever we are or become the richest family in town. Rather, the goal is to have enough money to lead the life we want.

If that’s the overriding objective, it becomes far clearer how we should manage our money. We want to avoid unnecessary risks and pursue strategies that have a high likelihood of success. That means buying insurance against major financial risks, diversifying our portfolios as broadly as possible, and eschewing efforts to beat the market and instead buying low-cost index funds that simply replicate the performance of the market averages.

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