Third Rail

Jonathan Clements

IF I’M EVER FEELING lonely, all I need to do is write about certain financial topics—and soon enough my inbox is brimming with emails, some vehemently disagreeing, others offering vigorous nods of assent.

A dozen of those topics are covered in HumbleDollar’s new chapter devoted to great debates—issues like whether money buys happiness, when to claim Social Security and whether individual bonds are superior to bond mutual funds. But those subjects aren’t the only ones that stir up readers. Here are four other contentions that are almost guaranteed to trigger pointed comments:

1. Budgeting is for the irresponsible. To be sure, some folks budget because it gives them a greater sense of control over their finances. But I’d argue that, if you’re saving a decent chunk of your income toward retirement and other goals, it doesn’t much matter much how you spend the rest of your paycheck—and there’s no need to budget.

Instead, the people who need to budget are those who aren’t saving enough, and who need to figure out where their money goes and become much more deliberate about their spending. For these folks, budgeting—especially if they make a point of writing down every dollar they spend—can unleash a newfound frugality.

But most of the time, I suspect budgeting is like dieting: Most folks who try it don’t get the results they desire, because—without a total commitment to change—it simply feels too much like deprivation.

2. Children aren’t cheap. Many people believe children are priceless. I can assure that this is not the case—and I have decades of bills to prove it. This has not deterred me from having two children or taking partial responsibility for two stepchildren.

I’m not saying that choosing to have children should be a financial decision. But I do think parents need to have their eyes wide open. Raising children is costly, making it harder to achieve other financial goals, such as early retirement.

That cost potentially includes paying $100,000, and perhaps far more, for college. I don’t think parents are duty-bound to cover their kids’ higher education expenses. But I do believe they have an obligation to guide their children’s college choices—and to dissuade their kids from attending a college that involves student loans they’ll be hard-pressed to repay.

3. An emergency fund is an unemployment fund. Financial emergencies may not be foreseeable, but most of them should be manageable if we have a modest amount of savings. The big exception: getting laid off.

One rule of thumb suggests keeping emergency money equal to six months of living expenses. I’ve always presumed it’s stated that way because the big financial risk is being out of work for that long. If you were, the cost could run into the tens of thousands of dollars.

What about other financial emergencies, such as a hefty car repair bill, a broken furnace or major medical expenses? The cost should be under $10,000. Take major medical expenses. Many policies have an annual out-of-pocket maximum, such as 2019’s $7,900 for an individually purchased policy. I’m not saying $7,900 wouldn’t sting. But you could run through far more money if you lost your job.

One implication: If you’re retired, you don’t need to hold nearly so much emergency money—and perhaps none at all. As part of your retirement income strategy, you might keep five years of portfolio withdrawals in cash investments and short-term bonds. What if you got hit with a surprise expense? You could always dip into your five-year stash, and then replenish from longer-term investments whenever the market allows.

4. Paying down a mortgage is a solid investment. I’ve been arguing this one for years—but it’s become a whole lot easier to make the case. The 2017 tax law roughly doubled the size of the standard deduction, while capping the itemized deduction for state, local and property taxes at $10,000. Result: Many folks now get little or no tax benefit from their mortgage interest, especially if they file as married filing jointly or head of household.

Let’s say you have a mortgage charging 4%. If you aren’t getting a tax deduction for the mortgage interest, it’s costing you the full 4%. You should earn more than that over the long haul by buying stocks.

What if your inclination is to purchase bonds? You might come out ahead if you buy bonds in a 401(k) where you’re getting a matching employer contribution. Even if you aren’t getting the match, you might do better if you buy bonds yielding more than 4% in a tax-deductible or Roth retirement account. But the odds are, you’ll also be taking far more risk. How so? The return from paying down a mortgage is guaranteed—but, in today’s world, a bond yielding more than 4% will involve some risk of default.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Get HappyDeveloping StoryWhere It Goes and Down the Drain. Jonathan’s latest books: From Here to Financial Happiness and How to Think About Money.

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Walter Abbott
Walter Abbott
3 years ago

I’ll put in my $0.02 early to get things going.

Budgeting is history. It gives the user a record of where, when and for what your money went. And history is a great tool for forecasting.

For many years prior to our retirement, we didn’t strictly budget. We’ve always had a practical feel for what was coming in and going out, but never wrote it down, and didn’t overspend. We funded our IRA’s and 401K’s and extra besides. The regular paychecks coming in filled in the cracks.

When we started seriously contemplating retirement, the thought of no more paychecks was kind of scary. The unknown, and all that. Once we had a couple of years accurate history, the unknown became known.

It has been a great comfort.

Phil M
Phil M
3 years ago

Great points, and as for paying down your mortgage, there’s another factor to consider besides risk. Paying off an extra $100 on your mortgage saves you 4% guaranteed. Investing in stocks might make you more than that, but you have to pay taxes on the profit – as much as 15 or 20% even if you wait one year. That means you have to make 5% just to match what you are guaranteed by paying down your mortgage.

Peter Blanchette
Peter Blanchette
3 years ago

As some people would say it is me, but your rationales for #3 and #4 confuse me! On the one hand in #3 you are advising(if in retirement) to keep 5 years of money in cash like investments(probably earning 1-2% if you’re lucky). Most people(admittedly only 80 to 90% of us) have the majority of their retirement savings in tax deferred vehicles. Whether I have to take money out for an unexpected expense from a bond fund, money market or equity fund it is all going to be taxed because it is coming out of a TaxDef vehicle. What am I gaining by having it coming out of low earning funds? Any decision on the cash to bond to equity allocation is an independent choice for other reasons. Putting money in “Buckets”(read Michael Kitces) for current spending is a laudable way to help people look past market downturns as a psychological tool. As to #4, when combined with #3 you are saying I should put 5 years of income in the lowest earning vehicles in #3 and then with #4 you are telling people who may have limited retirement savings that they should pull money out of retirement savings to pay down their mortgage. Your estimate of a 4% mortgage is a pretty good representation of what most people probably face nowadays. For me and I suspect most of us the $10,000 limit(I’m a NYer too) does not restrict our ability to take full advantage of charitable, mortgage etc deductions especially for old guys and gals who are the ones we are talking about. For many with limited retirement savings paying down the remaining portion of a mortgage is not always a good strategy if you still can get a partial break via itemized deductions. For families in the upper income levels I readily agree with you. Also, how about getting a reverse mortgage to pay off your mortgage if that is something that floats your boat. You don’t have to pay it back unless you sell the property or just leave this veil of tears. They recently changed the rules but it used to be that you could sell your house with a RM and then buy a new house with a new mortgage that also has a RM(saving on the additional sales commission). It is funny how only about 3% of eligible 62&over homeowners take advantage of one the last time I checked. Two years ago the fixed rate on the RM loan balance and available funds was about 5%. Which is not chopped liver. I need a drink.

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