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He Can Be Taught

Jonathan Clements  |  December 28, 2019

DEAR READER, I may write for you. But I also write for myself. Many of my articles grow out of intriguing ideas I stumble across or half-baked notions I want to explore further. The next thing I know, I’m scouring the internet for additional information and typing furiously on my laptop, all because I’m interested—and I hope you will be, too.

The good news is, after 34 years of writing about finance, I’m still learning things and still tripping across topics I’m curious about. Here are just six of the subjects that sparked my curiosity in 2019:

1. Health savings accounts. In recent years, I’ve had health insurance with a high deductible. But the insurance I’ve bought has never met the government’s official definition of a high-deductible plan, so I haven’t been able to fund an accompanying health savings account, or HSA. Result: I’ve largely ignored the merits of these accounts—a significant oversight on my part.

But over the past year, a number of HumbleDollar’s writers have mentioned HSAs, and it’s dawned on me what a bonanza they can be. You get a tax deduction for your contributions, which can be as much as $3,550 in 2020 if the health plan only covers you, and even more for households and those age 55 and older. All withdrawals for medical expenses are tax-free.

A smart strategy: Leave the account to grow tax-free and then use it to cover medical expenses in retirement. You can even save receipts for medical expenses that weren’t reimbursed by the insurance company and then use those old receipts to make tax-free withdrawals years later.

2. Health insurance. Just as I ignored HSAs, I didn’t bother much with the details of health insurance until I read an eye-opening article from one of HumbleDollar’s contributors, Rick Connor.

Rick’s suggestion: When looking at health insurance, calculate what your minimum and maximum payments will be over the next year. The minimum is the total annual premium. The maximum is that annual premium plus the out-of-pocket maximum. It’s an easy calculation—and it allows you immediately to grasp the best- and worst-case scenarios.

3. Paying down debt. I’ve long favored paying down debt over buying bonds. But it was only this year that I pondered a host of different scenarios, trying to figure out when it might make sense to buy bonds instead.

The answer: almost never. That’s true even if you’re considering mortgage debt, which typically carries a low interest rate and is potentially tax-deductible. Thanks to the higher standard deduction introduced by 2017’s tax law—and thus the limited gain, if any, that comes from itemizing—you’re almost always better off paying down your mortgage, even if the alternative is to buy bonds in a Roth account, with its tax-free growth.

4. Roth conversions. The 2017 tax law elongated federal income-tax brackets, so you can have a heap of income taxed at 10%, 12%, 22% and 24% before you leap to the 32% tax bracket. As HumbleDollar contributor John Yeigh noted in an article earlier this year, this opens up the chance to convert large sums from a traditional IRA to a Roth and still have the money taxed at 24% or less. It was an opportunity I hadn’t spotted, but I now hope to exploit.

For instance, in 2019, it takes some $346,000 in total income before a couple ends up in the 32% tax bracket, while for a single individual it’s $173,000. This assumes you take the standard deduction. Bear in mind that this opportunity could be time limited: Federal income-tax rates are currently scheduled to increase in 2026.

5. Saving ourselves. As with paying down debt, I’ve long stressed the importance of saving. But I finally ran the numbers—and even I was astonished by how much of our ultimate retirement nest egg will likely consist of the raw dollars we sock away. The reality: Perhaps half or more of the money we amass by age 65 will be represented by the actual dollars we set aside for retirement.

6. Stock market valuations. For not just years, but decades, I’ve written about the U.S. stock market’s rich valuations, including lofty price-earnings ratios and miserably low dividend yields. But what if the problem isn’t the price of stocks, but rather the yardsticks we use to measure them? In November, I explored whether fundamental changes in the way companies operate, including the use of stock buybacks and the emphasis on research and development instead of capital improvements, could partly explain today’s apparently nosebleed valuations.

When the article appeared, I expected a flurry of complaints from stock market bears, dismissing me as an apologist for overpriced stocks. But I heard barely a peep. The implication: Either there’s broad agreement that today’s valuation metrics are sending the wrong signal—or the market’s bears have been beaten into submission.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Just Do It and Eyes Forward. Jonathan’s latest books: From Here to Financial Happiness and How to Think About Money.

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Boss Hogg
Boss Hogg
1 year ago

Thanks for these pointers to other articles. Good point about writing, or explaining things to others, to understand something.

Dan Wicko
Dan Wicko
1 year ago

Thanks Jonathon!! I used Rick Connor’s healthcare cost method while signing up for Medicare this year and found it very helpful.

Steve Skillman
Steve Skillman
1 year ago

I’m certainly on-board with the idea of the Roth conversions while in the current environment (for me) of 22% and 24% tax brackets. I always try to remember the federal and state governments are co-owners of my traditional IRA and 401(k). But as long as they’re in my name, I get to pay all the management fees for them. I say convert now while you can – it looks like the federal rate for me will be at least 25% a few years from now. IRMAA complicates things, but it’s still a good deal. I like Schwab’s little calculator: https://www.schwab.com/ira/understand-iras/ira-calculators/roth-ira-conversion Whatever the result of the calculation, I subtract what I will be paying for IRMAA, which can calculated separately. And beware the cliffs!

medhat
medhat
1 year ago

While I am similarly perplexed by stock valuations and their relevance/irrelevance in today’s times, that hasn’t changed the fact that the market, at large, is pushing ahead regardless. So for that reason I figure “better to be in than out” and simply put the issue on the back shelf. It’s not that I don’t maintain an intellectual curiosity, it’s more some simple mathematics combined with pragmatism. For example, with gains in the S&P nearing 30% for the year, and the Nasdaq even higher than that, a market slump of similar measure puts me basically back at 2018 levels, which I find more than tolerable. The alternatives, diversifying into relatively undervalued sectors (emerging markets, anything non-US, etc…) would have brought me markedly less performance, yet still a downside risk. Thankfully I’m not in bonds! I’m an ultra-long timeline investor, and can stomach significant market instability, and with that being the case, why not ride the persistently hot hand? The “reversion back to the mean” argument waiting for a “correction” to historical P/E ratios seems a pessimist’s perspective of the oft-used saying that “past performance is no guarantee of future results”. Future performance may indeed be different! In the meantime, I’ll continue to ride the wave of equities until the broad market tells me otherwise;

Steve Booth
Steve Booth
1 year ago

I used HSAs every chance I got. However, I used them to pay my medical bills. That way I got the immediate tax benefit. You can also use them to pay your monthly premiums once you retire.

Roboticus Aquarius
Roboticus Aquarius
1 year ago

We use HSAs fully, contributing as much as possible, but also use them up fully each year. It would have been great to have HSAs back before we had significant health care costs. Still, that’s a nice 24% or so of marginal tax rates we don’t have to pay on the full contribution each year.

We also use Rick’s shortcut to gauging total healthcare spending risk. I’m ok with self-insuring at some level, but it feels like the conditions change a bit each year such that one really needs to stay on top of the maximum payout. We had several years in a row of paying the max, which at the time was a little over $15K. It makes the savings targets harder to reach when so much is going to healthcare.

After 25 years, our savings is comprised of about 40% contributions (25% own contributions, 15% employer matching contributions) and 60% returns.

There are many reasons for ratios to be higher than historical average. 3 biggies:
– Changes in revenue and expense recognition standards
– Very low interest rates (though, of course, there have been such periods in the past)

– IP is a much bigger part of the valuation pie than it used to be, I believe. Industrial production requires a lot of plant and equipment and I suspect it’s the primary or secondary driver of historical ratios (labor as well), but many businesses today seem to be built on software, programmers, and the IT equipment they require.

If rates increase 1.5% or so, stock prices will drop… but I don’t think the ratios will return to historical averages (i.e. about 14.5, I believe, for P/E) because of the other two factors above.

Jonathan Clements
Jonathan Clements
1 year ago

Thanks, as always, for your cogent comments!

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