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Long Time Coming

Jonathan Clements

IF MONEY ISSUES had the urgency of a broken air-conditioning system on a 100-degree day, we’d all be in great financial shape.

But all too often, financial troubles are years in the making. We bumble along, vaguely aware that things aren’t quite right. Sure enough, one day, the red lights are flashing and the alarm bells are ringing. But by then, it’s usually way too late to fix the problem—because the fix required taking action years earlier. Consider seven examples:

1. Living precariously. This may not be an issue for HumbleDollar readers, but it’s a big issue for most Americans. All too many families live paycheck to paycheck, with little or no financial safety net. We’re talking about folks such as the 37% of Americans who can’t handle a $400 financial emergency. One result: When the economy shut down earlier this year and unemployment spiked to 14.7%, millions of Americans immediately found themselves in dire financial straits.

I appreciate that those on the lowest incomes find it hugely difficult to save. But for everybody else, I wish there was greater thought given to the tradeoff between spending on baubles today and not spending so we’re better prepared for tomorrow. The baubles will provide only fleeting pleasure, while money in the bank can deliver an enduring sense of financial security.

2. Punting on retirement. Paying for retirement may be our final financial goal, but we should make it a priority from the day we enter the workforce. Why? If we’re aiming to retire at, say, age 65 with today’s equivalent of $1 million and our portfolio earns three percentage points a year more than inflation, we need to save an inflation-adjusted $11,700 every year if we start at age 22. What if we wait until 35 to begin saving? The required annual sum soars some 80% to $21,000.

3. Failing to diversify. Risk isn’t what happens, but rather what could potentially happen. If we own a lopsided portfolio—one that’s heavily skewed toward our employer’s stock, or to health care companies, or that includes only U.S. shares—perhaps all will be fine and we’ll roll along merrily for years with no ill effects.

But maybe our luck won’t hold. What if our employer turns out to be the next Enron, or health care is nationalized, or the U.S. suffers a malaise similar to Japan? This is a reason to own a globally diversified portfolio, preferably one built using total market index funds.

4. Overlooking inflation. Over the past decade, inflation has run at a modest 1.7% a year. That hardly seems worth worrying about and, in any given year, that’s probably the right reaction.

Yet the longer-term consequences could be dire. Suppose we favor cash investments and high-quality bonds. Based on today’s yields, there’s a decent chance our money won’t grow once inflation and taxes are figured in. What if we’re retired with a fixed monthly pension? After 25 years of 1.7% annual inflation, the spending power of that pension would be slashed by 34%—which is why we might also want to own some stocks, so we have a pot of money that has a decent shot at growing faster than inflation.

5. Discounting longevity risk. Many folks are aware that, at age 65, they can reasonably expect to live another two decades or so. What they fail to appreciate is how much variation there is around this median. Roughly speaking, a quarter of retirees won’t make it to age 80—but another quarter will live to their early 90s or beyond.

But where will each of us fall within this range? We won’t find out until we get there, which is why relying on average life expectancies is so dangerous. I hate to sound callous, but dying early in retirement is not a financial risk. In fact, at that juncture, all of our financial problems would be over. Instead, the big financial risk is living far longer than average and potentially exhausting our savings, hence my fondness for delaying Social Security to get a larger monthly check and buying immediate fixed annuities that pay lifetime income.

6. Ignoring long-term care. Among seniors, 44% of men and 58% of women will need long-term care (LTC). But it usually isn’t for that long, with stays at an LTC facility averaging less than a year for men and less than a year and a half for women. Still, a minority of seniors will spend many years in a nursing home—and the cost is potentially astronomical.

To be sure, there’s an element of moral hazard here: If we don’t have a plan for covering LTC costs, we can always fall back on Medicaid. But that will mean first spending down much of our wealth, plus we’re more likely to end up in a low-rated facility.

Don’t like that idea? We might decide we can shoulder the cost on our own, assuming we have a seven-figure portfolio. We might opt to buy LTC insurance, either the traditional or the hybrid variety. Or we could plan to apply for Medicaid, in which case we might want to give away a chunk of our money years before. Whatever the case, we should probably be thinking about how to handle LTC costs in our 50s—more than two decades before we’re likely to need long-term care.

7. Avoiding estate planning. There’s a good chance that death will arrive without much warning—and, to the extent we know our demise is imminent, we probably won’t want to spend any of our remaining days meeting with a lawyer. The upshot: We should get that will and those powers of attorney drawn up today. We should check those beneficiary designations. And, for both our own sake and the sake of our heirs, we should get our financial affairs in order.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Next Year ForetoldDialed In and Ain’t Everything.

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Langston Holland
Langston Holland
9 months ago

So many great points for the goal oriented, and as much as modern culture seems bent on eliminating the stick in favor of a world of hollow carrots, a good spanking like this certainly focuses the mind. 🙂

Your five retirement planning variables are, in stat’s lingo, mutually exclusive and collectively exhaustive. Deal with them properly and you’re set. Nevertheless I find it a hard sell to those that think they’ll live forever and conquer the world in the meantime. What I’ve done with anyone young enough that’ll listen is boil it down to one or two variables.

1. For the somewhat interested: Save 20% of what comes into your hands.
2. For the interested: Save 20% and invest it inside tax sheltered accounts.

Caveats: Specify a payable-on-death beneficiary to the account(s)*. Consider the money lost. Don’t tap into it for anything. Live under a bridge if you have to, just don’t touch it. It doesn’t exist until you retire. This kind of talk raises eyebrows and makes the point regardless of how strictly they may follow it.

My thought is that you should be able to maintain your 80% lifestyle through retirement. That’s how I sell it anyway and it’s a heck of a lot better than a hollow carrot. 🙂

* There’s a custom among some Christian missionaries to buy a cemetery plot in the country they go to as a symbol and reminder of their commitment. That’s where the POD idea came from even though it’s good practice regardless.

Gary's Shrink
Gary's Shrink
9 months ago

” Still, a minority of seniors will spend many years in a nursing home—and the cost is potentially astronomical.”

Personally, the prospect of that is abhorrent to me. My “insurance” plan is to invest heavily (mostly in time and sweat) to maintain my health which will give me the best odds of avoiding that dread scenario. It may sound callous, but I’d rather be dead than “exist” in a long-term nursing home situation where the next stop is more than likely the cemetery anyway.

Langston Holland
Langston Holland
9 months ago
Reply to  Gary's Shrink

I completely agree about existing in a nursing home – but I’m less convinced that I know what I’ll think if that time comes. This of course is anecdotal, but my Dad was diagnosed with liver failure when he was 81 and told me in the hospital that he didn’t want to live if he had to go on dialysis three times a week. He also had a living will that was worded likewise. He had enjoyed a very active lifestyle and had many impressive accomplishments from anyone’s point of view. I was not happy with his apparent decision due to my own selfishness of wanting him around as long as possible, but he meant it.

After a month or so in the hospital he changed his mind and had a great and thankful attitude about the dialysis. I was thrilled, and as always instructed and humbled by him. My new opinion: you just won’t know for sure until you get there.

In reference to Dr. Quinn’s reasonable looking stat, here’s a great list of LTC related stats from Morningstar.

R Quinn
R Quinn
9 months ago
Reply to  Gary's Shrink

Only about 4.5% of seniors are in a nursing home. Most LTC is rendered in the home.

Gary's Shrink
Gary's Shrink
9 months ago
Reply to  R Quinn

That’s a reassuring stat, I guess the odds really are in my favor. 🙂

Steve O
Steve O
8 months ago
Reply to  Gary's Shrink

do you have children

Gozo Rabat
Gozo Rabat
9 months ago

“I wish there was greater thought given to the tradeoff between spending on baubles today and not spending so we’re better prepared for tomorrow. The baubles will provide only pleasure, while money in the bank can deliver an enduring sense of financial security.”

I know you don’t need me to say this to you, Mr. Clements, but with “Pay yourself first,” you don’t even need to worry about that “tradeoff between baubles and tomorrow.”

Pay yourself first. But if you need help controlling excessive, dangerous spending, tear up credit cards and always pay cash. You can’t spend money you don’t have, when it’s not loaned to you via ready credit.

Meanwhile, that “Pay yourself first” balance ought to grow quickly in some bank or brokerage account. Once you have a growing some of money that you don’t want to lose, it becomes easier to focus on other ways to save, and other ways to avoid wasting money you can save.

____________________

Well, I acknowledge this view is simplistic. But if ever millions more Americans learn it, the sad figures of how few of us can take an emergency expense in stride would dramatically shrink away.

No one ever has a paycheck that is just the right amount, where it comes out even at the end of the pay period. Always too-big or too-little, and usually too-little.

But if you pull out 10% first, before you ever see it, and park it in some no-fee brokerage account, you’ll see how easy it really can be, to learn to save money.

Watching your wealth grow make a powerful incentive for saving more of it, and wasting less.

Regards,
(($; -)}™
Gozo

Thomas Taylor
Thomas Taylor
9 months ago
Reply to  Gozo Rabat

Pay yourself first is a simple principle I’ve used for my entire “working” life. The hard part is starting and then sticking with it through thick and thin. I think that’s where most people fail.

Gozo Rabat
Gozo Rabat
9 months ago
Reply to  Thomas Taylor

Mr. Taylor, I’d be curious to know, first of all, how many who start with it do fail at sustaining it and, second, how hard it is for how many people to start.

If I had my way, I’d like this to be part of a high-school civics/economics program. But then, I recognize that my view undervalues how many of America’s school kids would have no ways or means to get started.

Regards,
(($; -)}™
Gozo

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