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Long Time Coming

Jonathan Clements  |  December 12, 2020

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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