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Tiresome Debates

Jonathan Clements

WHEN I WORKED at The Wall Street Journal, editors used to quip that, “There are no new stories, just new reporters.” I don’t know whether that’s the case with politics, sports and technology articles, but it sure rings true for personal finance and investing stories. All too often, the latest hot topic just seems like a rehash of something I’ve witnessed—and often written about—before.

That brings me to three financial arguments that never seem to end. Others still get worked up over these debates. But I find they grow ever more tiresome:

1. Should you use the 4% withdrawal rate? This question gets revisited constantly. But guess what? I’ve yet to meet any folks who actually use the 4% rule or any similar strategy, where they withdraw a designated percentage of their portfolio in the first year of retirement and thereafter robotically increase the sum withdrawn each year with inflation.

I’m not saying the 4% rule isn’t useful. Before Bill Bengen published his seminal study in 1994, many folks had crazy ideas about how much they could safely withdraw each year from their retirement savings. We’re talking 6%, 8% and even 10%. Now, expectations are much more reasonable.

But before we once again start arguing over whether 4% is the precise right number, let’s drag our gaze away from our spreadsheets, look at the real world and ask a simple question: How many retirees will robotically increase their 2023 retirement withdrawals by 2022’s inflation rate—which might be 8% or 9%—after suffering double-digit investment losses this year? You could probably shake hands with all of them at the same time.

2. Should you take Social Security early and invest the money? Yes, if you’re a 100% stock investor, claiming Social Security at age 62 and then investing the money should be a winning strategy. I say “should” because there is risk involved. You’re giving up an almost sure thing—higher benefits down the road—for the hope that stocks will fare well. The odds, however, suggest that’ll be a winning bet.

Still, my head explodes whenever I see this debate rehashed for this simple reason: How many retirees do you know who have 100% stock portfolios, without a single dollar in bonds and cash investments? Again, I suspect you could shake hands with all of them at the same time. The fact is, if you have any money in bonds and cash investments, and you have no reason to think you’ll die before your late 70s, a quick breakeven calculation says you’d be better off spending down those conservative investments before you claimed Social Security. End of story.

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In other words, like the debate over whether 4% is the precise right number, the debate over whether to take Social Security early and invest in stocks is an absurd waste of time—because it’s totally divorced from how real people behave. My hunch: The only reason this stupid debate lives on is because it makes retirees who claim benefits early feel better about their decision. But these folks aren’t claiming early so they can invest 100% in stocks. Instead, they’re grabbing their benefit early either because they need the money or because they just hate the idea of delaying Social Security and then dying early in retirement.

3. Should you use your spare cash to invest or pay down debt? This debate is similar to the debate over whether to claim Social Security early and invest the money in stocks, but it’s more nuanced.

How so? Forget all the rhetorical huffing and puffing. If you think through the expected return and tax implications of different strategies, you can quickly come up with an investment hierarchy. For instance, if you’re eligible for a 401(k) plan with an employer match, that should probably be the top priority for your spare cash. Next up should be paying down high-interest debt, notably credit card debt. After that, you might fund tax-deductible or Roth retirement accounts, or use your spare cash to buy stocks in a regular taxable account. Those will likely be a better choice than devoting money to repaying student loans or mortgage debt.

But what if the alternative is to buy bonds or cash investments in a regular taxable account? In that case, you should probably pay down debt. The reason: The interest you’ll avoid by ridding yourself of debt will likely be higher than the interest you’ll earn by purchasing those bonds and cash investments.

Yes, paying down debt could leave you with less access to cash. But between emergency savings, credit cards, a home equity line of credit and the ability to withdraw your original Roth IRA contributions tax-free at any time, it should be possible to cover any surprise short-term expenses.

That raises the obvious question: If what I say is true, why do many folks resist paying down debt? Some may have mortgages or other debt with interest rates that are less than the yield they can earn on bonds, so buying bonds would be the rational choice.

But others aren’t so rational. Some folks cling to mortgage debt that’s costing them dearly, even after factoring in any tax savings. Other people argue that it’s somehow virtuous to always carry at least a little debt. Oftentimes, it seems these folks are puppets of financial advisors who nudge their clients to continue carrying debt. Why? That leaves more money in the clients’ portfolio—thereby ensuring the advisor earns fatter fees.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.

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TechnoPeasantx
TechnoPeasantx
2 months ago

Another consideration is the cost of health insurance. If you live in one of the 38 states with expanded Medicaid and taking SS before 65 forces you onto the ACA exchange then the premiums + potentially taxable SS means it usually pays to wait until at least 65. This assumes one can keep their income low enough to qualify.

J Naman
J Naman
2 months ago

The SS decision does NOT require complicated math. There are only three main issues: 1) Life expectancy is near 80 years old. 50% die before, 50% after 80. Think about your health and family history. Hold that thought. 2) For those who die at exactly age 80, the total SS payout adds up to exactly the same whether you take SS at 62, 65, or 72. That is the “breakeven” point. If you die before 80, the total payout for age 62 signup is MORE than waiting. If you die after 80, the total payout is MORE for those who waited, but the 62’s still get SS, just less than the max possible. 3)The deal maker/breaker: If you wait, do you starve, live on savings, or keep working to pay living expenses? Most people need the money and CAN NOT wait. If you have savings or income, then you can afford to wait if you expect to live past 80. Maybe die early? Then take SS at 62, leave assets to heirs. Otherwise, you lived off assets for 8-10 years and less is left for heirs. No complicated “8% a year” thinking

UofODuck
UofODuck
2 months ago
Reply to  J Naman

Thanks. That’s always been my problem with the 62,66,70 argument as there at least two unknown variables to consider: 1) when will we die, and 2) how much will we earn on our investments? If you choose to defer and then either die early or the markets tanks, you (or your heirs!) may not be happy.

SanLouisKid
SanLouisKid
2 months ago

Every time I read a good article like this I stop at certain points to “digest” it. Is what I am doing right? Should I be making changes? If my planning was right six months ago, should I adjust it because things have changed? I think once I got to the place where I didn’t mind leaving a little bit of money on the table I was happier. I may not maximize my social security payments, but I don’t care as long as I have enough money to do what I what and cover the basics when I’m no longer “doing.” Heck, I might even singlehandedly save social security!

Last edited 2 months ago by SanLouisKid
Kevin Thompson
Kevin Thompson
2 months ago

Social security maximization is just a financial decision based on calculation. If you can realistically forecast a guaranteed increase in your assets each year you delay, then ok take your SS early. However, we all know that is not possible. SS is providing you an 8% increase each year, in which you cannot solve for within your variable assets. A single year of deferral can make all the difference. Plus, it may also leave a higher benefit to your spouse.

as for the 4% rule, it is more a starting point or barometer. Right now municipal bonds have a YTM of 4-6% depending on the quality, and a TEY of 6-8% depending on tax rate and duration. So higher rates are definitely providing retirees with great opportunities.

Solution: IBonds at 9%, demand notes at 2-3%, municipal bonds between 4-6%, and treasuries north of 3%, there are some great opportunities at this time for the yield investor.

Last edited 2 months ago by Kevin Thompson
John Wood
John Wood
2 months ago

Good article, Jonathan, on what my friend likes to call “Champagne Problems” (can you imagine what these debates would sound like to people who are income, housing, and food insecure?).

I think the universal answer to all three items is: Do whatever you want. You’ve already won the money game. You can’t go wrong from here.

SanLouisKid
SanLouisKid
2 months ago
Reply to  John Wood

I’ve heard those referred to as “First World Problem” as well as “Champagne Problems.” Sometimes I stop and try to realize how lucky I really am.

James McGlynn CFA RICP®
James McGlynn CFA RICP®
2 months ago

Jonathan in your penultimate paragraph you mention if mortgage rates are less than bond rates it might be rational to have debt. Less than 2 years ago I refinanced a 15 year mortgage at 2.375%. To me this was a more rational action than doing a reverse mortgage if I needed it later. The cash today can be invested in 1 year Treasuries at near 4% -not to mention the I-bonds yielding 9%. I can slowly pay off the mortgage before starting SS at age 70 when the bond portion of my income will increase.

Kevin Thompson
Kevin Thompson
2 months ago

Financial wizardry from James Mcglynn. Using higher yielding assets to payoff low ytm mortgage. Fascinating. Borrowing money from the bank at 2%, placing those dollars into higher yielding assets to get a return while paying down your mortgage. Definition of financial arbitrage not to mention home asset values have increased 7.995% per annum in our area over the last 5 years since inception

Last edited 2 months ago by Kevin Thompson
Cammer Michael
Cammer Michael
2 months ago

Regarding #3, I started writing a reply agreeing that debt makes no sense, but as I wrote it, realized I might be wrong, deleted the whole thing, and am starting over with a question.
In the late 1970s-early 1980s my grandparents refused to pay off their mortgage even though they had the cash to do so. They were towards the end of the mortgage so payments were more principal than interest. Both inflation and money market returns were significantly higher than the mortgage rate. And they could take the full tax deduction benefits. The math worked out in their favor. I don’t think they paid it off until the 1990s.
For some retirees (or even a lot of other people given the low mortgage rates in the near past), could be there again, if not now, then soon? I have a friend who maxes out his retirement plans and pays off his credit card each month with a home equity line saying that it’s economical. Maybe he’s right to live the lifestyle he wants now while significantly investing in the stock market elsewhere?

Last edited 2 months ago by Cammer Michael
Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  Cammer Michael

As I mentioned in the story, if you have a very low mortgage rate, there will be higher returning alternatives, and that includes buying bonds in a regular taxable account.

SanLouisKid
SanLouisKid
2 months ago

My wife wanted the mortgage paid off. That was an easy calculation to do.

Ormode
Ormode
2 months ago

The answer to these three questions depends entirely on how much money you have. The retiree with $500K is in a different boat than the retiree with $10 million. The first retiree needs to maximize income – he should work until age 70, not take SS until he is 70, try to withdraw less than 4%. etc, etc. The second retiree has a lot more options, and may want to take SS early to lower taxable income, continue to save in retirement rather than withdraw anything, and in general do the exact opposite of the retiree who doesn’t have as much.

Last edited 2 months ago by Ormode
Michael1
Michael1
2 months ago
Reply to  Ormode

I may be missing something… How does taking SS early lower taxable income? I assume the thinking is that it does so since SS is only partially taxed. However, presumably one would still be getting whatever income they got from their portfolio before taking SS, so even though only partially taxed, it’s still additive so isn’t really lowering taxable income.

Kevin Thompson
Kevin Thompson
2 months ago
Reply to  Ormode

Yes and no. A retiree with say 1 million or 2 million in assets is not necessarily in better situation than one with 250-500k. Case and point, if the 250/500k individual has pension, SS, and annuities producing more than enough income annually than they can spend, they are in better situation than one with 2M of asset with no guaranteed income sources.

it’s not about the size of the assets, albeit important, it is about what the assets are producing on the balance sheet. I’ve seen multiple clients with 150k of guaranteed income with not a single worry inside of retirement, versus a person with a lot of assets trying to figure how to produce income and deal with sequence of returns.

Its all relative!

Tom Kubik
Tom Kubik
2 months ago

Zero debt in retirement eases fiscal and mental stress.

Last edited 2 months ago by Tom Kubik
parkslope
parkslope
2 months ago

I also don’t know anyone who follows the 4% rule. However, I wonder if the same can be said for the financial advisors who manage the portfolios of their retired clients.

Kevin Thompson
Kevin Thompson
2 months ago
Reply to  parkslope

We manage portfolios for retirement purposes and the 4% rule is more of a barometer than a rule. Portfolio distributions are determined by what is needed inside of retirement. Maybe we distribute a larger sum during our first years to offset social security and maximize our target tax rate. Maximizing tax rates can involve Ira conversions to Roth or maybe using QCDs to offset RMDs. Just depends on client and where we are, especially if you are concerned about future tax rates.

R Quinn
R Quinn
2 months ago
Reply to  parkslope

How do they determine withdrawals in retirement? How do they measure if their assets will last during years retired?

Kevin Thompson
Kevin Thompson
2 months ago
Reply to  R Quinn

As for your question Mr. Quinn, I would contact a CFP®️ planner to determine that, and yes I am speaking my own book. Forgive me. Haha

Joe Pucciarelli
Joe Pucciarelli
2 months ago

Jonathan – a long-time reader, and first-time commenter.

I especially enjoyed this article – an article where you pivoted from being a journalist to being an advisor. You took a position and explained why. Of course, it is my choice to agree with you or not, but that is not the point. The concise, direct, first-person writing style serves you and your readers well, in my opinion. You have built a career and reputation from which we can weigh the merits of your position. An important ingredient for success in life is choosing carefully whom we take advice from – in matters big and small.

The next topic that I believe deserves a similar treatment to this column is managing [financial] complexity, especially in retirement.

I am planning to retire in the next year, and as I tune my portfolio for that transition I am weighing what I, or my assignees, can reasonably be expected to manage ten or twenty years into the future.

Thanks again – Joe P

Kevin Thompson
Kevin Thompson
2 months ago

100% agree. As I was a victim of the same industry in which I partake, figuring out who to trust is by far the most important decision you must make.

Jonathan Clements
Admin
Jonathan Clements
2 months ago

Joe: Thanks for the kind words. I’ve touched occasionally on the topic of managing financial complexity in retirement. You might check out this article, which also includes some links to earlier pieces:

https://humbledollar.com/2022/02/paying-it-forward/

Jerry Pinkard
Jerry Pinkard
2 months ago

I paid off my mortgage 8 years early (25 year mortgage). It was a very liberating feeling to truly own our home. Perhaps I should have, but I never investing vs paying it off. My parents grew up during the depression and some of their frugality rubbed off on me which I am thankful for.
I paid off my mortgage 8 years early (25 year mortgage). It was a very liberating feeling to truly own our home. Perhaps I should have, but I never considered investing vs paying it off. My parents grew up during the depression and some of their frugality rubbed off on me which I am thankful for.

Last edited 2 months ago by Jerry Pinkard
Mark Magers
Mark Magers
2 months ago

I never read any assessment of the “opportunity value” of taking SS early. At 62 I can do more physically than I likely will be able to do at 70, maybe yes and maybe no. With an undiscounted breakeven at 82, this is a valid consideration. In my humble opinion!

Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  Mark Magers

Yes, you might spend more at 62 than at 70. But if it makes financial sense to delay Social Security, why not simply withdraw more from savings at 62?

David Lamb
David Lamb
2 months ago

Assuming one has those savings, yep!

AKROGER SHOPPER
AKROGER SHOPPER
2 months ago

Rules and more twisted shenanigans await us all as the years tick by. It’s good Jonathan provides the truth about SS and the need to be patient on when to claim our benefit. Perhaps the 4% will someday fade into the past and be replaced with another sure bet. Keep up the good work Jonathan, we always come back for more wisdom here at the HD.

David Lamb
David Lamb
2 months ago

The potential fly in the ointment of the SS “breakeven” analysis is the assumption that the SS retirement trust fund’s pending insolvency, now projected for the 2034/35 time frame, is dealt with in a way that maintains those benefits status quo. While I agree that is more likely than not, it is not a given. Folks who build their retirement plan on a foundation of SS without sensitivity to the possibility of ~ 20% benefits reduction, higher taxes on benefits, additional means testing, etc. might be in for a future shock.

5Flavors
5Flavors
2 months ago
Reply to  David Lamb

I am with you Dave. After the SALT deduction went away, think all bets are off taxwise/benefit wise. The pain of not optimizing was less than the pain of being a fool and not taking while I could. I did not need it then but took at 64, a compromise, and am happy for it. It did enable me to take more risk in my portfolio and honestly, don’t think it will matter that much either way. Other 3 points in article were spot on-as usual.

David Lamb
David Lamb
2 months ago
Reply to  5Flavors

We agree, 5Flavors, that when it comes to betting on taxes and related things, it’s a fool’s game!

Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  David Lamb

Some four out of 10 seniors rely on Social Security for half or more of their income:

https://www.ssa.gov/news/press/factsheets/basicfact-alt.pdf

A 20% benefits reduction would leave some of these folks hungry and perhaps even out on the street. It simply isn’t going to happen. Yes, I can see taxes going up and the Social Security eligibility age rising for those a decade or more from retirement. But the chance that existing retirees would see their benefits cut is so small that it isn’t worth considering — and, should it somehow occur, it would be reversed after the next election, when those who allowed the cut to happen are voted out of office.

wtfwjtd
wtfwjtd
2 months ago

It took Congress something like 3 days to consider, write, and pass some $3 trillion+ in immediate spending for Coronavirus “relief”, a problem that popped up only several weeks before. Do people honestly think that, when push comes to shove, Congress will let SS benefits for recipients 14 years from now be cut over a measly $2 trillion shortfall, projected over 50 years? Or that they would allow its even more nonsensical variant to happen, that SS is going “bankrupt” or “running out of money”, hence benefit payments will suddenly drop to zero overnight? Please. It’s like me claiming the moon must be made of Swiss cheese, because its surface has holes in it. It’s just nonsense.
I might have to quibble with you a bit here Jonathan. Of all the “debates” about Social Security, this–the unfunded shortfall resulting in benefits being cut or suddenly abolished for current recipients–is the one I find most absurd. But it is directly connected to the argument you put forward as being the one that makes your head explode, so maybe I’m just quibbling over semantics here. Either way, we can both agree–it ain’t gonna happen. Period.

Ormode
Ormode
2 months ago

The cuts would take the form of higher taxation of wealthier retirees. Right now, the income tax we pay on our SS goes into the SS reserve, not the general fund, and our IRMAA payments and NII taxes go into the Medicare fund. Not indexing the threshold for SS taxation automatically increases the number of SS recipients who are pay tax to fund SS. These taxes may could be increased if necessary, and the net effect would be lower SS payments to many recipients.

David Lamb
David Lamb
2 months ago
Reply to  Ormode

Ormode, the scenario I see is very similar to yours: perhaps the limit of 85% of SS benefits taxed at the Federal level will be increased, perhaps only for those above certain income levels (already a form of means testing), or perhaps any benefits reductions that actually come to pass will only apply to those of us with means or higher incomes.

Jerry Pinkard
Jerry Pinkard
2 months ago
Reply to  David Lamb

I took SS when I retired at age 66. One of my concerns with SS was the potential of future means testing which had the potential of affecting my SS payout. Many people said that would never happen and it may not, but I still believe it is a real possibility.

David Lamb
David Lamb
2 months ago
Reply to  Jerry Pinkard

Jerry, to my way of thinking the limit of 85% of SS benefits taxed at the Federal level is already a form of means testing, so who’s to say further such will not come to pass?? I agree with you, it’s certainly a possibility and people who choose to ignore it entirely do so at their own peril.

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