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THERE ARE USUALLY TWO answers to every personal-finance question: There’s what the calculator says—and then there’s how you feel about it. What does that mean in practice? Let’s look at an example.
Suppose you’re considering when to claim Social Security. Many retirees struggle with this question. On the one hand, the government offers a strong incentive to wait: For each year you forgo Social Security—up to age 70—your future benefit will grow by some 8%. That’s on top of inflation. But those who wait also pay a price. Each year that you delay is also a year during which you don’t receive benefits. Result: For those who delay claiming Social Security, it takes some number of years to break even on that decision.
Consider an individual who would be eligible for a benefit of $30,000 at age 67. To maximize his benefit, he could wait until 70. Then he’d receive $37,200—a substantial increase. But in the meantime, he’d be giving up three years of benefits totaling $90,000. How long would it take to break even? Putting aside inflation, the math is straightforward: Starting at age 70, he’d receive an extra $7,200 per year. To make up the $90,000 he earlier gave up would thus take about 12 years ($90,000 ÷ $7,200 = 12.5). To break even, he’d have to wait until age 82 or 83.
While 12 years might sound like a long time, this tradeoff still makes sense for a lot of people. Yes, 82 is only a few years less than the average U.S. life expectancy, which is age 84 for a 65-year-old man and age 87 for a 65-year-old woman. But that overlooks two factors: First, life expectancies differ dramatically among demographic groups. Education and profession are also key factors. As a result, your own life expectancy could easily exceed the average. Second, with Social Security, spouses are entitled to a survivor’s benefit. So, the right way to look at life expectancy is to consider the chance that either you or your spouse will make it to that breakeven point.
For most people, then, it’s worth delaying to earn the largest possible check. That’s what the calculator says—but that’s not what most people do. Most happily claim Social Security earlier. Why? That’s where the second answer comes in: how they feel about it.
Some people claim earlier because they like the peace of mind of a guaranteed check from the government. Others do it because they worry they might fall short of that breakeven point. And then there are folks who believe they’ll come out ahead by investing the cash they receive when they claim early. All of these are entirely legitimate reasons, even if they run counter to what the calculator would say.
Social Security isn’t the only question with two answers. Many other personal finance questions do as well:
Should you make extra payments toward your mortgage? The calculator says you shouldn’t, especially if you’ve locked in a low rate. If you have surplus cash, history says you’d be better off investing those funds in the stock market—where returns have averaged 10% a year over time—than using it to pay down low-interest debt. Still, there are reasons to ignore the calculator: Stocks may have impressive historical performance, but they don’t go up every year. Also, there’s the peace of mind gained from living in a home that’s fully paid for.
When should you cancel your term life insurance? Are you retired and living off your portfolio? If so, the calculator would say it’s illogical to keep paying for life insurance. But many people still do. That’s mainly because no portfolio is guaranteed to maintain its value forever. The stock market might fall, or an unexpected expense—such as long-term care—could cause a retiree’s investments to dwindle more quickly. To avoid that uncertainty, and to protect their families, some folks are happy to pay for insurance coverage beyond when it’s strictly necessary.
Should you choose an asset allocation that’s as aggressive as you can afford? For many people, this makes perfect sense. Why be unnecessarily conservative? But others see it in precisely the opposite way. Author William Bernstein offers this advice: “When you’ve won the game, stop playing with the money you really need.” In other words, don’t take on any more investment risk than necessary—even if it means, in theory, leaving potential gains on the table.
Should you complete a Roth conversion while you’re still working? Suppose you’re in a relatively high tax bracket—above 30%. If you do the math, you might find that, like most people, your tax bracket in retirement will likely be much lower. That would make a Roth conversion before retirement illogical. But some people still proceed with conversions at high rates. Why ignore the math? These folks worry that Congress might raise tax rates. Even in the absence of that, they worry that a surviving spouse would end up in a higher tax bracket. Finally, they like the idea of leaving Roth IRAs to their children.
Should you buy a house that’s either bigger—or smaller—than what you can easily afford? It might seem illogical to do either. But many people don’t care what the calculator says. Years of research on happiness say that money is best spent on experiences rather than things. While a house might seem like a “thing,” it also provides experiences. A bigger home might allow you to host family for the holidays more easily, or provide more room for kids to run around. A house that’s smaller than you can afford, on the other hand, could make you happy in a different way: Each time you walk through the front door, it’d be a reminder of how you’re building financial security.
Should you stick with index funds? Burton Malkiel is a retired professor and author of A Random Walk Down Wall Street. First published 50 years ago, Malkiel’s book was one of the first to argue against stock-picking and in favor of index funds—before index funds even existed. In his book, Malkiel posited that a blindfolded monkey throwing darts at the newspaper’s stock pages could outperform a professional investor. But in a recent interview, Malkiel didn’t hide the fact that he enjoys picking stocks. Malkiel acknowledged that he has no special skill in this area. “Do I think that I am making a bigger rate of return than through index funds? I’ve never calculated it,” he says, “but probably not.” So why does he do it? “Because it’s fun!”
In the world of personal finance, some debates seem never-ending. A reason for that, I think, is because people look at questions from different perspectives. Some believe that the calculator answer is the only legitimate answer to any question. Others disagree. Investment advisor Tim Maurer articulates this opposing point of view. “Personal finance is more personal than finance,” he says.
Ultimately, as you think through financial questions, I’d follow the lead of Burton Malkiel. While he enjoys picking stocks, he’s quick to add that “it’s not very risky for me because I have a good strong retirement fund.” And in that fund, there are no individual stocks; it’s all index funds. In other words, you don’t want to defy the calculator. Certainly, don’t do anything you can’t afford. But as long as you can afford to do something, there’s no obligation to adhere to what the calculator says is optimal. Instead, optimize for contentment, peace of mind and enjoyment.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.
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I’ve been having a rolling discussion with a friend of mine. He has started to take his SS at 62 and I’m waiting until 70. His reason was because he feels he’ll be spending mostly when he is younger and healthier and less later on. My reason is because The Spreadsheet says the numbers show an advantage long-term. Well, I promised him I’d compare approaches. And, for my wife and I, The Spreadsheet says we should both wait until 70 to get the most benefit until “End of Plan”. However, if I switch her benefit to start at 62, we would have a lot less to withdraw from investments in the lean years before my benefits kick in. Now, the numbers don’t lie: 70 is better for both of us. But, I just hate the idea of withdrawing a lot more – even though we’ll recover and have more down the road. So the question becomes: Follow the Heart or the Mind?
I have two comments about this article. FIRST, and very quickly, you need to take into account taxes when you compare the Social Security options. That could sway the time frame for payback considerably.
SECOND, and to me far more important is the decision whether to prepay any part of a mortgage. Again, there are subtleties. But I lean toward doing at least some prepayment if you can. Think about this:
Even low interest mortgages are actually extremely high interest obligations in their early years.
Here’s an example. If you look at a mortgage interest Loan Progress Chart for a 7% mortgage, you will see that for a 7% 15-year loan, in year 1, $961 of every $1,000 paid is really just applied to pay interest. In year 5, $774 of every $1,000 paid is still allocated to pay off interest. One only reaches the halfway point between interest and principal in year 10! (I looked at my old Chicago Title Insurance booklet for these numbers – they start at 7% and go up from there!)
Far more of the money paid in the early years of a mortgage is actually used just to pay interest, and so it doesn’t work on your behalf to lower the actual principal amount of the debt. So if you are in the early years of a mortgage, and you can afford it, it can be a huge benefit to find ways to prepay some of the principal. That works even for low-interest-rate mortgages in the early years.
I can’t say that emphatically enough. In an environment where home values seem to have topped out, and the market also seems to have hit a ceiling for a while, one doesn’t get much advantage from leveraging one’s home purchase. And, of course, the mortgage interest deduction will never come close to the money actually paid. Thus, for now, there is little chance of returns equal to the benefit that is gained by paying down mortgage debt. (The main benefit now for not doing it might be paying the mortgage off with cheaper dollars, but even that doesn’t mean much in the early years of a mortgage.)
It is hard to quantify the amount of benefit from prepayment because every homeowner is different, and you don’t need to do it all at once. But for everyone, prepayment keeps moving you ahead on the Loan Progress Chart to a point where more of your next payment will be principal and not interest, and even more for each succeeding one, ad infinitum. You constantly benefit in the future, because a higher proportion of all your future payments will go to pay down more principal than they would have, rather than going just to pay interest, and each prepayment has a cumulative effect.
In the early years, if you can do it, prepayment now can deliver orders of magnitude improvements in financial position – IMHO, far more even than paying off credit card debt during a mortgage’s early years. I don’t know where the tipping point happens – again, it probably depends on one’s specific circumstances, maybe somewhere in the late middle of the mortgage duration, I guess (if one ever happens.)
Interesting that even after reading the article, a few readers and contributors went down the SS claiming rabbit hole…Great piece, resonant of Morgan Housel and The Psychology of Money. I am faced with another example at the moment-whether or not to finance a car purchase. Even with interest rates where they are at the moment, the calculator seems to show that financing would likely be better than paying cash. My wife however has had it with debt and after a lifetime of mortgage, car and student loan payments. So, my equation is Happy Wife, Happy Life or calculator.
It seems as though most of us are subject to the “can I sleep at night” when it comes to our finances.
This is an excellent article. You have reminded us that, in contrast to “homo economicus” who does not exist, real people make decisions based not only on analysis, but also and even more so, on emotions. (Everyone should read “Thinking Fast and Slow” by Daniel Kahneman). This helps illustrate the difficulty in prescribing a one size fits all financial plan for any group, even after adjusting for age and financial situation. When asked how many shares of stock an investor ought to own, JP Morgan reportedly answered: “Sell down to your sleeping point”. If Adam will permit me, this was an acknowledgement of the fact that whatever the calculator may say, if we deny harboring doubts about our decisions, the next time the market falls we may make costly mistakes driven by fear.
I like to think of Social Security as longevity insurance, as the best annuity out there because of it being inflation adjusted. When you look at it that way then it generally makes the most sense to not claim before 70 as long as you have the cash flow to wait. We don’t need the money anyway but if we ever did it would be way off in the future, and so maxing the size of the payment just makes sense as an insurance policy against my wife living to age 115. I’m not planning on surviving much past 110.
If it looks like your income will be too high, then it makes sense to take SS early, and perhaps starting to withdraw from your retirement accounts as well. This will smooth out your average income throughout retirement.
Of course, there are some retirees who prefer to have a very high income in their later years, and are willing to pay IRMA and NII.
Great article Adam…..I always enjoy reading your no nonsense views.
I started collecting SS at age 62. My rational at the time was being able to do things (travel, etc.) while still young and healthy enough to do so.
Today, I’m dealing with some health issues that might not get me to age 70. So, no regrets on my decision to collect early. And……if God give me a few more years to spend on the “green side of the sod”, I doubt my attitude with alter from…..no regrets!
Adam, as you note there are many reasons to start or delay SS. I suspect a valid argument could be made for any age for a given individual. In that case the argument would be when the income is or will be needed the most considering the persons complete circumstances.
What I don’t understand is the concept of breakeven in the context of delaying benefits to age 70. The only reason a person could not “break even” is if they die in which case it’s all irrelevant.
The break even argument is used all the time, but it seems to me it reinforces the false notion that individuals have paid for their benefit through the taxes they paid and that there is a direct link between taxes paid and the benefit collected – which there is not.
I began my benefits at my FRA. When I compare what I have collected since then I find that in less than eight years of the first check the total benefits exceeded what I and my employers paid in taxes during my entire working years starting in 1959.
So in one – inaccurate – sense I have more than broken even as do the vast majority of beneficiaries.
For the folks who are convinced they paid for their benefits, I’d ask where the money has come from to pay my benefits for the last six years after I broke even. 🤑
“The only reason a person could not “break even” is if they die in which case it’s all irrelevant.”
Only if there is no surviving spouse to consider; to a long-lived surviving spouse, the timing of the claiming decision is *very* relevant. Sure, if spouses die within a few years of each other, it’s no big deal. But taking that bet is usually one against the odds, since there’s an average of something like 11 years between the death of spouses. But I rarely hear this mentioned in “break-even” discussions, as the decision about when to claim is usually framed on an individual-only basis, which is wrong a good deal of the time.
When experts discuss breaking even, the focus isn’t on breaking even on your payroll contributions. Rather, as Adam outlined above, it’s about breaking even on the decision to delay benefits.
I really do not understand the concern about breaking even. If I die before I break even, I won’t know and I won’t care. On the other hand, by waiting until 70 I got the largest possible base for future cost of living increases. (The fact that I didn’t need the income was, of course, a factor, but these discussions usually concern people who can afford the choice.)
Good point. I took another route. I began at FRA age – while still working and invested both my and my wife’s checks for several years. But as you say, most people do not have the ability to not use their SS upon retirement.