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The Other Answer

Adam M. Grossman

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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