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MANAGING MONEY IS about managing risk. But which risks? We all have a different collection of financial worries, and that drives the investments we buy and the insurance we purchase.
Problem is, every choice we make comes with a tradeoff. If we seek to fend off one risk, we often open ourselves up to other dangers. Consider five such tradeoffs:
1. Dying young vs. living long. When should we claim Social Security? Should we use part of our retirement nest egg to purchase an immediate annuity that pays lifetime income? If we’re eligible for a pension, should we opt for a lump sum or regular monthly payments?
These three questions all deserve careful analysis. But often, we answer based on worry: Are we most fearful of dying young, or is our big concern that we’ll outlive our money?
2. Enjoying today vs. prepping for the future. HumbleDollar readers tend to be masters of delayed gratification. That’s how many of us managed to amass enough—and often far more than enough—for retirement.
Once retired, we then strive to make the transition from diligent savers to happy spenders, and so we should. After all, that’s why we saved all that money. But from perusing comments on HumbleDollar, I’ve noticed that some take this a step further: They aim to really ramp up spending in their 60s because they figure that, later in retirement, they’ll spend far less and they won’t enjoy their money nearly as much—assuming they even live that long.
As I’ve mentioned before, I’m not sure this excessive spending is wise, in part because folks could face hefty long-term-care costs down the road. What’s driving the “spend heavily in our 60s” mentality? We might view it as a variation on point No. 1. Is our big fear dying young, without fully enjoying our money, or is it being prepared for the future, when that money might come in handy?
3. Getting rich vs. avoiding poverty. We all have both desires, but in varying degrees. One way to straddle these two is with the classic balanced portfolio, with its mix of 60% stocks and 40% bonds. Those who care more about avoiding poverty will likely opt for more bonds, while those whose greatest concern is getting rich might tilt more heavily toward stocks.
For some folks, these dueling impulses can translate into an odd use of their discretionary dollars. Think of the unsophisticated investors who keep almost everything in savings bonds and FDIC-insured bank accounts, but also spend money on penny stocks, lottery tickets, meme stocks and an occasional visit to the casino. The cash investments help them feel safe, while the longshot bets allow them to dream of riches.
Wall Street, and especially insurance companies, cook up products that aim to appeal to these twin impulses with a single investment. That’s how we end up with things like equity-indexed annuities, where investors can capture part of the stock market’s upside while being protected against losses. It’s a bad product, but a great marketing gimmick.
4. Simplicity vs. diversification. It’s possible to build a globally diversified portfolio of stocks and bonds with just two or three mutual funds or exchange-traded funds, thus combining simplicity with the safety offered by broad diversification. But what if we’re talking about a different sort of simplicity—limiting ourselves to just one or two financial firms, so we keep our finances simple for our own sake and that of our heirs?
I’ve never worried about diversifying across financial firms. I have almost all my money at Vanguard Group, and I use just one bank. But is this wise? For instance, in an era when financial firms are constantly under cyberattack, could thieves drain a financial firm of billions of client dollars, bringing the firm to its knees and leaving customers penniless? I have no clue whether this is a real risk or not, but I know it’s a major worry for others.
Countless times, I’ve also heard folks say they’d never buy an immediate annuity because of the risk that the insurance company involved might fail. Over the years, some small insurers have indeed gone bust. But what about major life insurers like New York Life, Northwestern Mutual and Mass Mutual? I find it hard to imagine one of these firms could fail—but others clearly can.
The concern over betting too much on one institution even extends to the federal government. Today, there are plenty of folks who fear Social Security benefits will be cut, especially once the Social Security trust fund runs dry in a decade or so. Again, this isn’t a fear of mine, but it’s a concern of many, and it’s one reason they claim benefits at age 62, the earliest possible age.
5. Insuring this vs. protecting that. By my count, there are eight major types of insurance: health, life, disability, long-term care, auto, home, renter’s and umbrella liability. Buy blanket coverage, and we might find we have precious few dollars left over for retirement savings and other goals.
To a degree, logic and necessity will guide our choices. Parents with young families should likely have ample life insurance, car owners are typically required to have an auto policy, mortgage lenders insist borrowers have homeowner’s insurance, and arguably everybody should have health coverage.
Still, that leaves a fair amount of leeway—and worry will likely dictate the choices we make. Those who worry about their health will often favor policies with low copays, low out-of-pocket maximums and fewer restrictions on the medical providers they use. Meanwhile, those who are risk takers might favor coverage with high deductibles, while skipping some policies they deem unnecessary.
We all have an image of ourselves, and about how conservative or aggressive we are. But action speaks louder than words. Take a look at your mix of investments and your collection of insurance policies. What does your financial life say about your worries?
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney and on Facebook, and check out his earlier articles.
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When we sold our house, I put the proceeds in a different bank from the one we use for checking as well as two credit cards. It made me feel safer to have that money at a bank that wasn’t linked to any other activity or accounts.
Thanks, Jonathan. I was wondering if you or one of your followers might be willing to expand a bit on why an equity-indexed annuity is a ‘bad product’. A friend suggested I consider a RILA annuity, which sounds similar, for a small portion of my retirement portfolio. Admittedly it sounds to me like an appealing way to help try to balance out peril #3.