SOCIAL SECURITY benefits are fairly modest—the average retiree receives $1,555 per month or $18,660 a year—but they’re a vital source of retirement income for countless retirees. Today’s burning question: How can we shore up the program’s finances? It’s estimated that Social Security provides some 30% of the income for the elderly and that nearly nine out of 10 people age 65 and older receive benefits. Social Security is even more important for women, 42% of whom rely on it for half or more of their income. Unfortunately, the Old-Age and Survivors Insurance (OASI) Trust Fund, from which Social Security benefits are paid, faces imminent shortfalls. The fund’s reserves are projected to be depleted by 2033, at which time continuing tax revenue will be sufficient to pay just 76% of promised benefits. There are no easy solutions. Both higher payroll taxes and lower benefits may be necessary. But how about some out-of-the-box thinking? Meet my suggested solution: the Save for Tomorrow program. The program would cost the federal government very little in the short run but save it vast sums in the long run. It involves the creation of a novel, completely optional retirement account. Here’s the basic framework: Parents, grandparents or legal guardians could opt to open and fund a Save for Tomorrow account for their children or grandchildren. The account would be triple tax-advantaged—contributions would be tax-deductible, funds in the account would grow tax-deferred and future withdrawals would be tax-free. Contributions would be subject to a lifetime limit for each child—say, five times the annual IRA contribution limit. For a child born today, that would mean contributions would be limited to $30,000, equal to five times today’s regular $6,000 IRA limit. Contributions could begin at birth. The contribution window would close once the child reaches age 10. Between ages 65 and 70—and no sooner—the beneficiary could claim her benefits. At that point, the funds in the account would be annuitized, with inflation adjustments, just as Social Security payments are. The beneficiary would then receive the higher of the annuitized income stream from her Save for Tomorrow account or the standard Social Security benefit. If the Social Security benefit is higher, the funds in the Save for Tomorrow account would be turned over to the OASI Trust Fund. Save for Tomorrow accounts would be overseen by salaried professionals and would reside inside the highly regarded federal Thrift Savings Plan. Given the super long time horizon—anywhere from 55 to 70 years—the funds would be aggressively invested, with nearly 100% in stocks. Upon a beneficiary’s death, any unused funds in the Save for Tomorrow account would be turned over to the OASI Trust Fund. Let’s run some numbers to see how this new program might work. I’ll assume the Save for Tomorrow account earns a 7% real return over its lifetime. For simplicity’s sake, I’ll also assume the account is funded by a lump sum contribution at birth. Finally, I’ll use the 4% rule to annuitize the account balance at ages 65 and 70. You can see the results in the accompanying table. Some observations: Contributing $6,000 at birth (scenario No. 1) generates an annual payout of $19,505 at age 65. This is higher than the average Social Security benefit of $18,660 that I referenced earlier. By waiting until age 70, the payout increases to $27,357 a year. For comparison purposes, the maximum Social Security benefits are listed in the table. Obviously, many retirees will receive far less than these numbers. Contributing $12,000 at birth leads to annual payouts of $39,011 and $54,715 at ages 65 and 70, respectively. Both of these top the current maximum Social Security benefits. The annual payouts are in real, inflation-adjusted dollars since I’m using a 7% real return for the calculations. Remember that the Save for Tomorrow payouts are tax-free, meaning they’re significantly more generous than those from Social Security, which are potentially taxed. The upshot: Even if the two benefits were equal in dollar terms, the Save for Tomorrow benefit would win out once taxes are factored in. The contributions are entirely funded by the private sector and are completely voluntary. While the new accounts would cost taxpayers very little—there would be a small loss in tax revenue due to the tax-advantaged nature of the accounts—the Save for Tomorrow program would save the Social Security program a bundle over the long run. How so? If someone died at age 64 with $1 million in his Save for Tomorrow account, that money would go to the OASI Trust Fund. In addition, anyone receiving the higher Save for Tomorrow payout isn’t drawing a cent from Social Security. If the Social Security benefit is higher than the Save for Tomorrow benefit, the latter dollars are returned to the OASI Trust Fund. Finally, any money left over upon the death of a beneficiary goes into the OASI Trust Fund. [xyz-ihs snippet="Mobile-Subscribe"] The biggest criticism of the Save for Tomorrow program would be that it primarily benefits the rich and their progeny. While this may be true, I could envision significant numbers of middle-class grandparents funding these accounts for their grandchildren. More important, the Save for Tomorrow program is a win-win for everyone. While beneficiaries would certainly benefit from the generosity and foresight of their parents and grandparents, so would everyone else. Every dollar contributed to the program would mean more money for the OASI Trust Fund, which would shore up the Social Security program. As I see it, the Save for Tomorrow program draws on many strengths, both financial and behavioral: The program maximizes compounding’s enormous power. Allowing money to compound uninterrupted for up to seven decades can achieve wonderful things. At a 7% real growth rate, $1 turns into $114 in 70 years. In the extreme case, $30,000 contributed at birth could swell to $3.4 million by age 70, providing $137,000 of annual income for life—or millions of dollars for the OASI Trust Fund should the beneficiary not receive the benefits for whatever reason. While it may seem unfair that a parent or grandparent could ease their progeny’s retirement in such a manner, consider that much of that money might eventually benefit society, should sizable funds remain when the beneficiary dies. The long time horizon enables taking much greater risk and achieving commensurately greater returns. A 100% stock portfolio is exceedingly risky over short and even intermediate time frames, but over six to seven decades, not so much. A globally diversified 100% stock portfolio may actually be less risky than cash or bonds over such time horizons, once inflation is taken into account. The program would reduce behavioral risk. The tectonic shift from company-sponsored pensions to individual 401(k) accounts failed to factor in the human element. We are humans, not “econs,” as Nobel Prize winner Richard Thaler says. Many of us simply don’t possess the knowledge, self-control or temperament to successfully save and invest for retirement—not to mention the even thornier task of drawing down assets in retirement. One of the great benefits of the Save for Tomorrow program would be that both tasks would be professionally managed, removing this burden from individuals ill-equipped to perform them. Will members of Congress read HumbleDollar and act on my suggestions? Probably not. I’m a realist. But perhaps farsighted families could find a way to build the notion of extreme compounding into their generational planning. John Lim is a physician and author of "How to Raise Your Child's Financial IQ," which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles. [xyz-ihs snippet="Donate"]

THREE YEARS AGO, I decided to write a book about money for my children, then ages 9 and 11. Raising Your Child’s Financial IQ: The Most Important Things is now finished. Here are six things I learned along the way—which apply not just to writing a book, but also to life more generally: 1. Yes, you can find the time I’m a physician, working 50 to 60 hours a week. When I get home, greeting me are two children eager for my attention. Where would I find the time and energy to write? My solution: Wake up at 5 a.m. and write for just 25 minutes. My experience shattered the romance I had always associated with being a writer. I discovered that writing a book is an extremely lonely and slow endeavor. At times, a voice in my head would whisper: “This is rubbish. You’re wasting your time. Who do you think you are, writing a book?” 2. Jerry Seinfeld’s hack A young comedian, Brad Isaac, asked Seinfeld if he had any advice: “He said the way to be a better comic was to create better jokes and the way to create better jokes was to write every day.” Isaac continued: “He told me to get a big wall calendar that has a whole year on one page and hang it on a prominent wall. The next step was to get a big red magic marker. He said for each day that I do my task of writing, I get to put a big red X over that day. After a few days you'll have a chain. Just keep at it and the chain will grow longer every day. You'll like seeing that chain, especially when you get a few weeks under your belt. Your only job is to not break the chain.” I realized my job was simply to show up and write every day. It shifted the focus away from the results to the process. For me, it was a gamechanger. While I had little control over the quality of my writing on any given day, I could control the physical act of sitting down and writing. This simple trick can, I believe, help you excel in anything you pursue, whether it’s becoming a comic, writing a book or training to run a marathon. The key: Make sure you turn up each and every day. 3. Power of compounding Money compounds, but so do many other things in life. I remind my children about the power of compounding daily. If we do 25 minutes every day of anything, our skills will improve. It was certainly true for my writing: By putting pen to paper each day, it not only became easier over time, but also my writing began to improve. 4. Impostor syndrome I found that perfectly formed thoughts, elegantly and succinctly expressed, did not flow directly from my consciousness onto the page. I also observed that my writing greatly improved after the second (or third or fourth…) draft. This was a great source of encouragement. But it dawned on me that there was a downside: In the quest for the perfect sentence, I could rewrite forever. This rewriting also plays into the “impostor syndrome”—the fears and doubts that come with such a lonely and ambitious undertaking. I realized that endless editing had become a way of procrastinating. If I were still editing, I was by definition not finished with my book. And if I wasn’t finished, I would not have to face the moment of truth—showing my work to the world and facing possible rejection. 5. Kindness of strangers After I finished the final draft of my book, I sent it to financial writers, bloggers and investors who I greatly respected. I meekly asked if they would read the manuscript and provide a blurb endorsing the book. In most cases, I was a complete stranger to them. I was blown away by the response. Not only did most of them read my draft, but they also kindly offered suggestions and gave me blurbs for the book. If there is one trait that all writers share, especially novice writers, it’s insecurity. It was inspiring and reassuring to receive kind feedback and the all-important blurbs from people I looked up to. Need help with your career or with some other endeavor? What I learned is that even those you consider famous or important will surprise you with their kindness. Don’t be afraid to ask for help—and be sure to pay it forward. 6. Love the journey J.K. Rowling was turned down by 12 publishers before Harry Potter was finally accepted for publication. Margaret Mitchell’s Gone With the Wind was turned down by 38. The list of bestselling books that were initially rejected by dozens of publishers is a long one. My point: Rejection does not equal failure, nor does acceptance guarantee success. Ask yourself: If you knew your book would never be accepted for publication, would you still write it? Do you believe enough in what you have to say to write for an audience of one? Whether it’s writing a book or any other challenge, you need to love the journey—and value it more than the destination. John Lim is a physician. His previous articles include Yielding Clarity, Grab the Roadmap and Bearing Gifts. Follow John on Twitter @JohnTLim. [xyz-ihs snippet="Donate"]

TAX-LOSS HARVESTING is a popular strategy at this time of year. It works best with mutual funds and exchange-traded index funds, for which very similar investments exist. By swapping your losing funds for similar investments, you can realize your tax losses and maintain your market exposure without violating the wash-sale rule. By contrast, tax-loss harvesting is difficult to implement with individual stocks. Is there a “nearly identical” investment for a company such as Tesla or Amazon? Furthermore, tax-loss harvesting only applies to taxable accounts, not tax-sheltered ones, which is where Americans hold the bulk of their retirement savings. Still, there’s a long-term strategy that investors can employ to capitalize on losing investments—including individual stocks—that’s tailor-made for tax-deferred accounts. The strategy: Perform a Roth conversion of the temporarily (we hope) down and out investment. To see how this works, imagine you invested $20,000 in Alibaba stock (symbol: BABA) within your IRA at the beginning of 2021. After this year’s beating, your holding is now worth just $10,000. If you still believe in the stock and plan to hold it long term, a Roth conversion of your Alibaba stock could make a lot of sense. If your marginal tax bracket is, say, 22%, you would owe $2,200 in taxes (22% of $10,000) on the Roth conversion. But once the stock is in your Roth IRA, you’ll never owe taxes on it again. If the stock soars in value over the next decade—the best-case scenario—you just saved yourself a bundle in future taxes. I believe this strategy is underutilized for behavioral reasons. First, there’s inertia. It takes work to file the necessary paperwork to do the Roth conversion. Second, humans are strongly present-biased. The tax savings from this strategy, however generous, won’t be enjoyed for years or even decades. But the pain of paying taxes on the conversion today is front and center in our minds. Finally, it’s painful to attend to our losing investments. Our pride is at stake. Behavioral quirks aside, there’s a little discussed downside to holding investments inside a Roth account. If the investment does poorly—say Alibaba is nationalized and your stock becomes worthless—you absorb the entire loss. Not so for investments held in a traditional IRA or 401(k). In these accounts, you and the Treasury are effectively investment partners, since the federal government has a partial tax claim on every dollar inside a traditional retirement account. If your account balance falls, so too does your tax liability. Individual stocks can and do occasionally go to zero. A broadly diversified index fund, on the other hand, will never suffer that fate. Hence, it’s probably safer to use this strategy for diversified investments such as mutual funds, particularly index funds. For instance, given the drubbing that emerging market stocks have undergone this year, emerging markets funds may now be great candidates for this strategy.

INFLATION IS BAD news for bond investors, but it’s really terrible for annuitants and those receiving company pensions. Bond investors can at least reinvest maturing bonds in newer bonds paying higher yields. But most income annuities and pensions pay a fixed monthly benefit for life. In fact, you can no longer even buy inflation-adjusted single-premium immediate annuities. Meanwhile, just 7% of all private-sector pensioners received automatic cost-of-living increases, according to a 2000 survey by the Bureau of Labor Statistics. Just how big a problem would sustained inflation be for annuitants and pensioners? In recent months, inflation has averaged 6%, as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). If it remained stuck there, it would cut a pension’s purchasing power in half in just 12 years. One pension, however, has near complete protection from the ravages of inflation. The Federal Employees Retirement System contains a cost-of-living adjustment (COLA) that raises payments annually. Here's how it works: If inflation, as measured by CPI-W, is 2% or less, the COLA matches it. If inflation runs between 2% and 3%, the COLA remains at 2%. Most important, if inflation exceeds 3%, the COLA equals the CPI-W minus one percentage point. In other words, the worst-case scenario is that the COLA lags behind inflation by one percentage point in any given year. If inflation spirals out of control at 10% a year, the COLA would add 9% to federal pension payments annually. If a federal worker’s pension were to lag inflation by one percentage point annually—remember, this is the worst-case scenario—its purchasing power would decline 26% after three decades. That’s not too bad, considering the alternative. An annuity or pension without inflation protection would have lost 94% of its value after the same 30 years. Federal pensions are also backed by the full faith and credit of the federal government. That’s no small thing when you compare them to state pension plans. In aggregate, statewide pension plans were only 72.9% funded in 2019, near the lowest point in modern history. Given the current headwind of ultra-low interest rates, that shortfall is unlikely to narrow. I’m certainly not predicting sustained 10% inflation. But even 5% inflation would drive down purchasing power by 77% in 30 years for those pensioners without a COLA. Worse yet, many economists feel that the official measure of inflation significantly underreports the true price increases we encounter in our daily lives.

AFTER A DECADE of rising stock prices, it’s time to look forward to the next bear market—and the three big benefits it’ll confer. First, a market decline is a great financial gift, but only if you continue to save and invest. While it certainly won’t feel like a gift, a bear market enables you to invest at lower prices, both by adding new savings and reinvesting dividends. Imagine you could choose from among three possible stock market scenarios. In scenario No. 1, the stock market climbs steadily in a straight line for 30 years. In scenario No. 2, you’re hit with periodic bear markets over the three decades. In scenario No. 3, stocks go nowhere for years, before powerfully rallying toward the end of the 30-year period. In all three scenarios, the market averages end up at the same level. The only difference is the path taken to get there. Assuming you’re in the workforce the entire time, and saving and investing consistently, which stock market would you choose to live through? If you picked scenario No. 3, congratulations. That’s the best market scenario if you want the greatest wealth at the end of the 30 years, because it offers the chance to buy stocks at lower prices, on average. What if you chose No. 1? Sorry, that’s the worst one. Meanwhile, No. 2 is somewhere in between. If you behave properly, by not selling and instead continuing to buy stocks, the more bear markets you have during your savings years, the greater the likelihood that you will ultimately retire with a larger nest egg. This may seem counter-intuitive. But remember, over very long time periods—think multiple decades—stock markets should mean revert. In other words, years of underperformance tend to be followed by years of outperformance—and those years of underperformance offer a great chance to buy shares cheaply. Second, we only learn our true risk tolerance by living through bear markets. Fred Schwed wrote the celebrated 1940 book about Wall Street, Where Are the Customers’ Yachts? In it, he offers this memorable passage: “Like all of life’s rich emotional experiences, the full flavor of losing important money cannot be conveyed by literature. You cannot convey to an inexperienced girl what it is truly like to be a wife and mother. There are certain things that cannot be adequately explained to a virgin by words or pictures.” There’s no way to know ahead of time how you will feel and, more important, how you will behave after losing a significant amount of money in the stock market. Asset allocation is the key determinant of your investment returns. Taking on more risk, by allocating more to stocks, should translate into higher returns over the long run. But how much risk can you tolerate without losing sleep and bailing on stocks during a bear market? One of the most important things in investing is to understand yourself, because we are our own worst enemy. Living through a bear market is really the only way to discover the mix of stocks and bonds we’re comfortable living with. In fact, I advocate that young adults start out with an 80% stock-20% bond mix, even though many “experts” would scoff at this and advocate a 100% stock allocation. A 100% stock allocation only maximizes your long-term returns if you don’t panic and go to cash the first time you experience a bear market. Maybe you’ll experience a bear market with an 80-20 portfolio and barely break a sweat, continuing to rebalance as you’re supposed to. In that case, going forward, you might raise your stock allocation to 90% or more. Third, bear markets put the kibosh on bull market foolishness. Not only do higher stock prices make investing riskier, but also the resulting euphoria sucks more people and more money into the market at the worst possible time. Perhaps the one certainty in investing is the cyclical nature of markets and human psychology. This long into a bull market, it’s easy to forget that stock markets can suffer terrible and terrifying short-term losses. One of my favorite quotes is from Sir John Templeton: “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.” Optimism is contagious. You may believe that you think and act independently. But when things are going well in the economy and optimism is rampant, it’s hard to resist the herd mentality. That’s simply how we are wired. Recall the late 1990s dot-com bubble. Near the peak, how many people did you know who weren’t invested in tech stocks? Want a more current example of the increasing flow of money fueled by optimism? Look no further than this year’s IPO market. A bear market will certainly dent your portfolio in the short run. But it might just save you even more in the long run—if it prevents you from falling prey to future market euphoria and the risky behavior that so often ensues. Even if we don’t get caught up in the optimism around us, we aren’t immune to its effects. When market participants engage in increasingly risky behavior, it raises the riskiness of markets for everyone. Never forget the cautionary words of Warren Buffett: “The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.” John Lim is a physician who is working on a finance book geared toward children. His previous article was Lay Down the Law. Follow John on Twitter @JohnTLim. [xyz-ihs snippet="Donate"]

I RECENTLY WROTE about the fallacy of time diversification. Time diversification is the widely held belief that market risk declines as our holding period lengthens. It’s one of the cornerstones of many investors’ approach to asset allocation and risk management. Financial theory, however, refutes time diversification because market risk—as measured by standard deviation—actually increases with longer holding periods. The math tells us that the dispersion of potential results widens with longer time horizons. This counterintuitive insight rests on the assumption that total returns have a normal, bell-shaped distribution and that year-to-year returns are uncorrelated. As an example, if stocks have an average historical return of 5% with a standard deviation of 30% and you hold for 30 years, the worst 1% of possible outcomes is a cumulative 90% loss. History teaches us that losses of this magnitude are within the realm of possibility. During the Great Depression, the Dow plunged 89% from its 1929 peak. It didn’t reach new highs, at least in nominal terms, until 1954—or 25 years later. Similarly, in 2002, the Nasdaq Composite index closed 78% lower than the peak it reached in 2000. It would take 15 years for the Nasdaq to return to its prior 2000 high. But there’s a major weakness in the argument against time diversification. Recall that it assumes that annual returns are uncorrelated. In other words, stock returns are assumed to take a random walk around their mean. While this assumption may be reasonable most of the time, it falls apart over longer time horizons and at market extremes. Consider what happens after the stock market experiences a major decline. First, dividend yields climb. It’s estimated, for example, that the dividend yield of the overall stock market was close to 14% in July 1932, when the Dow reached its Great Depression low. As share prices decline, the expected return from stocks rises. The Gordon equation states that the return we can expect from stocks are a function of dividends and the growth in dividends. By raising the dividend yield, tumbling stock prices sow the seeds for higher future returns. Result? A lost decade for stocks would set the stage for higher expected returns in the decade that followed. In other words, returns over long time periods aren’t random, but rather negatively correlated. What I’m describing, of course, is reversion to the mean. It’s the countervailing force that lowers the probability of long market streaks—both positive and negative. This doesn’t mean that a 30-year bear market could never happen. It’s just far less likely than standard statistical theory would predict. The other major argument in favor of time diversification: Most people save and invest over many decades. Such dollar-cost averaging substantially lowers the risk of stock investing during our working years, because we’re buying over time, rather than at a single price that could prove to be a market peak.