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Investing Blog Roundup: Safety-First Retirement Planning

When it comes to retirement planning, there are two broad schools of thought about how to cover your expenses. One method is to continue using a portfolio that looks much like the portfolio somebody would use during their accumulation stage (i.e., stocks, bonds, and mutual funds), albeit with a more conservative allocation. The other school of thought – the “safety first” method — relies on a different set of tools, such as bond ladders and annuities.

Elizabeth O’Brien of MarketWatch has more on the topic:

Other Money-Related Articles

Thanks for reading!

Are Dividends More Important Than Price Appreciation?

A reader writes in, asking:

“I’ve read that dividends account for the vast majority of the return of the stock market over history. I’m confused by the article you linked to last week about not being a dividend investor, given that dividends are so much more powerful than price growth.”

It’s true that, without dividends, you’d experience only a small portion of the market’s overall return over an extended period. But the idea that dividends are more powerful than price appreciation is a significant misunderstanding. (Unfortunately, I’ve seen this misunderstanding intentionally encouraged in the effort to sell products – dividend investing books, newsletters, etc.)

To explain, let’s look at an example of compound growth.

  • $1,000 compounded at 4% for 30 years gives you an ending value of $3,243.
  • $1,000 compounded at 5% for 30 years gives you an ending value of $4,322 (i.e., $1,079 more than you’d have with a 4% growth rate).
  • $1,000 compounded at 6% for 30 years gives you an ending value of $5,743 (i.e., $1,421 more than you’d have with a 5% growth rate).
  • $1,000 compounded at 7% for 30 years gives you an ending value of $7,612 (i.e., $1,869 more than you’d have with a 6% growth rate).
  • $1,000 compounded at 8% for 30 years gives you an ending value of $10,063 (i.e., $2,451 more than you’d have with a 7% growth rate).

The key pattern to notice here is that each additional 1% of return adds more to the ending value than was added by the previous 1% of return. This is just how the math works. Another important observation — which is simply another result of the same mathematical concept — is that, if you cut the return in half (e.g., compounding at 4% rather than 8%), you’ll experience less than half of the growth in value.

So, that last percentage of return — the eighth percentage point – added the most to ending value. But there’s nothing particularly unique about that eighth percent of return. That is, if we removed whatever it was that caused that eighth percent of return (such that you’d be left with a 7% growth rate), that would would have exactly the same effect as removing the cause of, say, the second percent of return. In either case, you end up with a 7% annual growth rate, and you end up with the same $7,612 ending value.

How This Applies to Dividends

The effects we’ve noticed above are amplified when we look at longer periods of time. And this is how people will sometimes come up with impressive-sounding factoids to convince you that dividends are more important than price appreciation.

For example, according to my 2012 edition of the Ibbotson Classic Yearbook — I haven’t purchased a copy for the last couple of years — from 1925-2011:

  • Large-cap stocks in the U.S. earned a total return (before adjusting for inflation) of 9.66%, of which
  • 5.42% came from price appreciation, and
  • 4.24% came from dividends.

Over a period this long (87 years), the difference between a 5.42% return (from price appreciation only) and a 9.66% return is staggering. If you had only experienced the price appreciation, you’d have just 3.24% of the ending wealth that you’d have if you’d gotten the total 9.66% return.

But the key point here is that if you had somehow earned just the 4.24% return from dividends (and had experienced no price appreciation), you’d have even less money.

In other words, factoids like the above can show us that it is important to reinvest dividends rather than spending them (if you’re in the accumulation stage, trying to grow your portfolio, that is). But they do not tell us that dividends are more important than price appreciation.

Investing Blog Roundup: Is Long-Term Care Insurance Likely to Be Beneficial?

One of the toughest questions about retirement planning is the question of long-term care insurance. The available policies have an assortment of drawbacks, and they’re expensive. On the flip side, needing to pay for an extended period of long-term care out of pocket would decimate many people’s savings.

This week, a new paper from two professors and two researchers at the Center for Retirement Research at Boston College takes a look at what percentage of people are likely to benefit from purchasing such insurance:

Investing Articles

Other Money-Related Articles

Thanks for reading!

Why Bother with Social Security Break-Even Calculations?

Broadly speaking, there are two general ways to assess the Social Security decision:

  • You can look at it as an insurance question (i.e., do I want to buy insurance against longevity risk), or
  • You can do a break-even analysis (i.e., how long do I have to live before I come out ahead as a result of delaying benefits).

An argument I’m seeing more and more often in financial publications is that it’s a mistake to even bother with a break-even analysis and that people should instead look at the question solely from the insurance perspective.

From the insurance perspective, delaying Social Security is automatically a good move because it creates an ideal alignment of outcomes. That is, it works out well in scenarios in which you live to be quite old. And those live-a-long-time scenarios are the ones that are the most financially scary. Conversely, delaying Social Security works out poorly in situations in which you die early in retirement, but those are the situations in which you are unlikely to run out of money anyway. I agree that this is an important point to consider in your Social Security planning.

But I still think break-even analysis is useful — for two reasons.

Firstly, just because something reduces risk doesn’t mean it’s a good deal. For example, most financial experts don’t recommend purchasing an extended warranty when you buy a new TV. Yes, it reduces a risk (specifically, the risk of having to replace your TV within the particular extended warranty time frame), but the degree of risk reduction is too small relative to the cost.

As it turns out, delaying Social Security is usually a good deal (especially for the higher-earning spouse in a married couple). But there’s no way to know that until you do the math yourself or read somebody else’s analysis.

A second reason is that, for some people, the reduction in longevity risk isn’t terribly important (or, at least, it isn’t their only concern).

For example, if your standard of living is already quite safe (e.g., because your spouse has a government pension that satisfies your desired spending level or because your portfolio is large enough to satisfy your desired spending level with a super low withdrawal rate), you have no need for longevity insurance. As a result, your goal with Social Security planning should simply be to maximize the total dollars at your disposal during your lifetime. And for those purposes, break-even analysis is a very useful tool.

And many people are somewhere in the middle. They are concerned about maintaining their living standard, but they’re also interested in leaving money to heirs. So it makes sense to look at the question from both perspectives.


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Investing Blog Roundup: Dividend Stock Investing

One of the more common strategies for active stock selection is to be a dividend investor — buying stocks with favorable dividend characteristics (e.g., high yield, stability of dividends, or high rate of dividend growth). This week blogger Darrow Kirkpatrick gave what I found to be a very balanced discussion of the pros and cons of such a strategy. In the end, Kirkpatrick comes to the same conclusion that I have.

Investing Articles

Thanks for reading!

Is It Important for Your Financial Advisor to Be Local?

At the recent Bogleheads event, one investor had the following question:

“I’m planning to hire a financial advisor. I want somebody who can help me as I get older and possibly less able to make financial decisions and who can help my wife manage things after I’m gone. But the advisors I hear most about are people who live nowhere near me. How important is it that a financial advisor be in your local area?”

As you might imagine, the answer is, “it depends.”

How Do You Prefer to Communicate?

Firstly it depends on how comfortable you are with communicating remotely about very important topics/transactions.

For example, I personally prefer written communication rather than in-person communication for important topics. So I’ve never felt a need to meet face-to-face with the professionals with whom I work. My only communication with Austin Frakt — the coauthor of my most recent book — has been via email and phone. We’ve never met in person. And I’ve never even talked on the phone with any of the attorneys whose services I’ve used for my business. My communication with them has been nothing but email.

Alternatively, if you do feel the need for real-time, face-to-face discussions with your advisor, would you be comfortable talking via Skype? Or would you not be comfortable unless you were physically sitting in the same room as this person?

And don’t forget that if the goal for this advisory relationship is for the advisor to someday work with your spouse, your spouse’s communication preferences (rather than just your own) should be a high priority here. After your death or incapacitation, would your spouse be comfortable working with an advisor across the country, whom he/she has never met in person?

What Services Do You Need?

The question also depends to some extent on what type of services will be provided by the advisor.

For example, if all you’re looking for is portfolio management (i.e., picking an initial allocation, then rebalancing as necessary and tax-loss harvesting when advantageous), that’s a very impersonal service. Your portfolio is probably indistinguishable from the portfolios of many other investors, so the advisor will need little to no ongoing input from you about how to perform the required tasks.

In contrast, if you want your advisor to provide comprehensive financial planning services, there’s going to need to be quite a bit of ongoing communication between the two of you, so if you really don’t like doing that sort of thing remotely, a remote advisor probably isn’t a good idea.

In addition, if you’re looking for somebody with state-specific tax planning expertise, a local professional is certainly more likely to have that than an advisor many states away.

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