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Investing Blog Roundup: T-Shares for Mutual Funds

In recent decades, investors have been putting considerable pressure on mutual fund companies to lower their costs. Morningstar’s John Rekenthaler argues that the same thing is beginning to happen with the cost of advisory services. The new “T” share class for advisor-sold mutual funds is one example of such pressures.

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The (un)Importance of Social Security Full Retirement Age

A reader writes in, asking:

“I read over and over that it’s ideal to wait until 70 to file for social security but that it’s important to wait until at least full retirement age. But what is special about full retirement age exactly? Am I wrong in thinking that it is not much better or worse than a year earlier or later?”

No, you are not wrong.

In terms of general Social Security rules, full retirement age is important because:

  • It’s the reference point around which your benefit is calculated (with a reduction for filing early and a bonus for filing later),
  • It’s the earliest date at which you can suspend benefits (though that’s much less frequently relevant these days after the changes made in 2015), and
  • It’s the point at which the earnings test is no longer applicable.

And full retirement age is often the best age at which to file for spousal or survivor benefits because:

  • It’s the point at which survivor benefits and spousal benefits stop growing (i.e., there’s no increase for waiting until 70), and
  • It’s the earliest date at which you can file a restricted application for spousal benefits (i.e., an application for just spousal benefits) for those who are still eligible to do so (i.e., anybody who was at least 62 years old as of 1/1/2016).

But, from the perspective of when to start receiving your own retirement benefits, full retirement age is nothing special. It’s just one of 96 possible months at which you can start taking benefits.

And in fact, of those 96 months, the first one and the last one (62 and 70) come up much more frequently than other months as the optimal time to start benefits.

If you could claim at any age (i.e., with delayed retirement credits earned for delaying beyond age 70 and with early claiming available prior to 62 — with an accompanying penalty), people in particularly good health would often want to wait well past age 70. And people in very poor health would often want to claim very early — perhaps in their 50s even.

But those aren’t options. So everybody who would be best served by claiming prior to 62 (if such were an option) will find “claim at 62” to be the best strategy. And everybody who would be best served by claiming later than 70 (if such were an option) will find “claim at 70” to be the best strategy.

In other words, yes, it is very uncommon that full retirement age happens to be the best answer for when to start receiving retirement benefits. (And for both spouses to start receiving retirement benefits at full retirement age is almost surely a mistake. In most cases, that would be a dominated strategy.)

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Investing Blog Roundup: Opening, Middle Game and Endgame of Retirement Planning

Retirement can last quite a long time. And, as Dirk Cotton points out this week, the risks facing you and strategies available to you are different from one stage of retirement to another. And it would be wise to explicitly account for such changes when crafting a retirement plan.

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Why Forex (Foreign Currency Trading) Is Useless and Dangerous for Most Investors

A reader writes in, asking:

“I recently saw an article that said that forex trading was invented to be a risk reduction tool. The nature of the rest of the article gave me the impression that it was just fear-mongering. Make me scared about the fate of U.S. Dollars so I turn my money over to them. But if you could discuss the matter in an article on your blog I’d be interested to read it.”

In some cases — which are rare for individual investors — currency-related investment products can be helpful as a way to reduce risk.

Example: Theresa is a self-employed engineer. She lives in the US (and therefore spends pretty much exclusively in dollars), but the majority of her revenue this year will come from completing a project for a client in the UK — a project for which she’ll be paid £70,000. She anticipates completing the project in October. If she wants to, she could use currency futures to “lock in” the current exchange rate so that she knows how much the £70,000 will actually be worth to her (i.e., in dollars), thereby allowing her to budget her finances accordingly.

Most people, however, are paid in the same currency in which they spend. So there’s no need to offset any such risk.

In fact, for most individual investors, foreign currency trading is not only pointless but also harmful.

Firstly, investing in currency is a zero-sum game, before costs. That is, with forex, the investment you’re holding is a currency (or a derivative product whose performance is based on the price of a currency), and currencies do not actually earn any money. (This is quite different from stocks and bonds, which do on average earn money.) With a forex trade, if one party earns money, it is solely because the party on the other side of the trade lost money. And, after accounting for transaction costs, the total amount earned by the two parties is not zero, but negative.

Second, forex allows for degrees of leverage (i.e., investing with borrowed money) that are truly insane for an individual investor. Forex brokers typically allow for 50:1 leverage, meaning that for each $1,000 you invest, you can buy $50,000 of something by borrowing the other $49,000. Investing this much borrowed money wildly magnifies your results, whether good or bad. Of course, the fact that you can borrow huge amounts of money doesn’t mean you have to. But forex does give you the tools to absolutely destroy your finances in a hurry.

Finally, most individual investors don’t engage in currency trading. As a result, you’re engaging in a zero-sum game (negative, after costs) with people who are, in most cases, professionals. They likely have more experience, better skills, and more information than you have.

Investing Blog Roundup: Americans Contributing More to 401(k) Plans

There’s a general consensus that, when it comes to funding retirement, we have a problem — some say an impending crisis, even. In short, most people aren’t saving enough money.

There is, however, some good news. Specifically, people are saving more than they used to. And there’s good reason to think that the trend will continue, because it’s largely the result of new policies in 401(k) plans (most importantly automatic enrollment, but also reasonable default investment options and lower costs), which aren’t likely to go away any time soon.

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How Pensions and Social Security Affect Asset Allocation

A reader writes in, asking:

“I am a retired government employee, and I receive a pension to the tune of roughly $50,000 annually. I have a relatively low risk portfolio; it is a mix of stuff but roughly 20-25% is in stock with the rest in bonds or CDs. I recently met with an adviser who said that my pension is essentially a big bond so it’s a mistake to have such low risk holdings in my retirement accounts. This is the first time I’d heard of this idea before. What do you think?”

It is a very common idea for people to count their pension or Social Security income as a bond holding. Many financial advisors and writers suggest doing so. Industry luminary John Bogle suggests doing so as well.

Personally, I do not like the idea because:

  1. It is confusing to many people, and
  2. It encourages people to use higher-risk allocations in their portfolios as a result of their pension/Social Security income, when in many cases the correct approach is to do exactly the opposite.

Instead, I think it is easier and more helpful to think of a pension (or Social Security) as exactly what it is: income.

For example if you plan to spend $60,000 per year, and you have pension/Social Security income of $50,000 per year, then you only have to spend $10,000 per year from your portfolio. In other words, your pension/Social Security income allows you to use a withdrawal rate that is one-sixth the withdrawal rate you’d have to use if you didn’t have such income.

What this does is it allows you to choose from a broader range of asset allocation choices.

That is, you could say, “my pension satisfies my basic needs. Therefore, I can afford to shoot for the moon with my portfolio, taking a lot of risk in the hope of achieving very high spending or a large inheritance for my kids.” Or, just as reasonably, you could say, “my pension satisfies my basic needs. Therefore, I have no need to take risk in my portfolio at all. I’ll stick to very safe holdings like TIPS, I-Bonds, and CDs, so that I don’t mess up a good thing.”

Either approach can be perfectly reasonable, and the correct answer depends on your personal risk preferences.

It is a mistake, in my view, to say that a person should necessarily take on more risk in their portfolio as a result of having a large pension (or other safe source of income).

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