Here are a few articles we were reading this month that we wanted to pass along to you. Enjoy!
Michael Kitces (Kitces.com) is well known for his writing on financial planning topics. In times like these where major legislation is on the forefront of changing the American tax system, he truly shines with a thorough breakdown of the House Republican tax plan. Keep in mind, this article was written on November 3rd and does not cover the Senate bill that passed in the early hours of Saturday morning. However, there are enough synergies between the House and the Senate for you to get a sense of what areas are being looked at.
As always, his comment section is also very active with thoughts on the specific rule changes. If you are looking for a plain English introduction on what changes are on the horizon, this is a great place to start.
For a comparison to the Senate bill, visit this Wall Street Journal article (subscription required). The House and Senate plans will soon be reconciled to create a final bill for President Trump's signature.
With the explosive buzz (and outright explosive price) of Bitcoin in recent weeks, the discussion of cryptocurrencies has gone mainstream, with people lining up on either side to call Bitcoin the future of currency or a bubble that’s soon to pop. But to a large extent, the debate over Bitcoin misses the underlying point, which is that Bitcoin is just one particular (albeit the largest and most popular) digital currency for what is really revolution technology underlying it: the blockchain, which can potentially be applied to a wide range of problems beyond just digital currencies. The basic principle is to recognize that cash “works” because physical currency is hard to replicate (i.e., hard to counterfeit), which means it’s reasonably safe to assume that whoever has the currency owns the right to use it.
However, if you created a system that could perfectly account for who held the money at any particular time, then in theory you wouldn’t actually need the cash anymore… just the running ledger of who had the money last. Blockchain is that universally accessible digital ledger – dubbed a “chain” because changes can only be made by adding new information to the end, which ensures the historical transaction record is maintained (which is further replicated across networked computers around the globe, to ensure that no one hijacks and fakes new records in the blockchain). The significance of this structure is that it means there’s no central authority required to enforce the rules, because the structure of the blockchain makes it prohibitively expensive (in terms of computing power and electricity) to change prior links in the chain. But the efficacy of the blockchain structure isn’t just for maintaining a transaction ledger of digital currency as it changes hands; newer cryptocurrencies, like Ethereum, attaches “smart contracts” to its blockchain – miniprograms that can be triggered to execute under certain conditions, essentially turning any form of software into a decentralized blockchain executing commands.
For those distrusting of institutions, the idea of decentralized blockchains is highly appealing, though the challenge is that the lack of a central power also permits anonymity (which may be appealing in some cases, but also supports illicit behavior), and prevents anyone from being accountable if something goes wrong. As a result, newer iterations of the blockchain are exploring a form of “permissioned” ledger, where identities are known, but only by select parties (e.g., banks or governments). And others are trying to figure out how to stack more smart-contract capabilities into the blockchain (without making it computationally unwieldy). Nonetheless, the fundamental point is that regardless of whether Bitcoin itself is the future or not – and regardless of whether its current value is justified or not – the underlying blockchain it’s built upon may still be utterly transformative of how everything from banking and currencies, to other technology tools, operate in the future.
William Bengen’s 1994 article introduced the concept of the 4% rule for retirement withdrawals. He defined the sustainable spending rate as the percentage of retirement date assets which can be withdrawn, with this amount adjusted for inflation in subsequent years, such that the retirement portfolio is not depleted for at least thirty years.
Specifically, Bengen found that a 4% initial spending rate would have been sustainable in the worst-case scenario from US historical data over rolling thirty-year periods with a stock allocation of between 50 and 75%.
While this assumption may reflect the preferences of many retirees to smooth their spending as much as possible, real-world individuals inevitably vary their spending over time. Retirees will not play the implied game of chicken by keeping their spending constant as their portfolios plummet toward zero. It is an unrealistic assumption.
With flexibility, the initial withdrawal rate can increase by more than one might think on account of the synergies created through decreasing sequence risk. In this regard, estimates obtained with a constant inflation-adjusted spending assumption may be overly conservative for those willing and able to adjust their spending over time.
Beginning in January of 2018, the military is switching from a traditional pension based on compensation and years of service, to a new “blended” system that combines the military pension with government contributions to a defined contribution plan account (the government’s Thrift Savings Plan [TSP]). The impetus for the change is that under the current system, the military pension isn’t vested until someone has at least 20 years of service – thus also sometimes referred to as a “20 or nothing” program – yet the reality is that more than 80% of service members leave the military short of the 20-year minimum.
Accordingly, the new system will offer a pension that is 20% smaller, but service members will also receive contributions of 1% of their pay into their TSP account (with the ability to earn a match of up to 4%) in addition to any TSP contributions they make themselves, and a new midcareer bonus (to ameliorate the impact of the prior 20-or-nothing rule). Notably, the new system will also give those who reach the 20-year pension threshold the option to convert a portion of their pension into a lump sum instead. The new system will apply automatically to those who enlist in the armed forces after December 31st of 2017, while those with 12-or-more years of service by the end of this year will be grandfathered into the current system; however, those who are currently enlisted (or officers who are commissioned) but with less than 12 years of service must decide (irrevocably) whether to stay in the current system, or switch to the new one.
The switch will almost certainly be better for those who don’t expect to stay in the military for 20 years (as under the old system they wouldn’t get any military contributions), especially if they’re also ready to save and maximize the military match, while those who plan to stay may prefer the old/current system (with the caveat that if life changes and they can’t stay, the 20-or-nothing rule could adversely impact them later). And the Department of Defense has published a calculator tool to help make comparisons. Ultimately, those eligible for the switch will have the entirety of 2018 to make the decision to switch (though those who wait won’t get military contributions to their TSP in early 2018 before they actually make the change).
With the rise of the internet, affluent investors have a wide range of sources from which they can gather financial news and information… which can make it especially hard for financial advisors to get noticed amongst the hundreds of websites all competing for investor attention. Spectrem evaluated the behaviors of ultra-high-net-worth investors (those with >$25M of net worth) to determine where they obtain their financial news and information… and perhaps surprisingly found that the majority still read the traditional daily financial press (e.g., Wall Street Journal, Financial Times, etc.) to gather financial information (and almost 3/4ths of those over age 65). 40% of wealthy investors also read the weekly financial press (e.g., magazines and other weekly news outlets, that tend to provide more in-depth coverage).
But only 35% of HNW investors watch cable news shows for information. In the context of financial advisors in particular, Spectrem found that the ultra-HNW investor does look to their own advisor for information (65% of investors), and that younger investors were more likely to seek out information directly from their advisor than from other online sources. Although Spectrem also found that ultra-HNW investors are more likely to be using social media than those with lesser wealth, particularly on the Twitter and YouTube platforms.
In the never-ending treadmill of life, milestones provide a meaningful way to get oriented about your progress, and as a result are often cause for celebration… or at least, should be, as a way to reinforce our own good behaviors and progress. Accordingly, White Coat Investor sets forth a series of major financial milestones that anyone/everyone should consider celebrating to maintain their own positive financial momentum, including: Becoming “Worthless” (the moment when you pay off all your student loans and other debt, and actually achieve a non-negative net worth of $0!); Buying a home (especially given the effort it takes to get a good credit rating and save for a downpayment in your early years); Reaching a net worth of $100k (because reaching a round number and adding a digit to your net worth is a good cause for celebration to maintain the momentum!); a retirement portfolio of $100k (as it’s one thing to reach a total net worth of $100k, but another to have it in just your future-focused retirement accounts!); achieving a $500k net worth; buying your first new car with cash (of course, some people don’t want to buy new cars at all, but if you do, it’s great when you can do it without taking on debt!); a $1 million net worth; a $1 million retirement portfolio; being “done” with your saving, where growth alone can get you to retirement at age 65; paying off your mortgage (once upon a time people actually had a party and burned the mortgage note!); and reaching the final milestones where you have enough retirement savings to cover your basic needs, then all your needs at your current spending, and finally all your needs at your “desired” rate of spending, when you reach the true moment of financial independence.
In late 2009, the New York Times ran an article about how the financial crisis didn’t “just” affect the average American homeowner; the affluent, too, were feeling substantial financial distress. And the response was nearly “vitriolic”, with readers both showing little empathy for the plight of the affluent, but outrage at the author for caring in the first place! Which in turn raises the question of why, exactly, such hatred was directed at the affluent in the first place – as notwithstanding the dialogue of the time, that “the one percent” had rigged the system and caused the collapse, it was obviously clear that not “all” rich people were connected or to blame, even as classic stereotypes of greedy rich people dominated.
Accordingly, Klontz actually did a subject study to analyze more than 1,000 wealthy individuals, to try to actually evaluate whether and to what extent the stereotypes of the wealthy really were accurate or not. The results, published in a paper titled “The Wealthy: A Financial Psychological Profile”, and a related literature review, found that feelings of resentment towards the wealthy stem from three psychological constructs: 1) money ambivalence and cognitive dissonance (paradoxically, those most likely to endorse anti-wealth beliefs were actually more likely to have money-worship scripts, suggesting the dislike stemmed at least in part from the implicit frustration of desiring wealth and struggling to achieve it); 2) the psychology of envy, which can further amplify the cognitive dissonance, especially in situations where the rich person had a similar prior background (potentially making us feel inferior for not achieving a similar result from similar circumstances); and 3) the Theory of Relative Deprivation, which recognizes that we assess our own well-being less based on the absolute level of our income or financial success, and more based on our relative results to others (such that the more acutely aware we are of the wealth of others, the more relatively inferior it can make us feel).
Notably, though, Klontz also points out that the discomforts that some people experience due to disparities of income can lead us to put an effective ceiling on our own wealth to keep us in a “financial comfort zone” relative to our peers. In other words, not only can significant wealth gaps incur a dislike of those who are much wealthier than we are, but there’s a risk that in becoming wealthy and separating from our peers, we can even trigger a dislike of ourselves that leads us to self-sabotage our own financial success.
In this Reddit thread, Redditors share their experiences growing up in a “FIRE” (Financially Independent/Retired Early) household, and the impact it had on them, in a world where many fear that by retiring early it will leave a bad impression on their children (about not needing to work). Yet one person recounts how when his father retired early at age 45, he was able to take an active role in his kids’ educations, improved his personal health, and left a very positive impression on his son about how to work smart … though he also witnessed marital strife amongst his parents because his mother had not retired early (for unspecified reasons). And another shares a similar story of having a FIRE’d father (when he was in middle school) who was able to be very engaged in his child’s education and extracurriculars (with a positive outcome).
In fact, notwithstanding the common fear that retiring early will set a “bad example” for children, a common theme amongst most children of parents who FIRE’d was that their parents still ended out staying active and engaged somehow (even if it was engaged with their wealth, such as by managing their real estate properties), and that consequently their parents still set positive examples for them. In other words, at worst the “risk” of setting a bad work ethic example by retiring early is entirely in the hands of parents who retire early about whether they still find a way to set a good example. Though as one person stated it more simply: “I really wish my Dad had spent more time at work instead of with me when I was a kid… said no one, ever.”