Biases: Fluid & Fuzzy vs Rational

In a perfect world, we would all make optimal decisions that would provide us with the greatest value and satisfaction.  In economics, the rational choice theory states that when you are presented with options, you would choose that which maximizes your personal satisfaction.  This theory assumes that you make your decision by weighing the costs and benefits, without emotion and external factors.  If it were only that simple.

Enter behavioral economics.  It draws on psychology and economics to try to explain why people sometimes make irrational decisions, i.e. not following predictions of economic models based on a consistently rational, self-interested, and “utility” maximizing approach?  Psychology explains this deviation of behavior from what is expected rationally to be caused by “biases.”  Common examples of biases include:

  • Anchoring- relying too heavily on one piece of information
  • Confirmation-focusing on information that confirms one’s preconceptions
  • Endowment-demanding much more for something owned than what you would be willing to pay to acquire it
  • FOMO- Fear of missing out- paying too much to get into the “game”
  • Loss aversion- valuing the pain of losing twice as much as the satisfaction of making a gain
  • Normalcy- refusing to plan for a potential disaster that has never happened before
  • Recency- predicting the future results by expected recent results to continue

Koen Smets’s recent article in the Behavioral Scientist “There is More to Behavioral Economics than Biases and Fallacies” defines behavioral economics as the field that confronts us with our deeply potentially irrational selves.  “We are bamboozled by biases, fooled by fallacies, entrapped by errors, hoodwinked by heuristics, deluded by illusions.”  Ouch.

This brings to mind Ebenezer Scrooge’s question of the Ghost of Christmas Future:  “Are these signs of things that will happen or may happen?”  Perfect question, Ebenezer.  Actually, there is a widespread misconception that biases explain or even produce behavior.  Biases merely describe behavior that may or may not be followed.  They are simply labels for an observed behavior that contradicts traditional economics’ simplified “rational” expectations.

The conversation about biases is generally negative:  they interfere with our decision making or undermine our health, wealth and happiness.  For example, consider loss aversion.  Ten of thousands of years ago, humans were more concerned about losing a week’s food supply than gaining an extra week’s.  Today, an individual might never invest their cash because of a fear of losing money and have the purchasing power of their funds decreased by inflation.  This loss aversion is part of our evolutionary DNA, but that doesn’t mean that we have to exhibit that behavior.

Biases are tendencies that are not uniformly shared or employed.  Mr. Smet describes human behavior as “fluid and fuzzy.” These days, speed and simplification are keys and behavior based on biases is increasing.  Knowing that people are taking shortcuts, marketing has really stepped up its game.

“Heuristics” are really becoming huge. They are the various techniques we use to solve problems, learn or discover by using shortcuts.  Persuasion heuristics save us time and effort in making many of the hundreds of decisions we are confronted with each day.  Robert Cialdini, author of “Persuasion and Marketing” and political consultant, offers six key principles to persuading (or perhaps hoodwinking) a consumer using heuristics:

  • Authority-the voice or face of authority drives results. (Celebrity endorsements work)
  • Commitment and Consistency-consistent follow through establishes trust (Repetition works)
  • Scarcity-create hype based on time limits and expirations. (I see this every time I go to book a hotel room)
  • Liking-people are persuaded by others liking something. (Tripadvisor)
  • Social Proof- Show evidence of results. (People like to hear positive statistics-whether or not they are true)
  • Reciprocity-Offer discounts, free trials, sample products (people tend to “return a favor”)

We know biases exist. Some of them are in our DNA; some we learn over time.  At the same time, people and companies are aware of these potential biases as they are marketing their products, services, or suggestions.  Certainly, for many small decisions we need to make every day, there is no problem with taking a shortcut and even employing a bias.

However, when it comes to really important decisions, such as your wealth and happiness, it’s time to step up your game and move from fluid and fuzzy to rational.  These very important decisions generally take more time and require more due diligence.   You need to make sure you thoroughly and objectively understand and investigate choices and understand the likely risks and rewards of each.  To keep yourself “bias-free” at these times, you may benefit from having the expertise, skill and objectivity of a wealth manager like DWM who works with these important matters every day.  There’s a time for fluid and fuzzy and a time for rationality.  We’re here to help you when it’s time for rationality. Give us a call.

 

 

 

 

 

Happy Independence Day!

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Everyone at DWM hopes you and yours will have an excellent celebration with family and friends on July 4th! Hopefully, there will be family reunions, great food, baseball games, picnics, parades, fireworks and more. Have a wonderful time!

We also hope you take a few minutes to think about why we celebrate July 4th. As many of you recall, Thomas Jefferson was the principal author of the Declaration of Independence, though John Adams, Benjamin Franklin and other members of Congress made 86 changes to the document before it was approved on July 4, 1776.   The Declaration consists of three main parts. First, it declares the rights of citizens. Second, it lists the grievances against England’s King George III. And, third, it makes a formal claim of independence.

The most famous words of the Declaration of Independence are:

“We hold these words to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of happiness.”

These powerful words still apply today. We hope that you, your family and all Americans are enjoying your life, liberty and pursuit of happiness on Independence Day and throughout the entire year!

Emptying the Nest

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It is an exciting time of year when smiling faces in caps and gowns are seen everywhere! Recently having the pleasure to witness my son’s graduation, the President of the University of South Carolina made sure that the graduates took the time to thank their parents for helping them get to this important occasion. Absolutely! So, congratulations, parents! Turning 21 or graduating from college are exciting milestones and your kids have now reached what we all consider to be the beginning of “adulthood” as they get ready to enter the “real” world. Kids grow up in all different ways and in all different stages – is your young adult ready for launch?

At DWM, we like to offer proactive financial advice for all members of our clients’ families. As your young adult is readying to depart the nest, however that looks, we think this is a good opportunity to provide some education, as they take the reins of their own financial future. Many college-aged kids have had a student checking account and understand how to use their debit card pretty well by now! They probably have some experience with having a job and budgeting for things they want to buy in the short term. However, some of the more complex financial topics can be intimidating for young adults, While they may have a solid background in finance, it is always good to review concepts like compound interest, building good credit, taxes, buying insurance and understanding 401(k)s, for once they land that first “real” job! We might suggest that a good place to start is by getting a copy of The Wall Street Journal. Guide to Starting Your Financial Life by Karen Blumenthal (https://www.amazon.com/Street-Journal-Guide-Starting-Financial/dp/030740708X ). This book covers issues about renting or buying your first home, basic investing, taxes, purchasing health insurance, buying a car, establishing good credit and saving for retirement, among other topics. Might make a perfect college graduation or 21st birthday gift!

In addition, this is a good time to help them make sure all of their accounts are properly set up, titled appropriately and that they have a savings program in place. Reaching the age of majority, which is age 21 for both Illinois and South Carolina, is a good time to change any custodial accounts like a UTMA and UGMA to individual accounts. It may also be helpful to talk about debt, perhaps review student loans and consider opening a credit card account to establish some credit history. Using debt wisely, having a good emergency fund and responsible budgeting are all really valuable conversations and will help your young adult navigate their new financial map.

Encouraging saving and investing is a fundamental lesson and the “pay yourself first” concept is an important one. Remind them that they are paying their future self and that, just like the rewards for eating right, exercising and wearing sunscreen, saving and investing will benefit the health of their future self (as well as their current self!).

One idea that might help is having an automatic savings app like the one found in The College Investor article https://thecollegeinvestor.com/17610/top-automatic-savings-apps/. Also from The College Investor, you can find numerous financial and investing podcasts available that your young adult may take interest in. Here’s the link to get started: https://thecollegeinvestor.com/6778/top-investing-podcasts/. Or maybe they would want a subscription that focuses on the economy, like The Economist or Wall Street Journal.

If working and the business offers it, they should always make sure to contribute to their 401(k) to get the most advantage of any company match. And, if they don’t already have one, starting a Roth account is another great investment savings vehicle, especially while their starting incomes and lower tax brackets will allow them the opportunity to make annual contributions. Up to $5,500 of their earned income can be directly contributed to a Roth account and the compounded gains will never be taxed. Your young adult can set up automatic transfers to investment accounts or savings vehicles so they get used to not seeing those funds in their everyday account, just like 401(k) contributions. It is a great way to plant the seeds for a successful future!

Once the young adult has gotten some traction and they have good financial habits in motion, encourage them to contact us and check out the Emerging Investors program at DWM http://www.dwmgmt.com/investors/. You can learn even more about the EI program by clicking on this link and accessing one of our recent blogs written by Jake Rickord http://dwmgmt.com/archives-blog/index.php/2017/11/. Our Emerging Investors program offers a specialized financial planning model with DWM investment strategies that uses the automated Schwab IIP platform. Our goal is to help them graduate to full DWM Total Wealth Management clients down the road. The best way to reach the level of a TWM client is not just by higher earning, but by stronger and earlier investing. We love to educate and help others plan for their financial future. We are always available if you or your young adult have any questions and would certainly welcome feedback.   Please let us know how we can be of assistance!

 

Rates keep going up! Should I Still Buy That McMansion I’ve Been Dreaming of??

BMIFeature-Rising-Rates-Minimal.pngThe ultra-inexpensive era of mortgage rates is coming to an end, and quickly. Mortgage rates have reached unprecedented 7-year highs. The average 30-year mortgage this week will cost consumers 4.7%, up nearly a full 1% from 2016.

While a 1% increase may not seem like the end of the world, it is important to realize the effect this may have over the course of a mortgage. Consider a consumer who purchased a home with a $200,000 mortgage in 2016. Assuming a 3.7% interest rate, this would amount to a principal and interest monthly payment of $921. In today’s environment, the same consumer may have a monthly payment of $1,037. Over the life of a conventional 30-year mortgage, today’s consumers may pay $41,760 more than those who locked in a rate in 2016.

Reviewing rates in today’s environment may leave some consumers discouraged. However, in comparison to many historical rates, today’s rates are actually relatively low. Take 1981, for example, when the average 30-year mortgage rate was 16.64%. Using a 16.64% interest rate, a $200,000 mortgage in 1981 would cost the consumer $2,793 per month, or, over the course of 30 years, $632,160 more than a consumer today.

For those looking to purchase a new home, the question remains: Is now a good time to buy? The answer is not so simple. There are a few factors to consider before determining if it’s the right time to buy for you.

First of all, as the economy improves overall, mortgage rates are likely to continue to increase. The culprit behind increased mortgage rates is actually surging wage growth. According to the Census and Bureau of Labor Statistics, average household income is at an all-time high, while mortgage rates have been laying low—until now. As wage growth continues to increase the money supply to consumers, consumer spending power increases. Unfortunately, increased consumer spending also increases demand for goods and will ultimately raise the price of goods–inflation.

With the expectation of rising inflation comes a steady increase in the yield of the 10-year Treasury note. The yield on the 10-year Treasury note, which usually affects the 30-year mortgage rate, has risen to its highest close since 2011, ending up at just over 3.1%.

In addition, the Federal Reserve has indicated that it will be raising short-term rates at least three to four times this year alone, and potentially several more times in the coming years.

Current home owners should also not expect to refinance anytime soon. As rates rise, the group of homeowners who would benefit from or be eligible for mortgage refinancing has decreased drastically by 46% this year, according to Black Knight Inc.—the smallest group since 2008.

But with mortgage rates trending upward and no sign of lowering again in sight, many people are choosing to strike while they still have the chance.

Overall, your decision depends on if you want to wait it out and hope that mortgages rates will decrease again, or if you want to buy now while the rates are still relatively low, even with the 1% jump. One effective tip to help counteract for the increase in mortgage rates is to lower your price range accordingly and look for a house priced lower than what you would have pursued had mortgage rates remained at their lowest point.

Of course, there are many other factors besides mortgage rates which may affect a consumer’s decision to purchase a home. For example, economic factors such as rising rents, home appreciation, and predictable monthly housing payments.

Bottom line: Rising rates are expected to continue for some time, so it is important to weigh all factors at play and make the decision that’s right for you today and in the future.

First Grexit, Then Brexit, Now Itexit?

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The future of the EU is in question again- for the 3rd time in 4 years. In June 2015, the Greek financial crisis brought us Grexit. Two years later, the Brexit vote passed. And, now we may have Itexit. The political turmoil in Italy could result in Italy renouncing the euro and reviving the lira. Italy was a founding member of the EU and its exit could cause severe economic disruptions worldwide.

The two parties that won the March 4th Italian elections, the Five Star Movement and the League, have been hostile toward EU rules and the interference by Brussels in Italy’s affairs. They joined forces to form a government and proposed euroskeptic Paolo Savona as their choice for economics minister. Mr. Savona co-authored a blueprint for Italy to leave the EU. Current Italian President Sergio Mattarella rejected Mr. Savona and effectively collapsed the attempt to form a government. Mr. Mattarella’s Democratic Party has supported staying in the EU and was a big loser in the spring elections. Now, it looks like new elections later this summer are likely, which could amount to a referendum on Italy remaining in the EU.  

In 2015, Greek voters overwhelmingly rejected EU bailout terms requiring austerity. Greece defaulted on some of its debt and ultimately agreed to a third bailout, worth $100 billion, which imposed further cuts on spending. Grexit proved to be a powerful force for the Eurozone to work together and develop closer ties and more consistent and tougher fiscal rules. Greece is on schedule to be free from the burden of bailouts in August.

The UK is scheduled to withdraw from the EU on March 29, 2019, with a 21 month transition period out to December 31, 2020. Despite delays in negotiations, the UK government and UK opposition party say Brexit will happen. Since Brexit, the British pound first slumped, then regained its losses against the U.S. dollar, but has remained down 15% to the euro. Bank of England Governor Mark Carney indicated that Brexit has reduced UK GDP by $60 billion already. There is an ongoing debate as to what the relationship between the UK and the EU will be post-Brexit. If there is no agreement on trade, the UK would operate with the EU under World Trade Organization rules, which could mean customs checks and tariffs on goods as well as longer border checks. It could also mean Britain losing its position as a global financial center and its citizens living in other parts of the EU will lose their residency rights and health insurance. The next negotiation summit will be this June.

Before the euro, Italy had the power to raise or lower interest rates on their currency to impact its value. A cheap lira made Italian exports less expensive around the world, strengthening their economy at home. But, with the euro, Italy has no control over interest rates or prices. The populists, who did well in the recent elections, complained that their spending power has declined with the euro and EU membership has undermined Italian sovereignty. However, now Luigi di Maio, leader of the Five Star Movement, has said his party never supported leaving the euro.

Many experts agree that if Italy left the euro, it would be poorer, likely default on its debts and the lira would become greatly devalued. A default could lead to retribution from other countries and potential asset freezes and economic isolation. If this occurred, the trustworthiness of the euro as a currency would be questioned and the impact could destroy confidence in the EU itself.

Let’s hope Italy stays in the EU. The UK is starting to realize that the populism that brought Brexit can be quite expensive and painful. The Greeks certainly didn’t like austerity, but the tough rules of the EU put their country in a better spot. Itexit would harm Italians, the EU and the world. Let’s hope if there is a referendum, the Italians will vote for the greater good and stay in the EU.

The End of an Era

barbara-bush 2Barbara Bush was one of our country’s most cherished Grande Dames of politics and we were all saddened recently when she passed. With her signature white hair and pearls and her no-nonsense attitude, we were a little in awe, as well as inspired, by her example of family loyalty, faith, public service and good manners. She broke boundaries as the First Lady and championed education issues in her life, while remaining a loving wife and strong matriarch for her family. Regardless of what you think of her family’s politics, Barbara Bush was a woman to be admired.

Part of her legacy will now be the grace and dignity with which she managed her end of life. Surrounded by family at her home, she left this earth with the peace and comfort that we all might aspire to. Achieving that smooth and tranquil transition requires some planning, however. There are certain things that can and should be arranged and recorded ahead of time so that one’s loved ones are not unduly burdened and so that your own comfort and care are well-managed.

Caroline Feeney, in an article on wealthmanagement.com, recently outlined some of the lessons learned by watching Barbara Bush. We think these are valuable to review.

1.Understand Probate – Anyone who has been through probate will tell you to avoid it! Probate can be expensive, time-consuming and becomes part of the public record. Protecting your assets with proper titling and using a revocable or living trust can keep assets from going through the probate system. All revocable trusts remain private and anyone can set one up for their beneficiaries.

2.Plan for Contingencies – Think of all the scenarios that might come up. Select trustees and successor trustees with care and with a back-up plan. Consider the age, health and circumstances of beneficiaries, like substance addiction or divorce protection, when determining the age or terms of your designations.

3.Personal Property Memorandum – These are the softer, more sentimental items that you own. Houses and cars are protected by a trust or designated titling and a personal property memo provides a plan for the smaller tangible items. Someone will have to address these personal belongings when you are gone and, since you know them best, you should outline your plans for taking care of them. You only need to refer to the memo in a will or trust for it to be legally recorded. The list can be changed and updated, as you see fit, without involving a lawyer each time!

4.Palliative Care – Less than 30% of people have a Health Care Power of Attorney (HCPOA) that spells out the kind of care you want to receive and the people that you want making the decisions on your behalf if you cannot. The HCPOA allows an agent to make health care decisions, if you are incapacitated, for things like life support, tube feeding or organ donation. Consider those that might not be overcome with grief as agents who are tasked to comply with your wishes.

5.Prepare an inventory of all accounts – This includes a list of all bank and investment accounts with passwords, as well as all digital assets, including social media accounts. You can use a password vault or keep a handwritten list in a safe and then give access to one of your designated trustees.

6.Have Tax Planning Up to Date – The estate tax limits have increased in 2018 ($11.2M individual/$22.4M married couple), so most of us will not need to worry about estate taxes, unless the legislation changes again! It is still a good idea to have all of your information gathered, organized and up to date to make it easier for your executors, trustees and beneficiaries.

7.Designated Beneficiary Planning – We always help our clients make sure that all assets are titled properly, including real estate, investment accounts, qualified plans, bank accounts and life insurance policies.

8.Review Plan Regularly – Once you have a good plan in place, you should review it every year or two or as there are any life changes. At DWM, we keep copies of your documents with our own summary “estate flow” to help manage this.

9.Use Professionals! – This includes a recommended estate attorney to prepare your plan, as well as a professional wealth manager, like DWM, to review it.

10.Everyone Can Have an Estate Plan – You don’t need to be a famous, well-connected political icon, like Barbara Bush, to be thoroughly prepared.

Estate planning can be a daunting and sometimes complicated task. Many of our clients have trepidation about the process when starting, but every one of them feel a great deal of relief and accomplishment when they have done all the work and have a good estate plan in place. Helping our clients navigate all of the requirements and considerations of estate planning is a very important and satisfying part of what we do at DWM. We are not lawyers, but we know our clients well and can help them understand the many objectives and appropriate pieces of a good customized estate plan. Please let us know if you would like to review your estate plan with us!

Supreme Court Overturns Ban on Sports Gambling

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On Monday, the Supreme Court struck down the 1992 federal law that said states couldn’t “sponsor, advertise, promote, license or authorize” sports gambling. The ruling in Murphy vs. NCAA agreed with New Jersey that the law was an intrusion into states’ rights to regulate activity within their borders. NJ had waged a six-year battle against the NCAA, NBA, NFL, MLB and NHL to allow sports betting. NJ will now join Nevada as the two states with legalized gambling. More will certainly follow. Illinois and South Carolina have already introduced bills and are moving towards legalization.

The states, the leagues and lots of others are all licking their chops to participate. The American Gaming Association estimates that $150 billion is wagered every year on illegal bets. Now, sports gambling could become more widespread, more systematic with an even larger market. Mark Cuban, owner of the Dallas Mavericks, believes that the overall value of sports franchises has doubled overnight. “It will increase interest in the arena or stadium, it will increase the viewership for customers online, and help traditional television networks.”

The NBA has discussed with state officials what it calls an “integrity fee” of 1% on all betting. The integrity fee would be needed, in part, to pay for more assistance to league officials to keep the league honest, thus policing players and coaches so that games are not “thrown” to win bets. MLB has proposed a .25% integrity fee. Ted Leonsis, owner of both the Washington Capitals and Wizards, said that the sport franchises need to be paid “equitably” for the content and “intellectual property” they provide to television.

Pennsylvania last year passed legislation to allow sports betting, which included a 36% tax on sports betting revenue. Nevada’s rate is 6.75%. While some states may resist on moral grounds (Utah’s anti-gambling stance is written into its constitution), most will jump on the bandwagon as soon as possible. It has been estimated that $245 billion in legalized sports betting could generate $16 billion in additional state tax income.

Sports data companies, like Sportradar and gambling companies, like MGM and Caesars Entertainment, are hoping to cash in. The betting public can now come out of the “underground” market. Legal bookmakers should do well-Nevada sportsbooks haven’t had a losing month since 2013.

And what about the players and their salaries? If the NBA received a 1% fee, under the current union contract, half of that would be owed to the players. So, if $50 billion of NBA related sports betting produced a $500 million “bonus”, half of that would go to the players. And, this extra money might raise the salary cap and cause crazy gyrations with many top players changing teams.

However, there’s only so much money to go around. Last year, Nevada’s sportsbooks had a 5% profit margin, according to the state’s gaming board. A 1% “integrity fee” would represent 20% of the profit. With everyone fighting for their piece of the pie, legalized gambling may not take off as quickly as expected.

Joe Asher, chief executive of William Hill US, part of a major British sports betting operation, cautions that tax rates and league fees could add to the complexities: “It’s not going to be easy to move customers from the black market into the legal market.” Time will tell.

The Money Talk

It’s no secret that today’s standard high school and college curriculums are missing a few very important details. One of the most overlooked areas is basic financial education. Discussing finances with your children can be a difficult topic to broach, but it is critical to their success in the long run.

One common misconception of having “the money talk” is the idea that kids must be sheltered from financial issues. In some instances this is absolutely true, but having a basic discussion about finances and instilling good values in your children is important. “The money talk” shouldn’t be seen as taboo, but rather as an opportunity to guide your kids and help them navigate potentially tricky financial issues and decisions that arise.

Here are some tips to help as you approach “the money talk.”

 

1.Be honest.

 

Chances are that at some point in your life, you’ve experienced highs and lows in your finances. No need to hide it! These experiences provide a learning opportunity for your kids and allow you to be open and frank about the reality of financial decisions—they can handle it.

If you ran up debts in your past and had difficulty paying these back, this serves as an excellent teaching moment. Learning from those you respect can be just as effective as learning the lesson on your own.

Also, this may go without saying, but be careful not to spread falsehoods about your current financial situation. Remember, your kids can handle it and will almost always know when you’re not being completely honest with them.

 

2. Talk in values, not figures.

 

If you’re hesitant to share your financial situation with your children, that is normal. You are certainly not alone on this, but it doesn’t have to be scary. The good news is your kids don’t always want to know (or need to know) every detail of your financial life. Don’t sweat the small stuff—instead, focus on teaching them the basics. Ask yourself, what do they need to know, and what is often missed in standard education? Children should have a solid understanding of concepts such as saving, budgeting, paying down debt, developing healthy spending habits, and compounding interest.

 

3. Use real-world experiences.

 

Life is full of sporadic but important financial lessons that can be found in everyday experiences. It’s up to you to look for these opportunities and expand on them with your children.

If you’re going to the bank, you may consider taking your children with you. This is a great time to demonstrate how transactions work and, if applicable, how an ATM works. To take it a step further, you may even begin the discussion on how money can generate interest.

When your children start their first jobs and start receiving paychecks, this is a convenient time to discuss the importance of budgeting, paying bills, and taxes. Talk through what their goals are for each paycheck and how much they may need to save in order to accomplish these goals.

If you are planning a family trip, consider letting them in on the budgeting. Showing them your budget, planning activities you want to accomplish with this budget, and building a trip around this information will help make financial planning seem tangible to them. This may also be a good time to remind your kids that goals often require sacrifice, and not every trip activity will be accomplished.

Try giving your kids an allowance and taking them to the grocery store. The grocery store can be a clear example of “needs” vs. “wants.” Your children need nutrients but most certainly would like to have a few candies as well. However, with a set allowance, they won’t be able to afford them all!

In closing, whether you realize it or not, you play an important role in your children’s financial future. In their early years, they rely heavily on you for financial advice to help them form healthy financial habits (and the occasional $20 bill for the movies). At DWM, we feel it is essential to educate your children about finances early on, so they can be better prepared for the future. That’s why we created our new Emerging Investor program to help younger folks invest early on and get started on the path to financial freedom! To learn more about this exciting new program, check out the full description here: http://dwmgmt.com/blogs/123-2017-11-29-20-49-47.html.

Put Longevity into Your Planning

We’re living longer.  Back in 1935, when Social Security was started, there were 8 million Americans 65 or older.  Today, there are 50 million and by 2060 there will be 100 million 65 and older. It is projected that in 2033, the population of 65 and older will, for the first time, outnumber those under 18.

In addition, there is a better than average chance that 65 year old investors with at least $1 million of investable assets will reach age 100. These folks not only have enough money to cover rising costs, they are also generally more physically fit, healthier and engaged.  BTW- May is Older Americans Month, with a theme of “Engage at Every Age.”

Longevity is having and will have a huge impact not only on social security but also on long-term financial planning.  The trust fund for social security retirement benefits is expected to be depleted by 2034.  After that, the program is projected to pay out about 75% of benefits.  At that time, the ratio of workers paying into Social Security, as compared to those receiving benefits, is projected to drop from 2.8 now to 2.1 then. Last month, Ginny provided information on social security including possible fixes http://www.dwmgmt.com/blogs/142-happy-national-social-security-month-.html.  We hope Washington will enact some appropriate changes soon, though we can’t control that process.

We can, however, control our own financial planning.  Here are some general tips on incorporating longevity into your planning:

  1. Plan based on living longer. For those of you in great health, use an eventual age past the actuarial age, perhaps even age 100.  Your plan may end sooner, but let’s make sure the plan is designed for you to have sufficient funds during your life time.
  2. Plan on your normal retirement expenses continuing until at least age 90. Most older Americans we know are engaged. They are working and volunteering, traveling, mentoring, learning, and participating in activities that enrich their physical, mental and emotional well-being.  Don’t expect your normal expenses to start declining before age 90.
  3. Plan on health care costs escalating faster than inflation. Investors worldwide agree that health expenses are their biggest financial concern related to longevity. This worry is most acute in the U.S. with 69% listing it as their number one worry, versus 52% globally.  We are currently using 6% as the estimated annual increase in health care costs in our planning for clients.
  4. Review your long-term care strategy early. Long-term care costs can be huge.  On the other hand, your plan might “end” without you ever needing long-term care.  What would be the cost and best way to insure? Should you self-insure?  Should you keep your current policy?  Should you modify it?  Every financial plan needs to address long-term care and develop an appropriate strategy.
  5. Use an ample estimate for inflation. Inflation can have a huge impact on expenses over a long period of time.  You should stress test the plan at inflation rates above 2%, such as 3% or higher.
  6. Use a realistic real return for investments. The real return for your investments is defined as your total return (which is the price change over the period + dividends/interest) less inflation.  From 1950 to 2009, the real return was 7%; composed of an 11% total return less 4% inflation.  Of course, the 50s, 80s and 90s all had double digit real returns.  Today, it’s a good idea for you to stress test your plan projections using lower real return assumptions like 2.5% to 4%, depending on your time horizon and asset allocation.
  7. Consider separating travel goals into two parts. When you are retired and mobile, your travel will likely be primarily for you (and your significant other) and may include your children and/or grandchildren. As you get older and can’t travel easily yourself, you might still provide a second travel goal to cover transportation of the kids and grandkids to come visit you.
  8. Don’t count on too much from Social Security. We work with successful people of all ages.  We think that long-term social security benefits may be subject in the future to some “means test,” perhaps the same way that Medicare Part B premium costs are tied to taxable income.  The younger you are now and more financially successful you are in your life will likely reduce the amount of social security you will eventually receive.  If you are not starting social security soon, consider using discounted values of future social security benefits in your planning.
  9. Work to have a planning graph that doesn’t go “downhill.” Our financial goal plans show a graph of portfolio value over time, beginning now until your plan ends.  If expenses and taxes exceed income and investment earnings in any year, then the portfolio declines.  If that situation continues, then the graph looks as if it is heading “downhill.”  A solid plan results in the graph moving uphill over time or at least staying level.  A solid plan therefore reduces anxiety about longevity as, year by year, the portfolio value stays “solid” without diminishing.

 

Just like possible changes in social security, none of us can control our future health or when our plan will end.  We can however, develop, monitor and maintain a long-term financial plan that will provide us with the best chances for financial success by recognizing the possibilities of longevity and incorporating it into all aspects of our planning.  We can also adopt and/or confirm an objective to “Engage at Every Age” for our own well-being, as well as making a difference in other’s lives.   If you have any questions, please give us a call.

 

Happy National Social Security Month!

Many Americans are worried about the state of Social Security and the possibility that benefits will be reduced or even disappear in the future. Even those already collecting Social Security benefits may be concerned that their monthly check could be impacted by the swelling population of beneficiaries and the inability of the taxes collected from the current workforce to keep up with the demand.

Every April, the Social Security Administration celebrates with a month of highlighting the agency’s mission to “promote economic security” and educating all of us on their programs and services. Social Security was originally created by President Roosevelt in 1935, as part of his New Deal plan, to develop a comprehensive social insurance program. There are three parts to the benefits in Social Security – retirement benefits, survivor and death benefits and disability benefits. This is a pay-as-you-go system, so the payroll taxes paid by the workers and employers today fund the benefits for the beneficiaries of the three SS programs.

Social Security is the single largest federal program and accounts for around 24% of all federal spending. According to the most recent report from the Social Security Administration, the benefits paid out by the Social Security retirement program will be more than what’s paid in, starting in 2020. When the program started in 1935, many workers paid into the program, but few lived long enough after retirement age to collect much in the way of benefits. The Social Security Trust Fund was created when the taxes collected surpassed benefits that were paid out. However, in 2010, the government starting dipping into these reserves to address the insufficient revenue. This trust fund is expected to be completely depleted by 2034 and benefits could be reduced to 75%-80% of current payments, unless something changes that will increase the money going into the trust fund or decrease the amounts being paid out.

We have all heard about Social Security benefits running out and have heard about the need for reform. We jokingly thank the Millenials for supporting something from which they may never recoup any income. But it really is a serious issue for the many Americans who have not saved enough on their own. As Investment News contributor, Mary Beth Franklin, notes, “By 2030, all baby boomers will be older than 65, meaning one in every five U.S. residents will be of retirement age”. This, of course, will put critical stress on the entire Social Security program.

So what can be done? Each year, the Social Security trustees use their annual reports to recommend that lawmakers address the projected trust fund shortfalls. We have heard about “means testing” for benefits, which already impacts Medicare Part B premiums. Means testing could take the form of more income taxes, a reduction in benefits, a surtax or some other method to correct the program shortfalls. Another possible solution talks about tying Social Security benefit checks to prices rather than wages, as price increases are slower than wage growth. This could correct shortfalls over time, but may present other undesirable effects. In a recent article, Ramesh Ponnuru, a Bloomberg View columnist, notes, “An implication of that change [using prices over wages] is that over time Social Security would replace a smaller and smaller portion of the income people made during their working lives.”

Congress is looking at a tactic to address the problem of insufficient retirement savings with a bi-partisan (remember that word?) bill, the Retirement Enhancement and Savings Act (RESA). This legislation would create a retirement savings program allowing access for workers who may not currently contribute to an employer-sponsored retirement plan. It would also offer a collective ‘multi-employer plan’ (MEP) that allows small businesses to share in the costs of plan administration and make it easier for them to offer retirement savings plans to their employees. The more that Americans can save on their own, the less of an impact SS benefit shortfalls will have.

We will continue to watch and wait for the legislators and administrators to solve this problem with Social Security. At DWM, we are all about helping you determine ways to save more, protect that savings and then invest it to have appropriate growth to achieve your goals. We work hard to help our “vintage” clients evaluate all of their options and strategies when applying for Social Security benefits. Benefits taken at the earliest age of 62 will reduce your lifetime benefits, while waiting to begin until the maximum age of 70 can increase your benefits by 8% a year after Full Retirement Age (FRA) is reached. We evaluate which is the most effective strategy for each client – whether waiting and maximizing your benefits or starting benefits at FRA and possibly avoiding any benefit changes that may occur. There is much to consider, but we are here to help navigate the sign-up, the strategy choices and all of the tax implications involved. Please let us know if we can help enhance YOUR retirement savings!