MONEY retirement planning

This Popular Financial Advice Could Ruin Your Retirement

two tombstones, one saying $-RIP
iStock

The notion of "dying broke" continues to appeal to many Americans. That's too bad, since the strategy is ridiculously flawed.

You may have heard of the phrase “Die Broke,” made popular by the bestselling personal finance book of the same name published in 1997. The authors, Stephen M. Pollan and Mark Levine, argue that you should basically spend every penny of your wealth because “creating and maintaining an estate does nothing but damage the person doing the hoarding.” Saving is a fool’s game, they claim, while “dying broke offers you a way out of your current misery and into a place of joy and happiness.”

I love a good contrarian argument, but for whom did this plan ever make sense? Perhaps people like Bill Gates who have so much money that they decide to find charitable uses for their vast fortune. But for the rest of us, our end-of-life financial situation isn’t as nearly pretty, and we’re more likely to be in danger of falling short than dying with way too much.

In a recent survey, the Employee Benefit Research Institute found that 20.6% of people who died at ages 85 or older had no non-housing assets and 12.2% had no assets left at all when they passed away. If you are single, your chances of running out of money are even higher—24.6% of those who died at 85 or older had no non-housing assets left and 16.7% had nothing left at all.

Now, perhaps some of those people managed to time their demise perfectly to coincide when their bank balance reached zero, but it’s more likely that many of them ran out of money before they died, perhaps many years before.

And yet the “Die Broke” philosophy seems to have made significant headway in our culture. According to a 2015 HSBC survey of 16,000 people in 15 countries, 30% of American male retirees plan to “spend it all” rather than pass wealth down to future generations. (Interestingly, only 17% of women said that they planned to die broke.)

In terms of balancing spending versus saving, only 61% of men said that it is better to spend some money and save some to pass along, compared to 74% of women. Perhaps that’s why, as a nation, only 59% of working age Americans expect to leave an inheritance, compared to a global average of 74%.

There are so many things wrong with this picture. The first is that Pollan and Levine’s formula of spending for the rest of your life was predicated on working for the rest of your life. “In this new age, retirement is not only not worth striving for, it’s impossible for most and something you should do you best to avoid,” they wrote. Saving for retirement is certainly hard, and I don’t believe that all gratification should be delayed, but working just to spend keeps you on the treadmill in perpetuity.

Besides, even if some of us say we’re going to keep working all our lives, that decision is usually dictated by our employer, our health and the economy. Most of us won’t have the choice to work forever, and the data simply don’t support a huge wave of people delaying retirement into their 70s and 80s. And as I have written before, I don’t buy into the current conventional wisdom that planning for a real retirement is irrational.

But perhaps the most pernicious aspect of the “Die Broke” philosophy is that it takes away the incentive to our working life—to get up in the morning and do your best every day, knowing that it’s getting you closer to financial security—and the satisfaction that goes with it. In the end, I believe what will bring us the most happiness is not to die rich, or die broke, but to die secure.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

Read next: This Retirement Saving Mistake Could Cost You $43,000

MONEY Generation X

Why Gen Xers May Be More Prepared for Retirement Than Boomers

alarm clock
Erik Dreyer—Getty Images

In the face of future hardship, some Gen Xers are actually improving their savings habits.

It is generally acknowledged that Gen Xers are hugely disadvantaged when it comes to retirement security. Gen Xers entered the workforce just as companies began to abandon traditional pension plans for 401(k)s, which shift the burden of saving and investing from the employer to the employee. And while baby boomers still stand to collect their full Social Security benefits, Gen Xers are retiring just as the program’s trust fund is forecast to run dry—around 2033, according to the latest report. That could cut their payout by about a third.

And yet Gen Xers have one big advantage over boomers: time. Not only do they have more working years left to save in those 401(k)s, but their investments have longer to grow tax-deferred. According to projections from the Employee Benefit Research Institute, both Gen Xers and Baby Boomers face significant deficits in the amount of money that they need to retire comfortably, but the more years workers keep contributing to a 401(k), the more those shortfalls decrease.

For example, a Gen Xer assumed to have stopped saving in a 401(k) faces a current shortfall of $78,297, while one with at least 20 years of continued contributions could find the average shortfall at retirement reduced to only $16,782. (EBRI’s retirement savings shortfalls are discounted back to a present value of retirement deficits at age 65.)

Other research suggests Gen Xers are fully aware of the challenges they face and are taking steps to overcome them. In a recent survey by PNC Financial Services, 65% of Gen X respondents said that they believed that they were solely responsible for their own retirement with no expectation of Social Security, employer pension or inheritance, while only 45% of boomers believed that they were solely responsible.

The PNC survey polled more than more than 1000 “successful savers”—those ages 35 to 44 had a total of $50,000 in financial assets, or at least $100,000 if age 45 or older. Compared to boomers, Gen Xers have more aggressive portfolios, are more heavily invested in stocks, and worry more that their savings may not hold out for as long as they live.

Even the financial crisis seems to have affected the two generations differently. When asked the ways in which their thoughts about retirement planning have changed over the last six years, 51% of Gen Xers said that they planned to save more to reach their goals, compared to only 37% of Boomers. And in what’s the most encouraging finding I’ve yet seen about Gen X, 28% said that they have increased the amount that they typically save and invest since the recession, as opposed to 22% of baby boomers.

In other words, the financial crisis seemed to have served as something as a wake-up call for Gen Xers. In the face of future hardship, some are actually adjusting their behaviors instead of burying their heads in the sand. Despite the odds stacked against them, Gen Xers just might get pushed into habits of thrift and rise to meet the financial challenges ahead. The good news: time is on their side.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

Read next: Why Wary Investors May Keep the Bull Market Running

MONEY stocks

Are Your Stocks Too Popular?

Experts have long argued that popular stocks tend to be too expensive—but they may be wrong

Having neither the time nor the accounting skills to scrutinize balance sheets, I tend to leave stock picking to mutual fund managers or simply invest in index funds for my retirement savings. But way back in the 1990s I decided to open a cheap online trading account with National Discount Brokers (since bought by TD Ameritrade,) and deposited a tiny bit of “play money” to experiment with.

I’m not sure how much I’ve learned about the markets, but I’ve learned a lot about myself as an investor. I tend to like consumer stocks such as Apple and Dunkin’ Donuts, since they sell products that I personally use or consume. I am attracted to stocks that have a compelling story, a loyal and growing following, and big expansion plans. I also like media and entertainment companies, and tend to steer clear of companies in industries I don’t know much about, like airlines, energy, industrials, and health care. I’m not totally susceptible to fads and still care about “fundamentals” like price-to-earnings ratios, but my decisions are too-often based on what’s known to experts as “heuristics”—mental short cuts like extrapolating from anecdotal evidence, or sticking with the familiar.

In other words, I am attracted to the popular stocks, which means that I might be missing out on a lot of buying opportunities of more obscure, less glamorous companies that I’ve never heard of.

In a recent presentation at the Morningstar Institutional Conference, Roger Ibbotson of Yale School of Management and Zebra Capital called this tradeoff the “popularity premium,” which is the excess returns investors expect and demand from buying stocks that are unfamiliar and unexciting.

According to Ibbotson, it is the popularity of stocks that leads them to be priced higher relative to their less admired peers, an aspect of risk that is frequently ignored. (You can read more about his theory in this Journal of Portfolio Management article.) In his analysis of popular versus unpopular stocks, the least popular stocks outperformed the most popular stocks.

This would suggest that, for example, instead of flocking towards the cool crowd (Alibaba, say) I might have been wiser to buy that ball bearing company in Ohio that just completed a spin-off (Timken). “The stock that you’re going to be talking about this year at a cocktail party is not the same stock you’re going to be talking about next year,” says Ibbotson. “There is no such thing as a permanently popular stock.”

But what if, as some behavioral economists believe, the market is actually being dominated by investors who are drawn to justly well-known and admired stocks but not “fad” stocks that just happen to be the flavor of the week and lack genuine intrinsic value?

And further, what if, as C. Thomas Howard of the University of Denver and AthenaInvest proposed in his recent book Behavioral Portfolio Management, professional investors such as mutual fund managers recognize that tendency and wind up buying those same well-known and admired stocks as a result? After all, Howard explains, “funds must attract and retain emotional investors, which means catering to client emotions and taking on the features of the crowd. As the fund grows in size, it increasingly invests in those stocks favored by the crowd, since it is easier to attract and retain clients by investing in stocks to which clients are emotionally attached.”

If that’s true, then just as popularity can create inflated prices that will quickly be corrected by the market, it can also create market darlings whose popularity, while not necessarily invulnerable, certainly has some longer-term staying power. In other words, popularity in and of itself is not always a bad thing. The trick, of course, is knowing how long it might last, and a balance sheet won’t necessarily tell you that.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

MONEY retirement savings

Borrowing From Your 401(k) Might Not Be Such a Bad Thing

carton of gold eggs, some are empty
GP Kidd—Getty Images

Most loans get paid back. It's cashing out that's the problem.

“Leakage,” using 401(k) or IRA savings to pay for anything other than retirement, has become something of a bad word in the personal finance world. One policy wonk, Matt Fellowes, the founder and CEO of HelloWallet, took the metaphor even further when he wrote that “the large rate and systematic quality of the non-retirement uses of DC [defined contribution] assets indicates that these plans are now being ‘breached.’ This is a massive systematic problem that now affects 1 out of every 4 participants, on average—which is more like a gaping hole in the DC boat than a pesky ‘leak.’

But leaks come in different shapes and sizes, and it turns out that some of them—such as taking loans from your own account, which you then pay back with interest—are less dangerous to your future financial security than others. Data from Vanguard shows that 18% of people participating in plans offering loans had a loan outstanding in 2013, and about 11% took out a new loan that year, which sounds like a very high rate. But the average loan was about $9,500 and most of it gets repaid, so it actually doesn’t represent a permanent drain on retirement savings. “Loans are sometimes criticized as a source of revolving credit for the young, but in fact they are used more frequently by mid-career participants,” note Alicia Munnell and Anthony Webb of the Center for Retirement Research at Boston College.

The real problem is what is known as a “cash-out,” when employees take a lump-sum distribution when they change jobs, instead of keeping their savings in their employer’s plan, transferring it to their new employer’s 401(k), or rolling it into an IRA. These cash-outs are subject to a 10% early withdrawal penalty (if you’re under the age of 59½) and a 20% withholding tax. Vanguard reports that 29% of plan participants who left their jobs in 2013 took a cash distribution. Younger participants with lower balances are more likely to cash out than older ones.

Equally risky, although more difficult to obtain, are “hardship withdrawals,” which allow 401(k) plan participants to access funds if they can prove that they face an “immediate and heavy financial need,” such as to prevent an eviction or foreclosure or to pay for postsecondary tuition bills. As with cash-outs, these withdrawals are subject to a 10% penalty as well as 20% withholding for income tax. (You can take a non-penalized withdrawal if you become permanently disabled or to cover very large medical expenses.) Employees must prove that they’ve exhausted every other means, including taking a loan from their 401(k). The rules governing IRAs are much more relaxed and include taking penalty-free withdrawals of up to $10,000 to buy, build, or rebuild a first home or even to pay for medical insurance for those unemployed for 12 weeks or more—situations one might argue it would be better to have established a six-month emergency or house fund to cover instead of taking from your IRA.

Policy watchers such as Munnell and Webb recommend tightening up regulations to reduce leakage, arguing in particular that allowing participants to cash out of 401(k)s when they change jobs is “hard to defend” and that the mechanism could be closed down entirely by changing the law to prohibit lump-sum distributions upon termination. It would also make sense to make the rules for withdrawals from IRAs as strict as those from 401(k)s, since more and more assets are moving in that direction as people leave jobs and open rollover IRAs.

But perhaps the biggest lesson of leakage is that if people are reaching into their retirement funds to pay for basic needs such as housing or health insurance, they may be better off not participating in a 401(k) until they have enough emergency savings under their belt. Contributing to a retirement plan is important, but not if you turn your 401(k) into a short-terms savings vehicle and ignore basic budgeting and emergency planning.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

MONEY Aging

Are You Mentally Fit Enough to Plan for Retirement?

Book with money in it
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People's ability to make sound financial decisions declines with age—even as their confidence about it doesn't.

In this era of “self-directed” retirement (no pensions, you make all the investment choices) postponing making a real plan poses a particular risk to future security. Not only are the logistics of planning hard enough—when to collect Social Security, how to budget for expenses, what to do with savings—but the decline in cognition that accompanies normal aging has a measurable negative impact on the ability to make sound financial decisions.

In 2010, researchers at the Center for Retirement Research at Boston College tested the financial literacy of a group of older people in the Chicago area by asking them questions such as the relationship between bond prices and interest rates, the value of paying off credit card debt, and the historical differences between stock and bond returns. They then retested the group every year and found that, among some participants, even while their knowledge of personal finance and investing was eroding, they remained just as confident about managing “day to day financial matters.” And perhaps because they remained so confident, more than half of them retained primary responsibility for handling their finances as their ability to do so was becoming increasingly compromised. (Other studies have shown that financial literacy scores decline by about 1 percentage point a year after age 60. )

One particular area of concern, and one that is often overlooked when discussing the future income of retirees, is the level of debt that older Americans are taking on near or at retirement. Debt later in life is problematic for obvious reasons: Payments can strain your income at a point where active earning years are ending; debt offsets asset accumulation, which you may be forced to reduce in order to service the debt; and finally, leveraging large housing debt in particular may leave older Americans with less resources to finance an adequate retirement.

Recent data from the Employee Benefit Research Institute (EBRI) shows that the percentage of American families with heads ages 55 or older that had debt increased from 63.2% in 2010 to 65.4% in 2013, with housing debt as the major component. Moreover, the percentage of families with debt payments greater than 40% of their income also increased, from 8.5% in 2010 to 9.2% in 2013.

Just because you have debt does not in and of itself mean you’re in financial danger. Nor does growing older automatically throw you into the kind of cognitive decline that could seriously impair your financial decision-making. But now that individuals are fully responsible for their own retirement security, part of that responsibility must certainly include the possibility that time may leave you less rather than more equipped to make the right decisions. As the saying goes: hope for the best but plan for the worst.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

MONEY retirement planning

Why Women Are Less Prepared Than Men for Retirement

Women outpace men when it comes to saving, but they need to be more aggressive in their investing.

Part of me hates investment advice specifically geared towards women. I’ve looked at enough studies on sex differences—and the studies of the studies on sex differences—to know that making generalizations about human behavior based on sex chromosomes is bad science and that much of what we attribute to hardwired differences is probably culturally determined by the reinforcement of stereotype.

So I’m going to stick to the numbers to try and figure out if, as is usually portrayed, women are actually less prepared for retirement—and why. One helpful metric is the data collected from IRA plan administrators across the country by the Employment Benefit Research Institute (EBRI.) The study found that although men and women contribute almost the same to their IRAs on average—$3,995 for women and $4,023 for men in 2012—men wind up with much larger nest eggs over time. The average IRA balance for men in 2012, the latest year for which data is available, was $136,718 for men and only $75,140 for women.

And when it comes to 401(k)s, women are even more diligent savers than men, despite earning lower incomes on average. Data from Vanguard’s 2014 How America Saves study, a report on the 401(k) plans it administers, shows that women are more likely to enroll when sign up is voluntary, and at all salary levels they tend to contribute a higher percentage of their income to their plans. But among women earning higher salaries, their account balances lag those of their male counterparts.

It seems women are often falling short when it comes to the way they invest. At a recent conference on women and wealth, Sue Thompson, a managing director at Black Rock, cited results from their 2013 Global Investor Pulse survey that showed that only 26% of female respondents felt comfortable investing in the stock market compared to 44% of male respondents. Women are less likely to take on risk to increase returns, Thompson suggested. Considering women’s increased longevity, this caution can leave them unprepared for retirement.

Women historically have tended to outlive men by several years, and life expectancies are increasing. A man reaching age 65 today can expect to live, on average, until age 84.3 while a woman can expect to live until 86.6, according to the Social Security Administration. Better-educated people typically live longer than the averages. For upper-middle-class couples age 65 today, there’s a 43% chance that one or both will survive to at least age 95, according to the Society of Actuaries. And that surviving spouse is usually the woman.

To build the portfolio necessary to last through two or three decades of retirement, women should be putting more into stocks, not less, since equities offer the best shot at delivering inflation-beating growth. The goal is to learn to balance the risks and rewards of equities—and that’s something female professional money managers seem to excel at. Some surveys have shown that hedge fund managers who are women outperform their male counterparts because they don’t take on excessive risk. They also tend to trade less often; frequent trading has been shown to drag down performance, in part because of higher costs.

Given that the biggest risk facing women retirees is outliving their savings, they need to grow their investments as much as possible in the first few decades of savings. If it makes women uncomfortable to allocate the vast majority, if not all, of their portfolio to equities in those critical early years, they should remind themselves that even more so than men they have the benefit of a longer time horizon in which to ride out market ups and downs. And we should take inspiration from the female professional money managers in how to take calculated risks in order to reap the full benefits of higher returns.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

Read next: How to Boost Returns When Interest Rates Totally Stink

MONEY College

How to Balance Saving for Retirement With Saving for Your Kids’ College Education

Parents often find themselves between a rock and a hard place when it comes to doing what's best for themselves and their children. One financial adviser offers a formula to make it easier.

It’s a uniquely Gen X personal finance dilemma: Should those of us with young children be socking away our savings in 401(k)s and IRAs to make up for Social Security’s predicted shortfall, or in 529s to meet our children’s inevitably gigantic college tuition bills? Ideally, of course, we’d contribute to both—but that would require considerable discretionary income. If you have to chose one over the other, which should you pick?

There are two distinct schools of thought on the answer. The first advocates saving for retirement over college because it’s more important to ensure your own financial health. This is sort of an extension of the put-on-your-own-oxygen-mask-first maxim, and it certainly makes some sense: Your kids can always borrow for college, but you can’t really borrow for retirement, with the exception of a reverse home mortgage, which most advisers think is a terrible idea.

The flip side of this, however, is that while you can choose when to retire and delay it if necessary, you can’t really delay when your kid goes to college. Moreover, the cost of tuition has been rising at a much faster rate than inflation, another argument for making college savings a priority. Finally, many parents don’t want to saddle their young with an enormous amount of debt when they graduate.

According to a recent survey by Sallie Mae and Ipsos, out-of-pocket parental contributions for college, whether from current income or savings, increased in 2014, while borrowing by students and parents actually dropped to the lowest level in five years, perhaps the result of an improved economy and a bull market for stocks. But clearly, parents often find themselves between a rock and a hard place when it comes to doing what’s best for themselves and their children: While 21% of families did not rely on any financial aid or borrowing at all, 7% percent withdrew money from retirement accounts.

If you’re struggling with this decision, one approach that may help is to let time guide your choices, since starting early can make such a huge difference thanks to the power of compound interest. Ideally, this would mean participating in a 401(k) starting at age 25 and contributing anywhere from 10% to 15%, as is currently recommended. Do that for a decade, and even if your income is quite low, the early saving will put you way ahead of the game and give you more leeway for the next phase, which commences when you have children (or, for the sake of my model, when you’re 35).

As soon as your first child is born, open a 529 or similar college savings account. Put in as much money as possible, reducing your retirement contributions if you have to in order to again take advantage of the early start. Meanwhile, your retirement account can continue to grow on its own from reinvested dividends and, hopefully, positive returns. Throw anything you can into the 529s—from the smallest birthday check from grandma to your annual bonus—in the first five or so years of a child’s life, because pretty soon you will have to switch back to saving for retirement again.

By the time you’re 45, you will have two decades of saving and investing under your belt and two portfolios as a result, either of which you can continue to fund depending on its size and your cost calculations for both retirement and college. You probably also now have a substantially larger income and hopefully might be able to contribute to both simultanously moving forward, or make catch-up payments with one or the other if you see major shortfalls. At this point, however, retirement should once again be the central focus for the next decade—until your child heads off to college and you have start writing checks for living expenses, dorm fees, and textbooks. Don’t worry, you still have another 10 to 15 years to earn more money for retirement, although those contributions will have less long-term impact due to the shorter time horizon.

Of course, this strategy doesn’t guarantee that your kids won’t have to apply for scholarships or take out loans, or that you won’t have to put off retiring until 75. But at least you will know that you did everything in your power to try to plan in advance.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

 

 

 

 

 

MONEY stock investing

New Study Identifies the Most Underappreciated Investment Skill

The magic ingredient turns out to be…wait for it…patience.

Several years ago, two Yale business school professors gave the personal finance industry a jolt by devising a formula for determining how active so-called actively managed mutual funds really were. What they discovered was that the portfolios of many mutual funds were so similar to their benchmarks that they might as well be considered closet index funds—in which case investors were paying higher fees for no good reason. These closet index funds tended to underperform their benchmarks, but funds with the least overlap with their benchmarks—those with the highest Active Share as defined as the proportion of holdings that is different than their benchmarks—on average outperformed their benchmarks net of fees, according to their analysis.

Now one of the inventors of Active Share has identified another very important trait of successful mutual fund managers: patience. In a recent paper, Martijn Cremers, now of University of Notre Dame, and Ankur Pareek of Rutgers, analyzed a large sample of actively-managed all-equity U.S. retail mutual funds over a 19-year period (1995-2013) and found that only those with both high active share and patient investment strategies, where managers hold stocks longer instead of trading frequently, tended to outperform by an average of 2.3 percentage points a year, even after management costs were taken out.

Historically investors have been able to partially measure a fund manager’s patience with the self-reported Fund Turnover Ratio, which is the ratio of all sales to buys in the calendar year over the number of fund shares outstanding. The lower the ratio, the less turnover in the portfolio, but the measure is still limited to a year. Now Cremers and Pareek have introduced a different measure, called Fund Duration, which measures the length of time the fund has held $1 of equities in the portfolio over the last five years in order to identify the most “patient capital.”

How patient is patient? The median holding duration in their sample of funds was 14 months, but those funds in the top 20% for Fund Duration generally held stocks for more than 24 months. Interestingly, Cremers and Pareek have found that fund duration on average has been steadily increasing since 2001, and turnover ratios have correspondingly declined.

The authors are careful to point out that simply holding stocks for a long period of time is not associated with greater investment skill. Rather, active share matters most among funds with long durations, while among funds with short durations the difference in the performance between closet index funds and high active share funds is statistically insignificant. (They also analyzed institutional investors and hedge funds and found slightly different results.)

Some examples of mutual funds with both high active share and high fund duration as of 2013 included Baron Growth Fund, Royce Premier Fund, and Franklin Small Cap Value Fund. That doesn’t necessarily mean that you should rush out to invest in these funds today. But Cremers and Pareek’s findings do suggest that investors interested in active management should both make sure that a fund’s portfolio is truly distinct from its benchmark AND that the manager has a longer-term buy-and-hold strategy.

If that approach sounds Warren Buffett-like, indeed the researchers do attribute the outperformance of the most patient and active mutual fund managers to their (Buffett-like) focus on stocks that a) other investors shun, b) are safe (i.e. have a low beta,) c) are value-oriented (high book-to-market ratio), d) have growing profit margins; and tendency to stick with those stocks over relatively long periods.

As for Warren Buffett himself, when Cremers and Pareek analyzed Berkshire Hathaway, they found that the Active Share of its public equity portfolio fell from around 80% in 2007 to 70% at the end of the sample in 2012. And while Berkshire Hathaway remains a relatively patient investor, the holding duration has shortened from over 4 years in 2002 to a bit over 3 years. Then again, Berkshire Hathaway isn’t an equities-only mutual fund. But it’s interesting to think that some mutual fund managers may be able to out-Buffett Buffett himself when it comes to public stocks.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

MONEY Kids and Money

All I Want for Christmas: Frugal Kids

Aesop Fables' The ant and the grasshopper.
British Library Board—Robana/Art Resource, NY Aesop Fables' The ant and the grasshopper. Designed and drawn on the wood by Charles H. Bennett, etc. Originally published/produced in W. Kent & Co.: London, 1857.

How to use the season's gift-giving frenzy to teach the difference between what we want and what we need.

A fable that’s frequently invoked when it comes to personal finance is Aesop’s “The Ant and the Grasshopper,” in which the ant busily spends his summer storing up supplies for the winter while the grasshopper frolics the warm days away, blissfully ignoring that times of need are around the corner. When the cold days arrive, the ant is warm and well-supplied while the grasshopper is ill-prepared and starving.

The analogy to retirement saving is clear. At a recent conference sponsored by Defined Contribution Institutional Investment Association (DCIIA,) Michael Finke of Texas Tech University pointed out that retirees with the highest wealth spend the lowest percentage of their income in retirement, suggesting that it was their innate ant-like frugality that in part helped them create such a large nest egg — not just their good fortune or career success. “The ants build up a habit of thrift, and when they reach retirement, they maintain their lifestyle of thrift,” Finke said. “It’s hard to turn an ant into a grasshopper, but you can turn a grasshopper into an ant.”

I was reminded of this recently when my six-year old daughter presented me a three-page-long Christmas list. The items on the list showed the habits of a budding grasshopper: giant teddy bears that had momentarily caught her eye on a recent shopping trip, “newer” versions of some toy that she already had and had long since abandoned. Very few of them were things that she really wanted—she was merely responding to the power of suggestion and, given a blank slate, had dutifully filled it and then some.

Not wanting to send her and her brother down the path of endless grasshopper-like consumption, I offered to instead get them both just one really big thing for Christmas—a trampoline—and nothing else. Even though this purchase would wind up costing me more, I thought it would teach them about trade-offs and spending on something that would hold its value for years. My daughter agreed in theory, but then found herself still wanting a few things from her list—a Christmas dress, the giant teddy bear. And I found myself caught between wanting to fulfill those desires while instilling in them a sense of ant-like restraint. Going through each and every item and debating whether they were really worth it seemed liked a giant buzz-kill on the holiday season.

That’s when a colleague gave me a brilliant suggestion to tell the kids that they can have four things: something they want, something they need, something to wear, and something to read. I was afraid that they might hate the idea, but they both embraced it, in part because it turned list-making into a categorical challenge, a game almost, and it also preserved their freedom to choose. I in turn was pleased because the framework forced them to prioritize desires, forego some things for others, and yes, distinguish wants from needs. (And also accept the fact that clothing and books are legitimate presents.) It wasn’t a completely ant-like solution, but it wasn’t all grasshopper either. I figure I can float the trampoline deal again next year.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

MONEY retirement income

The Search for Income in Retirement

Why we may be focusing too much on our nest egg and not enough on cash flow.

There are three components to retirement planning: accumulation, investment, and managing for income. And while we are usually more fixated on “the number” on our balance sheet, the bigger challenge is ensuring that a retirement portfolio can generate enough steady money as we live out our days.

In a recent academic panel hosted by the Defined Contribution Institutional Investment Association (DCIIA), professors Michael Finke of Texas Tech and Stephen Zeldes of Columbia University illustrated the challenge of getting into an income mindset by discussing what’s known as the “annuity puzzle.”

If people were to take their 401(k)s and convert them into annuities, they would get a lifetime income stream. And yet very few people actually annuitize, in part because they don’t want to lose control over their hard-earned savings. “Getting people to start thinking about their retirement in an income stream instead of a lump sum is a big problem,” Finke told the audience.

Also at play is the phenomenon of present bias, whereby half a million dollars today sounds a lot better than, say, $2,500 a month for the rest of your life. This is a major knowledge gap that needs to be addressed. A new survey of more than 1,000 Americans aged 60-75 with at least $100,000 conducted for the American College of Financial Services found that of all of the issues of financial literacy, respondents were least informed about how to use annuities as an income strategy. When asked to choose between taking an annuity over a lump sum from a defined benefit plan in order to meet basic living expenses, less than half agreed that the annuity was the better choice.

Granted, annuities are complicated products. In the past, they got a bad rap for not having death benefits and otherwise misleading investors, but the industry has evolved, and there are now so many different options that it would be quite an undertaking to wade through and understand them all. And annuities aren’t the only way to generate income. Another option people might want to consider is a real estate investment that can throw off consistent revenues from rent. The point is to start thinking more not just about accumulating money but about how you can make that money work for you by turning it into an income-producing asset.

In the meantime, academics like Zeldes are working on how to make annuitization more appealing. In a paper published in the Journal of Public Economics in August 2014, Zeldes and colleagues suggest that people are more likely to annuitize if they can do so with only part of their nest egg, and even a partial annuity can be better than no annuity at all. Zeldes also found that people prefer an extra “bonus” payment during one month of the year, which means that they essentially want their annuity to seem less annuity-like. I’m all for product innovation, but in this case I think we’d be better off learning the value of a steady stream—especially over a fake “bonus.”

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

Read more about annuities in the Ultimate Retirement Guide:
What is an immediate annuity?
What is a longevity annuity?
How do I know if buying an annuity is right for me?

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