Conventional planning, in my view, is wishful thinking and dangerous. Conventional planning was designed by Wall Street to sell products, not to obey common sense economic principles. This is why no economics or finance department teaches conventional financial planning.
Economics-based financial planning is at odds with conventional financial advice. This statement may seem surprising, unless you have been following my work for years. But it’s true. The two underlying methodologies, i.e. their underlying mathematical frameworks, have absolutely nothing in common. The economy determines your household’s highest sustainable standard of living based on your resources, that is, what you can afford to spend. And it adjusts your spending as your situation changes.
Conventional planning, in my view, is wishful thinking and dangerous. You set a desired retirement spending goal (mine is $1 billion a year) and you receive an investment strategy with the best chance of achieving that goal. What if this potentially super risky strategy fails, leaving you completely broke? “It’s not our problem. Read the fine print. We never guaranteed you a rose garden.” Conventional planning was designed by Wall Street to sell products, not to obey common sense economic principles. This is why no economics or finance department teaches conventional financial planning.
Full disclosure: I sell software based on economics-based financial planning. Now I’ve written a book (my 20th), Money Magic – An Economist’s Secrets to More Money, Less Risk, and a Better Life, which aims to show how economics-based financial planning can dramatically increase your standard of living, dramatically reduce your risk, and improve your lifestyle, at no extra cost.
Here are some of the unconventional ideas explored in my book.
Invest in stocks without any risk to your basic standard of living.
i call it Investment on the rise. The idea is simple. Allocate a certain amount of your resources to stocks and don’t spend a dime on these securities until you convert them into safe assets. That is, you treat your actions as bets in the casino that you are willing to lose in their entirety. But you disciplined yourself not to spend your earnings until you were safely back home. What you don’t invest in stocks, invest in long-term inflation-linked Treasury bills. They are called TIPS (Treasury Inflation Protected Securities). Barring the taxes associated with unexpected inflation, TIPS are the safest asset on the planet.
This upside down investing strategy sets a floor on your standard of living. The more (less) you invest in stocks, the lower (higher) your floor is. Upside investing is what most of us are looking for – keeping a hand in the market while protecting our basic way of life.
Here’s another favorite:
Cashing in your traditional IRA to pay off high-interest credit card, student debt, car loans, and mortgages can save you tens of thousands of dollars.
If your IRA is invested in the market, that surely sounds crazy. Why give up a potentially very high return on equities to pay off debt? Plus, cashing in your IRA, if it’s not a Roth, means paying taxes now on the withdrawal and a 10% penalty if you’re under 59.
My answers: Once you adjust the stock market for risk, its nominal return is much lower than the equally safe nominal rates you pay on your IOUs. But paying off, say, a 7% student loan is economically the same as investing in a perfectly safe 7% bond. Therefore, paying off the loan rather than investing in stocks which, at the time of writing, are earning less than 30 basis points per year ona risk-adjusted basis, is a huge arbitrage opportunity. Yes, you will have to pay taxes on the withdrawal. But these taxes must be paid afterwards. And with rates so low, the benefit of deferring taxes is small. Also, given the 2017 tax reform, your future tax bracket could be similar to your current bracket. Finally, you can avoid the penalty by regularly withdrawing.
Now, a warning from that college professor.
Don’t borrow for college.
It’s way too risky. Two out of five students do not graduate but borrow large sums to have the privilege of dropping out. Also, Uncle Sam – the main student lender – makes Uncle Scrooge look benign. Once you take his money, he’ll hunt you down for life, seizing your paycheck and even your social security check if you don’t pay it back. Additionally, it offers income-related repayment options that sound great, but are borderline scams.
Speaking of scams, Social Security runs three big ones that you should avoid. Here is one.
If you file for widows or divorced widows benefits at the same time you file for retirement benefits, you could lose hundreds of thousands of lifetime benefits.
Social Security’s own Inspector General reported that the agency let more than 13,000 widows make this mistake or made it for them, collectively costing them more than $130 million. Rather than fix the problem and reimburse those she ripped off, as her IG demanded, Social Security is continuing the practice.
Now for a warning about Roth conversions.
Roth conversions make sense if you’re in a lower tax bracket than where you’ll be later.
But if you take Social Security and convert too much, you can trigger taxes on your Social Security benefits. And, if you’re 63 or older, you can trigger much higher Medicare Part B premiums in two years.
And here’s something for the 4,000 of us who get divorced every day.
Before you advocate, force your children to take sides, and turn the former love of your life into your nemesis, solve the big question – the ratio of your standard of living in the future. Once you sort that out, everything can be valued and split based on that ratio. The alternative strategy, arguing over each possession one by one, starting with the toaster oven, will lead straight to a divorce war.
Then, a way to guard against the bogeyman of inflation that can go crazy.
Mortgages are financial and tax losers. But they are an excellent hedge against inflation.
Each inflation point allows you to repay in diluted dollars. As the book describes, you can roll your own inflation-indexed annuity by using a mortgage to purchase an annuity. But avoid reverse mortgages. They are way too expensive and risky.
Speaking, indirectly, of housing, here’s something that economists but few others know.
Home ownership comes with a huge hidden tax break that has nothing to do with mortgages.
Imagine living across from your precise physical and financial clone who, of course, owns an identical house. Now consider renting to each other. Your accommodation will not change unless you move across the street. But your two taxes will increase since the rent you pay yourself will be taxable.
Here is my latest book teaser.
Do not count on dying in time, according to your life expectancy.
If you do, you will likely be very disappointed and eventually run out of money before you run out of steam. Instead, plan for the catastrophic outcome of longevity – living to your maximum age of life. But make a spending plan that involves a lower standard of living the longer you live. This allows you to take a calculated risk that you will expire before, say, 100, without letting yourself have lunch on Meow Mix.