Tuesday, November 19, 2013

The $241,000 Kid (College Not Included)

I often wonder how the more than 95% of American workers who aren’t able to save enough for retirement will get by and what other strategies might be available to households who recognize that they probably won’t win the “Save 22 Times Your Required Income after Social Security Benefits 401(k)” Lotto1.

A few weeks back, I asked readers for their thoughts on the subject and I received some interesting comments.

A fellow financial planner, Mark Zoril, responded eloquently with what might be an obvious potential outcome, even if you don’t think of it as a strategy:
"I have been a financial advisor for 17 years and worked with many people that have very modest accumulations for retirement. However, what I have found is that over the years, their lifestyle, what they need to spend, has adapted to their limited income and modest means. They simply do not lead, in any way, extravagant lifestyles.
Mark identifies an outcome (a “strategy” in the game theory or evolution sense) that is important because it will be the most common scenario for families that can’t save enough: their standard of living will decline considerably after they retire.

Another strategy for funding retirement if you can't save enough is to limit your family size. This is not a strategy that I readily recommend, but then neither is the one that Mark notes.

I'm simply pointing out that having children may have a large impact on your ability to save enough for retirement. I also want to reinforce the thread that the decisions you make and your life experiences before you retire largely determine your standard of living after you retire.

I have three grown children and I can tell you two things about child-rearing: it’s expensive beyond belief and it’s rewarding beyond belief. 

How much does it cost to raise a kid? According to a 2013 U.S. Department of Agriculture report, it will cost an estimated $241,080 for a middle-income couple to raise a child born in 2012 for 18 years. That's up almost 3% from 2011.

But wait, there's more.

Despite this study's assumption, kids don’t leave home and support themselves at 18, anymore, like my wife and I did. Jobs are hard to find and a lot of kids "boomerang". Bump up that price tag a few more years.

Second — and this one is going to break your heart — the Dept. of Agriculture estimate of over $240,000 per child doesn’t include college costs. Add in an average $22,261 per year for a four-year public college and that $241,000 climbs to $330,000 per child.

(I’d personally feel blessed with these costs. One of mine is in med school and the others are taking the scenic route through college. Does any kid graduate in four years, anymore?)

If you’re interested in a cost more tailored to your specific household, the Dept. of Agriculture provides a “childcare cost calculator” with which you can further ponder the dollar cost of parenthood, but if you don’t have Internet access, you can achieve roughly the same experience by shaving your head with a cheese grater.

I had an economics professor in college who said that the ultimate form of birth control would be to show young couples the lifetime cost of raising a child.

(That’s how economists think. I’m pretty sure he had 2.3 children.)

So, the average cost of raising a single child far exceeds the typical retirement savings for 95% or more of American households. It's easier to fund retirement with a spare $330,000 or two lying around the house than it is with a couple of twenty-somethings lying around the house.

I’m not suggesting that you forego children to secure retirement, but you need to understand that there is a correlation. If you weren't able to save enough for your golden years but raised a happy, successful family of children and grandchildren, then pat yourself on the pack. Yours was the nobler accomplishment.

And every time someone writes me that they were able to save plenty of money for retirement and anyone who didn’t is one of those 47% slackers, I know the odds are quite good that the writer never had a family medical or other financial catastrophe.

And he probably doesn’t have children.

1If you can generate a 4.5% payout from your savings, through TIPs ladders, annuities, or stock and bonds portfolios, for example, you will need to save about 22 times (1 / .045) the amount of retirement income you will need less any income you will receive from Social Security benefits or pensions. For example, if you will need $40,000 a year to retire on and Social Security benefits will total $25,000, you will have a "gap" of $15,000. With a 4.5% payout, you will need to save about $333,000. If you will only be able to generate a 3.5% payout, you would need to save about $429,000.

Friday, November 15, 2013

Deep Risk, Discipline and a Punch in the Mouth

William Bernstein’s new e-book, Deep Risk: How History Informs Portfolio Design (Investing for Adults), is introduced with the story of Lucie White and Mark Villa, a couple who sold at the bottom of the market in 2009 and bought back in after missing the great run-up that followed. Sadly, not an uncommon story.

The passages that caught my eye in the first few pages of Deep Risk describe the couple’s plight:
“This story speaks volumes about risk. All investors experienced it during 2008–2009; if you did not lose sleep then, you’re not human. But the outcomes varied greatly from investor to investor, depending on their individual level of discipline
and. . .
“For the rest of this booklet, I’m going to assume that, like all investment adults, you’re disciplined and thus not vulnerable to the routine but serious buy high/sell low loss of capital.”
Let me repeat that. “You’re disciplined and thus not vulnerable.”

Notice how sweetly that rolls off the tongue.

Bernstein seems to say here that investment discipline is independent of context, but I know from his previous writings that he understands just how difficult that discipline is in bad times.  It's unbelievably difficult.

I have been young and old, dirt-poor and well off, through incredible booms like the 1990’s and horrendous crashes, like Black Monday and the Great Recession, and through the grinding stagflation of the 1970’s and, when it comes to decision-making, context matters.

Investment discipline is a function of risk tolerance and we know that our risk tolerance isn’t constant.

How difficult it is to maintain investment discipline depends on what’s going on around you, how much you have to lose and your prospects for earning it back and not just on some personal level of discipline you might have been born with or developed over the years.

Stock market discipline came easy throughout the nineties, but was a far different story come the end of 2007.

Bob is 25 and has $10,000 in his retirement portfolio. Discipline isn’t that hard to come by. His standard of living for the rest of his life isn’t at risk from a market crash and he has decades to recover from losses. Frankly, Bob doesn’t really expect that retirement day will ever come, so retirement savings aren’t quite real to him. In the words of that great finance sage and rolling stone, Bob Dylan, “When you got nothing, you got nothing to lose.”

Sam is 50 and his retirement savings account holds a lot to lose. On the other hand, he still has a decade and a half to recover from a loss and his salary is probably as high as its ever going to be. He can still save a lot. A big loss probably won’t change his lifetime standard of living. Discipline is more difficult for Sam than for Bob, but not as difficult as it will become.

At 64, Joe is about to retire. The prospects for earning back your losses are quite attractive when you’re young and have a lifetime of human capital on your balance sheet, less so when retirement is a year or two away. As I wrote in Even Your Portfolio Heals More Slowly as You Get Older, rebuilding your wealth is far easier when you’re earning a lot of money and saving for retirement than when you retire, have no earnings, and are spending 4% or so of your portfolio every year.

Donald is 70 and has been retired for three years. Returning to the workforce at anywhere near his old salary isn’t in the cards. His standard of living for perhaps the next 30 years depends on his retirement savings. Patiently waiting out a bear market and wondering if his standard of living is permanently declining before his very eyes requires more discipline from Donald than from all the others combined.

The salient point, I believe, is not that discipline comes cheap for 25 year-old Bob but dear for retired Donald, or easier for Sam in his fifties than for Joe at 64, but that you are, at various times in your life, Bob and John and Sam and Joe and Donald.

That discipline you found when you had twenty years until retirement and were packing away a large percentage of your peaking salary might not carry the day when you are 70 and watching your lifestyle flow into the black hole of a bear market, perhaps permanently.

Bernstein’s point about portfolio risk is that it will remain shallow risk — usually — if the investor doesn’t panic. The insurance against shallow risk becoming deep risk in this scenario, he says, is simple. Don’t panic. Adult investors don’t panic.

Getting out is usually the wrong decision. Of course, you never know. Maybe it's 1929 and getting out is the right move. If it were always the wrong decision, it wouldn't require much discipline.

My point is that avoiding panic is easier in some circumstances than others, and your capacity to avoid it before you retired may not suffice after you retire and have far less capacity to rebuild wealth. I suggest you rely on something safer than self-discipline.

If you have one safe “standard-of-living” portfolio that generates enough income to live on  and a separate risky “wealth” portfolio to possibly improve your standard of living or leave a bequest, you will be less likely to panic in a market crisis than if you depend on self-discipline. Your standard of living won’t be at risk.

Planning on self-discipline for protection is over-rated.

As that other great financial sage, Mike Tyson famously said, “Everyone has a plan 'till they get punched in the mouth.”

Tuesday, November 12, 2013

Deep Risk: Wealth versus Standard of Living

Standard of living and wealth are closely related but they aren’t exactly the same thing.

You can buy the same standard of living at dramatically different prices, for example, depending on which city you choose to live in. Your current standard of living in Manhattan would cost you less in San Francisco, much less in Wichita.

Even if you retire in place, you will no longer pay FICA taxes or need to save for retirement, so you can have exactly the same standard of living at a significantly lower cost without even relocating.

If you play around with consumption smoothing at E$Planner.com, you begin to see a number of things that can raise or lower your standard of living (discretionary spending) with a given level of wealth. You can delay Social Security benefits, for example, or pay off your mortgage and perhaps be able to spend more with the same amount of wealth.

That’s the benefit of consumption smoothing, arranging all your assets, borrowing power, and income streams to provide the highest consistent discretionary spending level, though these might not be the optimum strategies to maximize your portfolio value.

Consumption smoothing has convinced me that standard of living is a better metric for retirement planning than wealth. That thought hit home as I was reading William Bernstein’s new e-book, Deep Risk: How History Informs Portfolio Design (Investing for Adults).

(If you want to understand retirement finance, read this book. Then read the rest of Bernstein’s books, magazine articles and his posts from long ago at http://www.efficientfrontier.com. When you finish, you will know more about the subject than 99% of the population. Heck, you’ll know more than 99% of financial planners.)

Bernstein distinguishes between “shallow risk” and “deep risk” based on the amount of the potential loss and its duration, or how long it would take the investor to recover that loss. Normal portfolio variance is shallow risk, for example, and a major depression would be a deep risk.

I think of it a little differently. I think of shallow risk as financial risk that won’t impact my long-term standard of living, while deep risk can.

Bernstein identifies four major types of deep risk: long-term inflation, deflation, confiscation and destruction. He notes that deflation is actually a symptom of economic depression and not the disease. A year or two of deflation probably won’t destroy you, but long term deflation associated with an economic collapse (think Japan) might well do the trick.

Confiscation refers to the government seizing your assets. While taxation always does this to some extent, Bernstein is thinking more along the lines of Russia and Argentina. Massive confiscation is pretty unlikely in a developed nation like the U.S. and as Bernstein points out, it’s difficult, expensive and perhaps felonious to protect yourself against it.

Destruction is loss due to a war or a natural disaster and again, there is no reasonable way to protect yourself, unless you are ridiculously wealthy.

(I’m not sure where Bernie Madoff fits among the four horsemen, but theft and fraud have cost more retiree’s their life savings in the U.S. over the past 75 years than deflation, confiscation and destruction combined. Not covered in Deep Risk, it certainly warrants your consideration as a major risk to your standard of living.)

If you're a long-time reader of Bernstein, you know that he believes a retiree can't expect more than an 80% probability of successfully funding retirement. That's not because he thinks the safe withdrawal rates math is wrong, but because he thinks there are larger risks, like these four, that may render the withdrawal rate moot.

What actionable information did I take away from Deep Risk?  Perhaps not a lot, but then I was pretty much a Bernstein guy to begin with.

Perhaps I feel a little better knowing that, while I have done nothing to protect myself against destruction and confiscation, there is little I could do. Stashing gold bars in various banks around the world or buying real estate in those places probably isn’t in the cards for me. These are highly unlikely events in the U.S., anyway.

Since most countries moved away from the gold standard, instances of deflation around the world have greatly diminished. Still, deflation in the U.S. is possible and far more likely than losses due to war or a cataclysmic natural disaster.

The problem with protecting against deflation risk, as Bernstein explains, is that the solution (long term bonds) is a really bad one if we experience inflation, instead, and that is a far more likely possibility. Bernstein estimates that the likelihood of destructive, pervasive inflation is an order of magnitude greater than that of a depression.

That leaves inflation as the most likely of the four risks and not the 3% or 4% we typically see, but a long, grinding period like we experienced in the seventies. Deep Risk suggests two solutions, depending on whether you’re trying to protect yourself for the next 10 to 20 years, or the next 20 to 30. TIPs work better for the former, but Bernstein believes a globally diversified stock portfolio better protects us against inflation for money we probably won’t need in the next two decades.

Bernstein also writes that shallow portfolio risk can turn into deep risk if an investor chooses (or is forced) to sell assets at low prices during a market crash. In fact, he believes it is the most common way that people experience a real loss of standard of living.

And that brings me back to my initial thought about a standard of living metric. Bernstein often suggests two retirement portfolios, along the lines of Life Cycle Finance Theory, with one to provide the income we need to maintain our standard of living (he refers to this as a “liability matching portfolio”) and the remainder of our assets, if we are so fortunate to have any, allowed to grow in a risky portfolio.

This approach secures your standard of living while perhaps giving up some potential to grow your overall wealth. In essence, you have a “standard of living” portfolio that you don’t put at risk and a “wealth” portfolio in which major losses won’t impact your standard of living.

And, here’s the actionable information I gleaned from Deep Risk. Instead of thinking of my retirement assets as two portfolios, I’ll think of three. My risky portfolio will remain the same, but I may start thinking of my 20-30 year standard-of-living liabilities as being met by a larger stock allocation to mitigate the risk of a long bout of inflation and as a better solution than long bonds.

Thinking of wealth and standard of living as two separate but closely related financial metrics brings me greater clarity when I think about retirement planning.

So does reading Bernstein.

Thursday, November 7, 2013

How Much Does a $10 Office Visit Cost?

In my last blog, Retirement and the Affordable Care Act, I stepped through my reasoning for buying the cheapest health insurance policy I could find (it lowers my total healthcare costs) and explained how important it is for retirees to be able to buy private health insurance (you never know when your employer might retire you.)

Let’s take a quick look at what I could buy if I spent more.

Blue Cross Blue Shield of North Carolina, the only carrier offering policies in my half of the state for 2014, offers policies other than the $5,500-deductible Bronze Value plan I chose. I might have chosen their Silver Zero plan, Gold 1000 plan or Platinum 500 plan, among several other options. The numbers represent the individual deductible amounts and family deductibles are twice the individual amount.

Here are the key data points for each policy for my family of four.
Silver Zero. With this plan, I’d have no deductible to meet. Then again, I’d have to pay 50% of every covered medical claim until we reached the $12,700 family deductible amount. That doesn’t happen until we’ve spent $25,400. I’d get a break on prescriptions, paying 50% of their cost. My cheaper Bronze 5000 Value plan requires me to pay the full cost of prescriptions until I reach my overall deductible. Same with office visits. 

I’d get the larger doctors network with this plan, but as I mentioned in my previous blog, our doctors are mostly all available in the limited network.

So, I’d pay more for drugs and doctors in years with low total family claims with Bronze 5500, but I’d pay $8,628 more in annual premiums with Silver Zero. You can pay for a lot of doctors visits with $8,628 a year.

Our family out-of-pocket maximum would actually increase with the more expensive Silver plan.

Here’s a comparison of policies excluding the premium cost.
Gold 1000. I’d get small copayments for drugs and office visits and just 20% coinsurance. I’d also get the larger doctor network.

The family out-of-pocket maximum drops from $11,000 to $8,000 — if you ignore premiums.

Platinum 500. What would going platinum get me? I mean, besides an additional $14,592 a year in premiums? A $500 deductible, $10 office visits and $4 generic drugs.

The family out-of-pocket maximum drops all the way to $3,000, if you ignore premiums.

Gold and Platinum coverage are the kinds of policies people think they like. Ten dollars for a prescription, $15 for a doctor visit, $30 for a specialist. A huge list of in-network doctors. How do you beat a deal like that?

You beat it with lower premiums. Moving up another notch to Gold 1000 increases my premiums by $11,184 a year. (I love the way insurers only quote monthly rates. An extra $932 a month sounds a lot more attractive than an extra $11,184 a year, doesn't it?) 

Bankruptcy Protection

The most important number is the cost of annual premiums plus the out-of-pocket maximum. That’s your bankruptcy protection, or the most you would have to pay in any given year. As the bottom line of the table shows, that protection doesn’t increase by buying more expensive insurance in most cases. It decreases. You will pay more in a year with catastrophic medical expenses with more expensive policies.

Finally, here’s a graph of costs including premiums. You will notice what looked to be the least expensive policies are the most expensive when you consider all costs.
While my total costs for the Bronze Value 5500 plan will range from $16,296 per year to $27,296, depending on my medical costs, Platinum 500 is basically an “all-you-can-eat for $33,880 a year” deal. 

I hope you're hungry.

I’m liking my Bronze Value 5500 policy more and more.

These examples are specific to my family of four in North Carolina. Your mileage, as they say, may differ depending on specifics. In particular, NC hasn’t embraced ACA, so we have no real competition to lower rates here. Also, the premiums you see are for a family of four adults.

The basic principles will probably be consistent anywhere, though.

So, how much does a $10 office visit cost?

In our case, $14,592 a year.

Tuesday, November 5, 2013

Retirement and the Affordable Care Act

I read in the New York Times a few days ago that about 150 million Americans get health insurance from their employers and only about 10 million buy private policies. I’m one of the latter and have been since I retired in 2005. (That leaves a large part of America’s 314 million population without health insurance, but not my point.)

I still have five years to go before I am eligible for Medicare, but even then I’ll need a Medigap policy. Before the Affordable Care Act (ACA), I had a difficult time buying insurance. I ended up in North Carolina’s high-risk pool, which is going away at the end of 2013 because ACA policies will be available.

If you have health insurance from your employer, as I used to, then none of these things has much impact on you personally. If you retire before you’re 65 and eligible for Medicare, it would have become an issue for you without ACA. Trying to find affordable private health insurance when you retire (voluntarily or involuntarily) in your sixties before the Affordable Care Act was a bear.

The enormous amount of money I have had to pay for healthcare has been the biggest financial surprise of my retirement. I knew it would be burdensome.

I just wasn't prepared for this.

Over the past eight years I have spent just shy of $18,000 a year for health insurance to cover my family and I can't recall that I ever met a deductible on my $5,000-deductible policies or that a claim was ever paid. In fairness, I was protected against catastrophic medical expenses all that time, had I been so unfortunate, so the premiums weren't for naught.

I just spent a harrowing week trying to decide on a new ACA health insurance policy for my family and I’d like to share some of my findings. It seemed like an amazingly complex problem. I created a Space Shuttle Program-sized Excel spreadsheet, but was eventually able to narrow my choices to a handful.

Two things made the process simpler, one good, one not so much. The good part is that ACA forces all insurers to cover essential services in every policy, so I didn’t have to read each one closely to see what was not covered and how and why the insurer could rescind my coverage or cancel my policy if I made a large claim. ACA weeded out the junk policies for me.

Of course, being able to buy a policy at all with my pre-existing conditions helped. Prior to ACA, finding so many potential policies to consider that I needed a spreadsheet was never a problem. I was diagnosed with cancer in 2000, but Blue Cross Blue Shield of North Carolina (BCBSNC) claimed they refused to cover me because I took medication for a migraine headache one time back in the 1980’s. At least that’s what they wrote to me when I demanded an explanation.

The bad thing that made my selection process simpler was a lack of insurance carriers in North Carolina. BCBSNC actually ended up with a larger monopoly than they had before ACA. I read recently that Kentucky now has 180 policies available at Kynect. Carolina has Blue Cross Blue Shield.

I didn’t need HealthCare.gov. With one carrier in the state, you can just go straight to their website.

Their only real competition in North Carolina was Coventry Health before ACA and they had a small market share. As recently as a few months ago, Consumer Reports provided information on four or five carriers in NC and perusing their websites back then showed that competition was lowering prices. Then, just before the ACA marketplace opened up in October, they all pulled out of my area except for BCBSNC. (Coventry does offer policies in western NC.)

A story in the Raleigh News and Observer reported that the competition left after the state refused to expand Medicaid. That apparently signaled insurers that there might be lots of poor people here who would otherwise be on Medicaid applying for policies and, since poor people are usually less healthy, we no longer fit into their profit plans.

Ultimately, I found myself reviewing about a dozen or so policies, all from BCBSNC. My wife and two college-aged children each had separate pre-ACA policies from BCBSNC, since they refused to cover me. The kids’ policies were grandfathered under ACA; my wife’s was not.

I spoke with an independent agent for BCBSNC about the grandfathered policies and she told me they were better than new policies. I should keep them and get a family policy to cover my wife and me.

The main thing you should look for in a health insurance policy is not whether a $200 prescription will cost you the full price or a $25 copayment, but whether a major illness can bankrupt your family. Medical expenses are the leading cause of personal bankruptcy in the U.S. In insurance parlance, the most important factor is the “Out-of-Pocket Maximum”  (which I will call OOP Max for short), or the most you will ever owe in any one year of the policy.

Most policies describe OOP Max as the sum of your deductibles, copays, and coinsurance. I don’t know about you, but premiums also come out of my pocket, so I include them in the OOP Max. 

When I looked at the agent’s advice, insuring with three policies instead of one by keeping the grandfathered kids’ policies, the OOP Max became a problem. Each policy has its own OOP Max. A single family policy’s OOP Max added to the OOP Max’s for two more individual policies quickly becomes a very large number (near $40,000 in our case). The family policies covering all four of us topped out at around $30,000.

I rejected the agent’s suggestion and vastly simplified the selection process by deciding we would best be covered in the worst-case scenario by a single family policy.

I generated 5,000 random annual total claims and scatter plots for the four policies I was considering. The x-axis shows possible total claims in a single year for our family and the y-axis shows what the total out-of-pocket cost would be under each of the four policies. The numbers in the policy names indicate the individual deductible amounts (e.g., Silver 3000 has a $3,000 individual deductible. Family deductibles for the policies were twice the individual deductible.)

Costs would be about the same under all four policies for claims totalling up to about $10,000, but for larger claims, the OOP Max begins to kick in. Two of the policies limit OOP costs to $11,000 and two limit them to $12,700. Without premiums included, it looks like the four policies have only one of these two OOP Max levels.

Notice I am using the insurance carrier’s definition for OOP Max. Now, see what happens when I use my definition, which includes premiums.
As you can see from the graph above, the policies have four distinct maximum annual costs when their premiums are included. Also, it becomes more obvious that the true out-of-pocket maximums you might have to pay range from $27,608 to $38,616. Those are the worst-case scenarios you need to plan for, not the $11,000 to $12,700 range in the first chart that ignores premiums.

Big difference.

By the way, more expensive “Silver” and “Gold” policies don’t lower your OOP Max and give you more protection against bankruptcy. They do get you more doctor visits and lower cost prescriptions, but they have higher premiums. While it might feel good to pay a $25 copay for that $200 prescription or visit your doctor with no copay, saving several hundred dollars a year on premiums ultimately feels better.

Another question I needed to answer was whether to pay BCBSNC more money for access to their larger network of doctors. All of our doctors but one are available in the Limited plan and the Large Network plan costs about $1,300 more per year. You can pay for a lot of out-of network doctor visits with $1,300 a year, so I decided on the Limited network to lower premiums.

The next choice I needed to make was whether to pay a larger premium for a lower deductible. As I mentioned, over the past eight years we have never had a claim paid. In most years, then, we pay large premiums and get only negotiated doctor rates and catastrophic-risk protection in return. Smaller premiums are better if there are only small claims, of course.

What happens if one of the four of us has a large claim one year, say $10,000? My analysis shows that, for the worst policy of this group I considered, that would have to happen every two years for the lower deductible to be a better deal than lower premiums every year.*

My decision was to select the highest possible deductible policy ($5,500) with the lowest premiums and that made me realize that I could have come to the same conclusion with a much simpler analysis.

The more you self-insure, through higher deductibles and higher coinsurance, the lower your insurance policy costs. That’s obvious, of course, since you’re buying less insurance. So, the highest deductible and highest co-insurance policies will be cheapest.

The most important factor in selecting a policy is making sure that the Out-of-Pocket Maximum won’t bankrupt you. More expensive policies lower cost when your claims are low, but they don’t make much difference when claims are extremely high.

You have to make a purchase decision on doctor network access, but if you expect only a reasonable number of out-of-network visits to a particular doctor, the cost savings on your premiums may save you more than your out-of-pocket costs.

To select a policy, you have to decide what is important to you. Is it more important that you not pay a doctor $150 instead of a $25 co-pay, or that your total costs for the year is hundreds of dollars lower? What is the worst-case annual medical cost you can tolerate? Is it important that every doctor you see be “in-network”, or would you rather pay extra for a few out-of-network visits if your total annual costs were lower?

Had I thought through these basic issues, I suspect my analysis would have been much simpler than I made it, and I would’ve ended up with the same decision. I would have selected the lowest total cost (including premiums) policy, not with the highest deductible I could afford each year, but with the highest Out-of-Pocket Maximum I could handle in the worst imaginable year.

Focus on total costs for the year including premiums, not individual costs for an office visit or a prescription.

I think a lot of people search for a policy like an all-you-can eat buffet. They want to make sure any doctor they might wish to see is in-network, and prescriptions and office visits never cost more than $30.

That's an expensive way to buy health insurance, retired or not.

*To calculate the break-even in years, divide the additional OOP Max from the second policy by the increase in premiums. Often, you will find that an increase in premiums provides no increase in OOP Max and you will never be better off (from an OOP Max perspective) to pay the higher premium. For example, if paying an additional $1,000 a year for a policy with an OOP Max that is $2,000 lower, you would need to have large claims at least every two years to justify the higher premiums from an OOP Max perspective. Of course, the additional premium might provide other benefits.

Friday, November 1, 2013

Trick or Treat

Last night was Halloween. We rarely get more than a handful of trick-or-treaters, sometimes none. Last night we had just one group, but it was a group of twelve, so now I only have to eat half a large bag of mini-size M&M packets before Christmas candy shows up on the shelves.

In the “spirit” of the holiday, I was feeling a bit mischievous this morning when a friend called with a finance question.

“You recommended a 60/40 stock allocation for our retirement portfolio, right?” she asked.

“Well, my husband is rolling over his 401(k) and he says he will feel better with a 50/50 allocation of his part of our savings. Will that work?”

I told her a true story about myself from around 2000. (If you’ve read LocallyGroan.com, you know how I like to tell stories about myself. Inherited the weakness from my grandfather.)

I went to see a well-known and quite capable money manager on the West Coast during the Tech Boom about managing a large sum of money I had made on stock options. I told his managers that I wanted 40% of the portfolio invested in bonds and cash.

“We don’t do that,” they told me. “Holding bonds significantly reduces your expected return. We buy them on occasion and use other hedges when we anticipate a bear market, but in general, you can trust us to get you out of the market before a crash.”

We're market timers. We don’t need no stinking bonds.

I said “fine” and subsequently turned over 60% of my portfolio for them to invest in stocks and I invested all of the remainder in bonds. They were happy with their 100% stock allocation and I was happy with my 60/40 portfolio. While I was with them, the combined stock and bond portfolios outperformed the stock portfolio.

“So, if I increase the stock allocation of my part of the savings so it averages out to 60/40, should I tell my husband?” my friend asked.

“Whoa!” I told her. “I’m not going there. You know the NSA is listening to this, right?”

I can imagine times when you might treat a husband and wife’s retirement portfolios separately, but if the pool of funds belongs to both of you, one of you can’t invest in Russian ruble futures without affecting the other.

I stayed with that money manager for a few years and did OK. Ultimately, I was unhappy with the “exceptional manager” theory and decided to manage my own money with index funds and ETF’s.

And bonds, of course.

I read a letter a few years ago from the exceptional manager apologizing for not foreseeing the 2007 market crash and getting his investors out in time.

Sorry, kids. We ran out of candy.