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How To Think About Money: Here’s A Blueprint For Your Financial Affairs

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Jonathan Clements, How To Think About Money
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With Jonathan Clements, personal finance columnist, Founder and Editor of Humble Dollar, and Author of How to Think About Money

Jonathan Clements: Personal Finance Author, Philosopher, And Blogger

Steve’s guest, Jonathan Clements, is the founder and editor of Humble Dollar, a website focused on telling you all you need to know about money, without hype or hollow promises.  Earlier in his career, Jonathan spent almost two decades at The Wall Street Journal where he was a personal finance columnist.  Jonathan has authored several books.  His latest, How to Think About Money, aims to provide readers with a coherent way to think about their finances, so they worry less about money, make smarter financial choices, and squeeze more happiness out of the dollars that they have.

It’s Highly Unlikely You’ll Become A Billionaire… Or Make Up For It In The Stock Market

Steve highly recommends Jonathan’s blog, the Humble Dollar, to all his listeners.  One of the ideas they discuss is that people can’t do everything that they want in life.  For example, Jonathan first wanted to be an astronaut, even though he was no good at science; then, he wanted to be an architect even though he couldn’t draw.  His point is, when people are young, they’re told they can do anything they want, provided they work hard at it.  But, Jonathan says, that’s simply not realistic.

For example, Jonathan says, it is highly unlikely that most of us are going to become billionaires, just as an avid runner like himself could never clock a four-minute mile, despite trying really, really hard.  His point is, everyone has strengths and weaknesses and, often times, when they realize they can’t achieve their dreams, many try to make up for the difference in the stock market.

“That’s interesting,” chimes in Steve, “because it’s unlikely that most people will succeed in the stock market either.”  On average, after investment costs, most individual investors lag behind market averages.  Yet, every day, people day-trade stocks, take on margin debt to boost investment returns with leverage or make huge bets on a single stock or sector of the market.  And, of course, most don’t do all that well.

The message, integral to the concept of how to think about money, is that just as people are limited by the talents they have, they are also limited by the vicissitudes of financial markets.  At some point, individuals must level-set their expectations and focus on playing the best hand they can.

Financial Markets: The Toughest Game In Town

Jonathan believes financial markets are the toughest game in town, where individuals are woefully incapable of competing against people with access to the latest market research, fancy computers, and top MBAs.  In his book, How to Think About Money, he wants investors to focus on why they save and invest—not to beat the market, not to become fabulously wealthy, but so they can have enough to lead the life they want.  To earn reasonable returns over time, investors must be diligent about saving and investing and will be rewarded with the ability to buy what they want, if not everything they desire.

The real purpose of money, adds Steve, is to provide for and take care of the ones you love, to set priorities, and make hard choices.  Furthermore, academic research has shown that assets such as gold, silver, art, and even real estate have historically delivered lower results than the stock market.  Jonathan also quotes a study that looked at home prices from 1900 to 2014, which found that annual real estate returns were less than one percentage point above inflation.  But, insists Jonathan, people should look beyond returns on real estate—to the joys of home ownership, the stability they give your family, and factor in the imputed rent, which is what you would have paid to live in a comparable place.

Steve adds that buying a home keeps you on a level because it tracks the rising costs of home values over time and allows you to buy and sell at close to par when you move.  On the flip side, with rentals, there is no asset appreciation; it’s simply money out of your pocket and into someone else’s.

Jonathan adds an important caveat here on how to think about money in a manner harmonious with all aspects of your personal finances:  While people like to own hard assets, such as homes, it pays to not get carried away into buying an overly large house.  If you do, that’s essentially like renting a house that’s far bigger than you really need.  So buy a house that is the right size for your family and no bigger and invest your excess cash into earning higher returns.

How About Investments In Gold?

Finally, Steve and Jonathan turn to the allure of investing in gold.  As Jonathan points out, since the year 1900, gold has delivered an average real annual return of merely 0.7% above inflation.  Silver has fared much worse, with a real annual return of even less, 0.1%.  And diamonds?  Believe it or not, 0%.  So buy diamonds to satisfy your vanity, not for retirement gains.

That said, Jonathan does see diversification value in precious metal investments, particularly gold because gold tends to do well when stocks do badly.  It’s one of the few assets that have a so-called mega correlation with the stock market.  But since markets are volatile over short periods of time, make sure you rebalance your gold investments fairly quickly.  As an example, say you put 2% of your portfolio in gold.  Then, when the stock market is down 20% and your gold fund is up 100%, cut back your position in gold and use it to invest in the stock market.  This rebalancing process can add to your returns over the long run.  The problem, though, lies in human nature—when gold is up 100% and the stock market is down 20%, it takes a lot of courage to sell that gold and get back into stocks. This is something most individual investors simply do not have the foresight or stomach for.


Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

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Steve Pomeranz: Jonathan Clements is with me.  He’s the founder and editor of Humble Dollar.  He spent almost two decades at The Wall Street Journal where he was a personal finance columnist and his latest book is How to Think About Money.  I can tell you I’ve been following Jonathan for a lot of years.  I have a high respect for him, and I’m happy that he agrees to be on our show.  Welcome back to the show, Jonathan.

Jonathan Clements: Oh, thanks so much for having me on, Steve.

Steve Pomeranz: I was looking at your blogs, which can be found at the Humble Dollar, and I recommend it to all my listeners, and there were a couple that struck me, so I want to talk about them today.  One of the ideas that you put forth was that, in spite of what your parents told you, you probably can’t do everything really well in life and most of us are going to have limitations as well as talents.  Take us through that a little bit.

Jonathan Clements: Well, yeah, sure.  I think back to when I was a kid.  I think I first wanted to be an astronaut even …

Steve Pomeranz: Me too.

Jonathan Clements: …  Though I was no good at science.  Then I think I wanted to be an architect even though I couldn’t draw.

Steve Pomeranz: I wanted to be a pilot, but I’m colorblind.

Jonathan Clements: These are the things we imagine we can do when we’re younger.  When were younger, we do have the notion that we can do anything we want with our career.  We can amass as much wealth as we want, all it takes is the effort.  That’s the message that we receive.  It simply isn’t true.  We are all limited not only by the talents that we have, but also when it comes to investing by the nature of the financial market.  It is highly unlikely that you’re going to become a billionaire.  It is highly unlikely that you are going to become fabulously rich in the stock market.  It just isn’t the nature of the world.  One of the things that I talk about is, in my thirties, I became very serious about running.  I was a half-serious runner.  I did a number of marathons and half-marathons and I trained a lot.  I mean I was running up to 80 miles a week.  There is only so fast that I could run.  I was never going to be a Kenyan.  It didn’t matter how hard I tried.  In the mile, the fastest I ever got was a little bit under five minutes.  I would love to have run under four, I would have run like crazy to get there, and yet it was not within my physical capabilities.

Steve Pomeranz: But, you know, a five-minute mile is terrific.  I mean, come on.

Jonathan Clements: Yeah, it’s terrific.  I mean I’m not saying I was untalented, Steve, but I’m not …  I wasn’t super-talented.  I think a lot of us can say that about many areas of our lives.  We can think about our skill-set, and we can say, “I’m really bad at this.  I’m okay at that.  I’m pretty good at that.” For most of us, there’s something that we can say, “Yeah, I’m pretty darn good at that.” And that, hopefully, is the basis for your career and, hopefully, that allows you some basic decent living.

Steve Pomeranz: All right, the thing is though at this point, the idea that if you’re not going to be a CEO of a Fortune 500 company and you’re not going to make those kinds of multiple, multiple millions of dollars every year and so on, many people try to make up for the difference in the stock market to try to hit the big home run.  I think that’s an interesting point here because that’s unlikely to happen as well, right?

Jonathan Clements: Absolutely.  I mean we all know that the financial markets are what Charlie Ellis has called, a loser’s gain.  On average, after investment costs, most of us are going to lag behind the market averages.  Yet, everyday people are out there trying to do better.  They day trade stocks because they take on margin debt in order to try to boost their investment returns with leverage.  Some make huge bets on a single stock or on a single sector of the market and, of course, like lottery ticket buyers, there are a few big winners but most of us who pursue these strategies are going to fall flat on our face.  The message here is, you are limited by the talents that you have.  You may just not be built to be CEO.  You are limited by the nature of the financial market and the costs you incur.  At some point, you’ve got to say to yourself, “All right, I’m not going to be CEO.  I’m not going to beat the market averages but I’ve got to play my hand as best I can.”

Steve Pomeranz: Okay, but we’re all looking for shortcuts sometimes and you see a lot of self-help authors and get-rich-quick seminars, motivational speakers trying to convince us that we can do this.  I mean, right now, as I drive to work every day, I hear CNBC ads and there’s one ad in particular that catches my attention.  They promise you a 10% rate of return on New York real estate and you see other ads about buying real estate with no money down or learning how to flip homes.  Really, I think the bottom line is the only people who make money with these kinds of things are those people that are giving the seminars.  They’re the ones who are becoming rich at your expense.

Jonathan Clements: So true, Steve, it is so true.  If you want to get rich flipping real estate, start giving seminars about how to flip real estate.  That’s how you will get rich.

Steve Pomeranz: That’s right, that’s so true.

Jonathan Clements: It’s the same on Wall Street.  Who gets rich off hedge funds?  Not the people who buy hedge funds; it’s the people who run the hedge funds.  They’re the ones who are showing up on the Forbes 400.  They’re the ones who are ending up as billionaires.  Meanwhile, the poor schmucks who are investing in these funds, in many cases, they are getting mediocre returns or worse.

Steve Pomeranz: I’m going to give you an idea of a personal experience of mine.  Back in ’08 when everything was incredibly depressed, I decided I was going to take some money and I was going to put it into Amazon because it really had gotten …  I think it was down nearly 80, 90% from its previous high.  I bought 1,000 shares at $10 a share and about three, four months later it tripled in price.  I was like, “Wow, this is a three-bagger.  This is three times my money in a few months.” I can’t tell you how many times I’ve invested where the stock price would go down or I would be happy to a 10% rate of return but not a 300% rate of return.  So I sold it.  I felt pretty good about that.  Well, 10 years later, it’s 100 times my money had I held on, that $10,000 would have been worth $1 million and I thought I was making a really good decision.  You know 99% of the time, that would have been the right decision to make.

Jonathan Clements: The financial markets are the toughest game in town.  You are competing against people with access to the latest market research, fancy computers, MBAs.  The notion that any one of us is going to have some insight that’s going to allow us to have spectacular performance over the long-run, this simply isn’t the case.  What we need to do is go back to a bit of our first principles and say simply, “why do we save and invest?”  We don’t save and invest in order to beat the market.  We don’t save and invest to become fabulously wealthy or to be the richest family in town.  We save and invest so that we can have enough to lead the life that we want.  To lead the life that we want, to have enough money for that.  We don’t have to be fabulously wealthy.  We don’t have to beat the market.  We just need to earn reasonable returns over time and to be reasonably diligent about saving it.  If we do that, good things will happen, and we will have lives that are fulfilling without financial stress and where we can buy much of the stuff that we want, even if we can’t buy everything that we want.

Steve Pomeranz: I think people forget the real purpose of money.  It’s to take care of the ones you love.  It’s to take away the daily worries of living from paycheck to paycheck.  It is to give yourself a comfortable lifestyle to whatever degree it is and allow you to do certain things.  But none of us can do everything and you always have to make choices.  It’s always a question of setting priorities.  Very, very few and I’m talking very few have unlimited resources, most of us don’t.  Here’s a question, every decision that you make, when you do finally make a decision in life, whether it’s career or it’s personal, to get married, to have kids, every decision you make, what stock to invest and where to put your money eliminates a host of other decisions.  You’re really focusing and you’ve got unlimited probabilities or possibilities in your decision making.  You make a decision, it all collapses into this one choice.  So making that choice, and I want to talk about investing here, is very, very important.  You actually had some statistics on your site, which took a look at the actual rates of returns of all these different kinds of investments starting back in 1900.  You want to tell us about that?

Jonathan Clements: Yeah, I was drawing on a piece of academic research that looked at so-called durable assets or hard assets.  What we’re talking about here are things like gold or silver, investing in art, or investing in fine wines, or alternatively investing in real estate.  I was a little surprised by the results, to be honest.  They were higher than I imagined they would be.  Nonetheless, one of things that came out of this study was that a lot of these things that we think of as being potentially good investments like art, like collectible violins, like fine wine, they do have reasonable returns, but they are less than the returns that you would get by investing in the stock market.  In a sense that makes sense, right?  When you buy a really nice piece of art, you put it up on your wall.  You’re getting a huge dividend from that piece of art.  You get to enjoy it every day that you walk into your living room and take a look at it.  If you’re getting that sort of non-cash dividend, you’ve got to expect its return to be lower than something like a stock, where it’s purely a financial investment.  As a consequence, you shouldn’t delude yourself when you buy that collectible piece of art or that collectible violin that you’re really going to make a lot of money over time.  If you want to make money over time, the place to be is the stock market.

Steve Pomeranz: Well, that’s interesting because I’ve noticed in the 35 years I’ve been practicing as an advisor that people break down into generally two categories: people who are comfortable owning hard assets like real estate and those who can understand intangible assets like paper, like stocks and bonds and the like.  I think in the tangible world, that’s what you’re talking about.  Well, what is tangible?  Gold is tangible, real estate, art is tangible.  I guess musical instruments, that’s on the list as well.  What about the actual rates of return?  Now you quoted a study that was done between 1900 and 2014, let’s take a look at US home prices.  Do you have that there with you?

Jonathan Clements: If I recall, Steve, the figure was relatively modest.  It was less, in terms of the actual real estate price, it was less than one percentage point a year above inflation.  That is actually not as bad as it sounds because the biggest part of the return from home ownership is the ability to live in the house.  If you buy a house, theoretically you might get price appreciation that pretty much matches or is a little bit above the inflation rate, but of course, a lot of that’s going to be offset by the costs of ownership, things like maintenance, expenses, things like property taxes, things like homeowner’s insurance.  Then on top of that, you get this, what you can think of as a dividend or the imputed rent, which is the ability to live there.  That could be worth, depending on the market where you live, an annual value between 5 and 7% of your home’s value.  If you have a $200,000 home, you think about, “Well, how much could I rent that house out for?” You might be able to rent it out for $10 – $14,000 a year.  That is a reflection of how much value you get out of that house by living in there.  The problem is, while that return is very real, you do need to live somewhere, it isn’t of the cash variety.

Steve Pomeranz: Yeah, well, I mean you’re going to …  If you’re renting you can compare it to, well, you have to pay money out for rent.  If you’re living there, obviously you’re paying a mortgage or even if you paid cash for it, the money that you put into the house could have been invested elsewhere, which would have had a return as well.  But I think the way I’ve always looked at residential real estate is that by buying a home it keeps you on a level, so in future, you can buy other homes because it tracks the rising costs of home values over time.  Whereas you rent, you don’t have that asset appreciating along with it when you need to make a decision later down the road.

Jonathan Clements: There is a big caveat here though.  People like to own hard assets because of that tangible nature.  A lot of people think, “Well, you know I like owning real estate.  I’m going to go out and buy an overly-large house.” But if you do that, it’s essentially like renting a house that’s far bigger than you really need.  What you want to do is buy a house that is the right size for your family and no bigger.  If you do that, you’re not wasting rent.  If you buy a bigger house than you really need, it is like renting a place that’s bigger than you really need and you’re throwing away a big part of the potential return, and the money that went into the house could instead be invested in stuff that’s earning a higher rate of return.

Steve Pomeranz: Good point.  Let’s talk about gold here.  Everybody loves gold.  For some reason, gold has this magic aspect to it.  Looking at your notes here, the return since 1900, gold had a 0.7% annual real return.  So, that’s the return over inflation, less than 1% for gold.  I heard once, and I feel like this is true, that in Roman times an ounce of gold could buy you a really good toga, and today it’ll buy you a really good suit.  So it hasn’t really gained all that much in real terms, but here’s the data, only less than 1% over the rate of inflation since 1900.  Silver is even less, a 0.1% rate of return over inflation for silver and diamonds, zero.  These assets have a lot of volatility associated, right?

Jonathan Clements: The only reason to invest in precious metals, particularly gold, is not only as a diversifier for portfolios largely invested in stocks, a small investment in gold for portfolios heavily in stocks, you’re going to calm down that portfolio because gold will tend to do well when stocks are doing badly.  It’s one of the few assets that have a so-called mega correlation with the stock market.  But that alone isn’t going to pay for dinner.  If you want to invest in gold in order to calm down your portfolio and actually turn that into added investment performance, what you need to do is follow the policy of regularly rebalancing.  What that means is, you say to yourself, “Okay, I’m going to put 2% of my portfolio in gold or I would prefer gold stock.  At that moment in time when the stock market is down 20% and your gold fund is up 100%, cut back your positioning in gold and use it to invest in the stock market.  That rebalancing process can add to your returns over the long run.  The problem is, when gold is up 100% and the stock market is down 20%, it takes a lot of courage to make that trade and many, many people are not able to do it.

Steve Pomeranz: My guest, Jonathan Clements, founder and editor of Humble Dollar, again, spent two decades at The Wall Street Journal.  I highly recommend his blog, as I said, Humble Dollar.  To find out more about Jonathan and to hear this interview again, don’t forget to join the conversation at Stevepomeranz.com.  Thank you so much, Jonathan.

Jonathan Clements: It’s been my pleasure, Steve.

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