Life As A Bond: How To Manage And Make Money

With the stock market edging toward positive territory, you may be wondering what to do with whatever money you have left to invest.

Jonathan Clements, former personal finance columnist for The Wall Street Journal and now the director of Citicorp's financial advisory division, tells host Steve Inskeep that everybody could use a little bit of financial advice these days.

Clements, the author of The Little Book of Main Street Money: 21 Simple Truths That Help Real People Make Real Money, isn't a fan of a lot of the financial advice that is commonly given to the ordinary investor.

"I think one of the big problems out there is that a lot of financial advice is really very narrowly focused on stocks, bonds and mutual funds," he says. "And in fact, if people want to manage their money properly, they need to look at their entire financial life. And that means considering things like their debts, their real estate and maybe most important, the value of their human capital, which is the ability to pull in a paycheck. Getting that regular paycheck for a lot of people is sort of like getting interest from a bond."

For example, if you're just entering the work force and you're in your early 20s, then you're looking at 40 years of regular income. The source of that income, your human capital, can be thought of as a "big bond that you own," he says.

When it comes to diversification, Clements says, one of the things that is worth considering is investing "pretty heavily" in the stock market. Why? Because if you already have a regular income, you don't also have to maintain a lot of money in bonds and CDs.

Job security, however, plays an important role in this equation, and that's something that isn't so certain these days.

Clements says if your income isn't predictable — as might be the case if you're an aspiring actress or a salesman whose salary is based on commissions — then you'll want to be more conservative with your investment mix. He also says it's not a good idea to invest heavily in stocks from the same field that you work in. That way, if you lose your job and the industry you work in goes south, you're not going to see your entire portfolio tank at the same time.

"People should look at their finances and see, are they really, fully, properly diversified across their entire financial lives," he says.

Family background also plays a significant role in people's financial decisions. "If you look at how people manage their money, a lot of what they do is driven by what they learned as kids," he says. "If you're a parent, what you do with your finances is going to heavily influence your kids — [including] the things you say around the dining room table [and] the things you complain about."

Clements says his family all grew up with the story of his grandfather who inherited what today would have been a fortune of millions and millions of dollars. But his grandfather and his siblings blew it, he says. "We all grew up with this story of how the family fortune had been lost — and as a consequence of this, my two brothers, my sister and I are all incredibly careful with money."

Excerpt: The Little Book of Main Street Money

Book cover

Chapter Two: We Can't Have It All

Everything's a tradeoff.

If we take on the expensive car lease, we will have less for the summer vacation. If we opt to splurge on the summer vacation, we won't have as much for savings. If we decide to save like crazy for retirement and the kids' college education, we won't be able to buy as big a house.

Within reason, none of these choices is bad. But they are indeed choices—and yet often we give them scant thought. Instead, we haphazardly spend here and save there, without considering the implications for other areas of our financial life. In the previous chapter, we took the big-picture view of assets and liabilities. Now, it's time to take the same approach to spending and saving.

Doling Out Dollars

As we decide how to divvy up our paychecks, we need to make three basic choices. First, we have to weigh purchasing one item versus purchasing another. Next, we need to weigh purchasing today versus saving for tomorrow. And finally, when saving for tomorrow, we have to decide what we'll save for.

All this may make it sound like we enjoy a world of possibilities. But that is hardly the case. A hefty portion of our paycheck is oftentimes already spoken for, claimed by essentials such as mortgage or rent, car payments, taxes, health care, utilities, and food. Once these have taken their bite, our room to maneuver is considerably smaller. To be sure, we can live beyond our means in the short term, by tapping our home's equity, racking up the credit cards, or borrowing in other ways. But that isn't sustainable. Over the long haul, we are constrained by our incomes—which is why it's so important to make conscious choices, rather than haphazardly doling out our hard-earned dollars.

As we dish out those dollars, we may need to cut corners. There's a daunting laundry list of good financial practices, including maxing out our employer's 401(k) retirement savings plan, fully funding an individual retirement account, stashing dollars in 529 college savings plans for our kids, buying a home, keeping an emergency reserve equal to six months of living expenses, and covering ourselves with a heap of insurance, including disability, health, life, long-term care, homeowner's, auto, and umbrella liability insurance.

Overwhelming? It certainly is. Most of us can't possibly afford to do it all, so we need to decide what's critical and what is merely desirable. Many folks have four basic goals: They want to buy a home, help the kids with college, pay for their own retirement, and make sure they are okay if they're hit with some sort of financial calamity.

This last goal is often the easiest area to cut back on. Blanket insurance coverage may be comforting, but it is also mighty expensive. We can often trim costs by raising a policy's deductibles or reducing its benefits. We may also get by with an emergency reserve equal to less than six months of living expenses if, say, we have easy access to borrowed money through a home equity line of credit. Carrying less insurance and holding less emergency money can make particular sense if you and your spouse both work. Even if one of you gets laid off or can't work because of an accident or illness, you may be able to squeak by on the other spouse's paycheck.

Stiffing The Kids

After you've reined in the money you spend on protecting your family, the decisions get tougher. Do you go for the big house, pay for the kids' college, or fund your own retirement? I would argue that, if money is tight, it is no contest: Forget the big house, stiff the kids, and shovel those dollars into your 401(k).

I am not arguing that real estate is a lousy investment, that children ought to pay their own college costs or that there's virtue in financial selfishness. If you can afford to buy a big house and foot the bill for part or all of your children's tuition, that's great. But the fact is, you don't have to own a big house and you don't have to pay for the kids' college, but one day you will have to retire.

This might seem like an unnecessary tradeoff. Often, the temptation is to put off saving for retirement and instead deal with goals in the order they occur. That might mean buying the house in your thirties, paying for the children's college in your forties and then saving for retirement in your fifties. But financially, it makes sense to deal with goals concurrently rather than consecutively—and that means starting to save for retirement right away, while scaling back on the house and skimping on the college funding.

To understand why, suppose you are age 30. Your kids might be just 15 years from college, while your retirement could be 35 years away—and you might live another 25 years after that. The college bills may be a whole lot closer, but the time horizon for your retirement money is far, far longer. That means you can take greater risk by stashing more of your retirement nest egg in stocks, which should translate into higher long-run returns. In addition, with your retirement money, you may have the chance to fund an employer's 401(k) plan. No investment vehicle—not even a 529 college savings plan with its tax-free growth—can rival the financial benefits of a good 401(k). A traditional 401(k) plan will offer an initial tax deduction, tax-deferred growth, and possibly a matching employer contribution.

Moreover, if you don't start saving for retirement by your thirties, it can be awfully tough to amass enough by age 65. Imagine a world where you can earn a steady 5 percent a year. That might seem modest. But we're also assuming no inflation. In a world without rising consumer prices, 5 percent would be a pretty handsome rate of return. Indeed, at 5 percent a year, if you saved $400 a month starting at age 30, you would have $456,000 at age 65. What if you focus on other goals and don't get around to saving for retirement until age 40? Over the next 25 years, to amass the same $456,000, you would need to sock away more than $760 a month.

Getting an early jump on retirement savings doesn't just make the required savings rate less daunting. It also gives you options. When you are in your twenties and new to the work world, your job might seem wonderfully exciting and the prospect of working until age 65 might seem like no big deal. By your forties, the excitement may be long gone and you might be looking to go back to school or switch to a more stimulating but less lucrative career. If you have been saving diligently since your twenties, you will have those sorts of options. If you haven't, you are likely headed back to the office, possibly to a job you have come to loathe.

But what about the kids? If necessary, your children can always borrow to pay for college. In fact, there's a heap of financial assistance available to college students, including grant money and low-interest loans. By contrast, nobody will lend you money to pay for retirement, except maybe the local reverse-mortgage lender. Want to retire in comfort? You will to need to pony up cold, hard cash.

Street Smarts

  • Never forget that a dollar spent on one item is a dollar you can't devote to other desires.
  • To make it easier to amass enough for retirement, aim to start saving no later than age 30.
  • If money is tight, consider raising your insurance deductibles, keeping a smaller emergency reserve, purchasing a more modest home, and asking your kids to pay their own college expenses.

Excerpted with permission from the publisher, John Wiley & Sons Inc. Copyright 2009, Jonathan Clements.

Comments

 

Please keep your community civil. All comments must follow the NPR.org Community rules and Terms of Use. NPR reserves the right to use the comments we receive, in whole or in part, and to use the commenter's name and location, in any medium. See also the Terms of Use, Privacy Policy and Community FAQ.