6 money myths debunked | Fidelity Investment

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Don’t be bamboozled. Believing these myths could hurt your bottom line.  FIDELITY VIEWPOINTS  – 06/30/2021

Key takeaways

  • Establish good saving habits. Be sure to save some money from every paycheck.
  • Invest your savings appropriately for your goals and time frame.
  • Debt isn’t always bad but must be used responsibly.

There is no shortage of bad information out there—and falling for some of it can cost you money. It could be other people who steer you in the wrong direction, or it could be the things you tell yourself. Whatever the source, believing these myths could be hazardous to your financial health.

Myth #1: It’s not worth saving if I can only contribute a small amount

In reality: If you start early, around age 25, saving 15% of your paycheck—including your employer’s match to your 401(k) if you have one—could help you save enough to maintain your current way of life in retirement. It sounds like a lot, but don’t lose your motivation if you can’t save that much. Don’t be discouraged if you start later than age 25. Beginning to save right now and gradually increasing the amount you’re able to put away can help you hit your goals.

Save as much as you can while still being able to pay for essentials like rent, bills, and groceries. Fidelity’s budgeting guidelines may be able to help determine how much you can afford to save and spend.

  • Consider allocating no more than 50% of take-home pay to essential expenses (including housing, debt repayment, and health care).
  • Try to save 15% of pre-tax income (including employer contributions) for retirement.
  • Prepare for the unexpected by saving 5% of take-home pay in short-term savings for unplanned expenses.

Myth #2: The stock market is too risky for my retirement money

In reality: It’s true that money in a savings account is safe from the ups and downs of the stock market. But it won’t grow much either, given that interest rates on savings accounts are typically low. When it’s time to withdraw that money for retirement a few decades from now, your money won’t buy as much because of inflation. The stock market, however, has a long history of growth, making it an important component of your longer-term investment portfolio.

For instance, for a young person investing for retirement, a diversified investment strategy based on your time horizon, financial situation, and risk tolerance could provide the level of growth you need to achieve your goals.

There are a variety of ways to invest. Building a diversified portfolio based on your needs and the length of time you plan to be invested can be as complicated or as simple as you prefer. You can build your own diversified portfolio with mutual funds or exchange-traded funds—or even individual securities.

Even if you choose to manage your own investments, you may not be entirely on your own. 401(k) providers often offer example investment strategies that could give you ideas on how to build a diversified portfolio. You can invest in the funds in the model portfolio in the suggested proportions or you could use the models as a source of inspiration for your own investment ideas.

If you find investing daunting or don’t have the time to figure it out just yet, you might consider a managed account or a target-date fund for savings that are earmarked for retirement.

Myth #3: I’m young, so I don’t need to save for retirement now

In reality: Retirement can feel very far away when you’re young—but having all of those years to save can actually be incredibly powerful. That’s because time and compounding are important factors in a retirement savings plan.

Compounding happens as you earn interest or dividends on your investments and reinvest those earnings. Because the value of your investments is then slightly higher, it can earn even more interest, which is then packed back into the investments, allowing it to grow even more.

Over time, the value can snowball because more dollars are available to benefit from potential capital appreciation. But time is the secret ingredient—if you aren’t able to start saving early in your career you may have to save a lot more in order to make up for the value of lost time.

You can start by contributing to your 401(k) or other workplace savings plan. If your employer matches your contributions, make sure you contribute up to the match—otherwise you’re basically giving up free money. If you don’t have a workplace retirement account, consider opening an IRA to get started.

Myth #4: There’s no way of knowing how much money I’ll need in retirement

In reality: How much you’ll need depends entirely on your situation and what you plan to do when you leave the workplace.

But Fidelity did the math and came up with some general guidelines. Aim to save at least 15% of your pre-tax income every year—including employer contributions. To see if you’re on track, use our savings factor: Aim to have saved at least 1x (times) your income at 30, 3x at 40, 7x at 55, and 10x at 67.* Of course, everyone’s situation is unique and you may find that you need to save more or less than this suggestion.

Read about all of Fidelity’s retirement saving guidelines on Fidelity.com: Retirement roadmap

Don’t worry if you’re not always on track. Saving consistently, increasing your contributions when you’re able, and investing for growth in a diversified mix of investments could help you catch up over time.

Myth #5: All debt is bad

In reality: It’s true that carrying a balance on your credit card or a high-interest loan can cost a lot—significantly more than the amount you initially borrowed. But not all debt will hold you back. In fact, certain types of debt, like mortgages and student loans, could help you move forward in life and achieve your personal goals.

Plus, the interest rates on mortgages and student loans are typically much lower than those on personal loans or credit cards, and the interest may be tax-deductible.

No matter what kind of debt you take on, make sure you shop around for the best rates and never borrow more than you can afford to pay back on time.

Myth #6: Credit cards should be avoided

In reality: As long as you pay off your card balance in full each month to avoid interest, making purchases with credit can be worthwhile. Many credit cards offer a rewards program. If you make all your everyday purchases with your card, you could quickly rack up points you can redeem for cash, travel, electronics, or to invest.

Also, demonstrating that you use credit responsibly can help you increase your credit score, making it easier to buy a car or a home later on. It may even earn you a lower interest rate when you borrow in the future. It can be difficult to dig out of credit card debt, but if you control your spending and pay the card off every month, it could pay you back.

References:

  1. https://esj.seniormbp.com/SeniorApps/facelets/registration/loginCenter.xhtml

Investing is All about Your Behavior

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“Investing is not a hard science. It’s a massive group of people making imperfect decisions with limited information about things that will have a massive impact on their well-being, which will make even smart people nervous, greedy and paranoid.” Morgan Housel

“Financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know”, said Morgan Housel. There’s an element of investing, the behavioral side, that exist as the most important aspect. How you think about greed and fear and risk is so much more important than anything that you can know or be taught or learn at university. “Knowing what to to do tells you nothing about what happens in your head when you try to do it.”

“Doing well with money is not about what you know, it’s not about where you went to school or how smart you are, it’s how you behave”, says Morgan Housel, author of The Psychology of Money. “If you don’t have control over your behavior, over your relationship with greed and fear, over your ability to take a long-term mindset, over how gullible you are and who you trust, who you seek information from, you’re not going to do well at investing.”

If you can master or have some grasp over the behavioral elements of investing, that really matters, according to Housel. There aren’t many other fields that are like that. Like, it would be impossible to say that somebody who has no medical training, no medical experience, no backup could perform open heart surgery better than a Mayo trained cardiologist, that would never happen. But the equivalent of that does happen in investing. That an untrained investor can succeed at investing.

The single most important thing that matters to long-term investing success and what separates great investors from investors who do OK or do poorly over time is understanding that volatility in the short run does not prevent or preclude successful long-term returns over time.

Motley Fool’s David Gardener says investing is “…like wearing the home team jersey to your game this weekend. Whether your team wins or loses, you’re going to keep that jersey on, not just through a bad game or a bad season, but for years and years.”

Markets over a long period of time are volatile in the short run. That’s the cost of admission that you have to be willing to pay to do well over time.

Finance is guided by people’s behavior

To grasp why people bury themselves in debt, you don’t need to study interest rates or economic trends; you need to study the history of greed, fear, insecurity and optimism, according to Housel. Everyone has their own unique experience with how the world workds.  And what you’ve expereinced is more compelling and predictive than what you learn.  No amount of studying or open-mindedness recreates the power of fear and uncertainty.

Until you’ve lived through the fear and uncertainty, and personally felt its consequences, you may not undestand it enough to change you behavior.  In theory, people should make investment decisions based on their goals and the characteristics of teh investment options available to them at the time.

“If markets never fell, they wouldn’t be risky, and if they weren’t risky, they’d get really expensive, and when they get really expensive, they fall.” Morgan Housel

Bottom Line

“Whether or not you’re successful with money isn’t about knowledge, IQ or how good you are at math. It’s about behavior. And everyone is prone to certain behaviors over others.”  Morgan Housel

References:

  1. https://www.fool.com/investing/2021/06/24/great-quotes-morgan-housel-edition/

Buffett on Inflation

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“Inflation often feels like an abstract concept, but it hits everyday people the hardest.” Warren Buffett

Inflation is when the dollars in your wallet lose their purchasing power — either because the money supply has dramatically increased or because prices have surged, according to Bankrate.com.

Effectively, inflation occurs when the cost of goods and services in the economy goes up over a sustained period of time. Yet, inflation doesn’t happen overnight, and it also doesn’t happen when the cost of one particular good or service goes up.

From an economics perspective, inflation refers to price increases to the broader economy. And, price increases aren’t always synonymous with inflation — and some economic experts say a little bit of inflation is actually good for the economy. That’s for two main reasons: One, it prevents a deflationary trap, which experts say can be even worse than deflation because money loses value. Another reason is because households make better financial decisions when they expect stable and low prices.

“We may see prices rise on certain things like gas or milk, but it’s not necessarily inflation unless you see prices rising sort of across the board, across many different products and services,” says Jordan van Rijn, senior economist at the Credit Union National Association (CUNA).

The Berkshire CEO described high inflation as a “tax on capital” that discourages corporate investment. The “hurdle rate,” or the return on equity needed to generate a real return for investors, climbs when prices rise, Buffett said. “The average tax-paying investor is now running up a down escalator whose pace has accelerated to the point where his upward progress is nil,” Buffett added.

Buffett pointed out inflation can hurt more than income taxes, as it’s able to turn a positive return on investment into a negative one. If prices have climbed enough, people who make a nominal return on their investment may be left with less purchasing power than before they invested.

Inflation Causes

Given the federal government’s unprecedented loose monetary policy, fiscal spending spree and money-printing splurge over the last year, many economists have warned that such fiscal irresponsibility could result in a destructive wave of inflation.

‘I worry about inflation. I do not believe inflation is going to be transitory.’ Larry Fink, chairman and CEO, BlackRock Inc.

Defenders of federal government pandemic monetary and fiscal interventions have insisted that any resulting price inflation is just transitory. But recent data is showing that price inflation is hitting new highs and many economists believe that inflation is deep rooted and non-transitory.

However, the June’s Consumer Price Index (CPI) shows prices once again sharply on the rise. From June 2020 to June 2021, the data show that consumer prices rose a staggering 5.4 percent. Larry Fink, Chairman and CEO of BlackRock Inc., isn’t convinced by the Federal Reserve’s arguments that U.S. inflation pressures will fade away once supply bottlenecks and other temporary factors resulting from the COVID-19 pandemic fade away.

Economists lump inflation causes into two categories: demand-pull and cost-push inflation.

Cost-push occurs when prices increase because production is more expensive; that can include rises in labor costs (wages) or material prices. Firms pass along those higher costs in the form of higher prices, which then cycles back into the cost of living.

On the flip side, demand-pull inflation generates price increases when consumers have resilient interest for a service or a good.

While price inflation has many causes, much of the current inflation can be traced back to the policy of the Federal Reserve. The Fed essentially created trillions of new dollars to pump into the economy in the name of “pandemic stimulus.”

“The quantity of money has increased more than 32.9% since January 2020,” Federal Economic and Education (FEE) economist Peter Jacobsen explained in May. “That means nearly one-quarter of the money in circulation has been created since then. If more dollars chase the exact same goods, prices will rise.” 

“We are seeing very substantial inflation,” Warren Buffet said at a recent shareholder meeting. “It’s very interesting. We are raising prices. People are raising prices to us and it’s being accepted.”

The typical person’s standard of living declines as a result of price inflation, because what really matters is not what number appears on your paycheck but the purchasing power of your paycheck. Working-class Americans suffer tremendously when their energy bill increases by nearly 25 percent in just one year, for example.

It is not a secret that stocks, like bonds, do poorly in an inflationary environment, according to Warren Buffett.

“There is no mystery at all about the problems of bondholders of in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn’t going to be a big winner” Buffet states. “You hardly need a Ph.D. in economics to figure that one out.”

Regarding stocks, the conventional wisdom believes “…that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms; let the politicians print money as they might.”

The main reason it, stocks as a hedge against inflation, do not turn out the way conventional wisdom believed, according to Buffett, is that “stocks, in economic substance, are really very similar to bonds”.

References:

  1. https://www.bankrate.com/banking/federal-reserve/what-is-inflation/
  2. https://fee.org/articles/inflation-just-hit-a-13-year-high-here-s-why-you-should-care/
  3. https://markets.businessinsider.com/news/stocks/warren-buffett-berkshire-hathaway-warned-inflation-prices-tapeworm-investors-businesses-2021-5
  4. https://www.cnbc.com/2018/02/12/warren-buffett-explains-how-to-invest-in-stocks-when-inflation-rises.html
  5. https://fee.org/articles/the-costs-are-just-up-up-up-warren-buffett-issues-grave-warning-about-inflation/
  6. https://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/
  7. http://csinvesting.org/wp-content/uploads/2017/04/Inflation-Swindles-the-Equity-Investor.pdf

When to Claim Your Social Security Benefits

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WAITING TO CLAIM SOCIAL SECURITY WILL MAXIMIZE YOUR LIFETIME BENEFIT

  • If you claim Social Security at age 62, rather than wait until your full retirement age (FRA), you can expect up to a 30% reduction in monthly benefits.
  • For every year you delay claiming Social Security past your FRA up to age 70, you get an 8% increase in your benefit. So, if you can afford it, waiting could be the better option.
  • Health status, longevity, and retirement lifestyle are 3 variables that can play a role in your decision when to claim your Social Security benefits.

You can start claiming Social Security benefits at 62 and it can be tempting to take the money and run as soon as you’re eligible. After all, you’ve been paying into the system for all of your working life, and you’re ready to receive your benefits.

But you will not receive 100% of your benefits unless you wait until your Full Retirement Age of 66 years and 10 months if you reach age 62 during calendar year 2021. And if you wait longer, like until age 70 years young, you can receive even more benefits.

See the source image

If you start taking Social Security at age 62, rather than waiting until your full retirement age (FRA), you can expect up to a 30% reduction in monthly benefits with lesser reductions as you approach FRA, according to Fidelity Investments. FRA ranges from 66 to 67, depending on your date of birth. And your annual cost-of-living adjustment (COLA) is based on your benefit. So if you begin claiming Social Security at 62 and start with reduced benefits, your COLA-adjusted benefit will be lower too.

Wait to Claim

Health status, longevity, and retirement lifestyle are 3 key factors that can play a role in your decision when to claim your Social Security benefits. Unfortunately, you can not predict your future health status, but you can rely on the simple fact that if you claim early versus later, you will likely have lower benefits from Social Security to help fund your retirement over the next 20-30+ years.

By waiting until age 70 to claim your benefits, you could get the highest monthly benefit possible over your lifetime than if you start claiming at age 62.

And if you are married, you may be eligible to claim Social Security based on your spouse’s earnings. This may mean a significantly higher monthly payment for you if your spouse had a higher income than you during his or her prime earning years.

Basic Benefit Rules

After you reach age 62, for every year you postpone taking Social Security (up to age 70), you could receive up to 8% more in future monthly payments. Once you reach age 70, increases stop, so there is no benefit to waiting past age 70.

Members of a couple may also have the option of claiming benefits based on their own work record, or 50% of their spouse’s benefit. For couples with big differences in earnings, claiming the spousal benefit may be better than claiming your own.

Social Security payments are reliable and should generally adjust with inflation, thanks to cost-of-living increases. Because people are living longer these days, a higher stream of inflation-protected lifetime income can be very valuable.

Social Security can form the bedrock of your retirement cash flow and income plan. That’s because your benefits are inflation-protected and will last for the rest of your life. When making your choice, be sure to consider how long you may live, your financial capacity to defer benefits, and the impact it may have on you and your survivors.

References:

  1. https://communications.fidelity.com/pi/calculators/social-security
  2. https://www.fidelity.com/viewpoints/retirement/social-security-at-62
  3. https://www.fidelity.com/viewpoints/retirement/social-security-tips-for-couples

Investing Goals, Time Horizon and Risk Tolerance

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When it involves investing, it’s important that you start with your financial goals, time horizon and risk tolerance.

At times in calendar year 2020, the global economy seemed on the verge of collapse. Risk, ruin and enormous opportunity were the big stories of the year. Overall, the year was marked by change, opportunity, calamity and resilience in the financial markets.

Yet, in the financial markets, winners dramatically outweighed the losers, according to Forbes Magazine. Almost overnight, new winners were born in communications, technology, lodging and investments. Innovative technology companies in the S&P 500 Index propelled U.S. markets higher. And, many industries were more resilient than expected, in part because of an unprecedented monetary and fiscal response from Washington.

In light of the unprecedented upheaval, you, like everyone else, want to see their money grow over the long term, but it’s important to determine what investments best match your own unique financial goals, time horizon and tolerance for risk.

To learn the basics of investing, it might help to start at one place, take a few steps, and slowly expand outward.

Begin by Setting Goals

As an investor, your general aim should be to grow your money and diversify your assets. But your investing can take on many different forms.

For instance, it might help you to decide the investing strategies you intend to follow in order to grow your money. Such as whether you are interested in purchasing assets that could appreciate in value, such as equity stocks and funds, or play it relative safe with bonds and cash equivalents.

If you’re interested in investing in bonds, you will receive a steady stream of income over a predetermined time period, after which you expect repayment of your principal.

You might also be interested in pursuing both growth and income, via dividend stocks.

Learning to invest means learning to weigh potential returns against risk since no investment is absolutely safe, and there’s no guarantee that an investment will work out in your favor. In a nutshell, investing is about taking “calculated risks.”

Nevertheless, the risk of losing money—no matter how seemingly intelligent or calculated your approach—can be stressful. This is why it’s important for you to really get to know your risk tolerance level.  When it comes to your choice of assets, it’s important to bear in mind that some securities are riskier than others. This may hold true for both equity and debt securities (i.e., “stocks and bonds”).

Your investment time horizon can also significantly affect your views on risk. Changes in your outlook may require a shift in your investment style and risk expectations. For instance, saving toward a short-term goal might require a lower risk tolerance, whereas a longer investing horizon can give your portfolio time to smooth out the occasional bumps in the market. But again, it depends on your risk tolerance, financial goals, and overall knowledge and experience.

References:

  1. https://www.forbes.com/sites/antoinegara/2021/12/28/forbes-favorites-2020-the-years-best-finance–investing-stories/
  2. https://tickertape.tdameritrade.com/investing/learn-to-invest-money-17155

What the Inflation of the 1970s can Teach Us Today

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A Wall Street Journal survey finds that “strong economic rebound and lingering pandemic disruptions fuel inflation forecasts above 2% through 2023”.

The U.S. inflation rate reached a 13-year high recently, triggering a debate about whether the country is entering an inflationary period similar to the 1970s, according to WSJ. Americans should brace themselves for several years of higher inflation than they’ve seen in decades, according to economists who expect the robust post-pandemic economic recovery to fuel brisk price increases for a while.

Economists surveyed this month by The Wall Street Journal raised their forecasts of how high inflation would go and for how long, compared with their previous expectations in April.

On average, the WSJ survey respondents expect a widely followed measure of inflation, which excludes volatile food and energy components, to be up 3.2% in the fourth quarter of 2021 from a year before. They forecast the annual rise to recede to slightly less than 2.3% a year in 2022 and 2023.

That would mean an average annual increase of 2.58% from 2021 through 2023, putting inflation at levels last seen in 1993.

References:

  1. https://www.wsj.com/articles/higher-inflation-is-here-to-stay-for-years-economists-forecast-11626008400

Emotional decisions derail your finances

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Many investors expressed unbridled exuberance at the beginning of calendar year 2020 as equity markets reached new all-time high valuation. The fact that stocks also go down, or fluctuate in value, was not on the minds of most investors. This fact led many investors to take on more risk than they could handle emotionally and financially.

When the market went into a free fall in March due to pandemic related health concerns and the shutdown of the economy, investors understandably panic and wondered if they should move to cash, shift around their allocation or even get out of stocks altogether.  Unfortunately, many nervous investors made decision based on emotion and sold assets in a panic.

A few weeks after the drop, the market began to recover its massive losses. Investors not wanting to miss out on the market surge, began rushing back into the market with urgency and the fear of missing out on the recoverly. This time they asked why they didn’t own more stocks. This Jekyll and Hyde change in attitude may seem illogical in retrospect. However, when living in the moment, it’s easy to get caught up in the emotions of the day.

Implementing strategies to manage emotions and the actions you take is imperative.

References:

  1. https://www.kiplinger.com/investing/601852/8-investing-lessons-learned-in-2020

Psychology of Money

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“Look at market fluctuations as your friend rather than your enemy, profit from folly rather than participate in it.” Warren Buffett

Excerpts from: The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness by Morgan Housel.

The book’s premise is that doing well with money has little to do with how smart you are and a lot to do with how you behave.

  • “Financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.”
  • “Soft skills are more important than the technical side of money.”
  • “You think about and are taught about money in ways that are like physics (with rules and laws) and not enough like psychology (with emotions and nuance).”
  • “Finance is guided by people’s behaviors.“

“It’s been an ideal period for investors. A climate of fear is their best friend. Those who invest when commentators are upbeat end up paying a high price for meaningless reassurance. In the end, what counts in investing is what you pay for a business–through the purchase of a small piece of it in the stock market–and what that business earns in the next decade or two.” Warren Buffett

References:

  1. https://www.sloww.co/psychology-of-money-book/https://www.sloww.co/psychology-of-money-book/

Roth IRA

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“Roth individual retirement accounts were created to help middle class earners set aside money for retirement that they wouldn’t have to pay taxes on at withdrawal.” Barron’s

The Roth individual retirement account (IRA) was created to provide an alternative to making non-deductible contributions to traditional IRAs. Roth IRAs are funded with after-tax dollars, which means at withdrawal at age 59 ½ the money is tax-free. Comparatively, traditional IRAs are funded with pre-tax dollars, so distributions are taxed at withdrawal.

You’re taxed or penalized when you withdraw your Roth IRA contributions and earnings if your Roth IRA account isn’t at least 5 years old or if you’re not yet 59½. The earnings portion of the withdrawal may be subject to taxes and a 10% penalty.

The contribution limit for Roth IRA accounts is $6,000 a year in 2021 (or $7,000 for people 50 and older).

There are also income restrictions for Roth IRA.

  • Single individuals with modified adjusted gross incomes (MAGI) of less than $125,000 in 2021 can contribute up to the limit, but their contributions are phased out if their MAGI is between $125,000 and $140,000.
  • If individuals earn more than $140,000, single taxpayers cannot contribute to a Roth IRA. For married couples filing jointly, the threshold is between $198,000 and $208,000 in 2021. 

Individuals can also use Roth conversions, where they take money from a traditional IRA and move it into a Roth after paying a one-time income tax on the transferred assets since pre-taxed dollars converted to a Roth are taxable at ordinary income rates. These transfers can also be known as a “backdoor Roth,” because they’re working around income limits to push money into these ultimately tax-free accounts. 

References:

  1. https://www.barrons.com/articles/peter-thiel-roth-ira-propublica-51624558641
  2. https://www.edwardjones.com/us-en/investment-services/account-options/retirement/roth-ira

2 benefits of investing to meet your goal | Vanguard

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What’s your plan to reach your goal?

You could just add up whatever’s left over in your bank account after you pay your bills each month. But putting that money in a separate investment account instead can have major benefits.

It keeps you from buying something else

No matter how much you really want to check this savings goal off your list, it’s all too easy to spend the money on something else when it’s just sitting in your bank account.

Maybe you think that willpower alone will be enough to keep you on course. If so, that’s great! But what if it doesn’t?

The best way to ensure that your money goes toward your goal is to move it out of your bank account before you’re tempted to spend it. Keeping this money in a separate account also makes it easier to see the progress you’re making toward your goal.

It gives you a chance to reach your goal faster

Let’s say you want to save for a down payment on your first home. You expect to need about $10,000, and you budget $200 a month toward your goal.

Keeping the money in a bank account typically means you’ll earn a pretty low rate of return—0.5%, for example.

At that rate, it will take you a little over 4 years to reach your goal, during which you’ll deposit a total of $9,800.

If you instead invest the money in a moderate-risk mutual fund or ETF (exchange-traded fund) and earn an average return of 5%, you could reach your goal 4 months earlier—with total deposits of only $9,000.

By investing, you could reach your goal with less time and money

A bar chart showing that investing your money could help you reach your goal faster

References:

  1. https://investor.vanguard.com/other-savings-goals/