Pascals wager and Social Security

When people get close to retiring, they start thinking about social security.  One of the main questions is about when they should start taking Social Security.  For younger people, the Social Security full retirement age is 67.  If you elect to start taking your Social Security benefits then, you will receive 100% of the calculated benefits that you have earned.

You do have the option to take is as early as 62 or as late as 70.  If you take is early, like a lot of people decide to do, you lose about 7% of your annual benefit for every year early.  And if you decide to delay beyond 67, you get about 8% more in annual benefits for every year you delay, up to 70.  Beyond 70, there are no additional benefits, so it doesn’t really help to delay beyond that.

Here’s the question.  What’s the best age to begin taking Social Security?

Most people approach this in one of two ways.  First way – let’s just take it as early as possible because I want to retire ( and maybe get out of my miserable job.)  That’s okay, but it does leave you with a lot less money for the rest of your life.  Like 2/3 of the annual benefit, for as long as you live.  That’s a big downside.

The other way people commonly think about this is calculating a breakeven point.  So if I wait a couple of years, I don’t get those 2 years of Social Security income (and have to either keep working or live off my own savings), but my payout will be 2×8% = 16% more, every year for the rest of my life.  And this amount will be adjusted upward for inflation each year.  So I have to live approx. 12-14 years more to break even on this “investment”.  So if I think I am going to live beyond 80, I’ll get my money’s worth.  Yup.

However, I think that people forget that the longevity stats for living show the average age for men or women to live, when they are at a certain age.  For example, if you are a 67-year-old man, the average longevity is about 81.  About 14 years.  But what that really means is that half the population will live beyond that and some will live for decades beyond that.

This is where my thinking on Pascal’s wager comes in.  Philosopher Blaise Pascal was considering whether God existed, and if he should believe in God.  He reasoned that if he believed in God, but it turned out that God didn’t exist, his loss was that he could have sinned more without much consequence.  But if he didn’t believe in God, and it turned out God existed, he would live for eternity in Hell and misery.  He chose to believe in God.  The downside was much greater than any upside.

So, my current thinking on Social Security is that we should think about this not from a breakeven point of view, but more from a guarding against long-term bad situations, like living under a bridge eating cat food when I’m really old.

I have been diligent in investing for my life, and my health is reasonably good.  I am fortunate to have these, and I know not everyone can afford to think about Social Security this way.  This leads me to believe that the best option for taking Social Security is to delay until age 70, which provides the highest level of annual benefits, which are also inflation protected.  Almost like self-insuring, self-funding a longevity annuity without all the annoying costs and downsides.  And who can beat a guaranteed 8% annual investment return for every year I wait, that will be inflation adjusted every year in the future.  No one.

On the other hand, if your health is poor, I would go for early Social Security so I could live the fullest live in my remaining years.

It seems like taking Social Security at your full retirement age is not optimal.  You should either take it as early as possible (if you know you will not live long), or delay it as long as possible to ensure against a long life of poverty.

Wow.  That’s kind of a downer conclusion, but I do think it is the best way to think about when to take Social Security.


Begin with the end in mind

Stephen Covey wrote a bestselling book called “The 7 Habits of Highly Effective People”, which shares 7 lessons in Personal Change.  One of my favorites is “Begin with the End in Mind.”  This lesson seems to apply to almost everything in life.  Sometimes I think of this as getting the big things right.

I remember packing my VW at the end of a college semester to go home.  Somehow I got everything to college, but it never seemed to fit coming home.  I always ended up with the mini fridge or bike sitting on the driveway.  And I just wanted to get out of there.  Maybe I was in a rush.

But I found that with practice and by beginning with the big things, somehow everything would fit.  My plans weren’t perfect: just start with the big, heavy things.  The smaller things fit in wherever and I always found a way to get them in, without too much effort.

This is a great metaphor for your financial life.  There are so many people telling you all the details of every conceivable thing.  It seems overwhelming.  Add to that the instant interpretation of the ups and down of the market, most of which is just noise.  But it undermines your confidence and you start to feel like maybe you need help from one of the “experts”.  But just like packing your car coming back from college, you don’t need an “expert” and you don’t need a detailed plan that takes everything into account.  Just Begin with the End in Mind.  Start with the Big Things.

So what are some of the Big Things?   Here’s my list.

Retirement:  This is probably the biggest.  As a millennial, you should count on living to 100.  This means you will need a bunch of money to cover several decades of living without an income.  And nobody will give you a “loan” to cover living expenses when you’re retired.  So get started as soon as possible on this one.

Healthcare:  Most of us don’t have many health problems now, but when they do strike, they wipe people out.  It’s just like hurricanes along the coast.  One may not have hit you yet, but you know it will, and when it does, it’s going to be painful.  Living a healthy lifestyle is great “insurance” and makes life enjoyable for a long time.  And having some decent health insurance keeps catastrophes from wiping you out financially.

Debt:  I’m not against debt, but it has to be reasonable compared to your income, and of the right kind.  The right kind of debt is that which builds up your human capital (your skills, employability, etc.), or is for an appreciating asset (like a reasonable cost home, not a speculative or “stretch” house).  Try to avoid any other kind of debt, and pay it off quickly.  Especially credit cards.

College savings for kids:  If you have kids, then help them get a good education for the smallest price possible.  Saving anything, and considering the state university helps tremendously.  But get started when they are born, even with a small amount.

That’s it.  Everything else is the small stuff.  Keep it in check, but don’t sweat it.

What are your thoughts?

Life isn’t a dress rehearsal

While I was at Xerox, I had a boss who liked to say, “Life isn’t a dress rehearsal.”  By this, he meant that you shouldn’t just live to work, but also live along the way.  There would be no going back.  No do-overs.  He worked hard and many long hours, but he also tried to be home and do things with his family and friends as well.  When he retired at 65, I asked him if there were things that he wished he had done, but just hadn’t gotten around to.   I guess he had had a pretty good work life, because there were only a few things he mentioned.  And they were not about work – they were about family and friends and travel.  That was going to be his focus going forward into retirement.

You only get one shot at life.  So make sure you stay focused on what’s important to you, not just what feels urgent at the moment.  That includes your financial life.

At my stage in life, there are 2 things financially that I am focused on.  First, financial security after I stop taking a paycheck, and Second, helping others get closer to their version of financial security.

I am right on track for my own security, and that feels good.  But what feels even better, is taking all the knowledge and experience I have gained and helping others start their own journey.   I take the simplest and most automated path forward.  Essentially, my first step is to help them eliminate high interest debt.  This is mainly done by helping them find a few spending leaks that they won’t miss much, and automating additional payments on their debt to get it paid off fast.  After that, then we focus on building long term wealth.  We can automatically use the extra debt payment that was being made, and now funnel it into something like a Total Stock Market index fund, or target date index fund.  Then find some more.  Lastly, I always focus on automating everything.  Why?  Because our biggest issues with savings tend to be behavioral.  When the laziest approach is to do nothing and that results in good investments being made, life becomes simpler.  When we have to go out of our way to stop or change the investment, we many times won’t.  Just too much effort.  And that turns out to be a good thing.  So turn your busy lifestyle into an asset rather than an excuse.  Automate every investment.

I hope you are well on your own journey and will be able to help others as well.


Bottom Line: You’ve got to save more

Robert Powell wrote an interesting article in USA Today this week, where he summarized some recent research of David Blanchett, Michael Finke and Wade Pfau.

The summary of his summary is… you’ve got to save more.

5% of your salary won’t cut it.  10% won’t cut it.  Even 15% of your salary every year from age 25 to age 65 might not cut it.  The bottom line is that retirement keeps getting more expensive for people.

The reasons boil down to 1)Lower expected real (inflation adjusted) returns now and in the future, and 2)we are living longer.  By the way, they didn’t mention this, but there is also a large probability that you will receive less from Social Security in the future.

We don’t know the future, but we can see that stocks are near their high (price) relative to their earnings.  Since earnings are the engine that drives the long term price of stocks, and stocks usually revert to their long term mean, there is room for growth, but probably not at the same rate that occurred in the past few decades.  And as inflation returns to normal levels, we will likely see that your real returns will be a few percentage points lower than historical norms.  This means that whatever we save will grow more slowly, and that the amount we will be able to take out during retirement will be less as well.

Oh, and by the way, we are living longer, so we will need more money, not less.

And then there is the Social Security issue.  Current proposals in congress look to “solve” the issue for the next 75 years.  But if you read the fine print, what they really mean is that you will get less in retirement.  And the younger you are today, the less you will get in retirement.

What does all this mean?

Well, we need to take care of ourselves.  And we need to be more frugal and intelligent in how we do it.  So increase the amount you are saving, and do it today.  Find a second job to generate investing income and invest all of it.  And take care of yourself, because you might need to work a few extra years.

What’s the upside?  Well, if this doomsday scenario doesn’t come to fruition, you will be in great shape to enjoy a fantastic financial life.  And if it does, you are still okay.

One simple habit to make taxes less stressful

It’s tax season.  This is a truly exhausting period of time for many, as they wonder how much they owe, where their documents are, etc.  But it doesn’t have to be that way.

One simple trick that you should do every January is to set up two folders for the year.  Put them in the front of your desk drawer where they are super easy to find.  Label the first folder “Taxes 2017” and label the second folder “Healthcare Expenses 2017”.

I use these folders to capture everything related to taxes and healthcare expense during the year.  If I’m not sure, I still put it in the folder.  And here’s my method.  I put whatever document I have in the back of the folder.  This means that they are in chronological order at any point in the year, with the earliest ones on top.

If I donate to charity, I put the receipt in the back of the tax folder.  If I go to the dentist, I put the receipt in the back of the Healthcare Expenses folder.  When I pay the property tax bill (I don’t have a mortgage anymore), then I put it in the back of the tax folder.  You get the idea.

For those of you who work for an employer and get a W-2, that’s about all you need.  If you also have other income, pensions or social security and need to estimate and pay quarterly taxes, I do one other thing.  I fill in 4 tax vouchers, estimating what I will have to pay.  And then I put the dates in my calendar so I don’t miss it.  I used to do this in paper and envelopes, but now it’s all done electronically.  So I have a spreadsheet that helps me estimate quarterly taxes.

The key is to spend a little time up front to get organized.  This will give you peace of mind throughout the year, and a much easier tax season next year.

Let me know what systems you guys use.