FINANCIAL SECURITY is within your reach. Don’t believe me? Here’s a roadmap that demonstrates it’s possible for most Americans. Sam is a 22-year-old college graduate. He begins working right after college, earning $50,000 a year. He saves 20% of his income the first year, equal to $10,000. Each year, he gets a 2% raise. This raise is over and above inflation, which we’ll assume is zero to keep things simple. In addition to saving $10,000 a year, he takes half his annual raise and also socks that away. For example, in his second year on the job, his salary increases from $50,000 to $51,000. He takes half the raise, or $500, and adds that to his annual savings of $10,000, so he saves $10,500. He continues in this manner year after year. Since he’s saving half of each year’s raise, his savings rate slowly increases, reaching 25% at age 32 and 30% at age 43. Sam also consistently invests his savings, getting a long-term average annual return of 6.2%. More on that number later. Meanwhile, Sam’s standard of living isn’t stagnant. His annual spending rises from $40,000 right after college to $50,000 by age 40 to a little over $60,000 by age 53. What’s happening to his nest egg? By age 49, Sam has become a millionaire. The year before he became a millionaire, Sam’s cost of living was $56,000. That means, if he retired at 49 and wanted to maintain his current standard of living, he would need to draw 5.6% from his nest egg. Sam is a conservative guy and thinks 5.6% is too high. Maybe he could swap to a less stressful job with more time off, taking a 50% pay cut in the process. Since he made $82,000 the previous year, a 50% pay cut would mean an income of $41,000. Now, he only needs to draw $15,000 from his nest egg to maintain his $56,000 lifestyle, which would equate to a 1.5% withdrawal rate. That sounds a lot better. While it sure feels good to know he has options, 49-year-old Sam isn’t quite ready to throw in the towel. He continues to work and save as he’s been doing. Nine years later, at age 58, his nest egg has grown to $2,108,000. Sam is now seriously contemplating a career change or maybe even outright retirement. Can he pull the trigger? You bet. If Sam were to withdraw 4% of his nest egg—based on the popular 4% rule—that would equate to an annual income of a little over $84,000. That’s $20,000 more than he spent the previous year. Not only can Sam retire, but also he could seriously upgrade his lifestyle. Notice that it took Sam 27 years to become a millionaire, but only nine additional years to reach $2 million. Any guess on how many years it would take Sam to get to $3 million? Just five years. These numbers demonstrate the power of compound interest. Even if Sam stopped saving once he became a millionaire at age 49, his nest egg would still grow to $2 million. Instead of taking nine years, it would take 12 years—just three years longer. Are my assumptions realistic? The first set of assumptions are largely outside of our control. I call these the financial assumptions: Sam had a starting income of $50,000 a year. As it happens, the average starting salary for a bachelor’s degree graduate was just over $50,000 for the last three years, according to the National Association of Colleges and Employers. Median household income reported by the U.S. Census Bureau for 2016 was $59,039. Sam’s income grew 2% each year. Median wage growth since 1983 has been 4% a year. Subtract 2% inflation and you get 2% real income growth. Sam’s savings collected an average annual return of 6.2%. This number comes from assuming an 80% stock-20% bond portfolio and using real long-term rates of return of 7% for stocks and 3% for bonds. While we’ve enjoyed such performance historically, there’s a good chance returns will be lower going forward. But that doesn’t change our story much—because what drives Sam’s success, more than anything, is his savings habits. The second set of assumptions are largely within our control.  They are what I call the personal assumptions: Sam begins to save at age 22, which is the age many young adults graduate from four-year colleges. Sam saves 20% of his income right off the bat. Sam takes half of every annual raise and adds it to his yearly savings. I can already hear the objections: “Save 20% or more of my income? Get real. Maybe you can do that if you’re making a six-figure income, but otherwise you’re out of your mind. I can barely make ends meet living on $50,000.” Here’s my rebuttal: If $50,000 covers the bare necessities of life, how are those earning $40,000 surviving? Alternatively, what about those families earning $62,500? Surely they can live off 80% of their income—which would be $50,000—and save 20%? My point: Saving 20% of your income is never easy, because it means denying yourself things that you have the means to obtain right now. But what’s the alternative? The savings rate has hovered around 6% recently. If we run the same scenario as before, but change the savings rate to 6% and the name to Frank, here’s what we find: Frank reaches the $1 million mark at age 69 and $2 million at age 80. If Frank retires at 69 and uses the 4% rule, he would have annual income of $41,000. Just before quitting the workforce, however, he had been spending $116,000 a year. The bleak reality: A 6% savings rate means the financial milestones take many more years to reach. Frank waits two decades longer to become a millionaire. Even worse, the low savings rate equates to a higher spending rate, meaning Frank is faced with a difficult decision at age 69. He can retire and massively downgrade his standard of living—or he can keep working. Will you be a Sam or a Frank? Just remember the truism that applies not just to personal finance, but to all walks of life: You can have it easier now and harder later—or harder now and easier later. What about easier now and easier later? Lots of folks behave like that’s a choice, but it isn’t. John Lim is a physician who is working on a finance book geared toward children. His previous articles were Bearing Gifts and Lay Down the Law. Follow John on Twitter @JohnTLim. [xyz-ihs snippet="Donate"]

SOCIAL SECURITY benefits are fairly modest—the average retiree receives $1,555 per month or $18,660 a year—but they’re a vital source of retirement income for countless retirees. Today’s burning question: How can we shore up the program’s finances? It’s estimated that Social Security provides some 30% of the income for the elderly and that nearly nine out of 10 people age 65 and older receive benefits. Social Security is even more important for women, 42% of whom rely on it for half or more of their income. Unfortunately, the Old-Age and Survivors Insurance (OASI) Trust Fund, from which Social Security benefits are paid, faces imminent shortfalls. The fund’s reserves are projected to be depleted by 2033, at which time continuing tax revenue will be sufficient to pay just 76% of promised benefits. There are no easy solutions. Both higher payroll taxes and lower benefits may be necessary. But how about some out-of-the-box thinking? Meet my suggested solution: the Save for Tomorrow program. The program would cost the federal government very little in the short run but save it vast sums in the long run. It involves the creation of a novel, completely optional retirement account. Here’s the basic framework: Parents, grandparents or legal guardians could opt to open and fund a Save for Tomorrow account for their children or grandchildren. The account would be triple tax-advantaged—contributions would be tax-deductible, funds in the account would grow tax-deferred and future withdrawals would be tax-free. Contributions would be subject to a lifetime limit for each child—say, five times the annual IRA contribution limit. For a child born today, that would mean contributions would be limited to $30,000, equal to five times today’s regular $6,000 IRA limit. Contributions could begin at birth. The contribution window would close once the child reaches age 10. Between ages 65 and 70—and no sooner—the beneficiary could claim her benefits. At that point, the funds in the account would be annuitized, with inflation adjustments, just as Social Security payments are. The beneficiary would then receive the higher of the annuitized income stream from her Save for Tomorrow account or the standard Social Security benefit. If the Social Security benefit is higher, the funds in the Save for Tomorrow account would be turned over to the OASI Trust Fund. Save for Tomorrow accounts would be overseen by salaried professionals and would reside inside the highly regarded federal Thrift Savings Plan. Given the super long time horizon—anywhere from 55 to 70 years—the funds would be aggressively invested, with nearly 100% in stocks. Upon a beneficiary’s death, any unused funds in the Save for Tomorrow account would be turned over to the OASI Trust Fund. Let’s run some numbers to see how this new program might work. I’ll assume the Save for Tomorrow account earns a 7% real return over its lifetime. For simplicity’s sake, I’ll also assume the account is funded by a lump sum contribution at birth. Finally, I’ll use the 4% rule to annuitize the account balance at ages 65 and 70. You can see the results in the accompanying table. Some observations: Contributing $6,000 at birth (scenario No. 1) generates an annual payout of $19,505 at age 65. This is higher than the average Social Security benefit of $18,660 that I referenced earlier. By waiting until age 70, the payout increases to $27,357 a year. For comparison purposes, the maximum Social Security benefits are listed in the table. Obviously, many retirees will receive far less than these numbers. Contributing $12,000 at birth leads to annual payouts of $39,011 and $54,715 at ages 65 and 70, respectively. Both of these top the current maximum Social Security benefits. The annual payouts are in real, inflation-adjusted dollars since I’m using a 7% real return for the calculations. Remember that the Save for Tomorrow payouts are tax-free, meaning they’re significantly more generous than those from Social Security, which are potentially taxed. The upshot: Even if the two benefits were equal in dollar terms, the Save for Tomorrow benefit would win out once taxes are factored in. The contributions are entirely funded by the private sector and are completely voluntary. While the new accounts would cost taxpayers very little—there would be a small loss in tax revenue due to the tax-advantaged nature of the accounts—the Save for Tomorrow program would save the Social Security program a bundle over the long run. How so? If someone died at age 64 with $1 million in his Save for Tomorrow account, that money would go to the OASI Trust Fund. In addition, anyone receiving the higher Save for Tomorrow payout isn’t drawing a cent from Social Security. If the Social Security benefit is higher than the Save for Tomorrow benefit, the latter dollars are returned to the OASI Trust Fund. Finally, any money left over upon the death of a beneficiary goes into the OASI Trust Fund. [xyz-ihs snippet="Mobile-Subscribe"] The biggest criticism of the Save for Tomorrow program would be that it primarily benefits the rich and their progeny. While this may be true, I could envision significant numbers of middle-class grandparents funding these accounts for their grandchildren. More important, the Save for Tomorrow program is a win-win for everyone. While beneficiaries would certainly benefit from the generosity and foresight of their parents and grandparents, so would everyone else. Every dollar contributed to the program would mean more money for the OASI Trust Fund, which would shore up the Social Security program. As I see it, the Save for Tomorrow program draws on many strengths, both financial and behavioral: The program maximizes compounding’s enormous power. Allowing money to compound uninterrupted for up to seven decades can achieve wonderful things. At a 7% real growth rate, $1 turns into $114 in 70 years. In the extreme case, $30,000 contributed at birth could swell to $3.4 million by age 70, providing $137,000 of annual income for life—or millions of dollars for the OASI Trust Fund should the beneficiary not receive the benefits for whatever reason. While it may seem unfair that a parent or grandparent could ease their progeny’s retirement in such a manner, consider that much of that money might eventually benefit society, should sizable funds remain when the beneficiary dies. The long time horizon enables taking much greater risk and achieving commensurately greater returns. A 100% stock portfolio is exceedingly risky over short and even intermediate time frames, but over six to seven decades, not so much. A globally diversified 100% stock portfolio may actually be less risky than cash or bonds over such time horizons, once inflation is taken into account. The program would reduce behavioral risk. The tectonic shift from company-sponsored pensions to individual 401(k) accounts failed to factor in the human element. We are humans, not “econs,” as Nobel Prize winner Richard Thaler says. Many of us simply don’t possess the knowledge, self-control or temperament to successfully save and invest for retirement—not to mention the even thornier task of drawing down assets in retirement. One of the great benefits of the Save for Tomorrow program would be that both tasks would be professionally managed, removing this burden from individuals ill-equipped to perform them. Will members of Congress read HumbleDollar and act on my suggestions? Probably not. I’m a realist. But perhaps farsighted families could find a way to build the notion of extreme compounding into their generational planning. John Lim is a physician and author of "How to Raise Your Child's Financial IQ," which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles. [xyz-ihs snippet="Donate"]

“ENOUGH” IS a powerful notion. Unfortunately, it’s largely absent from financial conversations. The concept is rooted in deep self-awareness. It asks the question, how much do I really need to be happy? I believe we should ask this more often because, if we don’t, culture will fill in the blank—and the default answer will be “more.” Enough has two dimensions. The first dimension is about spending. Too often, we succumb to the hedonic treadmill—the endless pursuit of the next thrilling purchase, only to find our level of happiness unchanged. How’s that been working for you? The second dimension is about saving and investing. I’m guessing that HumbleDollar readers may grapple more with this aspect of enough. I certainly do. I’m talking about knowing when we’ve saved enough and reached our financial goals. In short, when is enough really enough? If we lack a concept of enough, we’ll end up constantly moving the goal posts farther downfield. The great enemy of enough is comparison. There will always be someone with more. If we allow it, comparison can be a killjoy. Making comparisons is a deeply ingrained human trait, but that doesn’t mean we can’t overcome it. Below is a far-from-exhaustive list of benefits that come with knowing what “enough” means to you. When you decide what constitutes enough: You can stop running on the hedonic treadmill and getting nowhere. You can jump off the “diminishing returns” curve of “more” before it flattens. You can stop comparing yourself to others and be more grateful for what you have. Your savings rate can grow alongside your income, and perhaps faster. You can reach financial freedom sooner. You can stop moving your financial goal posts. You can spend your money to buy yourself time. You can give generously to those in need. You can stop worrying about money and start living.

ARE THERE TIMES when a near 100% international stock allocation makes sense? I believe there are—and that today is just such a moment. Never in my life have I had such a low allocation to U.S. stocks. My overall portfolio is 60% stocks and 40% bonds. But the stock portion is comprised of just 15% U.S., with the remainder held in international stocks, split evenly between emerging and developed markets. I realize that’s unorthodox. It would certainly be viewed as heretical by most financial advisors. But I believe there are four reasons to buck conventional wisdom: 1. The “traditional” international allocation is irrational. It seems that most financial advisors and institutions recommend that international stocks account for 20% to 30% of a portfolio’s stock allocation. Like one of the 10 commandments, this advice has been handed down from on high and accepted without questioning. But is this recommendation actually evidence-based? Research by the Vanguard Group suggests that the benefits of international diversification, in terms of reducing volatility, plateau at around 40% foreign stocks. Further international exposure, Vanguard contends, leads to increased volatility. Others have suggested using global GDP as a guide. Today, the U.S. represents 25% of global GDP, so following this line of thought would mean allocating 75% of a portfolio’s stock allocation to international shares. On the other hand, efficient market proponents suggest weighting a portfolio according to global market capitalization, which would mean holding about 44% in international stocks, since U.S. companies account for 56% of global stock market value. No matter how you slice it, allocating just a quarter or so of a portfolio to international stocks makes little sense—and even less sense when considering today’s valuations, which I’ll get to shortly. Of course, investors aren’t machines. They need to be comfortable with their portfolios. It’s my contention that the low allocation to international stocks in large part represents home bias, the behavioral tendency to favor investments familiar to us and shun “foreign” investments (pun intended). Not only is this behavior irrational, I fear it could cost investors dearly. 2. The “global diversification through multinationals” argument is flawed. Vanguard founder Jack Bogle was famously unconvinced that international diversification was necessary. He argued that investing in the S&P 500 provides sufficient diversification since so many U.S. multinationals have sizable global revenues. Fair enough. This argument, however, can also be flipped on its head. By investing in international stocks, an investor gets significant exposure to the U.S. economy because the U.S. is a net importer of goods. If the U.S. economy thrives, so will the exporters that supply it with products such as textiles, commodities, cars and semiconductors. In other words, the same argument that people use to justify a low international allocation can also be used to justify a far higher international allocation. But it’s at this point in the debate that someone inevitably raises the dreaded F word: “What about foreign exchange risk?” 3. Currency risk is overstated. When U.S. investors hold foreign stocks, they have two exposures—one to the stocks themselves and the other to foreign currencies. If those currencies fall relative to the U.S. dollar—in other words, if the U.S. dollar strengthens in the foreign exchange market—that will lower the dollar value of foreign stocks for U.S. holders. This is what is meant by currency risk. This risk can be hedged and some funds that invest internationally do so, albeit at a cost. Because investing overseas introduces currency risk, many investment professionals warn against having too much exposure to foreign stocks. But currency risk cuts both ways. Just as a strengthening dollar is a headwind to returns on international investments, a weakening dollar provides a tailwind—assuming currency exposure hasn’t been hedged. [xyz-ihs snippet="Mobile-Subscribe"] Even if you shun international stocks altogether, you can’t completely escape currency risk in a globally interconnected economy. That’s because a depreciating dollar causes imports to become more expensive in dollar terms. This risk can be partly offset by owning international stocks, which benefit from a falling dollar. More important, the currency risk associated with foreign investments may be overstated. According to Elroy Dimson, Paul Marsh and Mike Stanton, changes in foreign exchange rates largely reflect differential inflation rates among nations. If inflation in the U.S. is higher than in the Eurozone, the U.S. dollar would weaken relative to the euro by a similar magnitude. In fact, Dimson and his coauthors found that—in inflation-adjusted terms—the change in foreign exchange rates has averaged less than 1% per year since 1900. They concluded, “This has important implications for long-run investors, as it means they are already protected to some extent from currency risk.” 4. U.S. stocks are in a bubble. The most compelling argument for overweighting international stocks today is valuation. Historically, U.S. and international stock markets have had quite similar returns, close to 7% a year after inflation. But historical returns and expected returns are two distinct animals. As I argued recently, expected returns from U.S. stocks are abysmal. Based on valuations and the tendency for asset classes to mean revert, the coming decade may be another “lost decade” for U.S. stocks. By any number of metrics, the U.S. stock market is in bubble territory. Ratio of total market capitalization to GDP? That would be 200%, the highest in recorded history. What about the cyclically adjusted price-earnings (CAPE) ratio? It’s at 38, a level only once surpassed, at the height of the tech bubble in 2000. Some argue that rich valuations are justified by record low interest rates. Maybe. But why are European stocks far less expensive, despite even lower interest rates? And what happens to stock prices if interest rates finally begin to levitate from today’s moribund levels? If you believe, as I do, that U.S. stocks are in bubble territory, does it still make sense to own them in the name of diversification? Does adding a “bubble asset” to your portfolio lower risk or increase it? Put yourself in the shoes of a Japanese investor in late 1989. Despite nosebleed valuations, you decide that Japanese stocks will form the core of your stock portfolio. How did that work out for you? You didn’t need a crystal ball to realize how poor the risk-return proposition for Japanese stocks was in the late 1980s. Instead, all you needed to do was look at valuations. I believe the same is true today for U.S. stocks. If expected returns for the U.S., developed international and emerging stock markets were similar, I’d happily diversify across global markets, holding a good chunk of U.S. stocks in my portfolio. But that’s not the situation we find ourselves in today. Due to the immense outperformance of U.S. stocks since 2009, the outlook is far brighter for foreign markets. Price matters. And I’d argue that today price trumps diversification when it comes to portfolio construction. Should stock markets mean revert and U.S. stocks underperform international shares over the coming decade—as I fully expect they will—I’ll happily return to owning U.S. stocks. As John Maynard Keynes purportedly said, “When the facts change, I change my mind. What do you do, sir?” John Lim is a physician and author of "How to Raise Your Child's Financial IQ," which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles. [xyz-ihs snippet="Donate"]

THIS WILL SOUND like heresy to buy-and-hold investors. But I believe risks are building within the financial system—and we ignore these risks at our peril. If you’re a diehard buy-and-hold investor who, come hell or high water, plans to dollar-cost average into the stock market, feel free to skip this article. It is not for you. On the other hand, if you believe—as I do—that there are more and less advantageous times to invest one’s capital, please read on. Like death and taxes, economic and market cycles are indisputable facts of life. It has been a long time since the U.S. has had a recession. The last one—the Great Recession—ended in June 2009. That means the current economic expansion is now a decade old. If we get through June without a recession, this will be the longest economic expansion on record. There is no law that limits the length of an economic expansion to one decade. By the looks of it, this economic expansion is headed for the record books. But here’s my concern: Many risks and warning signs are seemingly being ignored by investors, perhaps due to the unprecedented length of the current economic cycle and bull market. Here are nine huge risks—which, I believe, investors are blithely ignoring: 1. The yield curve is inverted. Based on the difference between 10-year and three-month Treasury yields, the yield curve inverted in March of this year and again in May. As I’ve discussed previously, this has been a reliable harbinger of recessions. In fact, I suspect the yield curve would have inverted earlier and, indeed, is currently more inverted than it appears, due to the Fed’s quantitative tightening (QT) program, which began in October 2017. As the Fed has attempted to shrink its balance sheet, QT has the effect of increasing the supply of long-term Treasurys, which raises their yields. In other words, just as quantitative easing (QE) lowered long-term interest rates, reversing QE raises them. The bottom line: Without QT, 10-year Treasury yields would likely be even lower and the yield curve even more inverted. 2. Stock market valuations—particularly in the U.S.—are very high by historical standards. By some measures, the market is as expensive as it has ever been. One of Warren Buffett’s favorite metrics for overall stock market valuation—the market value of all publicly traded stocks divided by GNP—currently stands at about 190% in the U.S. In Buffett’s own words during a 2001 speech, “If the ratio approaches 200%—as it did in 1999 and a part of 2000—you are playing with fire.” 3. Interest rates have been lower, and lower for longer, in this cycle than ever before. The enormous importance of interest rates cannot be understated. Nothing has a greater influence on the economy and markets. Interest rates determine the price of all financial assets by discounting future cash flows. Interest rates also control the availability of credit, which is the lifeblood of the economy. In December 2008, the Federal Reserve lowered short-term interest rates—as reflected in the federal funds rate—to essentially zero, where they remained for the next seven years, until the first rate hike in December 2015. This extraordinary policy was known as ZIRP, or zero interest rate policy. The fed funds rate remained below 2% until September 2018, or nearly a decade of extraordinarily low interest rates. To put this in perspective, from July 1954 to December 2008, the fed funds rate was below 2% for a combined total of just 66 months, or 5½ years. I don’t pretend to know the ramifications of keeping interest rates extraordinary low for so long—but then again, neither does the Federal Reserve. One thing is certain: Easy money induces risky behavior, and money has never been easier. 4. The jury is still out on the Federal Reserve’s quantitative easing experiment. QE simply refers to the policy by the Federal Reserve to lower long-term interest rates by buying up Treasury bonds. Since the Fed can “print” money, this also has the effect of injecting liquidity into the economy. When the Fed embarked on this policy, it described it as a temporary measure. But as with many things in life, the Fed may be discovering that QE was easier to get into than out of. The Fed’s balance sheet is down just 15% from its peak of $4.5 trillion. Moreover, it’s important to remember that QE is a global experiment. The European Central Bank just ended its version of QE six months ago. Japan’s QE is still going strong, buying not only bonds, but also stocks. Where has this massive global QE experiment left us? Negative interest rates, for one thing. Both the German and Japanese 10-year bonds are slightly negative. Imagine lending your money to the government for 10 years and having to pay for the privilege. If extraordinary times require extraordinary measures—the rationale for QE in the first place—might extraordinary measures not lead to extraordinary times? 5. Corporate debt is at record levels. Right now, companies are able to pay the interest on their debt with relative ease. But what happens during the next recession? Or when interest rates eventually rise? 6. Trade wars and tariffs threaten to squelch global trade. This topic receives more than enough attention in today’s press, so I have only two words to say about it: Smoot-Hawley. 7. This year has seen a huge jump in initial public stock offerings, including tech unicorns going public. It’s expected that the money raised in IPOs this year will exceed that in 1999, the height of the dot-com boom. That fact alone is not necessarily worrisome, as our economy is obviously much larger than two decades ago. What is worrisome is the valuation and lack of profitability of this year’s crop of IPOs. Stock prices reflect investor pessimism or optimism. Too much of the latter often leads to disappointment. 8. Federal government debt is exploding even during the peak of this economic cycle. Economists Carmen Reinhart and Kenneth Rogoff wrote a paper in 2010, exploring the relationship of government debt and GDP. The one-sentence summary: When the ratio of government debt to GDP exceeds 90%, growth in GDP falls significantly. The current economic expansion has been one of the slowest on record. One possible explanation: U.S. government debt as a percent of GDP has climbed sharply since the Great Recession, exceeding 90% in 2010 and never looking back. Today, it stands at 105%. The last time this ratio breached 90% was 1944 to 1949, due to the cost of the Second World War. Here’s something uncomfortable to ponder: What will happen to our debt during the next recession, when tax revenue will likely shrink? 9. Student debt is at record levels. To be sure, of all the forms of debt, student loans are probably the most benign, as they’re an investment in future earnings potential. Still, there are limits to even this. Today, there’s more than $1.5 trillion in student loans outstanding, which is almost 8% of GDP. John Lim is a physician who is working on a finance book geared toward children. His previous articles include My Sentence, Yielding Clarity and Grab the Roadmap. Follow John on Twitter @JohnTLim. [xyz-ihs snippet="Donate"]