Bad Advice at Any Price

The theme of this blog, which admittedly I often stretch and occasionally just ignore, is that the money advice we Americans get is lousy.

That advice comes from several sources. There are publications and US_Silvercert1 broadcasts of various kinds. Aside from often lacking much wisdom or insight, these sources of information suffer from the fact that they are aimed at a broad and anonymous audience. By their nature, they are one-size-fits-all, leaving individuals to work out for themselves any customizations that might be required. On the other hand, this advice is free or nearly so.

More near-free advice can be had from friends and relatives. Some of this is probably good, but given the general state of PF knowledge out there the chances of hitting on a gifted amateur with sound ideas is low.

At the top of the advice food chain are professionals who give advice to particular individuals, presumably based those individuals’ situations, in exchange for money in the form of fees and/or commissions. In principle, that ought to work best and I have no doubt that there are many paid advisors out there who do a great job. But I am also pretty sure that many others, maybe even most others, are not up to snuff.

I was reminded of this by two recent items from the publication end of the personal finance advice spectrum.

The first is from Kiplinger’s. Social Security Payback Option May Disappear serves as a good update to a post I ran a few weeks back on a clever Social Security maneuver. In a nutshell, the idea is that instead of choosing between a lower payment at 62 and a higher one at 70, a person can have it both ways. Start at 62 and then, if you are still healthy at 70, repay what you got without interest and start over at 70.

Combining a free option with an interest-free loan from the government is pretty compelling. Frankly, I was embarrassed that I had, a year ago, written about when to take Social Security without knowing of this facet. But I never pretended to be a particular expert on this corner of personal finance and I certainly do not charge anybody money for advice on it.

Alas, the Kiplinger’s article tells us that the government is on to this trick and may soon close it down. That’s not exactly a shock. What did raise my eyebrows was some background data buried deep in the piece.

In 2007, only about 500 people — out of more than 37 million retirees and their dependents receiving benefits — took advantage of the payback option. By 2009, the number had nearly doubled as more retirees learned how they could repay their benefits, interest- and penalty-free, and restart them at a new, higher level.

Fewer than 1000 retirees took the payback and restart option last year? Out of 37 million people getting checks? That is 0.0027%. More people played Major League Baseball in 2009 than took advantage of this peculiarity in the SS rules. It almost makes me wonder why the bureaucrats are bothering to even discuss plugging such a tiny hole.

I am not sure what percentage of old folks would ideally be paying back and re-filing. But it is important to keep in mind that the basic strategy of starting at 62 and then calling a do-over at 70 is something that would make sense for almost all SS recipients. In the ideal world, most 70-year-olds would be re-filing for higher benefits. I do not know what portion of the 37 million are 70 years old. Would it be unreasonable to take a rough guess that the profit-maximizing ideal proportion re-filing is something like 2.7% of recipients? That would mean that the actual number is a thousand times lower than what it should be.

What is wrong with the other 99.9%? The great majority of them, we presume, are simply the victims of poor one-size-fits-all advice from the mass PF media. Or perhaps they just listen to their friends. But some non-trivial portion, way more than 0.1%, paid an expert to give them advice. In fact, folks nearing retirement and in their early 60s are probably the best served demographic by financial advisors. Some of those advisors even hold themselves out as experts on such things as Social Security. And yet….

My other example of poor advice given one-on-one to the nearly retired is from CNBC. When Is Paying Off Your Mortgage the Right Move? is a typical exercise in making the relatively simple confusingly obscure. As I have written here repeatedly, the core issue on to pay off your mortgage or not is whether or not you can expect to get a better (after-tax) return on your money by investing it.

The CNBC story tells us of a soon to be retired couple in New Jersey who are advised by a certified financial planner to pay the mortgage down. (The article names the advisor and contains a link to his firm’s website in case you want to sign up.) He advised them that “they would need to make between 6 percent and 8 percent on their money to make it worth holding on to the mortgage.”

Setting aside the fact that 6% to 8% is actually not hugely ambitious as a projected return, I have to wonder how the CFP got that hurdle rate. The CNBC piece doesn’t say. (Why waste space on such trivialities? We need to know that the husband of the couple once owned an auto repair business but now sells real estate.)

But the article does say that the couple paid down a 30 year at 5.25%. Is it possible that the advisor took 5.25% and bumped it up a little to take into account the risk of investing? Did he forget the tax effects? Or is mortgage interest not deductible for this couple, which seems very unlikely given what we are told about them?

More to the point, the advisor, who undoubtedly assured the couple he was an expert on these things, is apparently ignorant of a little trick that might have helped his fee-paying clients. They could have refinanced the mortgage, reducing the interest rate by at least a full point. On an after-tax basis, I am guessing the cost would be close to 3%. That’s an investment hurdle rate that most people would expect to comfortably beat.

No Comments

  • By Mark Wolfinger, August 25, 2010 @ 1:13 pm

    Frank,

    Please don’t ignore the fact that many 70-year old people don’t have the cash to simply pay back all they have collected over the prior 8 years.

    This plan works when when you know, in advance, that payback is the goal. Then the money is saved and not spent.

    Regards

  • By Stagflationary Mark, August 25, 2010 @ 1:48 pm

    You are offering the same advice I was given in 1999 when I paid off my house.

    My tax preparer told me that I could earn more money elsewhere. A few years later, in hindsight, she told me that most people would have been better off just paying down their mortgage. You run that same risk here.

    “On an after-tax basis, I am guessing the cost would be close to 3%. That’s an investment hurdle rate that most people would expect to comfortably beat.”

    They can? Where?

    If we are going to compare apples to apples here, then people cannot expect to comfortably beat 3%.

    By comfortably, I mean safely.

    Paying down your mortgage is 100% safe so I would argue that it should be compared to other 100% safe investments. One should not compare returns without also factoring in risk.

    I-Bonds currently pay 0.2% over inflation. That’s down from the 3.4% they paid in 2000.

    10-Year TIPS currently pay 0.98% over inflation. That’s down from the 3.5% they paid in 2000.

    10-Year Treasuries pay 2.49%. That’s down from the 6% they paid in 2000.

    You will also be taxed on those investments, so in order to beat 3% you might have to be earning roughly 4%.

    You could take on more risk of course. Maybe you could get 6-8% as you suggest. I doubt it. Those sorts of returns weren’t generally prevalent in the wake of Japan’s housing bust.

    Our country has structural problems. Time are changing, and not for the better.

    http://illusionofprosperity.blogspot.com/2010/08/stock-market-risk-analysis.html

    http://illusionofprosperity.blogspot.com/2010/08/36-million-missing-jobs.html

    http://illusionofprosperity.blogspot.com/2010/06/cumulative-trade-deficit-nightmares.html

  • By Stagflationary Mark, August 25, 2010 @ 1:54 pm

    By the way, I do enjoy your blog.

    We just disagree on this.

  • By Kosmo @ The Soap Boxers, August 25, 2010 @ 2:48 pm

    “What is wrong with the other 99.9%?”

    Well, there is the very real risk that they’ll die without recouping what they’ve paid back. It’s the situation of a bird in the hand being worth two in the bush. It’s hard to predict if you’ll be the unlikely person who dies at 71.

    An interesting quirk in the mortgage argument that I don’t hear very often is that equity in a home is protected during bankruptcy. So if you’re headed toward bankruptcy, paying down your mortgage is an easy way to shield more of your money from bankruptcy (subject to limits). The worst thing your could do is a cash-out refi and use the proceeeds to buy some gold bars :)

    Note: I’m not suggesting that people use their homes as a bankruptcy shelter – just that the ability does exist.

  • By Frank, August 25, 2010 @ 3:54 pm

    Paying down your mortgage is 100% safe

    No, you have liquidity risk. You’ll have a significant amount of capital locked up in an asset that you may or may not be able to sell or borrow against when you need cash.

  • By Stephen, August 25, 2010 @ 4:09 pm

    Cambridge Savings Bank currently pays 4% on their special checking account. Is FDIC insured safe enough?

    The point is that you do the analysis and determine if it’s right for you. If treasury bonds are the only way you would invest that money, and their return isn’t high right now, then by all means, pay down your mortgage. If they’re high in a year, then by all means, invest in Treasury bonds instead.

    Look at mortgage prepayment as another “asset” in your asset allocation and allocate appropriately.

  • By Stagflationary Mark, August 25, 2010 @ 4:15 pm

    Frank,

    It was 100% safe for me and others like me. I should have been more clear.

  • By Stagflationary Mark, August 25, 2010 @ 4:24 pm

    I also would think it is reasonably safe to assume that the “soon to be retired couple” has significant savings and therefore the liquidity risk isn’t really much an issue.

    That’s certainly true in my case.

  • By Stagflationary Mark, August 25, 2010 @ 4:38 pm

    Stephen,

    That looked to be a good deal. Unfortunately…

    “…on balances up to $25,000″

    “Rates may change after account is opened.”

    I opened a checking account at Washington Mutual when it was paying 4% on checking. I watched the interest rate fall. I exited before the you know what hit the fan though.

    Cambridge Savings Bank looks to be solid though, at least according to BankRate.com.

  • By Stagflationary Mark, August 25, 2010 @ 4:47 pm

    For what it is worth, I’ll be buying EE Bonds before November more than likely.

    Guaranteed to earn 3.526% for 20 years and you have the option to walk away early fairly pain free if interest rates spike higher. You’ll only be earning 1.4% per year if you do though and will also be losing 0.35% in interest.

    Still, plenty of liquidity after one year has passed (can’t redeem for at least 1 year).

    http://illusionofprosperity.blogspot.com/2010/08/savings-idea-update.html

  • By jim, August 25, 2010 @ 6:45 pm

    I agree with Kosmo. I think most senior citizens taking SS don’t have the means to pay back 8 years of their SS. A large percent of retirees have relatively low incomes and rely on SS to pay their bills. Plus you would have many people who are now 70 but not in very good health so paying back the full 8 years of benefits with the hope of recovering the amount is not a good bet for them.

  • By Holly, August 25, 2010 @ 7:45 pm

    I doubt that I will ever pay off the mortgage I have now. We plan to move in 5-7 years to a much smaller 1200 sq. ft. house. Don’t know if I will pay cash–that will depend on interest rates.

    I think most retirees just want to loosen the purse strings, so they take the early SS. I think one should look at family trends. If you have two older siblings who are healthy and robust at 70+, then why not wait it out if you can?

  • By Holly, August 25, 2010 @ 7:47 pm

    Well, I guess I could say that some people are reticent to wait ’til 70 y.o. since they may be worried that the funds will dry up or the rules will change by the time they get their benefits.

  • By Craig, August 25, 2010 @ 9:37 pm

    We can quibble over quibbles, but StagMark makes very important points about risk. The only place I see confident 6-8% returns right now is in the rear view mirror.

    Now, I don’t have $115,000 lying around, and I’m not likely to find it in the couch cushions, so my fixed-rate mortgage probably remains in my portfolio as an “inflation hedge” for the foreseeable future. But if I did run into that kind of money, just as a windfall…I’m not sure what I’d do, but anything riskier than Treasuries would probably be a non-starter for me. I’d probably set up a CD ladder or something, just to bide my time a bit and see what happens to the risk-free rate–paying the (tax-adjusted) interest on my mortgage in the meantime.

    Holly also hits on the big risk of the great Social Security Arbitrage Play: that the rules will change and the rug will get yanked out from under you. Sometimes, I think it’s just too easy to out-clever yourself.

  • By Stagflationary Mark, August 25, 2010 @ 10:56 pm

    Craig,

    I turned bearish in 2004 because I kept getting insane mortgage offers in my mailbox. Sold all of my stocks. Citigroup was actually a top holding. Go figure.

    From 2004 to 2006, 1/3rd of my nest egg sat in gold and silver. All I wanted was a simple inflation hedge. That’s all. I sold them when they turned parabolic in 2006 though and at much lower prices than today’s, but a very good gain nonetheless. No desire to own them at these prices though and for the same reason Frank pointed out in one of his posts. (That’s how I stumbled onto this blog if memory serves.)

    http://badmoneyadvice.com/2010/07/should-you-invest-in-gold.html

    “Gold just sits there. If you buy actual coins and bars you can spend your evenings fondling it, but most investors today do not even get to do that.”

    Very amusing and very true. Here’s my current thinking on gold, for what it is worth.

    http://illusionofprosperity.blogspot.com/2010/07/is-gold-safe-store-of-value.html

    The bulk of my nest egg now sits in an inflation protected treasury ladder and an inflation protected I-Bond ladder. That’s my plan from here on out. I may never return to stocks.

    I value safety and have no great desire to swing for the fences any longer. I’ve got a suitable retirement nest egg as long as I don’t do anything stupid (or the US defaults on its debt and/or we hyperinflate).

  • By Chris, August 26, 2010 @ 9:03 am

    Where do I learn how to do these calculations? Any good books you recommend? Not necessarily advice but how to model these various scenarios.

  • By mightymouselives, August 26, 2010 @ 11:30 am

    I hate taxes. I mean that I hate tracking and calculating taxes, more than I hate paying them. The prospect of redoing 8 years puts me over the edge, though that’s just me, others are fine with it. Also I don’t expect to know more about my expected lifeline at 70 than I do now. My luck would be to repay at 70 and kick the bucket at 71. So, I pass.

  • By Mike, August 26, 2010 @ 12:00 pm

    What about the tax impact? SS benefits can be taxable. If I repay 8 years at age 70, I’m still out the income taxes (if any) that I paid in the previous 8 years, am I not?

  • By Stagflationary Mark, August 26, 2010 @ 5:06 pm

    Chris,

    I have a computer science and physics background. I mostly just apply what I’ve learned there to what I see in the economics world. Doesn’t hurt that I actually enjoy it.

    Here’s what we are up against though.

    http://en.wikipedia.org/wiki/Long-Term_Capital_Management

    “LTCM was founded in 1994 by John Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers. Board of directors members included Myron Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences.”

    If two Nobel Prize winning Economists can manage to lose more than they actually had under the guise of “long-term” “capital management”, then anyone can. Sigh.

  • By jim, August 26, 2010 @ 7:49 pm

    Mike raises a good point above. What happens with the income taxes that may have been paid on the 8 years of SS?

  • By Kosmo @ The Casual Observer, August 27, 2010 @ 10:45 am

    The Kiplinger article states:

    “As a bonus, those who repay benefits can claim a tax credit or a tax deduction — whichever results in a bigger tax break — for any income taxes paid on the benefits as they received them.”

  • By Mike, August 27, 2010 @ 11:08 am

    Wait a second, you mean you expect me to read the linked articles??

  • By Kosmo @ The Casual Observer, August 28, 2010 @ 12:24 pm

    The linked articles, any articles they link to, articles they link to … and so on – until you’ve read the entire internet.

    :)

    Actually, I Googled the basics of your questions and the Kiplinger article came up …

  • By Richard Maize, January 5, 2012 @ 1:38 am

    I dont know! Looking for something a bit different…

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