Should you invest in gold?

Long before there were ever stocks or bonds, the original investment was gold.  Heck, even before there was paper currency or even coins, gold was the original “money”. 

That begs the question, What role should gold have in your portfolio?  If you don’t want to read to the end, my quick answer is “None”.  However, if you want to have a bit of a better answer, let’s dig in.

Gold as an investment

Just like stocks and bonds, gold is an investment.  The idea is to buy it and have it increase in value.  Makes sense.  And historically, it seems to have been a good one—back in 1950 an ounce of gold was worth about $375 and today it’s worth about $1300.  Not bad (or is it???).

However, there is a major difference between gold (and broadly commodities) as an investment compared to stocks and bonds.  Gold is a store of value.  If you buy gold it doesn’t “do” anything.  It just sits in a vault collecting dust until you sell it to someone else.

That’s very different from stocks and bonds.  When you buy a stock that money “does” something.  It builds a factory that produces stuff or it buys a car that delivers goods or on and on.  What ever it is, it’s creating something of value, making the pie bigger.  That is a huge difference compared to gold, and it’s a huge advantage that stocks and bonds have over gold.  You actually see that play out by looking at the long-term investment performance of gold versus stocks.

Golden diversification

Statistically speaking, gold gives an investor more diversification than probably any other asset.  We all know that diversification is a good thing, so this means that gold is a great investment, right?

Well, not really.  Stick with me on this one.  Gold is negatively correlated with stocks (for you fellow statistics nerds, the correlation is about -0.12).  Basically, that means when stocks go up gold tends to go down, and when stocks go down gold tends to go up. 

Over the short term, that’s probably a pretty good thing, especially if you want to make sure that your investments don’t tank.  In fact, that’s one of the reasons gold is sometimes called “portfolio insurance”.  It helps protect the value of your portfolio if stocks start falling, since gold tends to go up when stocks go down.

However, over the long-term, that’s super counter-productive.  We all know that over longer periods of time, stocks have a very strong upward trend.  If gold is negatively correlated with stocks, and if over the long-term stocks nearly always go up, then that means that over the long-term gold nearly always goes (wait for it) . . . down.

That doesn’t seem right, but the data is solid.  Look back to 1950: an ounce of gold cost $375.  About 70 years later, in 2019, it’s about $1300.  That’s an increase of about 250% which might seem pretty good, but over 70 years that’s actually pretty bad, about 1.8% per year.

Contrast that with stocks.  Back in 1950 the S&P 500 started at 17, and today it’s at about 2900.  That’s an increase of about 17,000%, or about 7.7% per year.  WOW!!!

Just to add salt in the wound, inflation (it pains me to say since I think the data is suspect) was about 3.5% since 1950.  Put all that together, and gold has actually lost purchasing power since 1950.  Yikes!!!

A matter of faith

Fundamentally, if you have faith that the world will continue to operate with some sense of order, then gold isn’t a very good investment.  So long as people accept those green pieces of paper you call dollars in exchange for goods and services and our laws continue to work, gold is just a shiny yellow metal.

However, if society unravels, then gold becomes the universal currency.  The 1930s (Great Depression), the 1970s (OPEC shock), and 2008 (Great Recession) were all periods where gold experienced huge price increases.  Those are also when the viability of the financial world order were in question.  Each time, people were actively questioning if capitalism and banks and the general financial ecosystem worked. 

People got all worked up and thought we were on the brink of oblivion.  Gold became a “safe haven”. People knew no matter what happened, that shiny yellow metal would be worth something.  They didn’t necessarily believe that about pieces of paper called dollars, euros, and yuans.

Yet, the world order hasn’t crumbled.  Fiat currencies are still worth something.  Laws still work, so that stock you own means that 1/1,000,000 of that factory and all it’s input belongs to you.  Hence, gold remains just a shiny, yellow metal.  

The bottom line is that stocks have been a great long-term investment, and gold hasn’t.  And that’s directly tied to the world maintaining a sense of order.  So long as you think that world order is durable and we’re not going to descend into anarchy Walking-Dead style, then gold isn’t going to be a good investment.

So the survey says: “Stay away from gold as an investment in your portfolio.”

The best time to take social security

Social-Security-SSA

In the United States, Social Security is an important part of most peoples’ retirements, actually probably too important in many instances.  Social Security is a fairly simple program that was designed to be pretty idiot-proof.  You don’t really need to make many decisions for it, which contrasts sharply with all the decisions you need to make on your other investments (like tax strategiesasset allocationpicking investments, etc.).

With Social Security, you just work and the government takes its 12.4% (6.2% from you and 6.2% from your employer) of your compensation.  In fact, you don’t really have a choice in the matter and the government does it automatically.  Then when you get old, the government gives you a monthly pension.  Not real complicated on your end.

However, there is one really important decision you need to make regarding Social Security: when you start taking it.  Basically, you have three options: 1) Early retirement-when you turn 62; 2) Regular retirement-when you turn 67 for most of us; 3) Late retirement-when you turn 70.  And as you would expect, if you start taking Social Security later, you get a larger monthly check from the government.

This is obviously an important choice to make, and it’s one that gets a lot of press coverage with all sorts of people opining on what to do (I guess with this post, I am adding my opines to those ranks).  Generally speaking, the advice slants towards taking it later.  Yet, I wonder if that’s really good advice.  Using my handy-dandy computer, let’s go to the numbers to see what they tell us.

I checked my Social Security statement and I’ll be able to pick from one of the three choices:

Age to start taking Social SecurityMonthly check
Early retirement—age 62$1800
Full retirement—age 67$2600
Delayed retirement—age 70$3200

As you would expect, the answer to this riddle is a morbid one.  When do you expect to die?  The longer you live, the more it makes sense to delay taking Social Security so you can get the bigger check.  That’s not a tremendous insight, but when you do the math, you start to see some interesting things going on.  I fully appreciate that Social Security is very nuanced and complex, so I am just covering the simple basics here.

In my analysis to be able to compare the different scenarios, I assumed that I saved all the Social Security checks and was able to invest them at 4%, about the historic rate for a bond.  If you do that the table above expands to this:

Age to start taking Social SecurityMonthly checkHighest value
Early retirement—age 62$1800Die before age 79
Full retirement—age 67$2600Die between age 80 and 84
Delayed retirement—age 70$3200Die after age 85
Capture

That’s pretty profound actually.  The average life expectancy in the United States is 76 for men and 81 for women.  Doesn’t that mean that most of us should be taking Social Security with the early option?  That contradicts most of the advice out there on this topic.  That, ladies and gentlemen, is why Stocky is here for you.  This is where it starts to get fun, and we can apply a little game theory (awesome!!!).

When to start Social Security?

Actually, once you reach age 62, the life expectancy of those still alive (and able to make the decision on Social Security) is 82 for men and 85 for women.  This makes sense because you’ve survived to 62 so by definition you didn’t die before then (awesome insight, Stocky), and those early deaths pull down that initial life expectancy model.

Since women are better than men as a general rule (Foxy Lady took over typing for just a second there), let’s look at this decision as a 62 year-old-woman.  She needs to make a decision on when to take Social Security.  She knows her life expectancy at this point is 85, which means there’s about a 50% chance she makes it to 85.  So the worst choice for a 62 year-old is to take the early retirement option.  She’s probably going to live long enough that either full retirement or delayed retirement is the better option.

At 62 she does the smart thing, and decides to wait.  Her next decision comes at age 67, assuming she lives that long (there’s about a 5% chance she’ll die during those five years).  But a similar thing happens—when she was 62 her life expectancy was 85 (right on the border of picking between full retirement and delayed retirement), but now that she’s 67 her life expectancy jumps up a year to 86.  So if she makes it to 67 then she’s better off taking the delayed retirement (of course, there’s about a 4% chance she’ll die before she makes it to 70).

That’s a little bit weird though, isn’t it?  It kind of feels like you’re that horse with a carrot dangling over his head, keeping him walking forward.  It’s a bit of a conundrum.  At any given time, you’re better off delaying starting your Social Security, so the math tells you to keep waiting and waiting.  But if the dice come up snake eyes and you die, then you miss out on everything (not strictly true, but true enough for our analysis).

And keep in mind that since Foxy Lady hijacked Stocky’s computer, we’ve done this analysis for women.  The math tells you that it’s just about a wash between taking Social Security at 67 or 70.  Since women live on average 3 years longer, for men you would think it means that the advantage leans towards taking it early.

What does it really matter?

So the analysis tells us that we’re better off waiting if you’re a woman and it’s really close if you’re a man.  And of course the longer we wait, the further we come out ahead by taking delayed retirement instead of early or full retirement.  But how big of numbers are we talking?

Remember, the cut off for when full retirement becomes better is at about 80 years old.  The cut off for when delayed retirement becomes better is about 85 years old.

Future value of Social Security payments
AgeEarly retirement (62)Full retirement (67)Delayed retirement (70)
85$1,031,256$1,119,603$1,125,233
90$1,450,231$1,644,630$1,716,663
100$2,647,751$3,158,200$3,431,844

Those are meaningful differences.  If you make it to 100 years old, delayed retirement comes out about $800,000 higher than early retirement.  However, those are in future dollars, 38 years into the future if you’re 62 today and faced with this decision.  That $800,000 when you’re 100 would be worth about $370,000 today.  Of course that’s if you make it to 100, which isn’t really likely (about a 3% chance).

If you make it to 90 years old (you have less than a 30% chance) then the difference is about $260,000 in future dollars which is about $150,000 today.

Wrapping up, I’m really torn on this.  There’s a little bit of a prisoner’s dilemma type thing working that keeps making you want to push back when you start collecting.  And then when you look at the upside of delaying retirement, the numbers are pretty big (whenever you’re talking about hundreds of thousands of dollars, that’s real money), but the chances of us making it to that super-golden age are pretty small.

I suppose it’s best to wait, but I’m giving that a pretty “luke-warm” endorsement.  It certainly isn’t the “slam dunk” that so many pundits make it out to be.

Actually, I think the way the Social Security administration sets it up, the options are all pretty similar.  We all have this personal belief that we’ll live longer than average (but not everyone can live longer than average, expect if you’re from Lake Wobegon, MN).  And that makes us think we’re better off waiting, but it probably is all pretty equal.

Paying off your mortgage now a good thing?

Today we celebrate Tax Day.  Celebrate isn’t quite the best word, but let’s paint a happy face on this.

There a million things we can talk about with regard to taxes and personal finance, but let’s focus on one of the big changes that hit in 2018 that fundamentally affects a MAJOR financial decision we make—the mortgage on your house.

The major tax overhaul that passed at the end of 2017 is probably the biggest in my adult life.  It puts a few tried-and-true nuggets of tax wisdom on their head, particularly how “itemized deductions” are treated, including your mortgage.  Let’s dive in and see how that changes things.

Quick primer on how taxes were

Remember, I’m not an accountant, so this is my best understanding of how things were and are. 

Before, you as a tax payer had to decide to take the standard deduction or itemize your deductions.  You can only do one or the other, so the general idea is to do whichever is “greater”.

Standard Deduction 2017 2018
Single $6,350 $12,000
Married $12,700 $24,000

When you take the standard deduction, as the name implies, you just get to reduce your taxable income by a standard amount.  In 2017, if you were a married couple, that amount was $12,700.

The alternative is to itemize your deductions.  Things can certainly get complicated, but for most people your itemized deductions are your state income taxes, and if you own your own home your property taxes and the interest on your mortgage.  If those three items were more than $12,700 then it made sense to itemize your deductions.

In 2017, for the Fox family, our state taxes were about $10,000, property taxes about $6,000, and interest on our mortgage about $9,000.  All that adds up to about $25,000.  So, it made a lot of sense for us to itemize our deductions.  We got to reduce our taxable income by $25k instead of $13k.  That probably saved us about $4,000 in taxes.  Not bad.

Quick primer on what changed for 2018

There were a ton of changes in the new tax law (I think the actual document was well over 1000 pages—Yikes!!!).  But let’s hit the highlights.

The same logic holds where as a taxpayer, you should pick whichever is greater, itemizing your deductions or taking the standard deduction.  But that’s where some major changes occurred.

First, you can see that the standard deductions nearly doubled.  That alone makes the number of taxpayers who would take the standard deduction much higher than before. 

Looking at our situation from 2017, we had $25,000 in standard deductions while the standard deduction is $24,000.  Back in 2017 it was a no-brainer, but in 2018 it became nearly a wash.  But that’s just the tip of the iceberg.

The second major change is that there is a limit of how much you can deduct on your itemized deductions for state and property taxes.  In 2017 there was no limit, so in our situation we were able to deduct $16,000 ($10k for state taxes and $6k for property taxes). 

Now the limit is $10,000.  That’s a major game changer.  Using our 2017 numbers instead of deducting $16,000 for state and property taxes, we hit the limit of $10,000.  Add the $9,000 for mortgage interest and we can only deduct $19,000.  That is much less than the $24,000 standard deduction, so with the new tax laws, we will take the standard deduction

Basically, for it to make sense for you to itemize your deductions, you need to have over $14,000 of interest expense on your mortgage.  Just using round numbers, if your interest rate is 4% (and if it’s higher than that, you should refinance 😊), that means you’d have a $350,000 mortgage.  Anything less than that, and you’re better off taking the standard deduction.

How this affects your mortgage

Let’s bring this full circle, back to the headline of this post—How does all this affect your mortgage?

Remember that we have talked extensively about debt.  I told you how we could have gone mortgage-free but decided not to, how we took a car loan when we didn’t need to and that was a good thing, and in general the approach we use for debt.

If you boil it all down, basically you should take on debt if the interest rate is really low.  However, the tax change “increases” your mortgage rate because it’s not going to make sense to be able to deduct the interest.

Before if you had a 4% mortgage, after you deduct the interest on that mortgage from your taxes, it might seem more like a 2.5% to 3% rate.  Obviously, that’s a big difference.  Maybe your internal calculations look at a loan at 4% as high enough to pay off fast, but not one at 2.5%.  Makes sense.

However, now most of us can’t deduct that mortgage interest.

Mortgage rates are rising

For the past several years, we have been enjoying historically low interest rates which have translated to historically low mortgage rates.  However, that has been changing.  A few years back a 30-year mortgage might have been at 3.5% while now it is at 5%.

If you combine that impact with the tax deductibility, you have a major impact.  Before you had a low rate that was tax deductible.  Let’s say it was a 3.5% rate that “felt” like 2.5% after you deducted the interest on your taxes.

Now if you get a mortgage that rate will be 5%.  That’s an enormous change, big enough to fundamentally shift the decision of whether or not you should pay off your mortgage faster.

Remember, that paying off a loan is basically making an “risk-free” investment, similar to a bond.  Before, paying off your mortgage would give you a 2.5% guaranteed return.  That’s not great.  For the Fox family, we looked at that as too low.  We’d rather take on more risk and invest that money in the stock market. 

Now with the changes, being able to get a 5% guaranteed return changes our decision.  We wouldn’t do it at 2.5% but we would at 5%.  This becomes real because now Foxy Lady and I will start using extra cash we have to pay off our mortgage faster.

This is a huge game changer that impacts millions of Americans.  It changed a central decision we had to make for personal finance.  Maybe it will change that for you too.