Holidays on a Budget

Holidays on a Budget

Even in normal circumstances, the holidays can be stressful.  With the concerns about travel and the impact on many people’s income from COVID-19, the 2020 holidays are likely to be even more challenging.  In this post, I’ll provide ideas that might help alleviate some of that stress and help make the most of the season, even if you have to celebrate your holidays on a budget.

Gifts for Family

Most holiday celebrations in December and early January involve gift giving.  For me, finding the right gifts is far and away the most stressful part of the holidays even when money hasn’t been an issue.  If you need to get through the holidays on a budget, it becomes even more stressful.

Make a Holiday Budget

Every year, before I do any shopping, I make a list of all of the people for whom I “need” to buy gifts.  An important part of this process is figuring out who really needs a gift.  Did we exchange gifts last year?  Is each person really still so close I want to give him or her a gift?  Will it affect our relationship too severely if I suggest, in advance, that we not exchange gifts even if we’ve done so in the past?

Once I have my list, I then assign a budget amount to each person.  Parents get one amount per person, nieces and nephews another, and so on.  I check to make sure the total of my budgets isn’t more than I can or want to spend on gifts.  If it is, I revisit both the list of people and the individual budgets until the total amount is tolerable.

Having budgets for each person narrows the possible choices for gifts, sometimes making it easier to identify ideas for each person.  The hardest part is sticking to the budget, but paying your bills during or after the holidays will be much easier if you do.

Draw Names

Is your list of names too long?  One option is to draw names for people in a group, such as your family or other group that exchanges gifts.  A variation on this idea is Secret Santa (or whomever is associated with your holiday) where you keep the identity of the gift giver a secret.  In both cases, buying fewer presents will help keep your holidays on a  budget.

For many years, my husband’s family drew names for the people in my generation (his siblings and the spouses) and put a cap on the amount that could be spent on the gift.  Instead of having to buy gifts for 2 other couples or 4 other adults, we each bought just one gift for a single other person.  And, because the cap was less than we tended to spend before we started drawing names, the savings was even greater.   After a while, we decided that the people in our generation didn’t need gifts from each other at all, reducing both expenses and stress.

Make Presents

Lots of people enjoy getting homemade gifts.  Do you have a talent, like art or sewing?  Or do you enjoy cooking?  Some of my favorite gifts are things that my daughter has sewed for me and a ceramic pot for plants that a friend of mine made when I was sick many years ago.

Around the holidays, quick breads, such as banana, cranberry or zucchini bread, can be real treats to give as gifts.  They wrap really nicely, too.   Or, you could give pies or cookies.  One of my mother’s friends was quite a chef and gave homemade truffles as gifts.

One gift that I have given my kids and several nieces and nephews when they were newly living away from home (and not in a dorm) is a cooler full of frozen dinners.  I’d make a couple of extra servings of whatever meal I was making for our family and put them in labeled Tupperware containers.  They didn’t take much work and were greatly appreciated.

Coupon Books

Another essentially free gift idea is a coupon book of things you will do for a friend or family member.  One friend suggested giving 30-minute back rubs, car washing, cooking a favorite meal or taking a walk together.  My kids often gave me coupon books (see photo below) that included making a meal, doing the dishes, taking out the trash and the like.

Coupon Book

In many cases, you’ll enjoy giving the gift of your time as much as the recipient enjoys receiving it.

Making the Holidays More Fun for Kids

In many families, a large portion of the joy of the holidays comes from the laughs and smiles of young children.  Here are a few ideas for bringing more joy to your kids, even when putting your holidays on a budget.

Smaller Presents

When they were young, my kids seemed much more excited by having lots of things to unwrap than by getting expensive items.  Whenever possible, I would wrap the major pieces of a large present in several packages and wrap a number of inexpensive presents, just to increase the package count.  It might seem like a larger number of smaller packages might encourage kids to want too much.  I think, at very young ages (younger than 6 or 7), the joy is more important than that message.

New Book Every Few Days

If you want help getting your children into the holiday spirit, you could buy a handful of inexpensive books and give them one every few days leading up to your family’s big day. Robyn @ADimeSaved provides a list of 10 Ways to Get Free Books for Kids.  For some families, books focusing on the holiday might be appropriate whereas as any book that interests the child might be better in other families.  A nice benefit of buying books for your children is that you can then use them as an excuse to spend time together.  Bedtime stories were a very popular event every night at our house, even after both kids were old enough to read.

Advent Calendars

One of our family traditions was an Advent calendar.  An Advent calendar provides a small gift on each day from December 1 through 24.  While that tradition is specific to Christmas, it could easily be adapted for other holidays.

One of our nannies made Advent calendars for both of our kids, as it was a tradition in her family in Germany.  (As you can tell, we had some terrific nannies.)  She started with a heavy plastic sheet and covered one side with green felt.  Next, she cut it into the shape of a tree and sewed 24 pairs of numbers (from 1 to 24) and key rings.  She then found 24 inexpensive presents for each of the kids which she wrapped and hung from the key rings.  Below is a picture of a “loaded” Advent calendar below.

Advent Calendar

My kids loved getting up every morning to open their presents.  It was such a popular tradition that I kept it up until they were in their early 20s.  My goal was to spend no more than a $1 per day per kid on these presents.  Ideas included candy (limited to about 6 or 8 days), nail clippers, hair ties for our daughter, matchbox cars for our son (still not much more than $1 a piece if bought in a package), little pads of paper, small staplers and so on.  Where we lived, Target had a whole section of $1 items that I would peruse.  Another source of $1 items is the Dollar Store.

The picture above is from a few years ago when my son was in his early 20s.  By then, he was quite happy to have his gifts alternate between pairs of socks (the roll shape packages) and candy!

Create New Traditions

The holidays can be much more than just gift giving.  In our house, our big holiday tradition was cookie-making day.  Also, on Christmas day, the extended family played bingo with Grandpa leading the game.

Cookie-making day

One Saturday every December, all the cousins and both sisters-in-law on my husband’s side would come to our house to make cookies.  When the kids were young, they primarily decorated sugar cookies (frosting, sprinkles and the like) and went off to play in other parts of the house.  As they got older, they would help cut the sugar cookies, make corn flake wreath cookies (essentially corn flakes held together with melted butter and marshmallows, decorated with red hots) and join in making of other types of cookies, many of which had no relationship to the holiday but were well-loved.

One of the many memories from cookie-making day was the day that I put a metal teapot on the stove to make hot chocolate.  I got so involved in making cookies that I forgot about it.  A little while later, after all of the water had boiled away, the spout blew off the teapot and the heat caused the glass stove top to shatter.  There were glass shards not only all over the kitchen but into the dining room and family room.  As you can imagine, the adults spent a lot of time sweeping and vacuuming while we sent the kids to other rooms to play.  Fortunately, the only damage was to the teapot and stove top and no one was injured.

Make Decorations

Almost every holiday has decorations.  Keeping Up with the Bulls (@KUWTBulls) suggests growing your own pumpkins and gourds and using them to decorate for Halloween and Thanksgiving.  Similarly, she suggests making wreaths with greens and pine cones from nearby evergreen trees. I used to take greens from the yard and put them in baskets with ribbons to make our house more festive and smell nice at the same time.

Both when I was a kid and when our kids were young, our tree was decorated with paper chains or strings of popcorn and cranberries.  Although a tree is specific to Christmas, I suspect there are other decorations that could be made for whatever holiday you celebrate or just for winter, such as paper snowflakes.

When I was a teenager, I once made a gingerbread house from scratch.  The pieces didn’t go together very well, but, once it was covered in frosting and candy (the entire roof was made of Necco wafers), it looked pretty good!  Of course, now, you can buy the pieces for a gingerbread house in a box, though it probably costs more than making it from scratch.

A Family Game

As I mentioned, my husband’s family played Bingo on most holidays when it was too cold to spend much time outside.  Fabio Marciano (@fmarciano) suggested playing Bingo over Zoom.  There are several places to get Bingo cards that you can email, such as My Free Bingo Cards.  You just need to create and email them to your family members.  What a great way to keep everyone engaged if you can’t visit in person!

View Holiday Lights

When I was young, there was a pair of houses that shared a huge front yard on the way from our house to my father’s office.  Every year, that front yard was full of lighted decorations.  It was the highlight of our annual drive a few days before Christmas to look at lights.  I’m not sure how my father knew where to find the other locations we passed as this was long before the Internet.  These days many communities post tours on their websites that you can follow either by driving or on foot.  If you’ve gotten cold while looking at lights, especially if you walked, having cocoa, tea or hot apple cider is a nice way to end the evening.

Other Stuff to do in Winter

Here are some ideas of free or inexpensive things to do in the winter that aren’t related specifically to a holiday.  Nonetheless, they might help brighten your holiday season or help with the post-holiday lull.


@planneratheartblog tells me that some libraries have passes to museums that you can borrow for free in the same manner that you borrow books.  I’d never heard of such a thing!  You might check with your local library to see if they are available for museums in your community.

Outdoor Activities

For those of us that live in cold climates, there are many outdoor activities that can be done at little or no cost – sledding, hiking, ice skating on a local pond or outdoor rink, building snow forts or snow men, having a snow ball fight and so on.  Not only are these activities fun, but they also help eliminate cabin fever and provide an opportunity to get some exercise.  And, of course, exercise in and of itself is a great for morale and fighting the post-holiday blues.

Indoor Activities

When the weather isn’t conducive to any outdoor activities, there are plenty of things to do inside that are free or don’t cost much.  You can always have a cup of cocoa or hot cider after you’ve come in from your outdoor activity.  Or, you could watch a movie, play a game or read a book, all of which are even better on a cold night if you are able to do them in front of a fire.

For more information on these and many, many other ideas, check out this post from Marjoelin @RadicalFire.

Make the Most of your Benefits Package

Make the Most of Your Benefits Package

Many employers offer a benefits package.  The most common benefits are health insurance and a retirement plans, topics I’ve covered in other posts.  Some benefits packages have other features, such as dental and vision insurance, various kinds of disability and life insurance and, in Canada, extended health care.

In this post, I’ll identify the parts of your benefits package for which you might have to pay a portion of the cost.  I’ll also provide a brief explanation of each and what you might consider as you decide whether to purchase them.  Employers often provide other offerings in their benefits packages, such as access to an Employee Assistance Program or medical advisors, at no cost.  Because you don’t need to make an election or pay for these benefits, they are not covered here but you’ll want to be sure you understand all pieces of your benefits package so you can take full advantage of them.

Dental & Vision Insurance in Your Benefits Package

There are many similarities in the coverage under dental and vision insurance.  In addition, the processes for deciding whether to buy them have a lot of parallels, so I’ll discuss them together.

Dental Insurance

Dental insurance pays for preventative dental services (usually two to four cleanings per year), a portion of other dental expenses (fillings, crown, root canals, for example) and sometimes orthodontia. The amounts of these expenses that are covered depend on the deductible, limits and coinsurance.

Every dental insurance plan I’ve had offered by employers has had a very low maximum limit, such as $1,500 or $2,500 a year.  This coverage differs from most other insurance products. Most other insurance products protect against things you can’t afford to lose, such as the injuries caused by a car accident or a tornado that destroys your home, and often have you pay for the “predictable” part through a deductible.

Vision Insurance

Vision insurance generally covers the basics – eye exams related to vision correction, glasses and contact lenses – and doesn’t usually cover more serious eye conditions.  Some eye conditions are considered medical in nature and are covered by health insurance. If you have an eye condition, I suggest contacting your health insurer to see if it is covered as a medical condition.

Networks of Providers

Many dental and vision insurers create networks of providers. My experience is that there are huge differences in coverage in and out of network, so you’ll want to see whether your providers are in the network before making any cost comparisons.

One year, my eye clinic was listed as being in network, but it turned out my specific eye doctor was not. As such, it might make sense to call your eye doctor’s office before selecting vision coverage to confirm that your specific provider is in your network.

Cost Comparison

Because dental and vision insurance have such low limits, they don’t provide much protection against large bills. As such, the decision to purchase them is primarily a comparison of your premium with your covered expenses. That is, you want to answer the question, “Will I recover more from the insurer than I pay in premium?”

Each year, I estimated my family’s dental and vision expenses by type.  For dental, I considered how many family members get regular cleanings, what the visits would cost and whether either of my children had braces. I ignored all other dental expenses, such as fillings or root canals, for this part of my analysis.  For vision, I counted the number of vision exams, pairs of glasses and contact lenses my family was likely to need.

I applied the deductibles, limits and coinsurance to the expenses to get an estimate of what I might recover from the insurer.  I compared that amount with the premium. My post on health insurance provides more information about networks, coinsurance and deductibles.

Other Considerations

Discounts negotiated by the dental insurer with providers are another component of savings.  Similar to health insurance, the cost of dental services provided by in-network providers when you have dental insurance can be significantly less than the cost if you don’t have insurance.  This savings is difficult to quantify initially, but you can estimate it once you have used the same provider under a single dental insurer for a year or two or you can call your dentist and ask about the savings. You can then include those savings in your analysis as a cost covered by the insurer.

You’ll want to research whether your health plan includes basic vision exams for you and your covered dependents.  If your health insurance plan has that coverage (and your provider is in your health insurer’s network which will likely be different from the vision insurer’s network), you’ll want to exclude any recoveries from the health insurer or exclude those expenses from your list before estimating recoveries from your vision insurer.

How to Decide

If the premium and amounts covered by the insurer were fairly close or the premium was less the amount I estimated I would recover (including savings from discounts), I would buy dental and/or vision insurance.  If the premium was significantly more than the covered expenses, I usually took my chances that no one would need any expensive dental work and didn’t make the purchase.   In practice, I bought dental insurance when my kids had braces and usually didn’t buy it otherwise.

As with all other financial decisions, the risk-reward trade-off is an individual one so you will need to decide for yourself how much extra premium you are willing to pay to have a portion of unexpected dental expenses reimbursed by the insurer.  As you do so, remember that there is likely a fairly low cap on the total coverage provided by the insurer, so you’ll want to see how much of that maximum you’ll use up with your preventative and orthodontia expenses in evaluating that risk-reward trade-off.

Many vision insurance plans do not cover anything other than preventative services, glasses and contact lenses.  As such, the decision to purchase vision insurance is often a more straightforward cost-benefit comparison and is less focused on risk and reward.  Of course, if your plan covers other eye issues, you’ll want to take those into consideration in your decision-making process.

Employee Stock Ownership as Part of Your Benefits Package

I have seen three types of employer offerings related to employee stock ownership. I talked about the first, allowing or requiring employees to purchase company stock in their defined contribution plans, in this post.  The second is an Employee Stock Ownership Plan or ESOP which is also a part of a defined contribution plan. The third, an Employee Stock Purchase Plan (ESPP), lets you buy company stock, often at a discount.

Employee Stock Ownership Plan (ESOP)

Under an Employee Stock Ownership Plan (ESOP), an employer contributes company stock to an employee’s defined contribution account.  (For more information about defined contribution plans, see my post on that topic.) The employee cannot sell the stock until he or she resigns or retires from the company, though there are exceptions.

If you want to diversify your company stock holdings, you’ll need to talk to your human resources representative to understand your options, if any.  ESOP contributions are usually subject to vesting (increased ownership by the employee as his or her tenure with the company increases). When the employee retires or resigns, he or she will either receive a lump sum or periodic payments, depending on the terms of the plan.

Employee Stock Purchase Plan

An Employee Stock Purchase Plan (ESPP) allows employees to purchase company stock through payroll deductions.  Many employers offer their company stock at a price lower than is available if purchased through a broker.  The ability to purchase the stock at a discount can be a real benefit, as long as the stock price doesn’t go any lower than your purchase price before you sell it.

ESPPs have varying rules as to how long you have to hold the stock before you can sell it. Also, the tax treatment may be differ depending on how long you hold the stock.   I preferred to have as little of my investments in my employer’s stock as possible. Therefore, I generally purchased stock through the ESPP, but sold it as soon as was allowed to lock in the benefit of the discounted purchase price.

There is a drawback to the approach I took.  If you seek to be a senior executive in a company, company stock ownership is often considered a sign of loyalty and faith in the company.  As such, if this is your goal, you might consider keeping the stock purchased through an ESPP.

Dependent Care Flexible Spending Accounts (US)

Dependent care flexible spending accounts (FSAs) allow you to set aside a portion of your paycheck without paying any taxes on the money. You must use the money to cover out-of-pocket expenses that are related to care of dependent children or parents and are needed to allow you to go to work.  You do not pay Social Security or Federal income taxes on money put into or withdrawn from a dependent care FSA. In many states, you also do not have to pay state income taxes either.

There are restrictions on the types of expenses you can pay from your account. You can generally pay for child daycare (both traditional daycare and nannies), elder care, before-and-after school programs and sick childcare services, among others.  If you plan to use the money for other services, you’ll want to confirm that they are acceptable. This publication from the IRS web site provides lots of details about who can qualify and the types of expenses that are acceptable.

You lose any money you contribute to a dependent care FSA if you don’t spend it in the same year.  For most people, the 2020 maximum contribution was $2,500 if you were single and $5,000 if you are married. That amount hasn’t changed in several years.  If your dependent care expenses are highly likely to exceed that limit, the tax savings make it reasonable to contribute the maximum.  If your expenses are likely to be less, you’ll need to take care in selecting the amount of your contributions so you don’t lose any portion you don’t spend.

Life Insurance Included in a Benefits Package

Many employers offer group life insurance on one or all of the employee, spouse and children.


The type of life insurance offered by employers is term life insurance. It pays the stated benefit amount if the covered person dies during the policy period.  The policy period for an employer-sponsor plan often corresponds to a calendar year.

My employers generally provided life insurance on my life (as the employee) with a benefit amount equal to one year’s salary at no charge.  I was able to purchase more insurance on my life and smaller amounts on my spouse and children at my expense.


Group life insurance won’t provide the stated benefit if the cause of death is excluded from coverage. The most common exclusions with which I’m familiar are suicide and murder by the beneficiary.

If these nuances are important to your decision, you’ll want to ask your human resources representative what exclusions exist under your employer’s coverage. Much more importantly, if you are concerned about your mental health or your physical safety, please seek help! There are free crisis lines that will help with either issue or contact your local hospital for mental health concerns or police for safety issues.

How to Decide

Deciding whether to buy life insurance is often a tough decision, as we all like to think we will still be alive at the end of the year. We especially don’t want to think about what will happen if we or a loved one dies.  However, there are many people who should take advantage of this portion of their benefits package.   I offer some highlights of the decision-making process in the sections that follow, but refer you to my post on buying life insurance if you want more information.

How to Decide About Yourself

As you think about your coverage level, whether you have any dependents and, if so, whether they’ll be able to sustain their current lifestyle without your income and personal expenses are important considerations.  If you have no dependents and very little debt, you might not need more life insurance than one times your salary.  On the other hand, if you have children, have some or a lot of debt or are barely covering your expenses, you might want to buy more life insurance to make sure there is money to pay down your debts and/or support your children if you die.

You’ll also want to consider the cost of the life insurance and whether it fits in your budget. For more information on budgeting, see my introductory post and nine-part series with step-by-step details to create a budget, starting with this post.  If buying life insurance means that you don’t have enough money to cover the basics, you might need to take the riskier approach and not purchase life insurance or not purchase as much.

How to Decide About Your Spouse

The considerations for insuring your spouse are similar to buying insurance for yourself.  You’ll also want to consider whether your spouse’s employer provides any life insurance and, if so, compare the face amounts and premiums between the two plans.

How to Decide About Your Children

The amount of insurance available for the death of children is usually relatively low, in the range of $5,000 to $20,000.  I view the primary purpose of buying life insurance on children as covering funeral and related expenses. If you are able to afford a funeral and everyone who “should” attend can afford to get to the funeral, you are less likely to need life insurance on your children.  However, funerals and travel can be quite expensive, so life insurance on your children could cover some or all of those expenses. As always, you’ll want to evaluate whether the cost of life insurance on your children fits in your budget.

Disability Insurance

Disability insurance replaces a portion of your wages if you are sick or injured.  In the US, where workers’ compensation insurance covers workplace illnesses and injuries, disability usually covers only non-occupational illnesses and injuries. In other jurisdictions, it can cover both occupational and non-occupational illnesses and injuries.

Types of Disability Insurance

Employers offer wage replacement in a number of components, including sick time or paid time-off, short-term disability, long-term disability and supplemental long-term disability.

Sick Time or Paid Time-Off

Sick time or paid time off benefits usually pay you 100% of your wages when you are sick. There is often a limit on how many days of sick time you can take. More recently, vacation days are included in the limit and the total is called “Paid Time-Off.”

Short-Term Disability Insurance

After a stated waiting period called an elimination period, short-term disability insurance will replace some or all of your wages.  I have seen short-term disability plans that pay between two-thirds and 100% of wages (excluding bonus) for between 13 and 26 weeks. I have never had an employer charge me for short-term disability insurance, but imagine some employers might do so.

Some governments outside the US, including Canada, offer programs similar to short-term disability.  If your employer requires that you pay some or all of the premium for a short-term disability program, I suggest you research the benefits provided under any government program in your decision-making process.

Basic Long-Term Disability Insurance

After you have exhausted your short-term disability benefits, you may be eligible for long-term disability benefits if offered by your employer.  The basic long-term disability plans I have seen have paid between 50% of salary and two-thirds of the sum of salary and target bonus. Some long-term disability plans provide benefits for only a limited number of years while others will provide benefits until your normal retirement age.  In all cases, benefits stop, of course, if you recover and are able to return to work. I’ve had employers pay the full cost of basic long-term disability and others that required that I cover a portion of its cost. If you pay some or all of the premium for long-term disability insurance, the corresponding portion of any benefits you receive are not subject to income taxes, at least in the US.

Supplemental Long-Term Disability Insurance

Some employers give you the option to increase the percentage of your income that is replaced by long-term disability at your expense.

How to Decide

The decision whether to purchase any optional disability coverage depends on two key aspects of your financial situation. Are you able to support yourself and your family if you are ill or injured for a long time? Does the cost of the disability insurance fit in your budget?

At one (pretty unlikely) extreme, you don’t need to buy additional coverage because you have enough savings for retirement, any children’s education and maintaining your current lifestyle or you can live on just your spouse’s income for an extended period of time.  At the other extreme, you might find it difficult to afford disability insurance. In that case, you probably are also in the greatest need of it as one missed paycheck could be devastating financially. As such, the decision to purchase disability insurance is a balance between your need for the coverage in case you can’t work, your likelihood of having an accident or becoming serious ill, and your ability to pay the premium.

Accidental Death & Dismemberment Insurance

Accidental Death & Dismemberment Insurance (AD&D) provides additional life insurance if you die in an accident. It also pays you a percentage of the face amount of the policy if you lose or lose use of a body part, such as an arm, a leg or an eye.  Many employers offer this coverage. Some charge for it while others do not.

Business travel accident insurance is a form of AD&D that provides coverage only if you are traveling for business when the accident occurs.  Some policies also provide coverage if the accident occurs on the employer’s premises. Most employers do not charge for this coverage, but some may.

How to Decide Whether to Buy AD&D

I generally did not buy AD&D coverage, though obviously didn’t opt out of it when my employer covered the full cost. I had a desk job for my whole career, so could have gone back to work with at least some amount of disability.

If you have a career that is more physical, you’ll want to think about what injuries would make you permanently unable to pursue your current profession. You’ll want evaluate the amount of benefit that would be provided in case of loss or loss of use of a body part.  If your employer’s policy covers accidents in the workplace, you’ll also want to consider whether your workplace is dangerous, such as a manufacturing facility or an oil well, and, in the US, any recoveries you might receive from workers’ compensation insurance. As always, you’ll want to evaluate the potential benefits of this coverage in your specific situation relative to the cost of the insurance and whether it fits in your budget.

Group Legal Benefit

Some employers offer a group legal benefit either at their or the employee’s expense.  Features of this component of a benefits package can include:

  • A discount on legal representation.
  • Telephonic legal advisory.
  • On-line tools.
  • Other free or reduced-fee services.

I’ve never paid much attention to a group legal benefit, as I considered any legal expenses in my budgeting process and have been very fortunate that I have only had very predictable legal expenses (such as writing wills).

If you anticipate that you might need legal advice, it would make sense to estimate the value of any benefits your employer provides and compare them with the cost charged by the employer.  Even having a will written if you have dependent children can be quite expensive, so the value of the discount might be enough to justify the cost.

Extended Health Care Insurance (Canada)

In Canada, many of the basics of healthcare are provided through the government health plan.  However, many important expenses are not covered, including prescription drugs, medical devices (e.g., crutches, wheelchairs and orthotics), various practitioners (e.g., chiropractors, physiotherapists and psychologists) and many other types of medical expenses.

Extended health care insurance covers a portion of these costs, with the portion and specific costs covered varying from plan to plan. Some plans include dental and vision coverage, the portion of ambulance services not covered by provincial insurance, and semi-private hospital rooms.  The insurance includes many of the same coverage features (limits, deductibles, coinsurance) used in US health insurance. If you are considering the purchase of extended health care insurance, I suggest that you read my Health Insurance post, excluding the sections on HealthCare Flexible Savings and Health Savings Accounts.


I want to thank Laura Kenney for her invaluable help with making sure I clearly explained these aspects of a benefits package.

The Case for a Few Good Stock Runners

The Case for a Few Good (Stock) Runners

Many investors limit the amount of their investments in individual companies to manage the risk in their portfolios.  Others advocate holding on to stocks whose prices increase faster than the rest of your portfolio (which I’ll call stock runners) as long as the reason you bought the stock in the first place continues to hold true.  I’ve taken the latter approach with my portfolio with some success.

In this post, I’ll talk about how many stocks you might want to hold in your portfolio to maintain diversification.  I’ll then explain both strategies for dealing with stock runners in more detail.  I’ll close with an explanation of how the strategy of holding on to stock runners worked for me and provide examples of when it wouldn’t have worked.

How Many Stocks to Hold

If you plan to invest only in individual stocks (as opposed to including mutual or exchange-traded funds in your portfolio), many advisors recommend that you make investments in at least 10 companies.  Ten provides a balance between the amount of time needed to research a possibly longer list of companies to make an informed decision and creating diversification.

A Poor Performer

The goal of diversification is to reduce the impact of the poor performance of one stock on your total portfolio returns.  In my post on diversification and investing, I used PG&E as an illustration.  The chart below shows PG&E’s daily stock price over the 12 months prior to PG&E declaring bankruptcy in early 2019.

In the twelve months ending January 26, 2019, PG&E’s stock price dropped by 72%.  From its peak in early November 2018 to its low in January 2019, it dropped by 87%.

 The Benefit of More Stocks

Although diversification can’t completely protect you from such large losses, it can reduce their impact especially if you invest in companies in different industries.   If the only company in which you owned stock was PG&E, you would have lost 72% of your investments in one year.  If, on the other hand, you had owned an equal amount of a second stock that performed the same as the Dow Jones Industrial Average over the same time period (-6%), you would have lost 39%.  The graph below shows how much you would have lost for different numbers of other companies in your portfolio.

Portfolio returns by number of stocks

This graph shows how quickly the adverse impact of one stock can be offset by including other companies in a portfolio.  In a portfolio of five stocks (PG&E and four others that performed the same as the Dow), the 72% loss is reduced to about a 20% loss.  With 10 stocks (circled in red), the loss is reduced to 12.6% which isn’t much worse than the 6% loss for the Dow Jones Industrial Average.

The curve starts to flatten out quickly at about 10 stocks, supporting the common rule of thumb that a portfolio of only individual stocks should have representation from at least 10 companies.

Options when You Own Stock Runners

There are two schools of thought about how to treat stock runners.

  • One is that you should sell a portion of your holdings so that the value of your holdings in any one company is no more than 10% (one-tenth) of your total portfolio.
  • The other is that you should let your winners run. The latter view is consistent with the advice of Peter Lynch, one of the most successful mutual fund managers ever, who advocates looking to buy stocks that could become ten-baggers (worth 10 times what you paid for them).

When Holding on to Stock Runners Works

I have taken the latter approach and will use two of the stocks that have been in my portfolio for close to 30 years to illustrate.  Let’s say I had $100,000 to invest in 1992.  I put 10% of it in each of Boeing (BA) and Neogen (NEOG) stock.  I put the rest in an S&P 500 index fund.  (That’s not really what I did or the amount of money I had, but the changes make the example simpler.)

Neogen performed very well between May 1992 and August 1, 2020.  $1 invested in Neogen on May 1, 1992 was worth $169 on August 1, 2020!   By comparison, $1 invested in 1992 in the S&P 500 was worth $8 in 2020 and $1 invested in Boeing stock in 1992 was worth $16 in 2020.

The Two Strategies

The chart below shows what would have happened if I had managed this portfolio since May 2, 1992 under the two different strategies.  The purple line shows the strategy I use – buy and hold or let stock runners run.  The green line shows what would have happened to the value of the portfolio if I had trimmed my positions in Neogen and Boeing once a year so that the mix was 10% in each of Neogen and Boeing and 80% in the S&P 500.

Net Worth comparison including Boeing and Neogen as stock runners

The Benefit of Keeping Stock Runners

From 1992 until mid-2008, there really wasn’t much difference in the results of the two portfolios.  Since then, both Boeing and Neogen have significantly outperformed the S&P 500.  The purple line therefore moved above the green line and has consistently stayed higher.  On August 1, 2020, the purple line shows that the buy-and-hold portfolio had a value of $2.5 million.  The trimmed portfolio (green line) had a value of just over $1.5 million on the same date or only 60% as much.

Boeing had particularly poor results in the 10 months starting in October 2019.  Its price on August 1, 2020 was only slightly more than half of what it was on October 1, 2019.  Similarly, Neogen hit a high of 200 times its May 1, 1992 price in April 2018.  You can see these peaks in the purple line in the chart.  Even with these significant declines in Boeing’s and Neogen’s prices recently, the buy-and-hold strategy produced 66% higher returns.  If I had been able to anticipate these decreases and thinned my positions in these two companies in 2018 or 2019, my net worth on August 1, 2020 would have been even higher.

I caution that this example is somewhat extreme.  There are very few stocks, such as Neogen, that have produced such consistently high returns.  Nonetheless, the illustration highlights the benefits and risks of letting your stock runners run.

When Trimming Your Positions is Better

Before you get too excited about the buy-and-hold strategy, you should know that you can’t use it blindly.  I’ll use the examples of General Electric (GE) and Pacific Gas & Electric (PG&E).  I owned GE for a while and have a family member who owned PG&E, so am familiar with both companies.  From May 1, 1992 through early 2017, GE significantly outperformed the S&P 500 (increasing in price by a factor of 30 vs. 5.5) and PG&E produced roughly market returns, but was considered a reliable stock with a generous dividend.  Starting in 2017, both companies encountered financial difficulties and lost substantial portions of their market value.

The chart below shows the same comparison as above – buy-and-hold vs. trimming your positions – using GE and PG&E in place of Neogen and Boeing.

Net Worth comparison including GE and PG&E as stock runners

While the companies were doing well (up to the 2008 financial crisis), the buy-and-hold strategy produced better returns.   For the next 8 or 10 years, the two portfolios performed similarly.  Once the two companies encountered difficulties, though, in 2017, the annual trimming strategy started to outperform.


The conclusion that I draw from these illustrations is that, as long as you think a company can outperform the market, you will likely be better off letting your stock runners run.  However, if something changes at the company, you will likely be better off trimming the larger positions in your portfolio, at a minimum, or selling all of your stock in the company.  This conclusion reinforces the points Peter Lynch made in his book, One Up on Wall Street, that you should know the story behind every stock you own.  Brandon Smith makes a similar recommendation in his guest post for me that changes in a company’s management, market or financial position can be important sell signals.


Celebrating Our Second Birthday!

We hope you will help us celebrate our second birthday on Friday, October 2, 2020!  In the past year, we published 26 posts on topics ranging from life insurance to investing to financial planning to bitcoin.  In this post, I review what we’ve been doing, our most popular posts and ideas we have for future topics.

Focused on Investing

Our primary focus in the past year has been on investment education.  The posts started with some basics about stocks, expanded to include a number of different strategies for investing in equities, and also covered the related topics of diversification and re-balancing.  If you are interested in this topic, we suggest reading the posts in roughly this order, skipping any topics that don’t interest you.

In our first year, we published related posts introducing bonds and explaining risk and diversification.

Top Five Posts This Year

In Year 2, our most popular posts were these.

#1 Good Debt vs. Bad Debt

Good Debt vs. Bad Debt

One of my readers was considering a business expansion.  He was concerned that he would have to borrow money to finance the expansion.  There is a common misconception that all debt is bad.  In this post, I identify characteristics of good and bad debt.  Based on these characteristics, I think that his business expansion was a great use of debt.

#2 Don’t Make these Financial Mistakes

Don't Make these Financial Mistakes

Good Nelly wrote this guest post focusing on financial mistakes you might make during the COVID-19 pandemic.  Although the context of the post focuses on the current situation, many of the mistakes are actions to avoid at any time.  This post was featured on Personal Finance Blogs.

#3 Reading Financial Statements

Reading Financial Statements

This post is part of my series on investing.  One of the most important actions to take before investing in an individual company – whether it be a stock, bond or option investment – is to review its financial statements.  Every company’s financial statements are different, but they all contain the same key elements.  In this post, I use an example to help you look for the important line items in financial statements and identify the key ratios that investors review.

#4 Don’t Panic.  Just Plan It.

Don't Panic. Just Plan it.

I wrote this post just as COVID-19 was beginning to impact our lives and investments.  In the first half of the post (the “Just Plan It” part), I walk through the key components of a financial plan and how, if you have one in place, you will be much better prepared for the next economic crisis.  In the second half of the post (the “Don’t Panic” part), I provide many statistics about previous market crashes, highlighting the conclusion that selling after a crash is one of the biggest mistakes you can make.

#5 New Cars vs. Used Cars

New vs. Used Cars

This post is the only one in this year’s top 5 that I wrote last year.  It was #6 on last year’s list, so is a very popular post.  In it, I total up all of the costs of owning a car for a variety of different models, ages at purchase and lengths of time owned.  This post helps you understand whether and by how much you would be better off if you buy a used car rather than a new car.  For some cars, it is much less expensive to buy used, whereas for other cars it doesn’t cost much more to buy new especially if you plan to own it for a long time.

Top Five Posts Ever

These posts have been most popular since our inception.

#1 Advice We Gave our Kids

Advice I Give My Kids

This post was the one of the first ones I wrote.  It contains a list of 7 themes about money that my kids heard frequently as they were growing up or as they were starting to make their own financial decisions.  It talks about everything from cash for emergencies to when it is okay to quit a job without a new one to insurance.  In addition, I added two other pieces of advice I wished I had given them.

#2 Should Chris Pre-Pay His Mortgage

Should Chris Pay Off his Mortgage?

Chris @MoneyStir published a post giving a lot of detail about his financial situation.  He asked others for their opinions about whether he should pre-pay his mortgage.  In my response, I illustrated to Chris that, given his particular circumstances, he would be substantially better off a large percentage of the time after he fully re-paid his mortgage if he invested his extra cash instead of using it to pre-pay his mortgage.  One of the broader takeaways from this post is the importance of isolating a single decision and not confusing your thinking by combining separate decisions into one process.

#3 New Cars vs. Used Cars

Not surprisingly, since this post was in the top 10 in our first year and top 5 this year, it is near the top of the list for both years combined.  See above for more information about the post.

#4 Introduction to Budgeting

Introduction to Budgeting

This post is the first one we published.  It explains what a budget is, its benefits and the key steps for creating a budget.  It acts as an introduction to a series of nine additional posts with the step-by-step details for making a budget.  The process starts with tracking your expenses to see how you are currently spending your money.  It then moves through setting financial goals, determining your income and figuring out how you want to spend your money.  The final step is monitoring your expenses to see how you are doing relative to your budget.

#5 Good Debt vs. Bad Debt

This post is the only one that we wrote this year that made the all-time top 5.

Future Topics

I have a couple more posts related to investing planned to start our third year and then will go back to other components of financial literacy.  Some of these topics are:

  • Buying a home vs. renting
  • Mortgages
  • Reverse mortgages
  • Rental property
  • Annuities
  • Insurance for your bank accounts
  • 529 Plans
  • Extended warranties
  • Pet insurance
  • Income taxes (US and Canada)
  • What should be included in your budget

If you have any questions you’d like me to answer or topics you’d like me to cover, be sure to let me know.  While I can’t provide financial advice for your individual situation, I can provide insights on how you might make a sound decision.  You can send me a note from the Contact Us tab on this blog or at

Thank You!

In closing, I have a number of people to thank.

First is my daughter without whose assistance this blog wouldn’t be possible.  She reviews all my posts, brainstorms ideas with me and does all of my graphics, in addition to all the work she did to set up Financial IQ by Susie Q in the first place.  I also want to thank my mother who proofs all of my posts and adds terrific insights, both of which increase the quality of the posts.

I greatly appreciate the contributions of my guest authors – Kay Rahardjo, Brandon Smith, Good Nelly, Adam Wilson, Baruch Silverman and Graeme Hughes.  They provide content on topics with which I’m not familiar and allow me to take breaks which is especially helpful when I go on vacation or have visitors.

And, most importantly, I want to thank all of you – our followers!  The purpose of this blog is to provide unbiased financial literacy information to people like you.  We hope you find Financial IQ by Susie Q a great resource and that you’ll let your friends know about it.


Why I Chose Patience over Re-balancing


Many financial advisors recommend re-balancing your portfolio no less often than annually to ensure the asset allocation is consistent with your risk tolerance, as illustrated in this post from Schwab.  In the past, I haven’t been one to re-balance my portfolio, so I spent some time thinking about why I haven’t followed this common advice.  Up until recently, almost all of my invested assets have been equities, equity-based mutual funds or exchange-traded funds (ETFs).  As such, I didn’t need to do any re-balancing across asset classes.

In this post, I’ll explain re-balancing, its specific purpose and examples of its benefits and drawbacks.  I’ll also explain my strategy (which may or may not be right for you).

What is Re-balancing?

Re-balancing is the process of buying and selling securities in your portfolio to meet certain targets.  In the case of asset classes, the primary purpose of re-balancing is to maintain your target risk/reward balance.

Some people have targets that define their desired allocation across asset classes.  One common rule of thumb is that the portion of your portfolio that should be in bonds is equal to your age with the rest in stocks.  In my case, that would mean roughly 60% of my portfolio in bonds and 40% in stocks.  The goal of this rule of thumb is to decrease the volatility of your investment returns as you get older and closer to that age at which you need to draw down your assets in retirement.

How Does Re-balancing Work?

The process of re-balancing is fairly simple.  Periodically, such as once or twice a year, you compare the market value of your investments with your targets.  If there is a significant difference between how much you own in an asset class and your target percentage, you sell the portion of your investments that is above the target and reinvest the proceeds in something different.

Let’s say your target is 75% stocks and 25% bonds.  You start the year with $10,000 of investments – $7,500 in stocks and $2,500 in bonds.  If stocks go up by 10% and bonds go up by 5%, your year-end balances will be $8,250 in stocks and $2,625 in bonds, for a total of $10,875.  Your targets though are $8,156 of stocks (75% of $10,875) and $2,719 of bonds.  To put your portfolio back in balance, you would need to sell $94 (= $8,250 – $8,156) of stocks and buy $94 of bonds.

You can avoid selling any assets if you have money to add to your investments at the end of the year.  Continuing the example, let’s say you have another $500 available to invest at the end of the year.  That brings your total available for investment to $11,375 (= $10,875 of investments plus $500 cash).  Your targets would be $8,531 (= 75% of $10,875) for stocks and $2,843 for bonds.  In this case, you would buy $281 of stocks and $219 of bonds to meet your targets, eliminating the need to sell any of your assets.

What Does Asset Allocation Do?

The chart below compares the average annual returns and risk profiles of several sample portfolios with different mixes between stocks and bonds.  In the middle four portfolios, the first number is the percentage of the portfolio invested in stocks and the second number is the percentage in bonds.

Annual Returns for Different Asset Allocations 1980-2019

Average Returns

In this chart, the average annual return is represented by the blue dash.  When the blue dash is higher on the chart, it means that the returns on the portfolio were higher, on average, over the historical time period.


The green boxes correspond to the ranges between the 25th percentile and the 75th percentile.  The whiskers (lines sticking out of the boxes) correspond to the ranges from the 5th percentile to the 95th percentile.   When the box is tall and/or the whiskers are long, there is a lot of volatility.  In this case, it means that the annual return on the portfolio varied a lot from one year to the next.  At the opposite end of the spectrum, when the box and whiskers are all short, the range of returns observed historically was more consistent.

Comparison of Portfolios

I have arranged the portfolios so that the one with the most volatility – 100% in the S&P 500 – is on the left and the one with the least volatility – 100% in bonds as measured by the Fidelity Investment Grade Bond Fund (FBNDX) – is on the right.  You can see how adding bonds to the S&P 500 reduces volatility as the height of the boxes and whiskers gets smaller as you move from left to right.  At the same time, the average annual returns decrease as bonds are added to the portfolio.  Over the time period studied (1980 to 2019), the S&P 500 had an average annual return of 8.7% while the Bond Fund had an average annual return of 7.2%.  By comparison, returns on investment grade bonds are currently generally less than 4%.

Another Perspective

Because stocks and bonds are not 100% correlated, the volatility (spread between tops and bottoms of boxes and whiskers) of owning a combination of both is less than the volatility of owning just the riskier asset – stocks.  As I was preparing the chart above, I noticed, though, that the bottom whisker for the 100% bonds portfolio goes lower than the bottom whisker for the 80% bonds portfolio.

Specifically, there were more negative returns in the historical data (i.e., more years in which you would have lost money in a single year) if you owned just bonds than if you owned the portfolio with 80% bonds and 20% stocks.   The 80% bond portfolio had a negative return only 7.5% of the time while the 100% bonds portfolio had a negative return 10% of the time!  As more bonds are added to each portfolio, the blue bar/average moves down.  This downward shift actually moves the whole box and the whiskers down.

This relationship can be seen in the chart below.

The dots correspond to the portfolios in the previous chart with labels indicating the percentages of stocks in the portfolios.  The horizontal or x-axis on this chart represents the average annual return.  Values to the right correspond to higher average annual returns (which is good).  The vertical or y-axis represents the percentage of years with a negative return.  Values that are higher on the chart correspond to portfolios with more years with negative returns (which is bad).

Optimal Portfolios

“Optimal” portfolios are those that are to the right (higher return) and/or lower (fewer years with negative returns).  Any time a point is further to the right and at the same level or lower than another one, that portfolio better meets your objectives if probability of having a negative return is your risk metric.

More Stocks Can Be Less Risky

I have circled two pairs of dots.  The ones in the lower left corner are the two I’ve mentioned above.  The 20% stocks (80% bonds) point is lower than and to the right of the 0% stocks (100% bonds) point.  As you’ll recall, the average return on the 20% stocks portfolio is higher than the average return on the all-bond portfolio so the dot is to the right (better).  The percentage of the time that the annual return was less than zero was smaller for the 20% stocks portfolio so the dot is lower (also better).

There is a somewhat similar relationship between the 60% and 80% stocks portfolios (circled in green in the upper right).  The 80% stocks point is at the same level and to the right of the 60% stocks point.  As such, if average annual return and probability of a negative return are important metrics to you, moving from 80% to 60% stocks or 20% to 0% stocks would put you in a worse position as you would have less return for the same risk.

Re-balancing Can’t Be Done Blindly

Setting a target asset allocation, such as 80% stocks and 20% bonds, allows you to target a risk/reward mix that meets with your financial goals.  As I indicated, the purpose of re-balancing is to ensure that your portfolio is consistent with your goals.  However, it is important that you considering the then-current economic environment when re-balancing.

Interest Rates

For example, interest rates are lower than they were at any point in the historical period used in the analysis above.   Over the next several years, interest rates are unlikely to decrease much further, but could stay flat or increase.  If interest rates stay flat, the returns on bond funds will tend to approach the average coupon rate of bonds which is in the 1% to 3% range depending on the quality and time to maturity of the bonds held.  This range is much lower than the average annual return of 7.2% in the illustrations above.

If interest rates go up, the market price of bonds will go down, lowering returns even further.  As such, the risk-reward characteristics of bonds change over time.  I would characterize them as having lower returns and higher risk (the one-sided risk that prices will go down as interest rates go up) now than over the past 40 years.

Stock Prices

Similarly, the S&P 500 is currently close to or at its highest level ever in a period of significant economic and political uncertainty.  While I don’t have a strong opinion on the likely average annual returns on the S&P 500 in the next few years, I think it is likely to be more volatile in both directions than it has in the recent past.

If you re-balance your portfolio, you will want to form your own opinions about the average returns and volatility of the asset classes in which you invest.  With these opinions, you can decide whether the asset allocation you’ve held historically will still provide you with the risk/reward profile you are seeking.

Re-balancing and Income Taxes

Another consideration when you are deciding whether and how often to re-balance your portfolio is income taxes.  Every time you sell a security in a taxable account, you pay income taxes on any capital gains.  If you lose money on a security, the loss can offset other capital gains.  On the other hand, if you own the securities in a tax-free (Roth or TFSA) or tax-deferred (traditional or RRSP) account, re-balancing has no impact on your taxes.

Re-balancing Example

Let’s look at an example of the taxable account situation.  If you targeted a portfolio of 60% stocks (in an S&P 500 index fund) and 40% bonds (in FBNDX) from 1980 through 2019, you would have made the transactions shown in the chart below.

Rebalancing Stock Transactions

In this chart, the bars represent the amount of the transaction as a percentage of the amount of stocks held at the beginning of the year.  A bar that goes above zero indicates that you would have bought stocks in that year.  A bar that goes below zero indicates that you would have sold stocks in the year.  The proceeds from every sale would have been used to purchase the bond fund.  Similarly, the money used to purchase stocks would come from a corresponding sale of the bond fund.

In every year, you either sell some of the stock index fund or the bond fund.  The difference between the price at which you sell a security and the price at which you buy it is called a capital gain.  You pay income taxes on the amount of capital gains when they are positive.  In the US, many people pay a Federal tax rate of 15% on capital gains in addition to any state income taxes.  The Canadian tax rate on capital gains is of about the same order of magnitude.

Reduction in Return from Income Taxes

Income taxes, assuming a 15% tax rate, would have reduced your annual average return from 8.4% to 8.1% over the 1980-2019 time period.  Put in dollar terms, you would have had just under $250,000 at the end of 2019 if you started with $10,000 in 1980 and used this asset allocation strategy if you didn’t have to pay income taxes.  By comparison, you would have had about $220,000 if you had to pay income taxes on the capital gains, or 12% less.

As you consider whether re-balancing is an important component of your financial plan, you’ll want to make sure you understand the impact of any income taxes on your investments returns.

Why Only Equities?

You may have been wondering why I was invested almost solely in equities for all of my working life and not in a combination of asset classes, such as stocks and bonds.   My philosophy was that I preferred to use time to provide a diversification benefit rather than an array of asset classes.  By keeping my invested assets in stocks, I was able to take advantage of the higher expected returns from stocks as compared to bonds.

The chart below helps to illustrate this perspective.

Annual Returns - 1980-2019 - Time vs. Rebalance

It compares the volatility of the annual return on a portfolio of 100% stocks over a one-year time period with the same portfolio over five years and with a portfolio of 60% stocks and 40% bonds over one year.

The blue bars on the first and second bars (100% stocks for one year and five years, respectively) are at the same level, meaning they had the same average annual return.  Both the box and whiskers on the second bar are much more compact than the first bar, indicating that the annual returns fell in a much narrow range when considered on a five-year basis rather than a one-year basis.

Cost-Benefit Comparison

Comparison of the first and third bars highlights the cost and benefits of diversifying across asset classes.  The box and whiskers on the 60/40 portfolio are both shorter than the 100% stock portfolio.  That is, there was less variation from year-to-year in the annual return for the 60/40 portfolio than the 100% stock portfolio.   However, the average return (blue line) on the 60/40 portfolio is a bit lower because the 60/40 portfolio had an average annual return that was less than the 100% stock portfolio.

My Focus

The comparison on which I focused in selecting my investment strategy is the one between the second and third bars.  That is, I compared the volatility and average returns of a 100% stock portfolio over five years with the volatility and average returns of a 60/40 portfolio over one year.  As can be seen, there has been less volatility in annual stock returns when considered in five-year time periods.  Yet, the average return on stocks is higher than the average return on the blended portfolio.  Because I didn’t anticipate that I would need to draw down my investment portfolio, I was willing to look at risk over longer time periods and tolerate the year-to-year fluctuations in stock prices in order to expect higher investment returns.

Your time horizon until you might need the money in your investment portfolio and your willingness to wait out the ups and downs of the stock market are important considerations as you decide whether this strategy or a more traditional blended portfolio is a better fit for you.

Diversification: Don’t Get Misled by these Charts

Investment Diversification: Don't Get Misled by These Charts

Diversification is an important component of any investing plan.  It assists you in limiting your risk either to a single asset class or a single security within an asset class.  However, I have seen a couple of graphs from which you could form the wrong conclusions about diversification.  In this post, I show you the charts, identify the wrong conclusion that could be drawn from them, and explain and illustrate the correct conclusion.

Diversification Fallacy #1: A Combination of Stocks and Bonds Provides a Higher Return than just Stocks

I first saw a chart[1] in a post on Schwab’s website a couple of years ago.  It is the first graph on this page.  It was prepared in 2018 and compares the cumulative return on the S&P 500 and a portfolio that is 60% stocks (as measured by the S&P 500), 35% bonds and 5% cash from 2000 to 2017.  I’m not sure why Schwab chose to use an 18-year period for this chart, other than the beginning of the time period corresponds to the turn of the century.  The portfolio is re-balanced annually.  In that chart, the total return on the re-balanced portfolio is slightly higher than the S&P 500 (167% versus 158% or 5.6% vs 5.4% per year).

My Version of Chart

Because I can’t include the Schwab chart here, I created a chart (shown below) that shows a similar result for the same time period.  It compares the cumulative returns on the S&P 500 with those of a portfolio of 60% stocks and 40% 20-year US Treasuries (using an approximation I derived for older years).  The mixed portfolio is re-balanced annually, similar to the calculations in the Schwab chart.

Cumulative returns on S&P 500 and mixed portfolio
Cumulative Returns

In this graph, the ratio of the value of the S&P 500 at each year end to its value on December 31, 1999 is shown in purple.  The blue line shows the corresponding ratios for the portfolio of 60% stocks and 40% bonds.  The S&P 500 never makes up the losses it experienced in the first few years of this 18-year time period.

Incorrect Inference about Diversification

At first glance, these charts appear to imply that you can earn more if you hold a 60%/35%/5% mix of stocks, bonds and cash (or 60% stocks/40% bonds) than if you invest in just the S&P 500.  That conclusion confused me, as bonds tend to have total returns that are lower than stocks over the long run and cash has close to no return.   If you re-balance your portfolio annually, as assumed in the graph, your total return in each year will be 60% times the return on stocks plus 35% times the return on bonds plus 5% times the return on cash.  Since the returns on bonds and cash are less than the return on stocks, I was sure that the weighted average of the returns would have to be less than the return on stocks alone.

The Reality

It wasn’t until recently that I figured out why the chart looks the way it does.  The analysis was performed in 2018, so it used the most recent complete 18-year period available.

Historical Perspective

It turns out that period was a rarity in recent history – it was one of only three 18-year periods in which bonds had a higher total return than stocks when considering all such periods from the one starting in 1975 to the one starting in 2002!  If we go back all the way to 1962, the mixed portfolio had higher returns in about a third of the 18-year periods.  The chart below illustrates this point.

18-Year Cumulative Returns for period starting in 1963

Each pair of bars corresponds to an 18-year period (the time period in the Schwab chart) starting in the year shown.  The bar on the left in each pair shows the estimated cumulative 18-year return on a portfolio of 60% stocks[2] and 40% bonds[3] that is re-balanced annually.  The bar on the right shows the corresponding return on the S&P 500 during each period.  As you can see, in most recent years, the right bar (100% stocks) has a higher return than the left bar (60% stocks and 40% bonds).  In older years, the left bar tends to be higher.

How to Use this Information

If your investment goal is to maximize your return without regard to risk, a portfolio with 100% stocks will better meet that objective more than two-thirds of the time when considering 18-year periods and an even higher percentage of the time if you consider only more recent experience.  If interest rates increase substantially at some point in the future, you might look at the longer time period for deciding whether to add bonds to your portfolio, as interest rates were higher and rose in many of the years from 1962 to 1980.  But you’ll want to wait until interest rates are a fair amount higher than their current levels before those years are relevant to your decision-making.

If, however, you want to reduce volatility, adding bonds (or other asset classes) to your portfolio can help.  My post on diversification for investments provides several illustrations about how the addition of bonds to your portfolio reduces risk, but also reduces your total return.  As you consider using other asset classes to reduce volatility, you will need to consider your time horizon for your investments.  As indicated in the chart above, there have been no 18-year periods in the time covered by the analysis in which the S&P 500 had less than a 3% annualized return or 59% compounded return.

Fallacy #2: Diversification in Rank Order Matters

When I first saw this chart from Callan[4], I thought it was very impressed with how it illustrated the benefits of diversification.

Callan Periodic Table of Investment Returns

The font is small so your probably can’t read the words and numbers, but the visual impact is terrific.  Each column is a calendar year.  Each color corresponds to a different index.  The rows correspond to the order of the returns on each index in each calendar year, with the top row showing the index with the highest return; the bottom, the lowest return.

The indices by color (in the order they appear in the first column) are:

  • Rust: S&P 500 Growth
  • Olive green: S&P 500
  • Grey: MSCI (Morgan Stanley Capital International Index) World ex US
  • Dark blue: S&P 500 Value
  • Light green: Bloomberg Barclays Aggregate US Bond Index
  • Medium blue: Bloomberg Barclays High Yield Bond Index
  • Mustard: Russel 2000 Growth
  • Brown: Russell 2000
  • Light blue: Russell 2000 Value
  • Orange: MSCI Emerging Markets

Incorrect Inference about Diversification

At first glance, it appears that there is a lot of diversification among these asset classes, as the colored boxes move up and down on the chart from year to year.

The Reality

It wasn’t until I plotted the returns (using roughly the same colors) on a line chart that the true lack of diversification became apparent.

Annual returns from 1997 to 2017 for funds in Callan chart

Even though the order of the indices changes, as shown in the Callan chart, most of them actually move substantially in sync.  For example, the MSCI Emerging Markets Index moves all over the Callan chart not because it adds diversification but because its returns are much more volatile.  In 14 of the 20 years in the Callan chart, the MSCI Emerging Markets Index is either at the top or the bottom.  It moves in the same direction as most of the other indices, it just makes bigger moves.


The goal of adding new asset classes to your portfolio is to increase diversification.  Asset classes are diversifying when they have negative or even small positive correlation.  I provide a detailed explanation of correlation and diversification in this post.  The chart below shows the correlations between each pair of indices in the Callan chart.

Correlations between funds in Callan chart

High positive correlations are highlighted in red (as that means they aren’t diversifying).  Medium positive correlations are shown in yellow and small positive and negative correlations (the ones we are seeking) are in green.

It becomes quickly apparent that the only asset class that is diversifying over this time period is US bonds (Bloomberg Barclays (BB) Aggregate US Bond Index).  If you look at the line graph above, I have made the line for the Bloomberg Barclays Aggregate US Bond Index a bit thicker than the others to help you see its lack of correlation with the other investment classes.

Different Insights

While I found the diversification message misleading in this chart, I still found value in the data itself.

Investment-Grade Bonds add Diversification

First, as discussed above, the diversification benefit of investment-grade bonds relative to all of the stock indices is quite evident.  Interestingly, high-yield bonds are highly correlated with stocks, so don’t add diversification.

Asset Classes Show Risk-Reward Balance

Second, I calculated the average annual return and the standard deviations of those returns.  As shown in the chart below, the different indices are spread widely along the spectrum that balances risk and reward.

Average and standard deviations of returns on funds in Callan chart

Specifically, the Bloomberg Barclay Aggregate US Bond Index is in the lower left corner indicating it has a lower average return than all of the other asset classes over this time period but also has the lowest risk as measured by the standard deviation of the annual returns.  By comparison, the MSCI Emerging Markets Index has both the highest annual average return and the highest risk, as it is in the upper right corner of the chart.  All of the other indices fall in the middle on both average return and risk.

Selecting Asset Classes for Your Portfolio

As you are choosing the asset classes in which you want to invest, you need to consider all three of average annual return, risk and diversification benefits.  For example, if you have a very long time horizon and can tolerate the ups and downs of the returns, the historical data indicates that investing primarily in the Emerging Markets index would maximize your return.

If you have a shorter time horizon or are less able to watch the value of your investments go up and down, you might want to invest in something with a lower return, such as one of the stock indices.  If you have even lower risk tolerance or a shorter time horizon, you might want to add something like the Aggregate US Bond Index to your portfolio.  It is important to recognize, though, that adding the less volatile asset classes to your portfolio, even if they are diversifying, will lower the expected annual return on your portfolio at the same time it is lowering your risk.

Caution about Using Past Findings in the Future

In closing, I caution you that the time period covered by the Callan charts corresponds to a time period during which interest rates were relatively low and generally decreasing.  During the time period from 1997 to 2017, the highest yield on the 10-year US Treasury on a year-ending date was 6.7% at the end of 1999.    It decreased to 1.7% at the end of 2014 and increased very slightly to 2.7% by the end of 2017.  By comparison, it hit a high of 12.7% at the end of 1981 and is currently (August 2020) below 1%.  Neither extreme is covered by this time period.

The relatively stable returns on the Bloomberg Barclay Aggregate US Bond Fund Index may be more representative of the time period included in the analysis and may understate the overall volatility of that index over a longer period of time.  Similarly, the other indices may behave differently in other interest rate environments.

I suggest using the information in this post to enhance your understanding of the returns, volatility and diversification benefit of the different asset classes.  You’ll want to supplement this information with your views on future economic environments before making any investment decisions.

[1] I am not able to include the chart directly in this post as I am not willing to accept the conditions that would be required by Schwab to get its permission.

[2] As measured by the S&P 500.

[3] As measured by the iShares 20+ Year Treasury Bond Fund ETF starting in 2002 and my approximation of those returns for prior years.  I note that the Schwab chart uses the Bloomberg Barclays U.S. Aggregate Bond Index for bonds and the FTSE Treasury Bill 3 Month Index for cash.  I don’t not have access to that information.  Because I used a government bond index that tends to provide lower returns than a corporate bond index, I used 40% weight to bonds and ignored the cash component.

[4] Used with permission.  August 8, 2020.

Why I Don’t Hold the All Seasons Portfolio

All-Seasons Portfolio

The All Seasons Portfolio reports amazing statistics about its returns.  I’d never heard of the All Seasons Portfolio, so had to check it out.  As I’ll discuss in more detail, it is an asset allocation strategy with more than 50% of the portfolio allocated to US government bonds.  In this current environment of low interest rates, one of my followers asked my opinion of the portfolio as an investment strategy for the near future.  The answer is, as is almost always the case, it depends.  However, after studying the portfolio and relevant data, I won’t be aligning my portfolio with the All Seasons Portfolio.

In this post, I’ll define the All Season Portfolio, talk about when each of the components of the portfolio is expected to perform well and provide a wide variety of statistics regarding its historical performance.  I’ll also talk about the need to re-balance assets to stay aligned with the portfolio and the impact of income taxes on your investment returns.  I’ll close with how I’ve changed my portfolio based on this analysis.

All Seasons Portfolio

Ray Dalio is an extremely successful hedge fund manager.  If you have more than $5 billion in investable assets, he might consider accepting you as a client.  His fund is famous for the All Weather investment strategy.  According to Tony Robbins, in his book MONEY Master the Game, the annual returns on the All Weather portfolio exceed 21%![1]

Composition of Portfolio

In an interview with Robbins, Dalio described a much simpler version of the All Weather portfolio for the rest of us.  This asset allocation is called the All Seasons portfolio.  The allocation in the All Season portfolio[2] is:

  • 40% in Long-Term US Bonds (20+ years), using the iShares Barclays 20+ Year Treasury Bond fund (ticker symbol TLT)
  • 15% in Intermediate US Bonds (7-10 years), using the iShares Barclays 7-10 Year Treasury Bond fund (ticker symbol IEF)
  • 7.5% in Gold, using the SPDR Gold Trust (ticker symbol GLD)
  • 7.5% in Commodities, using the PowerShares DB Commodity Index Tracking fund (ticker symbol DBC)
  • 30% in the S&P 500

This allocation is illustrated in the pie chart below.

All Seasons portfolio Asset Allocation

Economic Indicators

The portfolio’s name, All Seasons, refers not to the four seasons of the calendar year but to four indicators of the economic cycle.  These four indicators are:

  1. Higher than expected growth (often measured using gross domestic product or GDP)
  2. Lower than expected growth
  3. Higher than expected inflation (often measured using the consumer price index or CPI)
  4. Lower than expected inflation

I note that there is overlap between the first pair of characteristics and the second pair.  That is, a period of higher than expected growth can have either higher or lower than expected inflation.

The chart below shows which of the five components of the portfolio are expected to perform well in each part of the economic cycle, according to Robbins.[3]







FallingTreasury Bonds

Treasury Bonds


Historical Performance

According to Robbins[4], the All Seasons portfolio had a compounded annual average return of 9.7%, net of fees, from 1984 to 2013.  By comparison, I calculate the corresponding value for the S&P 500 to be 8.4%.  In addition, the All Seasons portfolio had much lower volatility, with a standard deviation of 7.6%, as compared to the S&P 500 which had a standard deviation of 17%.  So, at first glance, the All Seasons portfolio seems to be a terrific option – higher return for lower risk.

My Estimate of Returns

There are many challenges to calculating the returns on the All Seasons portfolio.[5]  I made many assumptions to better understand the returns, so do not consider the statistics I’ve calculated as accurate, but I think they are close enough to be informative.

The chart below shows the annual returns on the S&P 500 and my approximation of the returns on the All Seasons portfolio from 1963 to 2019.

Annual returns on S&P 500 and All Seasons portfolio

From this graph, it appears that the biggest benefit of the All Seasons portfolio is that the non-S&P 500 asset classes diversify away a substantial portion of the significant negative returns on the S&P 500.  For example, in the three years in which the S&P 500 had returns worse than -20%, I approximated that the All Seasons portfolio lost an average of only 0.1%!

Returns by Asset Class

I wasn’t able to get a long enough history of Commodity price data, but was able to calculate the average return on the three other asset classes during those same years (1974, 2002 & 2008), as shown in the table below.

Asset ClassAverage Return in Years when S&P 500 Return was < -20%
S&P 500-30.5%
7-10 Year US Treasury Bonds8.0%
20 Year US Treasury Bonds15.2%

As can be seen, all three asset classes had positive returns in those three years, with Gold having the most significant increase.

My Investing Goals

I retired a little over two years ago, so have changed my investing goals to make sure I can meet my cash needs as I don’t have any earned income to cover my expenses.  Specifically, now that I’ve switched from the accumulation phase to the spending phase, I have less tolerance for volatility.

Goals While Accumulating

While I was accumulating assets, I wanted my invested asset portfolio to produce returns that were at least as high as the overall market.  I use the S&P 500 as my metric for market performance.  During that time, I was quite willing to tolerate the ups and downs of the market because I was diversifying my risk over time.  As a confirmation of my risk tolerance, I point out that I did not sell any assets during any of the market “crashes.”

My first market crash was October 19, 1987.  I can still remember being in the office that day.  The internet was not available to the general public, so our news came from TV and radio.  One of the senior people in the office had a TV in his office, though I suspect it had just the over-the-air channels as very few people had cable TV then either.  He told everyone what was happening in the market.  I asked him whether he was going to move his 401(k) money out of the market into a safer fund.  His advice was that it was already too late and that I should just hang on for the ride.  That was one of the best pieces of investing advice I’ve ever gotten.  I didn’t sell during that crash and haven’t sold during any of the crashes since.

Goals While Retired

Now that I’m retired, I am drawing down my assets.  I’ve made two changes to my asset mix to reflect the fact that I now need to spend my assets rather than add to them.

  1. Instead of having a six-month emergency fund in cash, I now have several years of expenses in cash.
  2. I’ve added a few individual corporate bonds (to be clear, not a bond fund) that mature in 3 to 5 years to my portfolio. When these bonds mature, they will add to my cash balance to cover my expenses in those years.

For the rest of my invested asset portfolio, I’ve maintained the same goal – meet or beat the S&P 500.

By having several years of expenses in cash, I know I won’t have to sell any assets during any market turmoil, such as we are experiencing now.  As discussed in my post on reacting to the most recent crash, the market has historically recovered in less than five years (excluding the crash of 1929) and has higher than average returns during the recovery phase.  As such, I don’t want to have to sell stocks when markets are down.

How I Evaluate the All Seasons Portfolio

As I said, my goal is to earn a return close to or higher than the return on the S&P 500.  I would be willing to take a small reduction in return for less risk, but not much given the other aspects of my strategy.  Therefore, I will look at the components of the All Seasons portfolio relative to what I can earn if I just invest in the S&P 500.

In particular, I am interested to see how these asset classes perform when interest rates are low, as they currently are.


Returns on bonds (unless held to maturity) and bond funds have the following characteristics:

  • The total return is equal to the interest rate on the bond plus the change in market value from changes in interest rate levels.
  • Returns are higher when interest rates are high or are going down.
  • The total return is similar to the interest rate itself when interest rates stay fairly stable.
  • Returns are lower when interest rates are low or are increasing.

Bond Returns vs. Interest Rate Changes

This relationship can be seen in the chart below which compares the change in the 10-year US Treasury bond interest rate (yield) with the change in the market value of iShares Barclays 7-10 Year Treasury Bond fund (ticker symbol IEF) in each year from 2003 through 2019.

Change in Price goes down when yield on 10-Year Treasury goes up

What Can Happen from Here

We are currently in the last situation listed above.  Interest rates are currently quite low by historical standards.  The chart below which shows the yield on the 10-year US Treasury bond from 1962 to 2020.  The last point on the chart is the interest rate on July 8, 2020 of 0.65%.  It is lower than the interest rate at the end of any year since 1962.

10-Year Treasury Rate from 1962 to 2019 with single major peak in 1981

For all intents and purposes, interest rates can do one of two things from their current levels – stay about the same or go up.  If they stay the same, the return on bonds funds will be about the same as the interest rate on the bonds – currently less than 1% for 10-Year US Treasury bonds and less than 1.5% for 30-Year US Treasury bonds.  If interest rates go up, the market value of the bonds will go down and returns will be even lower.

As such, I don’t believe the returns on bonds or bond funds in the near term will be high enough to be consistent with my investing objectives.  I will continue to buy individual corporate bonds that mature in the next few years to ensure that I have cash available to meet my expenses.  But, I do not plan to add any bond funds to the investment portion of my portfolio.   If I were younger and the time until I needed to draw down my investments to cover my expenses was longer, I wouldn’t invest in bonds at all in the current environment.


I am particularly interested in how gold has behaved, as it isn’t something I’ve studied much.  For the current environment, I’m interested in how gold behaves when interest rates are flat or rising.  The chart below shows how I defined historical periods as having interest rates that are either flat or rising.

10-Year Treasury Interest Rate rose from 1962-1967 and 1977-1980 and was flat from 1968-1977, 2004-2007 and 2013-2018

The line is the same line shown in the 10-Year Treasury Interest Rate chart above.  I have shaded periods in which interest rates have been relatively stable in blue.  The time periods in which interest rates have increased are highlighted in green.

The chart below has the same time periods shaded as the previous chart, but the blue line shows the percentage change in the price of gold between 1971 (when the price of gold was no longer set by the US government) and today[6][7].

Gold prices increased in most years in which interest rates were flat or rising

Looking back to the 1970s, gold prices were generally up quite significantly when interest rates were either relatively flat and when they increased.  While the increases in price were not as large in the period from 2003 to 2006, another time period when interest rates were flat, as in the 1970s, annual price increases were still generally in the 10% to 30% range, much higher than would be expected on the S&P 500.  Only in the most recent flat period are changes in gold prices not as consistently high.

Gold Funds

Buying gold means that you have to find a way to take delivery of it or pay to have it stored.  One article about the All Seasons fund suggested investing in SPDR Gold Shares[8] (ticker symbol GLD) which is an exchange-traded fund (ETF) physically backed by gold.  I compared the changes in prices of this ETF with the changes in the price of gold.  Although they generally track each other, as shown in the chart below, they are not a perfect match.  Nonetheless, this ETF appears to be a much easier alternative for investing in gold than buying gold itself.

very close match between gold and GLD ETF price changes from 2005 to 2019


I wasn’t able to get a long history of returns on commodities, but the table I provide earlier from Robbins’ book indicates that they are expected to behave in a manner similar to gold.

Overall Portfolio Evaluation

The chart below summarizes the annual average returns (on a compounded basis) for each of the asset classes for which I could approximate returns from 1963 to 2019[9].

Average returns from 1962-2019 on S&P 500 (7%), Gold (7%), 7-10 Year Treasuries (3%), 20-Year Treasuries (4%) and All Seasons Portfolio (6%)

Over this time period, it appears that Gold has had returns similar to that of the S&P 500, but the returns on US Treasuries have dragged down my estimate of the returns on the All Seasons portfolio.

I am particularly interested in how these asset classes perform when interest rates are either flat or increasing.  The chart below illustrates these returns using the same approximations as above.

Average annual returns when interest rates were rising and flat

In average in both rising and flat interest rate environments, gold has historical outperformed the S&P 500.  By comparison. both categories of bonds have underperformed and, in fact, have had average returns during those periods of roughly 0%.


The performance metrics reported by Robbins and others assume that you maintain the target mix in each asset class.  To accomplish that, you need re-balance regularly. That is, you need to to sell asset classes that have appreciated the most (or depreciated the least) and buy asset classes that have not performed as well.

What is Re-Balancing

Let’s look at an example.  At the beginning of a year, you invest $10,000 using the All Seasons portfolio.  Your portfolio looks like this:

Allocation of $10,000 using All Seasons portfolio

If your one-year returns were similar to those in 2019, your end of year asset allocation (light green) would not be the same as your target (dark green), as shown in the graph below.

End of year results compared to target for 2019 under the All Seasons portfolio

To reach the target allocation, you would need to make the following changes.

GoldSell $44
CommoditiesBuy $28
StocksSell $451
Medium Term BondsBuy $399
Long Term BondsBuy $67

To attain the high returns reported by Robbins, I suspect you need to re-balance the portfolio fairly often.  In my calculations, I assumed annual re-balancing on the first of each year.  How often you re-balance the portfolio depends on your personal preference, but should generally be more often when the prices of one or more of the asset classes is changing rapidly and no less often than annually.

Impact of Income Taxes

It is better to own portfolios you need to re-balance regularly in a tax-free or tax-deferred account.  Otherwise, you will need to pay income taxes on the net of your capital gains and capital losses.  401(k)s and IRAs are the most common tax-free and tax-deferred accounts in the US.  The Canadian counterparts are TFSAs and RRSPs.

Continuing the example above, you sell $44 of gold and $451 of stocks for a total of $495.  Without going into the details of the calculation, your cost basis for these two sales combined is $387, for a realized capital gain of $108.  Many Americans have a 10% tax rate on capital gains which corresponds to $11 on the capital gain of $108.  These taxes reduce your total return by 0.1 percentage point.  That might not sound like much, but it can add up.  If you make a $10,000 investment in this portfolio and taxes reduce your return from 10.0% to 9.9%, you will have $5,000 less after 30 years.  That’s half of the amount of your initial investment!

Changes I’ll Make to My Portfolio

The analysis presented in this post has refined my thinking about my portfolio in two ways.

First, I have confirmed my past thinking that I can maintain a substantial cash position, supplemented by some individual bonds held to maturity, as a hedge against the risk that the stock market will have a significant downturn.  Although holding several years of expenses in cash lowers the return on my total assets, I find it a much easier and less risky strategy than introducing bond funds into my portfolio.  That is, although the return on money market funds where I hold my cash is low, it isn’t much lower than the current returns on US treasury or even high-quality corporate bonds.  With the significant potential that the market price of bonds will go down, I am more comfortable with my cash position.

Second, I have invested in the SPDR Gold Trust (ticker symbol GLD).  I don’t plan to immediately move as much as the 7.5% of my portfolio into gold as suggested by the All Seasons portfolio (15% if I use gold as a substitute for commodities, too).   Rather, I plan to initially invest 1% to 2% of my portfolio in gold and add to that position as I gain more comfort and experience investing in it.


[1] Robbins, Tony, MONEY Master the Game, Simon & Schuster Paperbacks, 2014, p. 391-392.

[2] “Robbins’ All-Seasons Portfolio.”,  Accessed July 5, 2020.

[3] Robbins, op. cit., p. 390

[4] Robbins, op. cit., p. 395.

[5] There are many components of the calculation of returns, including assumptions regarding frequency of reinvestment and fees and the choice sources of data used to calculate the returns of the components of the portfolio.  As such, I am not able to replicate his calculations.  In fact, I found another source for returns on the All Seasons portfolio that, in the single year for which details were provided both sources, shows a return that was 3 percentage points higher than reported by Robbins.

[6] “Historical Gold Prices.” CMI Gold & Silver, Inc,, Accessed July 7, 2020.

[7] “Gold Prices.” World Gold Council,, Accessed July 8, 2020

[8] “Bringing the gold market to investors.” State Street Global Advisors,  Accessed July 8, 2020.

[9] As indicated above, the returns I calculated for the All Seasons portfolio are not as high as were calculated by Robbins.

Selecting Stocks with a Score

Selecting Stocks with a Score

A friend of mine really likes selecting stocks with a score, the Piotroski score in particular.  Briefly, Professor Piotroski created a set of nine financial ratios that contribute to the score. If a company meets a certain criterion and has favorable results on 8 or 9 of the ratios, his analysis indicates that the company’s stock is likely to do well. My friend is primarily a value investor. The appeal of the Piotroski score to him is that it focuses on value stocks and, while it relies heavily on statistical analysis, it isn’t a black box.

In this post, I’ll identify the group of stocks to which the Piotroski score applies. I’ll then briefly explain the financial ratios that determine the score. I’ll close with a specific example of a stock I bought solely using the Piotroski score and provide some general guidance on applying the results of the score.

Book-to-Market Ratio

What is It?

The book-to-market (BM) ratio is a financial ratio. The numerator is the book value of the company. This value is shown on the balance sheet in the company’s financial statements and is usually reported as “Shareholders’ Equity.”

The denominator of the ratio is the total market value of the company on the evaluation date as the financial statements. The total market value is the stock price multiplied by the number of shares outstanding and is also called the market capitalization.

In mathematical terms,

BM Ratio = Book Value divided by Market Capitalization

Piotroski waits for the financial statements to be published for a particular year end to get the book value. He then looks up the market capitalization on the evaluation date of the financial statements for use in the ratio.

Piotroski’s Criterion

In his paper, Piotroski identifies value stocks as companies that have BM Ratios in the highest quintile (highest 20%) of traded stocks. These stocks have high book values relative to their market capitalization. Looked at from the other perspective, these stocks have low market capitalizations (and therefore low stock prices) relative to their book value.

Recall that the book value is the company’s assets minus its liabilities. In theory, if the company were liquidated on the evaluation date of the financials, shareholders would get their portion of the Shareholders’ Equity, based on the proportion of shares owned. Therefore, a BM ratio of 1.00 means that the market capitalization of the stock is equal to the Shareholders’ Equity.

By comparison, the cut-off for the highest quintile of BM ratios[1] across all stocks reported in the ValueLine Analyzer Plus on May 29, 2020 is 1.47. The book values per share of these companies are almost 50% higher than their stock prices!   You can see why Piotroski might consider these stocks to be potentially good values at their current prices.

Why Might It Be High?

There are at least two reasons that the BM ratio might be high.

First, the market may perceive that either assets are overvalued or liabilities are undervalued. Both of these situations would cause the reported book value to be higher than its true amount.

For example, some companies have not fully funded their pension plans. That means that the estimated present value of the future pension benefits is more than the liability on the balance sheet. Companies disclose these differences in the Notes to Financial Statements. If the liability for pension benefits is understated, it will cause the company’s book value to be overstated.

Second, financial theory tells us that the market value of a company’s stock is equal to its book value plus the present value of future profits. If the market perceives that the company is unlikely to make money in the future, the market capitalization will be less than the book value.

The Piotroski score focuses on companies in the second category. That is, it attempts to identify companies that will be profitable in the future from among all of the companies that the market thinks will have negative future profits.

Piotroski Score

The Piotroski score is calculated as the sum of a set of 9 values of 1 or 0. There are 9 criteria in the calculation, in addition to the BM ratio being in the highest quintile. The process assigns a 1 if a company’s financial statement values meet each criterion and a 0 if it does not. As such, companies that meet 8 or 9 of the criteria are considered more likely to have above market average performance.

The 9 criteria are listed below:

  1. Return on assets (ROA) = Net income / Total assets at beginning of year > 0
  2. ROA this year > ROA last year
  3. Cash flow from operations > 0
  4. Cash flow from operations > net income
  5. Long-term debt / Total assets this year < Long-term debt / Total assets last year
  6. Current ratio this year > current ratio last year
  7. Shares outstanding this year <= shares outstanding last year
  8. Gross margin this year > gross margin last year
  9. Total sales / Total assets this year > Total sales / Total assets last year

Piotroski performed his analysis using data from companies’ financial statements from 1976 to 1996. The average of the one-year returns for the companies with scores of 8 or 9 was 7.5 percentage points higher than the average for all companies with high BM ratios and 13.5 percentage points higher than the average for the market as a whole.

How to Calculate It

If you are familiar with reading financial statements, you can calculate the Piotroski score yourself using the formulas above. Or, you could extract the key ratios from a source, such as ValueLine, Tiingo or Bloomberg, all three of which require subscriptions. I use the latter approach as I have a subscription to ValueLine that I use for a variety of purposes.

An easier option is to use a Piotroski calculator or screener.   I’ve never used any of these tools, but I used Google to find a couple free options you might try.

  • Old School Value – This Excel spreadsheet will calculate and show you how a company does on each of the 9 tests and the total score.
  • ChartMill – This screener lets you identify stocks based on their Piotroski score. As such, it helps you find stocks with scores of 8 or 9, but does not show you the details of the underlying calculation.

I suggest being careful to check the documentation of any of these tools to make sure that the descriptions of the 9 tests are the same as I’ve included above (which I took directly from Piotroski’s paper). In poking around on-line, I found more than one site that did not correctly specify the nine tests.

My Experience Selecting Stocks with a Score

Although I’ve looked at stocks using the Piotroski score several times, I’ve made only one purchase using it as my primary buying criterion. I purchased FUJIFILMS (FUJIY) in March 2012. At the time, FUJIY had a BM Ratio of about 1.40, as compared to a market average BM ratio of about 0.5. It had a Piotroski score of 8, having failed the test for an increase in gross margin.

For many, many years, FUJIY’s biggest product was film for cameras. With the advent of the digital camera, its market shrank rapidly. In the year before I purchased the stock, its price decreased by 32%. As I was looking at the company, it was transitioning its business from camera film to other types of related products, including medical imaging and, more recently, office products with its purchase of Xerox. With a good story and a high Piotroski score, I decided to buy the stock.

It turns out I was a little early in buying the stock. In the 12 months after I bought the stock, it decreased by 19% while the S&P 500 increased by 13%. However, if I had bought it a year later, my total return would have been much better over both the short and long term, as shown in the table below.

Total Return starting in March 2013
1 Year2 YearsUntil June 2020
S&P 500+22%+36%+110%


So, even though my returns were lower than the market average because I bought the stock too early in the company’s turnaround, I correctly decided to keep it after its first year of poor performance. That is, if I had sold the stock one year after I purchased it and bought an S&P 500 index fund, I would have been worse off.


As with any investing strategy, it is important that you understand the assumptions underlying the Piotroski score. I also recommend that you understand the story behind the company you are considering for investment, as described in my post on buying stocks based on their financial fundamentals. There are companies that may have a Piotroski score of 8 or 9 that don’t have a good turn-around story, such as the one I described for FUJIY. In those cases, you may not want to rely solely on the Piotroski score.


[1] Calculated in this case as Book Value Per Share at most recent fiscal year end divided by Price on May 29, 2020, so not exactly equal to the ratio as calculated by Piotroski.

Picking Stocks Using Pictures

Picking Stocks Using Pictures

Technical analysts select companies for their portfolio based on patterns in stock prices.  That is, it allows them to enhance their process of picking stocks by using pictures. This approach is very different from some of the others I’ve discussed, as buy and sell decisions are based in large part on these patterns and less on the financial fundamentals of the company. Every technical analyst has a favorite set of graphs he or she likes to review and their own thresholds that determine when to buy or sell a particular stock.

I’ve done just a little trading based on technical analysis, so asked Rick Lage, a family friend who has much more experience with this approach, to help me out. In this post, I will provide some background on Rick and provide explanations of the graphs he uses. I’ll also provide some insights on who I think is best suited for this type of trading.

Rick’s Story

Rick’s Background

“I was first introduced to the stock market in a Junior High School math class. I made my first trade with a stockbroker about 6 years after graduating from High School.

My interest in the stock market never faded. I was always focused on this platform to make money. Unfortunately losing money was a regular occurrence for many years in the beginning, with not many gains to be proud of.

My interest peaked in 1999 when I attended my first stock trading event in Las Vegas, known as the TradersExpo[1]. TradersExpo provides a wealth of information available for the beginner to the pro, including hardware, trading software, classroom instruction and more.

I personally have never been a day trader. Swing trading is more my definition. I do touch base with my stock watch list daily. It’s always managed and checking my technical indicators is a must.”

Rick’s Goals

“I stock trade for the challenge; not so much for the fun or success. If there is success the fun will follow. There will be losses. No doubt. But you learn how to manage those losses. You have no choice. Technical trading is my science.”

Rick’s Advice to New Traders

Rick says, “I have tried hard to never complicate the trade. There are many technical indicators, so don’t get overwhelmed. I pick stocks that have the momentum. Pick your favorite few indicators and go with those.”

Rick’s Tools

Rick’s favorite indicators are

  • Simple Moving Averages using 9 and 180 days (SMA 9 and SMA 180)
  • Price and Volume Charts
  • Relative Strength Index (RSI)
  • Moving Average Convergence Divergence (MACD)
  • Heikin-Ashi bar chart

I will provide brief introductions to each of these indicators, illustrating each with two stocks – Apple and Shopify. A graph of Apple’s stock prices from January 1, 2018 through mid-May 2020 is shown below. It had some ups and downs in price in 2018 and 2019, followed by a significant decrease and recovery so far in 2020.

Apple stock price from 2018 to 2020, starts at about 150, goes to 200, back to 150 by early 2019, over 300 by early 2020, down below 250 in March 2020, back above 300

Shopify had a steadier increase in 2018 and 2019, but much more volatility so far in 2020, as illustrated in the graph below.

Shopify stock price from 2018 to 2020. Starts around 100, goes to 400 in mid-2019, down to 300 by end of 2019, above 500 in March 2020, down to almost 300 then above 700

Simple Moving Averages (SMA 180 and 9)

In this context, a simple moving average (SMA) is the average of the closing prices for the past n days, where n is specified by the person making the chart. In Rick’s case, he looks at the 180-day simple moving average and the 9-day simple moving average. For the former, he takes the average of the closing prices for the previous 180 days; for the latter, the average of the closing prices for the previous 9 days.

SMA Charts

Technical analysts add their favorite SMA lines to the chart of the stock’s price. For illustration, I’ve added the SMA 180 and SMA 9 lines to the Shopify and Apple stock price charts below.

Shopify stock prices from 2018 to 2020 with 9-day and 180-day moving averages. Apple stock price from 2018 to 2020 with 9-day and 180-day moving average lines.

SMA Indicators

Technical analysts then look at the crossing points on the chart to provide buy and sell indications. For example, a technical analyst might look at when the closing price line (black in these charts) goes up through the SMA 180 line (blue in these charts) and call it a buy signal or an indication of a time to buy a stock. You can see an example of a buy signal, using this method, for Shopify around May 1, 2019, as indicated by the green circle.  The buy signals for Apple are much more frequent using this criterion, two of which are indicated with green circles.

Similarly, a technical analyst might look at when the SMA 9 line (yellow/orange in these charts) goes down through the SMA 180 line and call it a sell signal. Using this criterion, there was a clear sell signal for Apple in early November 2018, as indicated by the red circle.

Every technical analyst has his or her favorite time periods for SMA lines. In addition, each technical analyst selects his or her own criteria for buy and sell signals based on those SMA lines. The shorter the time period associated with the SMA, the more often buy and sell transactions will be indicated. When I use SMA graphs to inform my buy and sell decisions, I use fairly long time periods as I am a long-term investor. By comparison, some people trade in and out of stocks several times a day, so use very short time periods, such as minutes or hours.

Price and Volume

A price and volume chart shows plots of both the price of a stock and its volume on a daily basis, color-coded to indicate whether the stock price went up or down each day. The graph below is a price and volume chart for Shopify.

Shopify Price with each day showing high, low, open and close. Days when price went down are in red (about 1/2 of the days), otherwise bars are green. Below price chart is a bar chart showing the daily trading volume.

The upper chart has rectangles (called boxes), sometimes with lines sticking out of them (called whiskers). The combination of the boxes and whiskers is often called a candle. There is one candle for each trading day.

Price & Volume Indicators

A red box indicates that the price was lower at the end of the day than at the end of the previous day; a green box, higher. Green boxes can be interpreted as follows:

  • The bottom of the box is the opening price.
  • The top of the box is the closing price.
  • The bottom of any whisker sticking down from the box is the lowest price on that day. If there is no downward whisker, the lowest daily price and the opening price were the same.
  • The top of any whisker sticking up from the box is the highest price on that day. If there is no upward whisker, the highest daily price and the closing price were the same.

Red boxes can be similarly interpreted, but the opening price is the top of the box and the closing price is the bottom of the box.

The lower section of the chart shows the number of shares traded each day. If the bar is green, the stock price went up that day, while red corresponds to down.

Technical analysts use these charts to identify trends. A really tall green bar in the lower section green is an indication that a lot of people think the stock will go up so are buying. Many technical analysts consider this a buy signal. Similarly, a really tall red bar is considered by some to be a sell signal. My sense is that you need to be very quick to respond using this type of strategy, as you don’t want to sell a stock after everyone has already sold it and the price has dropped or buy it after the price has increased.

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is intended to measure whether a company’s stock is in an over-bought or over-sold position. If it is over-sold, it is a buy signal; if over-bought, a sell signal. The RSI is one of a broad class of measures called oscillators, all of which are intended to evaluate whether the market is over-bought or over-sold.

The RSI is determined based on a moving average of recent gains and the moving average of recent losses. The value of the RSI is scaled so it always falls between 0 and 100.

The RSI was developed by J. Welles Wilder. He considers the market over-bought when RSI is greater than 70 and oversold when it is below 30. There are many other ways in which the RSI chart can be used to identify trends and inform trading decisions that are outside the scope of this post.

The chart below shows the RSI for Apple (blue) and Shopify (orange).

Apple and Shopify Relative Strength Indices with red line at 70 (sell signal) and green line at 30 (buy signal).

The red horizontal line corresponds to RSI equal 70, Wilder’s over-bought signal. The green line is Wilder’s over-sold signal at RSI equals 30.

In this chart, there are several times when both stocks were over-bought. That is, the RSI for both stocks goes above the red line. Apple was considered slightly over-sold a few times, when the blue line crossed below the green line. By comparison, Shopify’s RSI came close to indicating that it was over-sold a few times, but never went below the green line.

Moving Average Convergence Divergence

The Moving Average Convergence Divergence indicator (MACD) is similar to the Simple Moving Average indicator discussed above. However, it uses an exponentially weighted moving average (EMA) instead of a simple moving average. A simple moving average gives the same weight to each observation. An exponentially weighted moving average gives more weight to more recent observations. MACD can use any period – minutes, hours, days, etc. For this illustration, I will set the period equal to a day. If you are trading more often, you’ll want to replace “day” in the explanation below with “hour” or “minute.”

The MACD was defined by its designer as the 12-day moving average (EMA 12) minus the 26-day moving average (EMA 26). MACD is compared to its own 9-day moving average to determine buy and sell signals. As with the simple moving average, the MACD crossing its 9-day moving average in the upward direction is a buy signal. When MACD falls below its 9-day moving average, it is a sell signal.

MACD Charts

The graph below shows Shopify’s daily closing prices along with the EMA 12 and EMA 26 lines in orange and green, respectively, starting on February 1, 2020.

Shopify price chart from Feb 1 2020 to May 11 2020 with EMA 12 and EMA 26.

This next chart shows the corresponding values of MACD (black) and its 9-day moving average (green).

Shopify MACD and 9-day simple moving average of MACD.

If you compare the two graphs, you can see that MACD goes below the 0 line on the second chart on April 1, 2020. This transition is consistent with the orange line crossing above the green line on the first chart on the same date.

MACD Indicators

When Shopify’s MACD is bullish, its MACD is greater than its 9-day moving average or the black line is above the green line in the second chart above. This situation has been seen several times in the past few months – for short periods starting on February 11, March 23 and May 4 and a longer period starting on April 9.

The Apple MACD chart, shown below, has gone back and forth between bullish and bearish (black line below the green line) much more often in the past few months. It sometimes changes from bearish to bullish and back again on almost a daily basis.

Apple MACD with 9-day moving average (sell signal).

The “convergence” and “divergence” part of MACD’s name refers to how the MACD behaves relative to the price. The relationship is somewhat complicated, so I suggest you refer to one of the sources I mention below if you are interested in this feature of MACD charts.

Heikin-Ashi bar chart

Also known as a Heikin-Ashi candlestick chart, the Heikin-Ashi bar chart is similar to the price part of the Price-Volume chart described above.   However, instead of using the actual high, low, open and close prices, all four of the points on the candle are calculated in a different manner. The purpose of the adjustments is to make a chart that makes identifying trends easier. I refer you to one of the resources below to learn the details of how these values are adjusted.

Heikin-Ashi Charts

The charts below show the Heikin-Ashi charts for Shopify and Apple for the past six months.

Shopify Heishen Ashi candles Apple Heikin Ashi Candles

As mentioned, they look a lot like Price charts, except the boxes corresponding to the adjusted open and close and the whiskers corresponding to the adjusted high and low. The boxes are colored green when the adjusted close is higher than the previous adjusted close and red otherwise.

Heikin-Ashi Indicators

Here are some of the indicators people review when using Heikin-Ashi charts:

  • Longer boxes are indicative of trends. In the charts above, you can see that the Apple chart tends to have longer boxes than the Shopify chart.
  • When there is no whisker on one end of the box, the trend is even stronger. For example, neither the Apple nor Shopify charts have upward whiskers on the red boxes from mid-February to mid-March 2020. This time period corresponds to the time period highlighted by the red arrow on the chart below when both stocks’ prices were going down.

Apple and Shopify closing prices from Nov 1 2019 to mid-May 2020. Red arrow showing downward trend in Shopify price from mid-Febrary 2020 to late-March 2020. Green line showing upward trend in Shopify price from early April 2020 to mid-May (end of chart)

Similarly, almost none of the green bars in the last month of the Heishen Ashi chart have downward whiskers, corresponding to the time period in the price chart indicated by the green arrow.

Time periods when the boxes are short, have both whiskers and change color often are indicators of changes. For example, the Apple Heikin-Ashi chart from mid-January to mid-February shows several bars of alternating colors. Apple’s price changed from an upward trend to a downward trend in this period, as shown in the purple circle in the chart below. Identifying turning points is very important in deciding when to buy and sell stocks.

Apple closing prices from Nov 1, 2019 to mid-May 2020. Circle around prices from late Jan 2020 to end of Feb 2020 where price bounces up and down

Who Can Use Technical Analysis

Technical analysis isn’t for everyone. It requires people who (a) have the ability to focus on markets fairly closely every day in the case of swing traders or all day in the case of day traders, (b) are happy with growing their portfolio with a large number of small “wins,” and (c) have a solid understanding of the charts being used.

Time Commitment

Unlike many other investment strategies, many day traders and swing traders do not consider a company’s financial fundamentals in their buy decisions. Instead, they monitor the patterns in their charts. Without the comfort of believing that the companies they own have sound fundamentals, it is important that they follow their charts consistently so they can quickly sell any positions that are not meeting expectations.

Lots of Small Wins

In my post on financial fundamentals, I talk about Peter Lynch’s concept of a 10-bagger – a stock whose value is at least 10 times what you paid for it. In that paradigm, the goal is to attain better-than-market-average returns by getting average returns on most of the positions in your portfolio and big gains on one or two positions.

By comparison, the goal of day traders and swing traders is to make a very small amount of money on every trade, but to make lots and lots of those trades. If you earn 0.1% on average on every trading day, it compounds to just over 20% a year!

For many of us, buying and selling with gains of less than 0.1% per security seems really small and might not seem worthwhile. As such, you need to be willing to be happy with lots of little wins rather than a 10-bagger if you want to be a day trader or swing trader.

Understand the Charts

One of the requirements of using technical analysis is to make sure you understand how to interpret the charts correctly. For example, Southwest Airlines (ticker: LUV) has done very poorly recently from the impact of COVID-19. The plot below shows its closing stock price from February 15, 2020 through May 20, 2020.

Southwest Airlines closing price from Feb 15 2020 to late May 2020.

As can be seen, the last stock price on the graph (about $29) is almost exactly half of the stock price in mid-February (peaked at $58.54). As such, while it has had a few days on which the price increased, the overall trend has been down.

The RSI chart is shown below. Remember that an RSI value of less than 30 is an indication that it might be time to buy the stock.

Southwest Airlines Relative Strength Index chart from Feb 15, 2020 to May 20, 2020.

In this example, there was a buy signal when the RSI crossed below the green line (30) on February 25. The closing stock price on that day was $49.66. If you had bought the stock on that date, you would have lost 41% in the subsequent three months as the stock was at $29 on May 20, 2020.

As you can see, interpreting charts takes time and expertise. If you are willing to invest the time to learn all of the nuances of each type of chart and monitor your positions, technical analysis might be the right investing strategy for you.

There’s a lot more to know about each of these indicators than I’ve provided in this post. Here are a few links to other sources of information to learn more.

  • Stock Charts
  • Technical Analysis for the Trading Professional by Constance Brown, McGraw-Hill Education, 2nd Edition, 2012.
  • Investopedia

How I Use Technical Analysis

I primarily rely on analysis of the underlying fundamentals of a company when I purchase individual stocks. Once I make the decision to buy a stock, I look at the charts to evaluate whether the timing is good for a purchase. If the consensus of the charts I review indicates that the position is over-bought (i.e., price is too high), I will wait to see if the price decreases before buying.

In addition, I use technical analysis in my Roth IRA, where there are no capital gains taxes on trades so more frequent trading isn’t adversely impacted. I follow a large handful of industry ETFs using technical analysis and buy and sell them as each one appears to be doing well. Because I am trading in industry exchange-traded funds (ETFs) and not individual stocks, I feel comfortable looking at my positions once a week. My thought is that industries aren’t likely to experience sudden weaknesses not seen throughout the market in shorter time frames.

When I pay sufficient attention to the positions in my Roth IRA, I tend to get about or slightly above market-average performance. However, when I don’t look at my positions and re-balance regularly, I find that my performance suffers which just confirms my first point in the previous section that using technical analysis requires time and diligence.

[1] There are now TradersExpo events held regularly in many cities (subject to change by the coronavirus).

How to Buy Life Insurance

How to buy life insurance

Choosing the right type of life insurance policy and its death benefit can be confusing. Not too long ago, I published a guest post from Baruch Silverman of The Smart Investor on the different types of life insurance. In this post, you’ll learn how to buy life insurance.  Specifically, I’ll help you evaluate which, if any, of those types of policies fit your situation and how to select your death benefit.

Why are You Buying It?

The first thing you want to consider is why you are buying life insurance. Three common purposes are:

  • the death benefit.
  • the investment returns.
  • sheltering gifts to your heirs from income taxes.

Death Benefit

If your primary purpose for purchasing life insurance is the death benefit, you’ll want to focus on term and whole life insurance.

Investment Portfolio

Some people use life insurance similar to other financial securities (such as stocks and bonds). Variable life and universal life have investment components to them. In simplified terms, the total amount you pay as premium for these types of life insurance is split between the amount to cover the cost of a whole life policy and the excess which can be invested. As such, the life insurer doesn’t invest the portion of premium related to the death benefit.  Further, the life insurer reduces the excess to cover its expenses, a risk charge and its profit margin before investing it.

Variable and universal life policies include the cost of whole life insurance.  Thus, only people who want the coverage provided by whole life insurance might consider using life insurance as part of their investment portfolio. Even then, the returns may not be as high as other investment vehicles with similar risk because of the additional costs charged by the life insurer.

Tax Shelter

Sheltering gifts to your heirs from income taxes only applies to the very wealthy (those who have more than $11 million in assets). I’m assuming that the vast majority of my readers aren’t in this situation, so won’t address it here.

Other Considerations

All types of life insurance can have an indirect impact on your investment portfolio. If you purchase life insurance in an amount that will cover your dependents’ basic living expenses, it allows you the option to invest your portfolio in riskier assets in anticipation of getting higher returns. That is, the death benefit itself could be considered a low-risk investment.  It reduces your overall portfolio risk when added to the other assets you own.

Do I Need Life Insurance?

Some people don’t need the death benefit from life insurance. In that case, it doesn’t make sense to buy life insurance as an investment security either. In the last section of this post, I provide the details of estimating your target death benefit. People whose target death benefit is zero are those who don’t need life insurance.   Briefly, characteristics of people who have a target death benefit of zero are:

  • Their available assets are more than their debts. Available assets exclude any illiquid assets (such as any real estate or personal property they own), savings for their dependents’ retirement (but not their retirement as they don’t need retirement savings after you die), emergency savings and any savings designated for large purchases.
  • They have enough money to cover their dependents’ education expenses.
  • Their dependents can support themselves on their existing income plus your available assets, including being able to make debt payments as they are due or after using available assets to pay off any debts.
  • They have enough money to pay any end-of-life expenses related to their death.

If you aren’t sure if you meet these criteria, keep reading!

Term vs. Whole

If  you’ve decided that you are buying life insurance for the death benefit, you need to decide whether term life or whole life insurance will better meet your needs. The primary differences between the two options are the length of time you need the insurance and the cost.

Term Life

If you think you will need life insurance for a limited period of time, term life insurance is likely better for you. For example, you might have dependents who aren’t currently able to cover their living expenses and the cost of any debt.  In that case, you might want to buy life insurance that will pay off your debts and support your dependents until they are independent.  If your needs change, many insurers will let you convert a term life insurance policy to a whole life policy without having to provide medical information or have a physical, one or both of which are often pre-requisites for purchasing whole life insurance.

Term life premiums are constant over the term of any policy you purchase. However, if you buy a policy when you are older, the premium will be higher than if you buy the same policy when you are younger.

Whole Life

If you think you will need life insurance for your entire life, whole life insurance is likely better for you. For example, if you have a spouse or disabled children who will never be able to support themselves, whole life insurance could supplement your savings to help make sure they are able to live more comfortably, regardless of when you die.

In addition to the death benefit, whole life insurance gives you the option to borrow money. As you pay premium, life insurers designate a portion of your premium as the cash value. The cash value is always owned by the insurance company, but you are able to borrow an amount up to the cash value at any time without prior approval, any collateral or impact on your credit score. The interest rates on cash-value loans are less than many other sources, particularly credit cards. If you die before the loan is re-paid, the amount of the loan will be deducted from your death benefit.

Cost Comparison

Whole life insurance is much more expensive than term life when you are young, but eventually becomes less expensive.

Probability of Dying

The graph below provides some initial insights into the difference in cost between whole life and term life, as it shows the probability that you will die at each age. I calculated the values based on 2016 data from the Social Security web site.

Probability of dying for each year of age

Not surprisingly, the probability you will die increases at each age. If you buy whole life insurance, it will cover the entire portion of the graph from your current age until you die. As such, there is a 100% probability that the life insurer will pay your death benefit (assuming you continue to pay your premiums). It is just a question of when.

If you buy a 20-year term policy and you are 30 years old, only the deaths that occur in the portion of the graph below highlighted in green would be covered. That is, you will receive the death benefit if you die between ages 30 and 50 and will get nothing if you die after age 50.

Same line graph with blue shading from ages 30-50

The probability you will die is much smaller in this narrow window than the 100% probability you will die at some point.

Present Value of the Death Benefit

There are many factors that determine the premium for term life and whole life insurance policies, but the most important component relates to the death benefit. Actuaries (who help price life insurance) usually base the portion of premium related to the death benefit as the present value of the death benefit expected to be paid, on average, in each year.

One-Year Term Policy

The chart below shows the present value for $1 of death benefit for several sample policies. For illustration only, I have calculated the present values using a 3% interest rate and the probabilities of dying from the charts above.

Present value of death benefit divided by death benefit at each of ages 25, 35, 50

The easiest way to see the impact of the increasing probability of dying is to look at the present value of the death benefit for a 1-Year Term Life policy. You can see it increases from almost zero (actually $0.0015 per dollar of death benefit) at age 25 to $0.042 per dollar of death benefit at age 70 which corresponds exactly to the increase in the probability of dying at each age.

Policies with Longer Terms

There are also increases in the present value of the death benefit for the Whole Life and 20-Year Term Life policies as the age you first start buying the policy increases.

You can also see that the present value of the death benefit at age 25 for the Whole Life policy is much, much larger than the present value for either of the two term life policies. This relationship corresponds to the graphs above which compared the probability of dying in a 20-year period as compared to the 100% probability that you will die at some point.

The difference between the Whole Life and 20-Year Term Life policies is fairly small at age 70, because there is a high probability that you will die between age 70 and 90 – the period covered by the 20-Year Term Life policy. In fact, almost 80% of people age 70 will die during the 20-Year Term Life policy period.  As such, the present value of the death benefit for a 20-Year Term Life policy at age 70 is very roughly 80% of the present value of the death benefit for a Whole Life policy.

Annual Premium

The insurance company collects premium over the full life of the insurance policy to cover the present value of the death benefit. That is, you don’t pay all of your premium to the insurance company in one lump sum, but rather on an annual or monthly basis.

Unless you die during the policy term of the Term Life policy, you will pay premium for more years under a Whole Life policy than under a Term Life policy. Therefore, the differences you see above are larger than the differences in premium payments.


The chart below shows the annualized amount of the loss costs. That is, I divided the present values of the death benefits by the average number of years an insured is expected to pay their premium. For example, for the 20-Year Term Life policy, the denominator was calculated as the sum of the probabilities that the insured would be alive in each of the 20 years and therefore able to pay his or her premium.

Approximate loss cost per year per dollar of death benefit at ages 25, 35, 50 and 70

Although these relationships are not precise, they are roughly representative of the differences in annual premium you might pay for the different types of policies at different ages. At age 25, the annual cost of a Whole Life policy in this illustration is roughly three times the cost of either of the Term Life policies. By age 70, the annual cost of a Whole Life policy is less than the cost of 20-Year Term Life policy because, while the present value of the death benefit isn’t all that different between the two policies, people who buy Whole Life policies make more premium payments, on average.

Reality vs. Illustration

It is important to understand that I prepared these examples as illustrations to help you understand the differences between Whole Life and Term Life insurance premiums. In practice, life insurers use different tables showing the probability of dying and different interest rates than I used for illustration, as well as using more sophisticated methods for calculating the present value of the death benefit and including provisions for expenses, risk and profit.

In practice, I’ve seen estimates that Whole Life annual premiums are anywhere from three to fifteen times more than Term Life premium at young ages. As you are looking at your options, you’ll want to get several premium quotes, as they vary widely depending on your age, location, gender, health and many other factors.

How Much to Buy

As with any financial decision, there are two conflicting factors that will influence the amount of the death benefit you buy on a life insurance policy – your budget and your financial needs. In the section, I will talk about how to estimate the best (i.e., target) death benefit for your situation. Once you’ve selected an amount, you can get quotes from several insurers to see whether the premium for that death benefit will fit in your budget or whether you will need to find the best balance between premium affordability and death benefit for you.

Rules of Thumb

Not surprisingly, there are some rules of thumb for guiding your selection of a death benefit. Some of the ones I’ve heard are:

  • Three to five times your salary
  • Ten times your total earned income (i.e., salary, value of benefits and bonus)
  • Ten times your total earned income plus $100,000 per child for college

Rules of thumb like these can provide some insights, but they, by definition, can’t take into account your personal circumstances.

Tailored Approach

A better approach for selecting a death benefit is to analyze your own finances and goals for buying life insurance.   I suggest calculating your target death benefit as the total of the amounts needed to meet your goals, considering the following components.


If you have debt, you’ll want to consider whether your dependents will be able to continue to make the payments on the debt out of their own income. For example, if your spouse’s earned income is high enough to continue to make your mortgage payments, along with all of the other expenses he or she will need to cover if you die, then you might not need to include the remaining principal on your mortgage as a component of your target death benefit. On the other hand, if you are concerned about your dependents’ ability to continue payments on any debt, you’ll want to include the outstanding principal on those debts as a component of your target death benefit. I’ll define this amount as “Debt Principal to be Pre-Paid.”

Final Expenses

When you die, your dependents will incur some one-time expenses. These expenses can include your funeral or memorial costs and professional expenses to settle your estate. I’ll call the amount of these expenses, “Final Expenses.”

Net Future Living Expenses

The next component of your target death benefit calculation is the amount you need to cover your dependents’ future living expenses.

Current Expenses

Start with your household’s total expenses from your budget. This amount will include monthly expenses for everyone in your household, the amounts you are setting aside each month for your designated savings and any amounts you are setting aside for your spouse’s retirement. To be clear, it will exclude any amounts you are saving for your own retirement.

You can eliminate any monthly expenses or amounts for designated savings for things that are only for your benefit. For example, if you spend enough money on clothes for your job to include it in your budget, you can eliminate those expenses. Similarly, you can also eliminate any expenses related to a vehicle that only you drive or designated savings to replace it.

Earned Income

You then need to calculate your dependents’ monthly earned income. This amount may be calculated in two parts – current monthly earned income and future monthly earned income. For example, your spouse may currently work part time as you are relying primarily on your income for support. If you die, your spouse may be able to work full time to increase his or her earned income. Alternately, your spouse may need some education (discussed below) to get the qualifications needed for his or her desired profession.

Extra Expenses

Next, you’ll need to calculate the amount of any expenses that your household will have because of any changes in your spouse’s availability to provide household services. For example, your spouse may work part-time while your children are in school and provide childcare after school. If your spouse starts working full time after your death, you will need to add after-school care expenses to your budget.

Time Periods

The last factor that goes into this calculation is the length of time until you think your dependents will become self-sufficient. For children, you might assume that they will become independent after they turn 18 or graduate from college. The ability of your spouse to become self-sufficient will be a function of his or her skills, education and/or need for more education and household responsibilities (e.g., childcare or elder care).

I suggest splitting the calculation of this component of your death benefit into three time periods – short-term, medium-term and long-term. For each time period, you’ll calculate your net living expenses as expenses minus income. For any periods for which income is more than expenses, set the difference to zero.

  1. Short term – During this time period, you’ll use your current monthly expenses, excluding your personal expenses, and your dependents’ current monthly earned income.
  2. Medium term – During this time period, you’ll use your current monthly expenses with adjustments for extra expenses for services currently provided by your spouse and your dependents’ future monthly earned income.
  3. Long term – During this time period, you’ll assume that your children (other than those who will always be dependent on you for care) are self-sufficient, so can eliminate all expenses related to children and their care from your expenses. You’ll use your spouse’s future monthly earned income. In many households, income in this period will exceed expenses so there may not be a need for death benefits to cover expenses in this period.

You also need to estimate how many months each of these three time periods will last.

Net Future Living Expenses

Your Net Future Living Expense amount for each time period is calculated as the number of months it will last multiplied by monthly net living expense amount. You can then calculate your total Net Future Living Expenses as the sum of the three amounts you calculated for the three time periods.

For those of you who like to see formulas instead of words, you will calculate:

  1. Short-term Net Expenses = Greater of 0 and Current Expenses – Current Income
  2. Medium-term Net Expenses = Greater of 0 and Current Expenses + Extra Expenses – Future Income
  3. Long-term Net Expenses = Greater of 0 and Future Expenses – Future Income
  4. Net Future Living Expenses = (number of months in short-term period x Short-term Net Expenses) + (number of months in medium-term period x Medium-term Net Expenses) + (number of months in long-term period x Long-term Net Expenses)

You could refine this amount by considering inflation and investment returns. Depending on your investment strategy and the time until the funds are used, your investment returns, on average, can be more than inflation. As a conservative first approximation, I suggest using the total without adjustment for inflation and investment returns.


There are two types of education expenses that you might want to include in your target death benefit calculation:

  1. The portion of the cost of education for your children that you want to provide. Some people suggest $100,000 per child for college. This amount may or may not be the right amount depending on how much you expect your children to contribute to their educations, how many years of college education you want to support and what type of school they attend. Prestigious colleges can cost as much as $75,000 to $80,000 a year currently (2020), while in-state tuition (assuming your children live at home while attending college) can cost as little as $15,000 a year in some states. Other children may not go to college or may attend a trade school.
  2. The cost of any education your spouse needs or wants to allow him or her to work in a profession he or she enjoys and allows him or her to earn enough money to increase his or her independence.

Target Death Benefit Calculation

You can now calculate your target death benefit as follows:

Debt Principal to be Pre-Paid

Plus        Final Expenses

Plus        Net Future Living Expenses

Minus   Savings in excess of your real estate and personal property assets, emergency fund, designated savings and spouse’s retirement savings

Plus        Education Expenses

Minus   Amounts in existing college funds

Minus   Any amounts included in your Net Future Living Expenses designated for college

If you are single with no debt, this amount could be zero indicating that you might not need to buy life insurance. If you are married with no children, don’t have a lot of debt and have a spouse who can increase income or decrease expenses to be self-sufficient fairly quickly, you may need only a small death benefit. At the other extreme, if you have several children and a spouse who won’t be able to be financially independent for many years or ever, your target death benefit could exceed $1 million.   As you can see, the specifics of your financial situation are very important to setting a target death benefit and a rule of thumb may not work for you.