There are no sacred cow investment options. Amber Pawlik



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Why I am Not Saving for Retirement Now

Virtually every financial advisor preaches the following things: start saving for retirement early, take advantage of your employer’s 401K, use before-tax money, and pay off your mortgage. Here is why they are all wrong.

 

Let’s start with saving for retirement early. The time value of money is true of course, $1 invested today will be worth more 40 years from now than 20 years. But as far as retirement is concerned, the main goal is generating a large lump sum of money before you retire—how you get there is of no concern.

 

When you retire, ideally you want to have a big enough lump sum of money such that you can live off of the interest alone. If you had $1 million saved, which earned 6% every year, you would earn $60,000 per year in interest. If you spent less than $60,000 every year, you would never touch the core $1 million dollars and you could live indefinitely on your money. Both of the following paths will get you to $1.5 million when you hypothetically retire at 70. For ease, the tables are laid out in 10-year increments. All tables below assume 6% interest unless otherwise stated.

 

Path 1: Dutifully save for retirement every year starting at age 20:

 

Age

Original

Added

Interest

End

20

 $                     -  

 $        50,000

 $        19,858

 $            69,858

30

 $            69,858

 $        50,000

 $        75,105

 $         194,964

40

 $         194,964

 $        50,000

 $     174,045

 $         419,008

50

 $         419,008

 $        50,000

 $     351,230

 $         820,238

60

 $         820,238

 $        50,000

 $     668,542

 $      1,538,780

70

 $      1,538,780

 

 

 $      1,538,780

 

Path 2: Put larger sums of money towards an investment starting at age 40:

 

Age

Original

Added

Interest

End

20

 

 

 

 $                     -  

30

 

 

 

 $                     -  

40

 $            50,000

 $     150,000

 $        99,117

 $         299,117

50

 $         299,117

 $     150,000

 $     296,131

 $         745,248

60

 $         745,248

 $     150,000

 $     648,952

 $      1,544,200

70

 $      1,544,200

 

 

 $      1,544,200

 

 

When you are in your 40s or 50s, you will probably be in a much better position to put a lot towards retirement. The first path has you putting about $400 per month towards retirement starting at 20. The second has you putting around $1,250 per month starting at age 40. Putting this much in your 40s usually becomes easier. Your 20-year student loans will be gone when you are in your early- to mid- 40s. Your 30-year mortgage may be gone when you are in your 50s. Your children will be grown when you are in your 50s. The $50,000 kickstart money I included above at 40 assumed that you likely have saved up some money by 40. Also, given inflation, your wage, while not totally catching up to inflation, will be more caught up in your 50s than in your 20s.

 

Another reason to favor putting money into retirement when you are older is that, unfortunately, since the U.S. government abandoned the gold standard, the dollar loses value over time. The federal government proudly promises to keep inflation at "just" 2%-3%. Here is a chart that shows how a dollar made when you were 20 will plummet to just $0.23 by the time you retire:

 

Dollar Value

Age

 $                             1.00

20

 $                             0.74

30

 $                             0.55

40

 $                             0.41

50

 $                             0.31

60

 $                             0.23

70

 

If the market performs at 6% but money diminishes by 3%, this is an effective growth of 3%. I put the same inputs in the plans above through the same model but at 3% instead of 6%

 

Plan 1:

 

Age

Original

Added

Interest

End

20

 

 $        50,000

 $          9,039

 $            59,039

30

 $            59,039

 $        50,000

 $        29,343

 $         138,382

40

 $         138,382

 $        50,000

 $        56,631

 $         245,013

50

 $         245,013

 $        50,000

 $        93,303

 $         388,316

60

 $         388,316

 $        50,000

 $     142,587

 $         580,904

70

 $         580,904

 

 

 $         580,904

 

Plan 2:

 

Age

Original

Added

Interest

End

20

 

 

 

 $                     -  

30

 

 

 

 $                     -  

40

 $            50,000

 $     150,000

 $        44,313

 $         244,313

50

 $         244,313

 $     150,000

 $     111,140

 $         505,453

60

 $         505,453

 $     150,000

 $     200,950

 $         856,403

70

 $         856,403

 

 

 $         856,403

 

 

You come out more with Plan 2, where you put your money in at the end.

 

Fiat money is like a rotting fish: You have to use it before it goes bad. Since money made when you are 20 will not hold its value as you age, there is some wisdom in not making the money you want to retire with until you are closer to retirement age.

 

Another reason to not put your money into any kind of specific retirement plan is because such plans have penalties, instituted by the government, should you withdraw the money before 59 ½ years old.

 

What I am about to write may come as a complete shock: But you may, just may, want to buy things with a high price tag while you are in the prime of your life, your 20s, 30s, and 40s. That money that would have otherwise gone to a retirement account, or perhaps is already there, could be used to put a nice down payment on a house, build a pool, take a great vacation, put your kids in a top notch school, and so on.

 

The idea that you should put a lot of money into retirement—something you can't cash in on for 40 or more years—makes an assumption that you already know the course of your life for that whole 40 years, and won’t ever need or want the money stuffed into a retirement account.

 

 

 

 


                                                                                                    

 

 

 

 

 

 

People talk about the time value of money. Let’s talk about the time value of life. You could skimp and save like a proper Puritan for the eventual retirement goal by denying yourself, say, a pool—but for that X many years that you were without a pool, you had a less fun time than you could have. To be morbid, what if a family member of yours had unexpected medical bills which you wanted to help with, but couldn't, because your money was tied up?

 

Until I am closer to retirement age and I am fairly certain I have very few other financial goals to consider, I do not plan on investing heavily in any kind of "tax-saving" yet potentially penalty-imposing 401K account. Also note that it wasn't until I was in my 30s that I realized I may want such lump sums of money. In my 20s, I never had any such consideration.

 

Instead of locking yourself into a retirement account, this is my recommendation for lifelong financial plans: save the minimum usually ~$3,000 requisite and then open a low-cost, diversified index fund. Companies such as Vanguard or Scottstrade are places to start looking to start such a fund.

 

With a diversified fund, such as the S&P 500, your money will grow at a nice click—but you have access to the money at any time.

 

If you open one up, and you manage to put $5,000 toward it ever year, if you don’t end up spending it on anything, you have a nice little lump sum of money to do something with in not too many years. $27,000 can come in quite handy for many things, such as buying a car.

 

Age

Original

Added

Interest

End

26

 $          3,000

 $          180

 $          3,180

27

 $          3,180

 $    5,000

 $          491

 $          8,671

28

 $          8,671

 $    5,000

 $          820

 $        14,491

29

 $        14,491

 $    5,000

 $      1,169

 $        20,661

30

 $        20,661

 $    5,000

 $      1,540

 $        27,200

 

One of the disadvantages of Path 2 described above is that you end up putting in $500,000 whereas in Path 1 you only input $250,000. By opening up an investment account, this problem goes away. Here, you are still taking advantage of the time value of money but you are not forced to not touch your money. In the long run, opening an account such as this can easily morph itself into a nicely sized retirement account.

 

Now let's talk about that sacred cow according to conventional financial wisdom—employer-based 401Ks. These plans are like a set of children’s swimming floaties: They are the only thing people use and they give a false sense of security.   

 

Let’s talk first about the fees. Whereas companies like Vanguard offer accounts that cost only about 0.17% in fees, most government-instituted employer-offered 401Ks have fees of 1%-2% or more. Again, with your 6% growth (and 3% inflation), this takes quite a chunk.

 

The reason for such fees is because most are “managed” funds, meaning that they elect some paid “expert” to hand pick certain stocks for you. It has been shown that even the best experts cannot hand select stocks better than diversification can. A study done many times has asked experts to pick out one favorite stock and then compare it to a portfolio of stocks picked by throwing a dart. The dart consistently wins. The dart, unlike the experts, is allowed to pick several stocks. An unmanaged, diversified fund, which also happens to have much lower fees, is simply the way to go.

 

Do yourself a favor: Browse a site like Vanguard or Scotttrade and look especially at their rate of returns. Now compare it to your employer-offered 401K. Also look at their fees, options, and oh yes, all of the wonderful charts they have to help you pick what options are best for you.   Now are you starting to see what you've been missing?

 

I do recommend taking advantage of your employer’s 401K if they match, but only up to the amount they match. If they match your money at a rate of 50%, well, you simply can't beat a return on investment of 50%. But I would recommend putting your money in after tax money. Yes, after tax money. I explain more here. The main reason: You won’t get penalized should you want to pull that money out.

 

It is interesting also to note that before-tax money may make you more money in the long run—should the market perform as well as expected and should you not take it out before 59 ½ years old—but the government actually makes substantially more on your before-tax money than it does on your after tax money. Also consider this: If the market were to totally tank, your before-tax money is locked in, and you cannot take it out. There is no investment that is completely without risk and forcing you to keep your money in the market via penalties means you cannot respond appropriately should something bad happen with your money.

 

I think employer based 401Ks are a scam. Do you really think these were set up in your best interest? Why do you need forced into it if it were in your best interest? There are many, many individuals and companies making boatloads by earning their 1%-2% off of nearly all American workers' retirement accounts. And the government gets its handsome cut as well.

 

Now let's look at another sacred cow of financial advice: paying off your mortgage.

 

First, I will tell you: I hate debt. I think there is something psychological in many female's brains that they completely despise debt. Virtually every male knows he will work for all of his able years. Knowing this, it does not bother him that he will have debt to pay monthly. For many women, they suspect that they will not be working for part of their able years, should they have children. Or, perhaps they are like me; as a working mom, I went part time. If you have no or less income, you really don't want bills. This is my theory on why women want debt gone more so than men.

 

However, in both the short term and the long term, paying off your mortgage may not be the best option. Everything—like almost all financial decisions—comes down to the interest rate. If, and only if, you put the extra money you have into something that will grow at a higher interest rate than your mortgage (or other debt) is, you end up profiting more, even in the long run. Here are the numbers:

 

In this example, which is very simplified on purpose, say you had a debt of $100 at 4%. If you put no extra principle toward it, in one year, you owe $4.00. If you were instead to put $10 towards principle, it would be down to $90 and you would instead owe $3.60. This is a savings of $0.40. Yay, time value of money!

 

But wait: If you had $10 and put it into something that earned 6%, in one year, you've managed to create, as if out of thin air, $0.60.This is $0.20 more than the $0.40 you would have saved. As a check sum, putting money into a 6% investment instead of paying down 4% is essentially the same as making a 2% investment. Indeed, 2% of $100 is the $0.20 we are the better with the investment option.

 

To brace you for what you can expect if you go this route, given these two scenarios, your balance sheets would look like this:

 

Pay down 4% debt option:

 

Debt

Profit

Net

 $    93.60

 $           -  

 $  (93.60)

 

Invest 6% option:

 

Debt

Profit

Net

 $  104.00

 $    10.60

 $  (93.40)

 

Yes, the total interest that you pay to the debt in the invest 6% option is more. But you also have a larger profit. More money will leave your hands, but even more money than that will come back to your hands.

 

With your mortgage, or other debt, if you wanted, you could invest your extra pennies in such an investment account and let it grow until it is enough to pay off your debt—and you will get your debt paid off quicker than had you dutifully paid down the debt each month. And, the entire time you had access to your money should you need or want it—unlike if you had paid down a mortgage, in which your assets would be tied up in your house.

 

But, if your investment account was making you a handsome 6% each year, a question arises: why would you take this precious lump sum of money earning you quite a bit of money per year and use it to pay off a debt of a lesser interest rate? Let's say 10 years into your mortgage you owe a remaining $100,000 on it. In your investment account you have $100,000: Finally, enough to get rid of the mortgage! But this $100,000 is earning you $6,000 this year. Your 4% mortgage is only costing you $4,000 in interest this year. If you gave up this $100,000, that extra you are making in interest off of it is gone.

 

Even if you lost your job, tapping into your investment account to pay the total mortgage does not make sense. Instead, it makes more sense to take from the investment account only what you may need to pay minimum payments, continuing to let the investment earn money for you—possibly your only source of income while looking for another job.

 

There is of course a risk in an investment account. If you pay down your debt, you assuredly save that much % as you get rid of the debt. Your investment account is not guaranteed to make 6% or any % and may even make negative %. But the overall average of the stock market is to always go up. Even after the recession of 2008, most losses were made back up in a few years. I would not recommend opening an investment account with money that you aren't willing to sit on for 2-3 years in order to make up for potential losses.

 

Based on my knowledge of finances, these are my generic recommendations of what to do with your extra pennies: If you have any debt that is at a high and/or adjustable interest rate, per the math, pay this debt down first. Run like hell from a bank savings account, where you are likely to only earn 0.3%.

 

Here is somewhat of a twist for you though: If you have any debt that is small, around $50,000 or less per loan, regardless of interest rate, I would, despite my just stated advice, recommend paying this down before opening an investment account. Or perhaps open the initial account, but put most money after that towards the small debt. The reason is that indeed investment accounts can be risky. Paying off small debt can usually be reached within 5 years or less, giving you access to that monthly money quickly.

 

For your mortgage, if you are under water on your mortgage, meaning you owe more than your house is worth, I would recommend trying to get out from under water, especially if you want to move. If you ever need to move—say your local job market tanks—it is ideal that you are in a position to pack up and go. After you are out from under water (the situation of many 25-40 years olds right now), I recommend looking at other options.

 

My main argument here is against those who would have you bending over backwards for 15 or more years in order to pay off a very large mortgage debt, preventing you from using that money for enjoyable things while in your youth. It neither makes financial sense or "life" sense.

 

I wonder if there is a way to put an "interest rate" on a purchase that may bring you joy. For instance, buying my child a quality pre-school education will increase the quality of our family's life by X%. Sitting on a comfortable couch instead of boxes will increase our quality of life by Y%. Such a metric may help quantify some financial decisions.

 

It should be kept in mind that there is no one investment that is a sacred cow above all others—not retirement and not paying off your debt. These are all just potential options among a wide variety. This is a key to all of economics: there is no one magical investment or product that should be sought after to the automatic detriment of all others. For instance, some think that person (or a country as a whole) should amass a lot of gold. Gold is only one product—one that can't feed or shelter you should you need it. Retirement, paying off debt, are all good goals, but should be weighed against all others appropriately.

 

Keep firmly in mind that I am not advocating you go three sheets to the wind with your money and spend it on cigarettes and blow. I am not advocating to do whatever with your money but rather to let the extra money you have grow in a way that is smarter than what current financial leaders preach you do.

 

I actually have another, more sinister reason for encouraging you to open an investment account: I want you to get a taste for money. I want you to see how great it can be to watch your money grow and feel rich, driven by the engine of capitalism. When you see your money grow in a personally managed fund, you want to keep investing in it—you don't need the heavy hand of the government forcing you to keep your money in the market—watching your money grow is an enjoyable and exciting thing. When faced with the question of if you want to buy, say a car, you may really think twice because of how well your account is doing and how much less you will make per year. You may start saving money, say by eating out less, so you can watch your money grow even more. It is a much more inspiring goal to watch profits go up than to watch debt go down. It is also more inspiring to make money in 5 years than in 40. Make it a challenge: Grow X dollars in Y years. For instance, try growing $25,000 in 3 years. When you get there: Jackpot!!

 

Opening such an account for your child would be a great gift, not just monetarily, but also as a great financial lesson. When I was little, I was given a savings bond, and I was blown away that simply by holding on to it, it would grow in value. My love affair with saving money started then. You can teach your child so much by opening such an account for them. I also get my children a silver coin for Christmas each year for similar purposes.

 

Now, to make you mad. The government inserted itself into your retirement by setting up Social Security. Let's say you pay $5,000 in social security tax every year as does your spouse for $10,000. If instead of paying this tax, you could invest this money at 6% for 40 years, you would make $1.5 million. Yup, $1.5 million. I wholly encourage you to do the math so you can touch, feel, and play with these numbers. Do you think if you had $1.5 million that you could safely retire without a government safety net? I thought so!

 

Be prepared though that, if you are 30 years old today, you will probably need around $2 million to retire. Yes, $2 million. Here is my dare for you tonight: Find an online retirement calculator and calculate how much you need to retire. Let's say you and your spouse want to live on what would be $50,000 of today's money 40 years from now. Due to yearly 3% inflation, in 40 years, you actually need over $150,000 per year to retire and in 50 years, you need over $200,000. Again, I would like you to do the math so you can play with and get to know, love, and in this case, hate these numbers. I told you I wanted to make you mad—and you NEED to start getting mad.

 

Many think of inflation as the price of bread increasing. Well, the price of bread will eventually increase, but it is usually big ticket items, like college, housing, and medical costs that rise rapidly, heavily affecting the overall average of all things. These things often rise in double digit percentages. A 13% increase in price in something that costs $50,000 or $200,000 is a big blow to most people's finances; yet people are focused on the price of bread, milk, or gas. (I do however remember when bread was just $0.87). Medical costs likely will be a concern for you when you retire—with socialized health insurance, these are sure to rise.

 

You need to understand retirement numbers first for your own financial health and for that of the country. We've seen many countries, such as Greece, and cities, such as Detroit, experience financial collapse, and it is almost always due to a government's inability to pay retirees' pensions owed.

 

The current system of Social Security poses this very same threat to the United States. This program simply transfers wealth such that there is a producer group and a parasitic group. Workers work most of their life, pulling a wagon burdened by many people sitting on the wagon, then stop working to go sit on the wagon themselves. And our wagon keeps getting heavier and heavier. People talk about U.S. budget problems but few want to admit that it is due to Social Security.

 

It doesn't have to be this way. To use the wagon analogy, it is possible a person, uninhibited by anyone in the wagon, got it moving so fast that at some point they stop pulling and simply hopped on to enjoy the ride.

 

Take control of your finances and your retirement. No matter the obstacles in your way, knowing the numbers and managing your money wisely will put you in the best position possible, not just for retirement, but for an entire lifetime of happiness and wealth.

Amber Pawlik
July 28, 2013


On ‘Demand Side’ Economics: Why Spending Cannot Improve the Economy but Freedom Can
Amber Pawlik
This article seeks to explain as clear as possible one of the most intellectually difficult economic concepts to grasp: how inflation will destroy an economy. It is meant to give answers to the economics questions many people have today. It covers the basics of economics and then argues against the long held belief, originated by John Maynard Keynes, that stimulus money will jumpstart an economy. It can be considered an Economics 101 and 201 course.

This article is protected under the US Copyright Act of 1976. No part may be copied.

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