The financial education millennials aren’t getting

And I find it appalling, but not surprising. Ours was not much better. However, we should have done better by the next generation, and as in all other matters of managing society, we did not. So I’m donating time to fix this by explaining the whole reasoning as clearly as I can.

Why it matters: this is how you get to retire. Without this, you work until you die. If that sounds fun, stop reading and prepare to embrace lifelong serfdom.

In retirement, the idea is that you aren’t working, but life will still cost money. Two ways one can afford that: have a big enough money pile that it lasts you to the end, or get income to replace a paycheck. Imagining any other outcome is fantasy, though it is reasonable to include cost-of-living cuts in that planning as long as you also think about unavoidable cost-of-living increases.

Therefore, in essence, your retirement planning means figuring out how to replace the work income, or how to save enough money to last you. If you do neither, plan to work until you fall apart, then eke out a living in poverty–and even that may be taken away. You can’t know what’ll happen forty years out. By now, you should be alert to the probability that the reality turns out worse than you were promised.

The two methods can work together. Your big money pile can generate income, which you then live on, with the money pile itself as some security against a real disaster.

You cannot trust Social Security (for income to live on) or Medicare (for affordable medical insurance, the number one crumple zone of retirement money disasters) to be there. That’s because my generation let the politicians steal too much, yet mine will demand that you sacrifice so that mine gets what it was promised. (We will then die off, sticking you with the bill, all the while grumbling about you. Aren’t we charming? This is why we, as a class, have no basis to look down upon you; we forfeited that right by talking a great game about your future, then doing absolutely zero to back it up. We didn’t bus the tray of our life.) But in the meantime, you need to look out for yourself, and it is safest to plan for the government to do nothing to help you in your old age. Then if they do, hurrah, but it’s a pleasant surprise.

Some employers will offer a retirement savings plan as a benefit. This is nearly always flawed, but far better than nothing, especially if the company matches some of your contributions. How you do this affects your Federal income taxes, so it’s important to understand the different kinds.

There used to be things called ‘pension plans’ that would give you retirement income someday, as a benefit of a long career with one employer. (Kindly stop laughing. My generation was the one from whom that sky-pie was yanked away.) Our precious corporations declared war on pension plans, and lacking all spine, my generation surrendered. We will be the last ones to get the last few of those, for the most part, and if it makes you feel any better about this, most of us won’t even get any. Our parents did.

Don’t get concerned about the insulting interest rates from bank savings accounts. That just means that bank savings are not the place for your retirement savings, because you retire on the money your money earns (and money in bank savings currently earns nothing of note), not on the money you save. That’s why an early start is most important: your $1 at 22 may become $10 by 62. The piddly savings you can afford in your early working years will be the dollars that work longest and hardest for you. But do bear in mind that things go in cycles, that your parents remember 7% interest rates on savings. They also remember 14% interest to buy a car. That sword always cuts both ways.

There are two basic types of retirement savings, both of which exist in employer-sponsored and private forms. You must understand these to have any potential for retirement savings. For ease of description, we’ll call them Trad(itional) and Roth. They appear both in 401k plans (work-sponsored) and IRA plans (something you usually do on your own without employer involvement). Salient difference: what you put into the Trad is deducted from your taxable income, up to a limit, but someday when you take money out, those distributions (withdrawals by you so you can live) will be taxable. What you put into a Roth is not deducted from your taxable income, but in retirement, withdrawals will be tax-free–or so they promise us now.

The skepticism you sense here is based upon three things: a long history of government ineptitude and evil, the fact that my generation will probably eat all the cookies (then blame you for not baking enough; aren’t we sweet?), and the bird in the hand outlook (once you get the benefit, it is too late to steal it back). I, myself, do not believe the Roth promises. I believe that when the time comes, government will renege on them, and count on a cowardly and supine citizenry to kneel and pay the tax. Because I do not believe the promises, I want my tax benefit now, so that it’ll be too late for government to take it away later. For me, that means that a Trad IRA is most sensible.

I also prefer the basic wager of a Trad IRA: if I retire with high income, yeah, those taxes will be brutal…because I am well off. Boo hoo. Whereas in case I retire with low income, my tax burden will be less than if I’d paid the tax up front, and in the meantime, I got many years’ use of the money to make more money.

How you feel is up to your confidence in the future and your own tax planning. Let’s say you take the Roth promise at face value. If you are low income, a Trad IRA’s tax writeoff would mostly be worthless to you. Only higher income people gain much from tax writeoffs, since tax rates are higher on higher incomes. The ideal Roth saver would be a person of low income who saves diligently all his or her life, gradually building up an impressive money pile from careful scrimping and smart investing. If you think that’s you, then by all means do so. The ideal Trad saver would be a person with higher income who accents that high income by taking the tax benefit now, ideally reinvesting the savings for still more gain, or a person who has zero faith in government promises. If either is you, then the Trad makes sense. (I wouldn’t say we are high income, but we are middle income, and I have zero faith in government promises. Advantage: Trad.)

But remember that you can do both, provided you don’t contribute to both in the same year. So if you decided to put money in a Roth while you were young and po’, and then in a Trad while you finally started to make real money, that’s fine. You just need to make a choice each year which to contribute to, and live with it. Both accounts would continue to exist, and if you handled them well, to make retirement money for you. That would also mean not putting all your eggs in one basket, a philosophy of which I approve with a mighty approving.

Okay. Here is how it works in real life practice, each of the four rough possibilities:

Employer Trad (usually also called a Traditional 401k): you agree to have your employer take money out of your paycheck. The employer may match the amount up to a preset limit. A financial institution holds onto these funds, though you remain their owner. The institution offers you a limited number of ways to invest the funds for gain. A few institutions offer great options. Most offer mediocre to lousy options. (Also, the institution gets a big fee for sitting on your money pile, and if you think you do not ultimately pay it, you are naïve. One way or another, no matter how clever the shell game, you always pay all fees, and the sooner you grasp that, the better.) However, even if the options are not great, they beat all hell out of no retirement account at all. And in a Trad, at least you get the tax bennie up front, in essence paying you a bonus every time you contribute. Always contribute at least up to the employer match, and if you can afford more, pour it on.

Employer Roth (usually also called a Roth 401k): like above, except no tax writeoff; you are planning to get to take money out tax-free when you are old. Other than that, same basic philosophy except that piling extra money in now is not getting you a greater tax benefit. Even so, you might still do it.

When you leave that employment, the vested percentage of your account is still yours. Hopefully you worked there long enough to become 100% vested. The sooner you get it away from your former employer, the sooner it is secure from some mismanagement or stupidity on their part. (That would be illegal, of course, but it happens all the time. If you saved $200K, and lost half of it due to an unscrupulous former employer, will it make you whole if the employer goes to jail? Of course not.) Because there’s a lot of stupidity and mismanagement in our precious corporate world, you want to take possession of your 401k funds at your earliest convenience. This is called a “Rollover.” In effect, it becomes (or goes into) one of the following, depending on what it was before:

Personal Trad (usually called a Traditional IRA): this is when you sign up with a bank or brokerage for your own version of the Employer Trad. You deposit some money, and you can invest it however the bank or brokerage allows. Short version: with a bank, you will make no money, so that’s stupid. A lot of people have these at Schwab, Fidelity, Scottrade, TD, or other discount brokerages.

Personal Roth (usually called just a Roth IRA): when you sign up for your own version of the Employer Roth. Same principles, different investing options. The most salient fact–the tax impact–is the same; the ‘Roth’ descriptor is key here. (Roths came along later than traditional IRAs, so if you speak of an IRA without Roth, people think you mean a traditional IRA.)

So when you leave an employer, and want to take your retirement money with you, you either have a personal account of the right type into which you can merge it (“roll it over” in industry lingo), or you will have to open one. The brokerages will be delighted to help you do that, and they’ll even go get the assets for you. Most brokerages have lower minimums for retirement accounts, because they find that profitable (since people rarely loot their retirement accounts). However, you will very likely first have to sell any mutual funds you hold. That’s fine, as they are probably subpar investments anyway. Traditional mutual funds typically are. Key thing to know: there is no salient difference between a Rollover Trad IRA and any other Trad IRA. They share the same tax issues.

You can convert a Trad IRA to a Roth, if you’re willing to pay all the associated tax on every dollar in the account. I’d have to have a good reason to do that, but everyone’s circumstances are different, so I can’t say no one would ever do that. For example, suppose you already had a personal Roth IRA, and you rolled over a relatively tiny Trad IRA, and this was a year of not very high taxable income. As a Roth believer, you might go ahead and pay the tax to roll the Trad IRA into your Roth, because this is a low income and thus a low tax year, minimizing the bite and simplifying your accounts.

Two paras ago, I mentioned mutual funds. If your mind generated the question “Wait. How is a mutual fund different from an IRA?”, and you then felt that you sounded dumb, relax; the question is natural. An IRA is at heart a form of bank account, like a regular savings account: it’s a money pile. A mutual fund is an investment option (like a stock, bond, CD, what have you) available to an account’s holder. Thus, your whole account is an IRA or 401k, in which you might or might not choose to own one or more mutual funds, depending on what you think is to your advantage. A mutual fund is basically a bunch of stocks and/or bonds bundled up together. Simplified further, it most resembles a single stock–at least, it resembles that more than it resembles a bank account.

Thus: I might say “I hold shares of the Fidelity Magellan Mutual Fund in my Trad IRA account.” However, I would never say: “I hold shares of a Trad IRA in my Fidelity Magellan Mutual Fund account.” Cart before the horse.

So how does one pile up this money? From a strategy standpoint, the goal is to make the biggest possible heap of money in the most tax-advantaged way. As my CPA has drummed into me, there is tax avoidance (which is legal), and tax evasion (which is a felony punishable by imprisonment and fines). Earlier, we went over the decision process between Trad and Roth, which is a very personal one; the math favors one or the other depending on how you forecast your life will unfold. Whatever you pick, if you’re twenty right now, I would guess that you’ll need close to $2 million to retire comfortably, but no one really knows. Safest way is to keep saving until you do know. It’s not possible to retire with too much money.

If your main retirement is with an employer, and you’re under 35, know this: conventional separately managed mutual funds (i.e., run by a trained professional with discretion as to what the fund will buy and sell) usually underperform the market. They get paid handsomely anyway, which I personally think is disgusting. Why pay someone handsomely to do worse than the market? I don’t need to hire ineptitude; I can supply all of that I might want, right, free of charge? (Gods know I often have.) There is usually an index mutual fund among the account’s investment options, which I consider nearly always the most sensible choice, because it outperforms the pros in a majority of cases simply by doing its best to achieve the market return minus very modest fees. It buys and holds the securities that are in the index, period. However, be prepared for some fluctuations in value over a lifetime, as you go through market crash cycles. Those typically occur when a lot of people are doing a stupid thing, which you can expect the public to do as soon as it forgets the lessons from the last fiasco. In my life, they were in 1987, 2000, and 2008; my guess at the next one is circa 2020. Every ten to twelve years isn’t a bad guess. The only certain way to avoid those market crash cycles is to invest so that you never really make any money, so that’s like saying the only way to stay out of the hospital is to commit suicide. True, but no way to plan your life.

If you have a retirement account that only you control–either rolled over from an employer, or started on your own–you have many options, including many that were not available to me in my callow youth. If I had it to do again today, with a full working life ahead of me, I’d put it all in several different index ETFs, and put new money into whichever was lagging the rest (on the logic that the laggard is most ripe to bounce back). It is therefore time to explain about index ETFs.

We covered my complaints about conventional separately managed mutual funds, and my preference for index mutual funds. While the latter are usually more sensible, both suffer from the outdated conventional mutual fund model. ETFs–exchange-traded funds–are technically also mutual funds, but unlike conventional funds, their shares aren’t created and destroyed daily as people buy and sell. A finite consistent number of their shares exist, one may buy those shares on the open market, and one can set a limit price. Index ETF fees tend to be very, very low–as they should be, because any non-moron owning a computer and subscribing to a market news service could manage an index ETF. An index ETF manager has the discretion/choices of a U.S. Marine recruit in boot camp.

What it means is that if a young person started a Trad IRA and put all his or her contributions into an S&P 500 index ETF, or other stock index ETF, and kept doing so all his or her working life, the following would be true:

  • That person would probably retire in comfort.
  • That person would probably not ever need any more advice from me.
  • That person would probably not stress much about it.
  • That person’s trad IRA would probably outperform any employer-ruled 401k s/he might also have.
  • I would be very happy for that person.

Oh, that person would deal with job changes and rollovers, sure; however, the rollovers would probably go to bulk up the existing IRA. The biggest issue would be the need to avoid going over one’s allowable tax-deductible annual contribution, because the limit is not per account–it is per person, per year, and exceeding it sucks. The IRS makes sure it will suck. Take whatever actions you must in order not to exceed it.

If that seems a little unfair, think on this: if your biggest problem is having to ask some questions and do some math to figure out how to put the max into your retirement portfolio every year, you are very fortunate or very thrifty. But if you already have enough basic savings to act as your crisis crumple zone, you could always just open up a taxable brokerage account (householded with your IRA for easy review and management) and invest that money however you see fit.

And some year, maybe the year you are out of work for four months and money got tight, maybe you’ll come up short of the max to put into your retirement. If so, you’ll have money in the brokerage account to move over and make the full contribution. In the meantime, if you have to sell a stock or ETF to raise that cash, you’ll pay tax on part of the gains (the dividend and capital gain part), but it’s rarely a big hit. Nothing like the three-finger shocker you’d get if you’d put it all in a conventional mutual fund that lost 20% that year, and then notified you in December that oh, by the way, here’s the amount of taxable income our realized gains and dividends will cost you. Yes. It really is that bad. Such a fund can lose a bundle, and due to tax laws, have to distribute capital gains and dividends so that the IRS can tax you on them. I trust you can see how miserable that would be. If you are wise, unlike me, you will opt out of receiving and paying that invoice.

Does it sound like this is a lot simpler than people make it out to be? I think it is. You can make it as complicated as you choose, but for most people I think simplicity and a mechanical investment discipline are best. There are no guarantees, just like there are no guarantees one won’t die in a car wreck tomorrow. Just as you maximize your odds of safe travel by driving defensively, you maximize your odds of safe and profitable investing by doing sensible things.

One last word on market trends. On any given day, you can find pundits writing articles ‘calling a top,’ ‘calling a bottom,’ predicting a crash, predicting a huge runup, anticipating a ‘correction’ (that’s marketese for ‘dropping a financial deuce’), and so on. They all have one thing in common: no one ever calls them to account when they are wrong. That’s why Jason Kelly, one of the better financial authors and a very good guide to the nuts and bolts of smart investing, calls them “Z-vals” (zero-validity predictors). They might as well be rolling dice. Since they are never fired or hanged when they are wrong, their opinions mean nothing, and should mean nothing to you. Don’t let them get you worked up or demoralized. They don’t really know; they just get paid to write articles.

And always remember: you retire not on the money you saved, but the money you made.

As for me, I’m your Robin Hood. I hate Wall Street, a snake pit full of entitled criminals that goes about buying and selling elected leaders like some cities used to sell and buy human beings. I hate all the people, and there are many, who have positioned themselves to take away more of your money than they deserve and earn. I don’t make any money from your gains. The only satisfaction I get is the moral joy from helping you game the system to your advantage.

My payoff is to sit here and do the mental math about the revenue denied to a class of criminals because of each person I tipped off.

Good hunting.


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