Updated: Apr 5, 2022
March 15, 2021
What I Wish I Knew Robert Gaan, CFP®
As I sat down to write this, I found myself thinking about fundamental issues with which many of you are already familiar. I share them here because it is always a good thing to be reminded of the basics. I also want to encourage you, if you have not already, to share what you know with the young adults in your life at the beginning of their accumulation phase and in need of a best practices philosophy.
My younger son is finishing up his final year at UC Berkeley. A year from now, he should (hopefully) be off my wife’s and my payroll and be gainfully employed as a computer programmer for some tech company. Our older son already graduated from Cal and is working as a business consultant in the alternative proteins sector (think Beyond Burger). While it is hard for me to fathom how someone with my youthful looks and vigor has two adult sons, I paused recently to reflect on the important stage of life at which they both find themselves. They are at the starting point of the path to build their own financial futures. Decisions they make now could affect what the future holds for themselves and their families. I asked myself, “What would twenty-something Rob Gaan need to know about personal finance, given what I know now?”
The simple answer is: know the difference between saving, trading and investing.
Saving is the process of accumulating capital for emergencies and near-term purchases. Savings need to be safe and liquid. Savings can be used to temporarily cover your monthly overhead should you unexpectedly lose your job. Savings is what you use to put a down payment on your first house or condo. The proper place for your savings is in a bank account. You do not invest your savings, because you cannot risk losing principal at inopportune times.
Trading is speculating, and results are often driven by emotion and short-term swings in supply and demand. While trading can be lucrative (as the exploits of Reddit subscribers trading shares of GameStop in their Robinhood accounts recently demonstrated), it is hard for “normal people” with a day job and myriad other demands on their time and attention to consistently replicate trading success momentum over the long term. When I think back to the dot-com boom of the late 1990s, I recall the large number of “normal people” who quit their day jobs to become day traders. A few experienced dramatic and well publicized success. Others persevered through the disruption and built (or rebuilt) their retirement nest eggs. But most went back to their day jobs. While trading can be additive to an investment strategy, we do not recommend it as the foundation of a long-term investing plan.
Investing is the process of buying assets that may increase in value over time and provide returns in the form of income (dividends and interest) and/or capital gains. Investing requires patience, forward thinking and a global view of the economy and of the markets in which you are investing. Successful investors “pay themselves first” by regularly earmarking a portion of their current earned income for reinvestment in their investment portfolio. Investments require monitoring and maintenance and periodic rebalancing, and should be driven by fundamental analysis, not emotion.
I was disappointed and concerned to read in a recent industry survey that of those workers in the U.S. with access to a company-sponsored retirement plan, fewer than 50% actually participate. In my view, a company-sponsored retirement plan is the perfect vehicle for investing.
For one, it automates and systematizes the process. A portion of every paycheck is deposited into your retirement plan account. You don’t have to facilitate the deposit. Often the money isn’t even missed because it was never in your hands. The value of strategic inertia cannot be overstated here. That same survey reported that employees who had to “opt out” of their company’s retirement plan (in other words, do nothing) were much more likely to stay in the plan, whereas those who had to “opt in” (in other words, proactively join) did so less often.
Second, retirement plans offer serious tax advantages. Whether you defer money into the Traditional pre-tax option, which lowers your current income tax liability, or the Roth option, which provides tax-free withdrawals from your retirement account, all returns on your retirement plan investments grow tax deferred. This means that your retirement assets will grow faster because there are no taxes to be paid on investment returns every year. I generally recommend that younger employees choose the Roth option. When you are younger, your tax bracket tends to be lower, which means that the current tax break that the Traditional deferral affords you is not as valuable. In addition, since you will not be drawing from your Roth account for 20, 30 or 40 years, you maximize the opportunity for long-term, tax-free growth.
Third, most employer plans offer participants a wide range of investment options with professional management. If you are just starting out, I recommend you invest in a Target Date mutual fund. A Target Date fund is an age-based investment that helps you take more risk while you are young and get more conservative over time. All you have to do is select the fund with the “target date” that is nearest to the expected year of your retirement.
Lastly, there may be other perks. Some employers match employee contributions (free money!). There is also a Savers’ Tax Credit of up to $1,000 for individuals with income below $33,000 and up to $2,000 for married couples filing jointly with income below $66,000.
It’s important to note that there are tax penalties assessed if you withdraw funds from your retirement account prior to age 59 1⁄2. That’s why it is important that you balance your deposits between savings and retirement. Also, the money you defer from your paycheck into a retirement plan is always yours. You can transfer your retirement plan account balance from employer to employer as you advance through your career. You can also roll your retirement account balance from an employer plan to an IRA (Individual Retirement Arrangement) account. I do not recommend making the same mistake I made in 1988 when I changed jobs. I was offered the option to transfer my 401(k) balance ($2,700) to my new employer’s plan or to receive a lump sum distribution. I chose the lump sum option. I had to pay taxes and early withdrawal penalties on the amount. I took the balance and purchased a “rad” stereo system (it was the 80s). Not long ago (just to torture myself), I calculated how much that $2,700 would be worth now if, instead of taking the distribution, I had left it in the plan and invested it in a mutual fund. For my experiment I chose Fidelity’s Contrafund. Needless to say, I have neither the stereo system nor the approximate $207,000 I would have had if I had invested, and stayed invested, in Fidelity’s Contrafund.
In summary, this is the advice I suggest be passed along to young people making their first step into the adult world:
Save for emergencies and near-term purchases.
Systematically invest for your retirement.
Take advantage of opportunities to be tax efficient.
Work hard and be patient. The process of building wealth is not always exciting. Speculating should not be the foundation of your long-term financial plan.
Call your parents from time to time. It really makes their day.
Side Note: Don’t Miss Out on the Earned Income Tax Credit Tyler Hewes, CFP®
In the spirit of speaking to investors at the beginning of their accumulation process, we thought it might be helpful to briefly mention an important note about the Earned Income Tax Credit (EITC) for the 2020 tax year.
Taxpayers who qualified for the EITC in 2019 may find that they do not qualify for the benefit in tax year 2020 due to job losses caused by COVID-19. In response, the IRS will allow workers to report earnings from either 2019 or 2020, whichever provides the greater tax credit, on their 2020 returns. The EITC is available for low-to-moderate-income workers with or without children. This is a credit available to workers with an income lower than (approximately) $57,000 with an average credit of around $2,500. The EITC is a refundable tax credit, meaning it can reduce the amount owed by the taxpayer and even generate a refund. It is based on a percentage of earned income (including wages, tips, and net self-employment income, but not unemployment income). Visit this IRS’s website (https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/who-qualifies-for-the-earned-income-tax-credit-eitc) for more details or consult your tax preparer to see if you or someone you know may qualify.
Information contained in this publication is obtained from sources believed to be reliable; however, no representation as to accuracy and completeness of this information/data can be provided. Data used may be based on historic returns/performance. There can be no assurance that future returns/performance will be comparable. Neither the information, nor any opinion expressed herein, constitutes a solicitation by us for the purchase or sale of any securities or commodities. This publication and any recommendation contained herein speak only as to the date hereof. Christopher Weil & Company, Inc., with its employees and/or affiliates, may own positions in these securities.
All investments involve risk, including the risk of losing principal. It is vitally important that you fully understand the risks of trading and investing. All securities trading is speculative in nature and involves substantial risk of loss. Further, the investment return and principal value of an investment will fluctuate; Upon liquidation, a security may be worth more or less than the original cost. Past results do not guarantee future performance.
Investment in mutual funds is also subject to market risk, investment style risk, investment adviser risk, market sector risk, equity securities risk, and portfolio turnover risks. More information about these risks and other risks can be found in the funds’ prospectus. You may obtain a prospectus for CWC's mutual funds by calling us toll-free at 800.355.9345 or visiting www.cweil.com. The prospectus should be read carefully before investing. CWC's mutual funds are distributed by Rafferty Capital Markets, LLC—Garden City, NY 11530. Nothing herein should be construed as legal or tax advice. You should consult an attorney or tax professional regarding your specific legal or tax situation. Christopher Weil & Company, Inc. may be contacted at 800.355.9345 or firstname.lastname@example.org.