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.