Where Do I Put This?

There are a lot of different accounts that you can use to save for your future. Each of them has a set of advantages and disadvantages. Even though there are dozens of different titles for these accounts, it’s best to view them as being members of a category. There are employer retirement offerings, personal tax-deductible accounts, personal tax-free retirement accounts, and taxable accounts. If you know what these are, feel free to skip the next few paragraphs. There are some moderately chuckle-worthy jokes, but who knows if they’re worth your time?

Let’s start with the most simple, the taxable accounts. You’re probably the most familiar with this variety. The most common versions are checking accounts, savings accounts, brokerage accounts where you can trade investments, and your piggy bank even. This is money that you’ve already paid tax on (or should have…) You don’t have to pay tax on the original amount that you put in, but any gains when you sell, and even the earnings of your investments, will be taxable. The main advantages to a taxable account is accessibility, expense, and freedom of investment choice.

The Roth IRA is another account that you fund with money that you’ve already paid tax on. These are the darling of most financial planners. They’re kind of like the good china that you like to have around, but are wary to use because of just how good it is. Money goes in after tax, and when it comes out its tax free. Even the earnings, as long as you’ve had it for 5 years or more. There are fairly strict rules to funding these because of just how good they are. Single tax payers have to earn less than $117k to fully fund this bad boy ($5,500 or $6500 if you’re over 50). Ageism! There is the wonderful “back-door” option if you make too much, but that’s NSFW. Just kidding, but it’s a bit more complicated and not this focus of this post.

Employer retirement offerings come in all shapes and sizes. You could have a 401k, a 403b, a 457, a SIMPLE IRA, or any number of pensions or profit sharing plans. Some companies even allow a Roth option that has all of the goodies of the Roth IRA but without the income limits. Granted, if you’re making enough to be barred from the Roth contribution, that tax deduction is pretty handy. Ooops, spoiler, employer plans offer a way to avoid paying taxes on that money until you take it out. No capital gains taxes, just pure sweet income taxes. Employees can normally contribute the most tax-free dollars to these plans, but they often have limited investment options and some adverse account fees.

The IRA (sans Roth classification) is our first tax-deferred option. You can contribute $5,500 (or $6,500 if you’re over 50 because, again, ageism) and deduct it from your gross income to avoid paying tax on it. Singles who earn between $61k and $98k and have a work retirement plan option, or any income if you aren’t covered can deduct some. Marrieds between $98k and $118k, or $183k to $193k if your spouse is covered but you aren’t, can also deduct.

Okay, so now you know what they are, but what are you supposed to do with them? Find out next time. Just kidding, I’ll keep going.

The best way to decide which account to use is mostly based upon your income.

$0 earned income: You can contribute only the taxable accounts as retirement accounts require earned income. Dividends, interest, and money you found on the street do not count as earned income.

$0 to Roth Limit: If you’re covered by an employer plan, and they offer an employer match where they add money to your account based on what you earn or save, save up to the limit for the employer match. It’s free money. After that match, or if you don’t get an employer contribution, you can choose between the Roth or the normal IRA. You’ll have to figure out which you value more. Tax free growth, or paying less in taxes. All options are available to you. The world is your oyster. I don’t get that expression. Is it about pearl potential? Otherwise you’re locked in dark, smelly shell. Not ideal.

Roth Limit to IRA Deduction limit: You still want to get at that employer match. After that, you have a choice. You’re making a fair amount of income, so chances are good that the tax deduction is pretty great. You can either save up to the employer plan limit, or save outside of it in a deductible IRA. This decisions mostly comes down to investment options and account fees. If you don’t like your employer choices, or if the account has high fees (ask your HR guy or boss), you can still get a deduction in the IRA where you have more. You can also say throw caution to the wind and just toss that money in a non-retirement account, but I’d only recommend this after you consider backdooring that sweet, sweet Roth.

Over the IRA deduction limit: If you want to deduct contributions from your taxes, and, to be fair, you are in a pretty high tax bracket, you’re pretty much stuck with your employer plan. That’s not a bad thing. It happens to plenty of people. And at least you’re not paying taxes on that money, yet. If you want to save more than your plan allows, you can contribute to an IRA but not get the tax deduction. That money can still be invested and avoid capital gains and taxed dividends/interest. Earnings will be subject to taxation as income, though. If you’ve exhausted both limits, you’re stuck with the taxable account, but at least that’s something.

The most important thing to do is save and invest your savings to let them grow. You’ve got a lot of options for your savings, and none of them are worse than the alternative of not saving.

Lessons in the Stock Market

About ten years ago, my dad gave my sisters and I some money in an online brokerage account. Not a lot, but enough to buy a couple of shares of the companies of our choice. He wanted us to learn about the stock market; the highs, lows, tedium, mania, and possibly, the hubris. Like any market, for any buyer, there’s a seller. For every bet on a company, there’s a bet against it. In the stock market, it’s rare that you’re betting against another individual investor. The majority of free floating cash is being invested by professionals on Wall Street. It was just three young teenagers taking on some person in a suit earning a fraction of a small country’s GDP.

My oldest sister bought a couple of shares of Disney. The middle sister bought AOL. I couldn’t figure out how to buy shares in Taco Bell, and the Zune wasn’t working out as well I as hoped for Microsoft, so I finally settled on TiVo. We had just recently bought a TiVo and I was sure the rest of the country would follow our lead.

2008 hit, and my sister’s learned the lesson that my dad was hoping for: you can’t invest only in one stock. My sister’s choices had taken a hard hit, and they ended up selling at the bottom.

TiVo, however, won a major lawsuit concerning their DVR and pausing of Live TV patents. The stock tripled. I was clearly a born stock picker. I sold enough to cover my initial investment, and then bought back in when shares fell after an earnings report where the lawsuit was the only bright spot. The news started telling me that TiVo was ripe for acquisition for its patents as it couldn’t keep up with the bigger companies. So, I held on.
TiVo remained single after being courted by a few conglomerates, and it became abundantly clear to me that TiVo wasn’t going anywhere. Cole McClarren, market guru, decided that it was time to invest in China.

I bought a cheap cable company because if I knew anything back then, it was television, and the people of China were definitely about to hop on board. Within a year the stock had gone up over 800% due to a hostile takeover. I held on, as a similar company had gone up 20x in the same situation, and I didn’t want to get out on the way to the top. The next week, the stock bottomed. All of my initial capital and TiVo earnings were now worth a grand total of 28 cents.

Last week, TiVo was sold to Rovi for over $20 per share, 4x what I had paid originally.

My on again, off again relationship with the stock market is not the only reason that I believe in passive, diversified investing. Jack Bogle (founder of Vanguard), Warren Buffet (Warren Buffet), and countless other (here’s one, and another, and one with monkeys) have convinced me that it’s not worth the time, attention, and money (out of the investor’s pocket) to try to beat the market. Some of the most powerful companies in the world are throwing billions of dollars and hundreds of MIT educated quantitative analysts at this problem and still failing to S&P 500 over a medium-term time horizon. The days of stock pickers outsmarting Wall Street stock pickers are over, if they ever existed. The advent of near-perfect information brought on by the internet age has brought us closer to an efficient market than ever before.. Intuition is no longer king. Shorter fiber optic cables rule the day.

“Stop right there, Cole. I was right about Tesla and Facebook. My hunches are almost always right.” Welcome to one of the beautiful intersection of confirmation bias and cognitive ease. We are more likely to find examples of events that conform to our own expectations, so if you expect that you can beat the market, you’re going to remember more instances where that would have been true. It’s much easier to remember times when you were right than times that you were wrong, and the easier it is for your brain to retrieve information, the firmer your beliefs are in that instance (see Thinking Fast & Slow). The times that you were wrong fall by the wayside. That’s how pundits like Jim Cramer can make hundreds of predictions a year and be celebrated for the few that worked out. We tend to remember the winners and forget the losers.

I’m not trying to say that there are no benefits to playing the stock market. I enjoy gambling as much as the next person. It’s the perspective on the situation that’s important. We call our client’s stock picking accounts their “Las Vegas” accounts for a reason, so you should never put more into them than you’re willing to lose. Make no mistake. You are not betting against your friend who you once saw drink tequila off of the floor. You’re betting against companies with billions of dollars of manpower, software, and equipment.

 

 

The Myth of Vanishing Retirement

I read an article on Gawker the other day claiming that millennials will never be able to retire. It cited the likelihood of Social Security dissolving and the lack of pension plans as reasons that the system is rigged. If you’re interested, go read it. It’s short, but not nearly as charming as anything on our blog. Just come back. I’ll miss you…

Before you call your parents in a panic, or start selling your plasma, be aware that the system is not rigged. The system has evolved. If Social Security disappears, that’s 12.4% of your income that could end up back in your pocket. Pension plans don’t just take all of the money that’s set aside for employees and invest it. That money also has to pay the company that manages it. It has to pay an actuary to do a lot of expensive math to figure out exactly how much to put into the plan. And, on top of that, it has to cover the insurance that makes a pension plan a guarantee in the first place. These expenses are the main reason that companies have decided to forgo defined benefit plans in favor of giving employees control of their retirement.

The money set aside for pension plans doesn’t just go away. The responsibility of handling it has changed. With that responsibility comes a potential for a higher return. Pension plans need to be able to guarantee benefits for their employees, and so they invest in safer securities. Low risk often equates to low reward.

The real danger to your retirement is your own inaction. People, like the author of that Gawker article, and the legions of commenters, don’t see the potential in these generational changes.  The reality of this change doesn’t get communicated as often as the potential negative consequences. People aren’t likely to read an article about how they need to do a little more with their money. They’re much more likely to read an article blaming shortfalls on something out of their control.

Retirement is still in the cards. You have more flexibility in when to retire than ever before because you aren’t tied to the same company until you’re 65. You are in control of your own destiny.

Personal Finance: The Basics

It’s not what you think. Craft beer and Yoga Pants are a staple of the Basics, but (unfortunately) not of personal finance. Personal finance is overwhelming to some people and easy as pie to others. Everyone has a different relationship with money, but there are a few rules that apply to everyone.

The Key to Getting Ahead is to Spend Less than you Earn

If you’ve ever lived paycheck to paycheck, you know how it feels to be on the treadmill of life not gaining any traction. The standard is to spend 10% less than you make, or conversely, save 10% of your income.  Even $20 a month will put you ahead of where you were last month. It can be daunting to think about saving at all when you’re used to having too much week left at the end of your money, which brings us to the next point…

Pay Yourself First

We’ve all heard it a thousand times but here’s what it really means: Let’s say your take home pay is $2,000 a month, to save 10% you’ll need to put away $200. Ordinarily, people spend normally and then hope they have enough left over to save a little. With a little consciousness and planning, you can set up an automatic transfer to put $200 into a separate savings account and live as though your take home pay is only $1,800 a month. The best way to do this is to have 10% direct deposited into a separate savings account from your paycheck. By paying yourself first you’ll never spend more than you earn and always live within your means. It’s funny because that first month cash flow feels tight but by the second or third month almost no one misses that 10%. Human psyche, amiright?!

Budget to Build Wealth

Budgeting is extremely important but I’m not talking about allocating every penny into specific spending categories – for the average Joe that’s just an unnecessary, stress inducing task. However, you MUST pay attention to where your money is going or it will be gone before you have a chance to even think about saving. The majority of people I speak with who have credit card debt or find themselves counting the seconds until next payday are those who also don’t track their spending claiming it to be too depressing. You know what’s depressing? Being 50 years old with $0 saved for retirement and thousands in debt because you didn’t want to budget at age 25.

There are countless ways to budget and a TON of really useful tools online. My favorite is www.Mint.com because it is free and automatically downloads from your credit cards and checking account to track and categorize your spending. Like I said, don’t worry about being painstakingly detailed because for most people that’s just not sustainable. The main thing is to just be conscious and deliberate with your spending. Enjoy your money, you work hard for it. The ultimate goal is to get to the point where your money works hard for you.

Time is on your Side

You’re young, and fabulous and have all the time in the world to save, right? Right!? Well it’s true, you are fabulous, but youth is your biggest tool for financial leverage. My good friend Albert Einstein said it best, “Compound interest is the eighth wonder of the world.” Let’s go back to the example above, you make $2,000 a month and save $200 of that starting at age 25. At age 65, you’ll have almost $700,000, assuming an 8% return (historical average), despite only actually saving $96,000 — magic, almost. If you waited until age 40 to start saving and put in the same $96,000, $320/month, you’d only have $304,000 at age 65. Your equal contributions are worth more than two times as much if you just start small and steady while you’re young (and fabulous).

– Alicia Reiner

Welcome to Our Blog!

Welcome to the EdgeAhead blog. This is where Alicia Reiner and I, Cole McClarren, will share our thoughts and guidance concerning practically anything related to money. For this post, my words are left-aligned and Alicia’s are coming from the right. Most of our posts will be separate, but for our first post we both wanted to introduce ourselves. Sometimes we’ll get technical and explain implications of mind-numbingly exciting new tax law. Other times we’ll wax poetic about the value of conscious spending.  Maybe we’ll review a book. Maybe we’ll experiment with visual poetry. Maybe we won’t.

I want to simplify the financial messages that young people are getting. Personal finance is quite simple at its core, but human behavior and emotion complicate it. The key to success is persistence, and that’s no different for financial success. I want my blog articles to be motivating to those who are struggling to stay on track.

My posts will center around three main concepts: self-improvement, imbalances in the world of finance and business, and oxford commas. Random Facebook posts and advice from past generations often do nothing more than create noise and confuse the tenets of sound financial fitness. We must understand our goals and manage our money effectively in order to live optimally.

Personal finance doesn’t have to be scary and daunting if you stick with big concepts and take baby steps to get there. For example, living within your means is a central theme of a sound lifestyle. It’s accomplished through the big concept, spend less than you make. Small tasks, like having $25 per week directly deposited into a savings account, are how we make that concept actionable.

This blog will be our way of communicating our ideas and beliefs to clients, both current and potential. Expect to see a new post every couple of weeks, or if something major happens in the wide world of finance.