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mattnewport comments on Open Thread: April 2010, Part 2 - Less Wrong
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You forgot to add:
-Everyone else is trying to do the same thing, so look at your actually expected real rate of return on all this saving you're planning (negative even before taxes on withdrawls or dividends, over the last 10 years, and with high volatility), and then hang your head and ask why you even bother.
I bring this up because I save a lot and use the tax-advantaged options, but when I look at the numbers, I have to ask, what's the point? After taxes (which will have to go up as the tidal wave of unfunded obligations comes due) and inflation, you barely get anything out of saving. (Yes, there's the no-tax Roth, but you get to invest very little in it.) Plus, if you save it for long enough not to be penalized on withdrawl, you have to put off consumption until waaaaay into the future, when it will do less for you.
It just seems like you'd be better off buying durable assets or investing in marketable job skills, which are more robust against the kinds of things that punish your savings.
I've been exploiring the "infinite banking" option: mutual universal whole life insurance that you can borrow against and which gets a steady, relatively high rate of return and is tax-shielded and has a long pedigree. Seems a lot better than following the herding into IRAs which will probably have their promises violated at some point.
As Rain said, asset allocation is important. The standard advice to put most of your savings in low cost index funds has the merit of simplicity and is not bad advice for most people but it is possible to do better by having a bit more diversification than that implies. Rain suggests a percentage allocated to international index funds which is a good start. US savers with exposure to foreign index funds, emerging market funds, commodities and foreign currencies (either directly or through foreign indexes) would have done better over the last 10 years than savers with all their exposure concentrated in US equities.
Diversification is the only true free lunch in investing and by selecting an asset allocation that includes assets that are historically uncorrelated or negatively correlated with US equities it is possible to get equal or better average returns with lower volatility over the long term.
If I were in the US I would share your concerns about future tax increases and raids on currently tax protected retirement accounts but I'd argue that just suggests a broader view of diversification that includes non-traditional savings approaches that are less exposed to such risks.
I think most investors (and particularly US investors) are over-invested in their home countries. Since most people's individual economic circumstances are correlated with the performance of the economy as a whole this is poor diversification. Similarly I think it is unwise for people to have significant weighting in sectors or asset classes strongly correlated with the industry they personally earn a living in. Programmers should probably not be over-weighted in tech related investments for example and it is probably a bad idea to retain significant stock in your own employer for most employees. I believe Rain is a government employee and so I would suggest that a lower than normal allocation to government backed investments would be appropriate in that situation for example.
Okay, but in a 401k, you're stuck with the choices your employer gives you, which may not have those options. (usually, the choices are moronic and don't even include more than one index fund. Mine has just one, and I reviewed my cousin's and found that it didn't have any. Commodity trades? You jest.)
And if you're talking about a Roth, well, no mutual funds, not even Vanguard, will let you start out your saving by dividing up that $4000 between five different funds; each one has a minimum limit. You'd have to be investing for a while first, complicating the whole process.
And if you mean taxable accounts, the taxable events incurred gore most of the gains.
The US is not alone in that respect -- other, long-developed countries have it even worse.
Right, that's what I was referring to: investing in job skills so you can high-tail it to another country if things become unbearable (and hope they don't seize your assets on the way out).
I'm not in the US so I'm not fully familiar with the retirement options available there. Here in Canada we have what seems to me a pretty good system whereby I can have a tax sheltered brokerage account for retirement savings. In many cases it is hard to argue with the 'free money' of employer matched retirement plans and the tax advantages of particular schemes but I think it is wise to be mindful of all the advantages and disadvantages of a particular scheme (including things like counterparty risk regarding who ultimately backs up your investments) and take that into consideration when weighing options.
This is definitely an issue when starting out. Transaction costs can make broad diversification prohibitively expensive when your total assets are modest. I see it as something to aim for over time but you are absolutely right to be mindful of these issues. If you have a reasonable choice of mutual funds you can look for ones that are diversified at least internationally if not across asset classes outside of equities and fixed income.
This is why I like the options available in Canada. Between self-directed RRSPs and the new TFSA the tax-friendly saving options are pretty good.
Indeed, and this is one reason I'm working towards my Canadian citizenship. It has relatively healthy finances compared to the UK where I grew up. I don't think the necessity for some form of default on the obligations of most developed countries' governments is widely appreciated yet.
This is in line with the broader view of diversification I am advocating. Over the typical individual's expected lifespan this is an important consideration. I think it is a sensible long term goal to diversify in a broad sense so that you maintain options to take your capital (human and otherwise) wherever you can expect the best return on it. Assuming that this will always be the same country you happen to have been born in is short sighted in my opinion.
On a diversification related note, this proposal from Ian Ayres and Barry Nalebuff is an interesting take on the merits of diversification across ones own lifespan.